A combination of spending restraint and improving tax collection have significantly reduced our budget deficits to sustainable levels. Our fiscal performance since and during our transition to democracy has been impressive despite elections, and indeed better than our own forecasts.
CHALLENGES FOR REGULATORY AUTHORITIES,POLICY REFORM PRIORITES AND FUTURE CO-OPERATION 11 JULY 2006
Pension funds require explicit reference to hedge funds in their asset allocation rules
For retailisation, requirements can restrict the minimum investment size
Requirements can also be placed on the intermediaries’ qualifications and experience, while disclosure of the risk; trading strategy; previous performance; corporate structure; directors; tax consequences; objectives; and expenses to the client could be made compulsory
The regulatory debate in South Africa has focussed on investor protection.
Hedge fund supervision
No legislation regulating the establishment and operation of hedge funds in South Africa
Current legislation pertaining to collective investment schemes, the Collective Investment Schemes Control Act (CISCA) has been developed to accommodate alternative types of collective investment schemes like hedge funds, as well as the traditional types
It has enhanced consumer protection and disclosure for most CISs
Eased the investment limits under which fund managers operate. The limits have been eased to allow fund managers to improve their fund's performance without compromising the protection that these limits the investor.
Collective investment schemes are prohibited from using leverage and short selling strategies
Enough liquid assets to ensure there are sufficient resources to continue the operation of a scheme for three months in the event of the winding up of a manager
Despite CISCA, the South African legislation does not make provision for a regulated product structure with the freedom necessary to follow a typical hedge fund strategy
Creation and regulation of Funds of Hedge Funds (FOHF) is therefore also a challenge
Current areas of disagreement between the FSB and the industry include
Pricing: Prices of hedge funds are traditionally priced every three months. The FSB would prefer a daily pricing system
The trading cycle: The norm for hedge funds is a three-month trading cycle. The FSB proposes a 1-month trading cycle
Capital adequacy: If the trading cycle is shortened, the investment manager should provide sufficient liquidity
Investment managers and the marketing of hedge funds in South Africa
Hedge fund managers are regulated as investment managers under the Financial Advisory and Intermediary Services (FAIS) Act in terms of which investment managers must be licensed by the FSB
The registrar has the power to prescribe additional requirements, allowing hedge fund managers to be in a class separate to other traditional managers, on the basis that they require more intensive supervision relative to standard CISs
Although hedge fund products are not outright prohibited, the FSB offers no protection to clients in these investments. The FSB is therefore attempting to put structures into place that will allow for a competent supervisory framework for leveraged hedge funds.
National Treasury is still refining its policy position to hedge funds, and therefore these proposals must be viewed in the context of being a work in progress:
The benefits of product regulation to mitigating systemic risk is limited
A preferred approach is to follow the Financial Services Authority approach and register hedge funds (possibly only those above a certain size) and have ongoing communication and data submission.
Feeding into this surveillance, the FSB could interact directly with hedge funds in getting qualitative information on their investment strategies, as well as to engage with the SARB (who would in turn engage with the banks, as the lenders), on credit and liquidity risk issues in the hedge fund environment.
Offshore developments should be monitored and engaged on, as any global systemic risk will spill over to the SA market
National Treasury is in agreement with the FSB on their views of marketing regulation, and strongly supports the idea that a balanced approach needs to be taken between marketing and product regulation so as not to stifle the innovation Hedge Funds foster.
Regulators and supervisors should foster an environment in which market discipline, in particular counterparty risk management, constrains excessive leverage and risk-taking.
Effective market discipline requires that counterparties and creditors obtain sufficient information to reliably assess clients' risk profiles
Placing the onus on market participants to provide discipline can make good economic sense; private agents generally have strong incentives to monitor counterparties as well as the best access to the information needed to do so effectively.
For various reasons, however, creditors may not fully internalize the costs of systemic financial problems, and time and competition may dull memory and undermine risk-management discipline.
Accordingly, supervisors and regulators should ensure that banks and broker-dealers implement the systems and policies necessary to strengthen and maintain market discipline, making several specific recommendations to that effect.
An alternative policy response, being advocated by some in the international policy arena, is the direct regulation of hedge funds.
Direct regulation may be justified when market discipline is ineffective at constraining excessive leverage and risk-taking.
So far the majority of international authorities have put their weight behind the claim that in the case of hedge funds, market discipline can work.
Investors, creditors, and counterparties have significant incentives to rein in hedge funds' risk-taking.
Direct regulation runs the risk of imposing costs in the form of moral hazard, the likely loss of private market discipline, and possible limits on funds' ability to provide market liquidity.
In focusing on counterparty risk management, these recommendations are not intended to prevent failures in the hedge fund industry.
An appropriate regulatory response should aim at ensuring that when hedge funds fail, as some inevitably will, the effects will be manageable and the potential for adverse consequences to the broader financial system or to real economic activity will be limited.