Study Notes On Regulation 28

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This presentation serves as study notes for the e-learning material titled: "South African Hedge funds and international developments"

These notes focus on the amended Regulation 28 South Africa and its Impact on the Hedge Fund Industry.

http://www.hedgefund-sa.co.za/regulation-28

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Study Notes On Regulation 28

  1. 1. Regulation 28 Study Notes
  2. 2. Objectives • to protect investors of retirement funds from – Effects of poorly diversified portfolios – Over exposure to higher-risk asset types • Ensure that retirement contributions are invested in a prudent manner – Protecting investor – Channelling economic development and growth • Insurance policy assets must meet Reg 28 requirements
  3. 3. DEFINITION A hedge fund is an asset which uses any strategy or takes a position that could result in the portfolio incurring losses greater than its fair value at any point in time and which strategies or positions include but are not limited to leverage and net short positions • Managed by a licensed hedge fund Financial Services Provider • Subject to any prescribed conditions
  4. 4. background • Many amendments since inception in 1998 • Reasons for amendments – Inconsistencies in the regulations eg definitions – Loopholes which allowed retirement funds to avoid regulatory rules – Ability for retirement funds to invest in assets exposing them to unacceptable risk levels – Credit risk issues – No provision for Islamic compliant retirement funds
  5. 5. Current regulation • Prescribes maxima for certain types of investments • No restrictions bank-issued money markets and government bonds • No guidance on use of derivatives • Registrar may exempt funds from certain maxima
  6. 6. process • Public consultation • Key issues brought up – False mordenisation of market – Limit on debt too strict – Restrictions on alternative investments may hinder economic growth – Investments in Africa may promote development of South Africa • After feedback amendments made to the current regulation
  7. 7. amendments • Greater accountability for trustees • Sturdier markets for corporate debts • Greater protection of investors • Greater use of alternative investments • Expansion into foreign markets done responsibly
  8. 8. Explanation of new regulation • Refining of definitions to mitigate risk of avoiding regulation • Tighter definitions to reflect risk-return profile of investments • References updated to reflect changes in exchange environment
  9. 9. Preamble and principles • Preamble frames regulation • Retirement fund board must invest savings in a manner that – promotes long term sustainability of asset values – takes into account environment, social and governance issues • Better guidance to trustees investment strategy • Recognise that a too conservative approach can be damaging to long term savings in the same way a too risky approach is
  10. 10. Preamble and principles • Strengthen investment process • Improve transparency • Improved accountability of trustees to the Registrar • Principles captured in Investment Policy Statement (IPS)
  11. 11. Investment policy statement • Inform a fund’s investment approach on aspects identified in the regulation including: – Promoting relevant education of trustees – Monitoring compliance of the fund and its agents – Asset-liability matching – Performing appropriate due diligence on investments – not relying heavily on credit-ratings from credit rating agencies – Long term sustainability of fund – Any other relevant details
  12. 12. Asset limits • Investments done within the limits of the regulation • Provisions made for breaches beyond the control of the board • Board should make investment decisions based on what is best for the fund and its investors • Asset limits should not prevent fund from reaching optimal investment • Board may apply for a breach of limit from the Registrar
  13. 13. Asset limits • Mindful of the importance of individual member protection and fund sustainability • Exceptions for certain existing individual contract arrangements • Allowance outside Reg 28 until such a time they may be changed • Some asset definitions are narrow • Anything outside definitions may fall under debt • Exceptions – hedge funds - private equity - alternative investments
  14. 14. cash • Instruments collectively used for liquidity management • Includes money market instruments • Concern over maturity transformation in money market funds • Strengthening needed to protect investors and safeguard against future financial instability
  15. 15. Debt instruments • Improved diversification • Reduce regulatory induced distortions • Better support to corporate debt instruments • Lack of transparency leading to information asymmetry between investor and issuer • Aggregate limit for debt raised to 75% • Stricter limits across issuer sub-categories for unlisted debt instruments • Credit ratings may be used for broad due diligence
  16. 16. Equities • Asset class • Include preference and ordinary shares only • Aggregate limit of 75% • Limits on issuer sub-categories • Limits checked for inflationary pressures and updated accordingly • Limit on unlisted equity 15% subject to diversification and valuation requirements
  17. 17. Immovable property • Unlisted property may have significant risk management implications • Limits on exposure • Limits on sub-categories as well • Limits checked and tested by Registrar over time and updated accordingly • Debt instruments backed by property listed as debt
  18. 18. commodities • Have hedging potential • Fund can invest in listed commodities – Max 10% gold – Max 5% other commodities – Combined maximum of all commodities of 10%
  19. 19. Other assets and alternative investments • Hedge funds and private equity defined • Prevents these products from being reported as the linking structure • Guidance to investments activities • Hedge fund defined as such and no other products hiding under hedge fund disguise • Accessing hedge funds and private through funds of funds providing extra layer of due diligence and diversification • Registrar impose extra requirements
  20. 20. Foreign assets and regional development • Foreign assets currently defined • Recognised foreign exchange falls away • To be considered as listed an exchange must be listed on an exchange that is a full member World Federation of Exchanges • Allows exposure of retirement funds to foreign assets through a suitably regulated vehicle • Inward or dual listed securities on an SA exchange treated as listed • Subject to limits - 75% equities – 50% dent • Foreign markets have access to South African capital
  21. 21. Look through • Use of hedge funds as loophole to hold risky assets in the past • Funds may not use asset structure to avoid asset limits • Disclose underlying assets • Exceptions are private equity and hedge funds • Definitions ensure that look-through is not abused • De minimis rule applied to lessen far-reaching disclosure requirements
  22. 22. borrowing • Funds may never borrow funds for purposes of investing borrowed funds • Only allowed to borrow when acing liquidity problems in paying members leaving the fund • Limit on the amount borrowed and time constraint • Stay away from exploitative arrangements and inappropriate loan terms
  23. 23. Reporting, exclusions and exemptions • Not all funds used in calculation of percentage limits • An FSB regulated entity offering a Reg 28 compliant product excluded from limit calculations • Funds may apply for exemption for a given time and certain limits • Funds should act in best interests of stakeholders which may be in conflict with Reg 28 • Funds may engage Registrar and apply for exemption based on these grounds
  24. 24. implemantation • Effective from 1 july 2011 • Contracts before 1 April 2011 exempt • No contracts that are not Reg 2 compliant may be sold • Warning against exploiting the exempt contracts
  25. 25. Conclusion • Reg 28 now rigorous, flexible and fair • Suitable to the South African context • Challenges may arise in implementation and funds may engage the Registrar in this regard

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