The first draft of the default regulations applicable to retirement funds centred around default investment portfolios, default preservation provisions and a default annuity strategy and was released on July 22 2015 for public comment. National Treasury (Treasury) confirmed that a total of 45 submissions were received together with engagements between Treasury, the Financial Services Board (FSB) and industry stakeholders which has led to the revised second draft.
Following public comment, the regulations have been revised with the following objectives:
- Make compliance easier, thereby aiding in reducing compliance costs;
- Enable flexibility by using more of a principles-based approach to regulation as opposed to a rule-based approach; and
- Encourage and facilitate better and appropriate decision-making by members.
The second draft of these regulations was gazetted on December 23 2016 for public comment to be submitted to Treasury by February 28 2017. Essentially, the regulations aim to achieve lower charges within the industry and make improvements in market conduct with the ultimate objective of helping retirement fund members in South Africa to retire more comfortably. This forms part of the greater reform programme aiming to deliver better customer outcomes across the financial sector.
The following significant provisions were revised in the second draft and form the basis of what the default regulations are aiming to achieve:
1. Default investment portfolio
- Investment products that have elements of a guarantee or smoothing of performance based fees have been included where these were previously prohibited. The performance fee element will be subject to, in the interim, compliance with an industry standard that should simplify the methodology and disclosure for funds motivating their use to the FSB as part of their compliance with the default regulations and Regulation 28;
- The default investment portfolio regulations will only be applicable to defined contribution retirement funds;
- When selecting default investment portfolios, the Board of Trustees will be required to place equal emphasis on active vs passive strategies;
- Clarification has been made in the regulations that counselling is limited to the provision of information rather than advice; and
- The previous requirement provided that Boards of Trustees must consider member characteristics and needs, which has now been omitted.
2. Default preservation
- Compulsory funds must, in their rules, make provision for paid up benefits of members’ leaving the service of their employer until the exiting member instructs the fund to make payment or transfer benefits. The fund must also supply the member with a paid-up membership certificate;
- The first draft made provision for “pot-follows member” in addition to “in-fund” default preservation. The revised draft regulations clarifies that a member’s pot(s) can only be consolidated with the consent of the member and not automatically;
- Although there were numerous requests following the release of the first draft that the regulations should specify a de minimis amount for preservation, these regulations still don’t prescribe a de minimis amount nor an amount that a paid-up member can withdraw from the preserved benefit. This is obviously an issue as part of the debate around the proposals on compulsory preservation that was meant to come into effect on March 1 2016; and
- The first draft required fees to be the same for both active and paid-up members, the second draft allows for investment fees to be the same, but that there be differentiation in administration fees given the various ways in which these fees can be expressed such as quoting a percentage of salary vs. a percentage of assets under management.
3. Default annuity strategy
- Treasury has advised that concerns were raised in the responses received, about the implications of automatically defaulting members into annuity products that could be irreversible, for example, a life annuity. The regulations now make reference to an “annuity strategy”, and thereby changing the default into an “opt-in” rather than “opt-out”;
- In-fund and out-of-fund annuities are now eligible to be provided as part of the annuity strategy, provided that the stated principles are complied with; and
- Treasury has also explained that this part of the regulations has been considerably simplified which is a sentiment that we tend to agree with.
We are of the belief that any new regulations pertaining to the retirement fund industry placing greater emphasis on clarity and simplicity for the individual members with the ultimate objective of improving the final outcome, are certainly positive.
The difficulty is that in aiming to improve compliance and/or providing greater member support, this often results in additional costs. This increase in costs is in itself contradictory to the objective of improving final outcomes for fund members. It is likely that for this reason, the consideration described in item 1e, above of this summary has been omitted, however, it is important that members are not looked at, as a group – all with the exact same requirements as opposed to as individuals. What is good for one is not necessarily good for the other in terms of all fund-related aspects, not only with regard to default regulations.
On the debate of performance fees, I certainly supported the fact that these were previously prohibited. In discussions I’ve had with fund members over the years, performance fees are firstly not understood or even known and secondly, leave a sour taste in members’ mouths with the query “does the investment manager give us back performance fees when they perform poorly?” arising fairly frequently. We do understand that certain financial instruments such as hedge funds are inherently complicated as far as performance fees are concerned, but perhaps the performance fee debate can be discussed with a focus on traditional assets such as balanced funds making use of conventional asset classes.
Lastly, and something I am particularly passionate about, is how these regulations will be communicated prior to, and when they eventually come into being. We know how poorly the majority of industry stakeholders handled engagement on certain of the retirement reform provisions that were implemented on March 1 2016. We also know how sceptical members can be toward the implementation of significant changes.
In order to avoid the vast dissatisfaction that the previous retirement reform proposals caused (although we feel that the provisions were positive for the most part) there needs to be emphasis on the benefits of the regulations and the message needs to be targeted, unambiguous and relatable which, after plenty of persistence, slowly builds the trust of members that retirement funds are a means to providing them and their families with positive financial outcomes.