• Kobus Hanekom

Are the proposed new conditions for exemption in terms of section 7B of the PFA ‘fit for purpose’?

Personal notes and observations by Kobus Hanekom subsequent to workshops arranged by the Pension Lawyers Association in Cape Town, Durban and Sandton lead by Rosemary Hunter and himself.

The FSCA’s draft guidance notice on section 7B exemptions has caused a great deal of controversy and debate in the retirement industry. A part of the debate relates to some of the specific proposals made. The more significant debate however revolves around those issues that were not mentioned and discussed. These include the role and function of the sponsor in all commercial funds. As South African employers migrate their employees to umbrella funds, the typical role they played in establishing and supporting their corporate fund has to be replaced by another entity.

One school of thought believes that independent trustees and/or trustees elected (directly or indirectly) by members and/or their employers can, on an ‘arm’s length’ basis, select and appoint the providers of products and services needed to assist the fund’s board to ensure that the fund fulfils its objects efficiently and cost-effectively.. Another school of thought believes that in a ‘mega fund’ environment, this is best achieved by the sponsor – preferably a large financial institution that the membership trusts and that has both the discipline and the financial muscle to weather financial storms.

The independent trustee school, with proponents such as Rosemary Hunter, believes that giving a commercial sponsor the power to appoint its employees or others financially dependent on its goodwill to the board of an umbrella fund is inconsistent with the statutory and common law duty of those in positions of trust to avoid conflicts between their duties to their principal (in this case the fund) and their own interests and/or their duties to third parties (in this case the sponsor). This, she says, is because

  • the fund is a not-for-profit entity the bests interests are served by purchasing what it considers most ‘fit for purpose’, ‘value for money’ goods and services from providers in a truly competitive market; whereas

  • the sponsor is a for-profit entity which wants control over the fund so that it will be a ‘captured customer’ for its products and/or services and those of entities related to it. .

The sponsor school, with proponents such as myself argue that in umbrella / multi-employer funds, a sponsor is an essential part of the retirement funding solution and has to be recognised as such. This is because the relationship between the employer and the umbrella fund is primarily contractual, and the solution offered is akin to a product designed and supported by the sponsor. In terms of this approach, the sponsor takes responsibility for the research, development and design of the packaged retirement fund solution. The solution, once considered and approved by the board, will then be directed, controlled and overseen by the board of the umbrella fund in accordance with section 7C of the Act. In occupational funds such as union, bargaining council or local government funds the role of the employer is played by the union, bargaining council or local government structure.

The points of departure of the two schools do not appear to be the same.

The sponsor school argues that if we wish to ensure good retirement outcomes for members then, based on what we learn from the most effective retirement fund industries in the world, we need to ensure a form of compulsory membership, large funds with economies of scale that can offer competitive prices as well as unquestionably good governance. To be able to achieve that, we need to embrace both union type funds as well as commercial umbrella funds and adjust the law to ensure that they function optimally and deliver the desired outcomes.

For the independent trustee school, any mechanism that gives a commercial sponsor effective control or influence over decisions made on behalf of a fund in relation to matters in which the sponsor has a financial interest effectively constitutes an unresolvable conflict of interest. What is needed, Hunter says, is a board comprising trustees who are wholly independent of commercial providers of the main products and services of the nature required by the fund and who have the power to appoint and terminate the appointments of such providers as they consider necessary in the fulfilment of the objects of the fund. This approach by implication places a question mark behind the status and viability of all commercial funds established by sponsors including retirement annuity, preservation, beneficiary, unclaimed benefit and of course umbrella funds.

Concerns with the draft proposals

One of the requirements of the Pension Funds Act is that members are entitled to elect 50% of the board of trustees. This requirement works well with a typical occupational fund established by an employer for his employees. The requirement is more problematic when it comes to industry type funds (such as union, bargaining council funds) and commercial funds (such as umbrella, retirement annuity, preservation, beneficiary or unclaimed benefit funds). Section 7B however empowers the FSCA to grant a fund an exemption from this requirement on application subject to conditions determined by it.

(i) Commercial funds exempted on condition that 50% of the board are industry professionals independent of the sponsor.

The FSCA took a bold step and indicated that it would be prepared to provide such an exemption for commercial funds on condition that 50% of the board are persons who are industry professionals who are independent of the sponsor. I welcome this step. Hunter, on the other hand, says that it still tacitly accepts that the other trustees may be tied to the funds’ sponsors.

The part that is very problematic is the requirement in the draft guidance notice is that in such a board, a decision can be taken (not by the normal majority) if supported by least 50% of the board on condition that 70% of the independent trustees supported the motion. In a typical board with three independent trustees (and three non-independent ones) it will mean that each one of the independent trustees must vote in favour of a decision. This effectively gives them a veto right which at a time when we are super aware of the dangers of state capture and corporate fraud, concentrates an extraordinary amount of power in these individuals. These powers are a significant departure from the principles of King IV and could lead to a governance failure with significant risks for both the fund and the members. While Hunter agrees that it is dangerous to put veto power in the hands of one trustee, she thinks that the board of a fund should be free to choose investment products and portfolios they consider will serve the best interests of the fund, even if the products and portfolios are offered by competitors to the fund’s sponsor.

In my opinion the proposal relating to the voting powers of independent trustees is not workable and must be realigned with the balance of power provisions of King IV. I do not know that you will find an example like this in any other area of the law or in any other jurisdiction in the world.

Other requirements proposed in the draft notice that require adjustment include

(ii) Subcommittees must also have 50% independent trustees

Where the board will in any event be required to approve a committee’s recommendation, this requirement is unnecessarily restrictive. In addition, in committees that are authorised to make decisions on behalf of the board in terms of a detailed delegation protocol – such as the allocation of death benefits – it is difficult to see how such a provision will add value.

(iii) Round robin decisions to be ratified at trustee meetings.

Mega funds cannot wait to take decisions until they meet 4 times a year. They must be able to take decisions as and when required and implement them. In law, round robin decisions are binding as soon as they are taken, but, for record-keeping processes they are recorded in the minutes of the next meeting. Hunter however points out that the common law position is that unless the rules of the fund allows a majority decision, it must be ratified at the next ordinary meeting. To avoid a situation where any trustee feels overrun, a practical arrangement is to allow any trustee to request that a decision be postponed until he or she has had an opportunity to engage and/or make a presentation to the board

(iv) The difference in requirements for union and commercial umbrellas too big

While we support the recognition of these union and bargaining council structures in principle, the treatment of these funds will be at odds with the very strict and detailed requirements that are being laid down for commercial umbrella funds. If “good retirement fund benefits” are our key objective, it is not that easy to reconcile the fit and proper requirements that independent trustee will have to comply with compared to the total lack of skills requirements for the union type umbrella funds.

The law on sponsor participation?

Is there any law in South Africa that says a commercial fund may not have a sponsor who takes responsibility for aspects such as the business plan and the design / population of the fund offerings – for the consideration and approval of the board? The answer is no, there is no such law. If the role of the sponsor is defined in the registered fund rules and is not inconsistent with the PFA, it becomes part of the operation of the fund that has to be directed, controlled and overseen by the board ito section 7C(1) of the Pension Funds Act.

In Australia, umbrella funds (master trusts) have shown significant growth. In that jurisdiction a substantial amount of assets is invested in what they call retail funds – funds sponsored by a large financial services institution. In that country members can choose between an industry fund or a retail fund - so it is interesting that even though retail funds are somewhat more expensive than industry funds, the sense of value they offer is such that substantially more assets continues to be invested in these funds.

In the United Kingdom the most cost effective type of registered retirement fund is one without a board of trustees. It is in the nature of a group retirement annuity where the contract is between the member and the insurer. Master trusts however became increasingly popular over the past few years The UK is currently investigating the operation of these funds (around 80) to ensure that their management, governance procedures and infrastructure is fit for purpose. The focus of the UK authorities, quite correctly, is on operational matters – such as who is the strategist, who takes responsibility for the business plan, who is the funder and so on (all matters that the sponsors of commercial funds typically attend to in South Africa).

There are therefore good reasons why we could and should recognise the sponsor in especially South African commercial umbrella funds. In doing so we may wish to take guidance from the very compelling examples of such funds in operation in other jurisdictions.

The way forward

My request to the drafters of the FSCA guidance notice is that they realign the note with the principles of King IV as requested.

As a second step I ask that they do a special investigation and engage with the industry on the most effective way to run mega commercial umbrella funds and other commercial funds.

We have to start with the end in mind and that is “how best do we ensure good retirement outcomes for our members”. Once we have agreement on the outcomes, compelling solutions will present themselves.


Kobus Hanekom

Principal Officer: Sanlam Umbrella Fund

Contracted Principal Consultant: Simeka Consultants and Actuaries

5 July 2018

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