I OVERVIEW OF RECENT ACTIVITY
The regulatory requirements affecting the asset management industry in South Africa are continuously amended and refined by the relevant policymakers and regulators. Specific themes emerging from recent and ongoing reforms concern the adoption of direct regulation in respect of all persons playing a role in the financial sector and the implementation of regulatory proposals of international bodies in the aftermath of the global financial crisis. These and other changes are discussed below against a background of a high-level overview of relevant regulatory requirements.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
i Main regulators
The national government department responsible for setting policy in respect of the regulation of private and public sector investment in South Africa is the National Treasury headed by the Minister of Finance. The main regulators responsible for administering applicable legislation are the Financial Services Board (FSB) and the South African Reserve Bank (SARB).
The FSB supervises and enforces compliance with the laws regulating financial institutions and the provision of financial services.2 The FSB is funded by levies on financial institutions. The FSB is organised in sector-specific departments, each headed by a registrar and deputy registrar (e.g., the Pension Funds Department is headed by the Registrar of Pension Funds). The legislation administered by the FSB is fragmented, with a specific piece of primary legislation applying to each of the different types of financial institutions and service providers regulated by the FSB, namely credit ratings agencies, insurance companies, pension funds, collective investment schemes, friendly societies, financial services providers, and exchanges and related service providers (such as stockbrokers, clearing houses and securities depositories).3 Broadly speaking, subordinate legislation is made by the Minister of Finance, while the FSB is given wide powers to regulate approved financial institutions and service providers through conditions, directives, rules and the like.
The SARB is responsible, inter alia, for formulating and implementing monetary policy, supervising the banking sector and administering South Africa’s system of exchange controls.4
It is the stated policy aim of the government to move toward a twin peaks model of regulation, in terms of which supervision and monitoring of the health and soundness of financial institutions will generally be exercised by the Prudential Authority (a new regulator to be established out of the SARB), and financial market conduct and customer treatment will be regulated by the Financial Sector Conduct Authority (a new regulator to be established out of the FSB).5
Another regulator, the Financial Intelligence Centre, is responsible for administering the anti-money laundering and related requirements of the Financial Intelligence Centre Act (Act 38 of 2001), which responsibility it shares with the FSB (in respect of non-bank financial institutions) and the SARB (in respect of banks).
Various ombud schemes provide recourse for customers who have disputes in relation to, for example, financial services, insurance or pension fund matters.6
All financial institutions are subject to the Financial Institutions (Protection of Funds) Act (Act 28 of 2001) in terms of which the FSB may take enforcement action against financial institutions who fail to comply with legal requirements, or apply to court to appoint a curator to take control of and manage the whole or part of the business of a financial institution.7 The Minister of Finance may appoint a curator to a bank.8 A high-profile example of such curatorship is that of African Bank, which is currently under curatorship.
ii Intermediaries and advisers regulated under the FAIS Act
Persons (other than service providers who are specifically regulated in terms of other legislation, such as stockbrokers and managers of collective investment schemes)9 who provide intermediary services or advice to clients in respect of financial products (including insurance products, bank deposits and securities) are subject to detailed regulation under the FAIS Act.
At present, the following four types of licences issued under the FAIS Act are relevant in the asset management context:
- a Category I (issued to financial services providers providing non-discretionary intermediary services or advice);
- b Category II (issued to financial services providers who provide discretionary fund management);
- c Category IIA (issued to financial services providers who manage hedge funds on a discretionary basis); and
- d Category III (issued to administrative financial services providers who aggregate client funds or securities, often through providing one-stop investment platform services).
Such licence holders (termed authorised financial services providers) are bound by the principles and rules set out in applicable codes of conduct created by the FSB.
Individuals exercising oversight over the rendering of financial services by a licence holder under the FAIS Act (termed ‘key individuals’) or who represent the licence holder in rendering financial services to clients (termed representatives) must, in order to illustrate the required level of competence, successfully complete certain regulatory examinations prescribed by the FSB.10 A limited exemption applies to this requirement in respect of licence holders not domiciled in South Africa who are licensed under the FAIS Act to provide intermediary services only.11
Licence holders must comply with financial soundness requirements. In terms of these requirements, the assets (excluding goodwill, intangible assets, investments in and loans to related parties and investments with or loans to persons to whom the licence holder renders financial services) must exceed the licence holders’ liabilities (excluding loans subordinated in favour of other creditors).12 In addition, licence holders who hold client assets must maintain liquid assets equal to or greater than between four and 13 weeks of annual expenditure, depending on the type of licence held.
III COMMON ASSET MANAGEMENT STRUCTURES
Investor funds are commonly pooled for investment purposes through two types of FSB-regulated financial institutions, namely collective investment schemes and long-term insurance companies who issue linked policies.
Other types of investment structures (not directly regulated by the FSB) include exchange traded funds (other than those registered as collective investment schemes) and private investment vehicles housed, for example, in partnerships.
i Collective investment schemes
Collective investment schemes are managed and administered by a manager.13 The administration of each scheme is overseen by a trustee or custodian.14 Each scheme is established by way of an agreement (referred to in the legislation as a deed) between the manager and the trustee or custodian.15 In practice, the terms of such agreements follow model wording settled by the FSB. A scheme would typically have more than one portfolio or fund. Prior FSB approval is required before a person may act as a manager, or a trustee or custodian, and before the manager may establish a scheme or a portfolio.
Four types of domestic collective investment schemes are currently permitted, namely collective investment schemes in securities, property, participation bonds and hedge funds.16 Collective investment schemes in securities (which also include money-market funds, feeder funds and funds of funds) make up the overwhelming majority of the approved schemes, and collective investment schemes in property and participation bonds are relatively rare.17
Collective investment schemes in securities are subject to detailed prudential investment requirements. Board Notice 90 (BN90) of 2014, which came into effect on 8 August 2014, sets out the portfolios that may comprise a collective investment scheme in securities, the types of investments that may be included in portfolios of a collective investment scheme in securities, as well as the conditions, limits and the manner in which the portfolios and securities may be included. With limited exceptions, collective investment schemes in securities may only invest in equities if the relevant securities are listed, and may not use financial instruments in order to leverage the portfolio.18 Collective investment schemes in securities are open-ended, and managers are typically required to provide valuations and redemptions on a daily basis.
Hedge funds that invite or permit ‘members of the public’ (as defined in CISCA) to invest money or other assets must, if formed prior to 1 April 2015, transition to hedge fund schemes duly registered under CISCA in accordance with a transition plan approved by the Registrar, and after 1 April 2015 may only be created within such registered schemes.19 Two types of hedge funds may be registered under CISCA.20 Qualified investor hedge funds may only permit investment by investors who have ‘demonstrable knowledge and experience’ in financial and business matters that would enable them to ‘assess the merits and risks of a hedge fund investment’ (or are advised by a financial services provider having such knowledge) and who invest at least 1 million rand. A retail fund does not have such restrictions. Generally speaking, retail funds must comply with more detailed regulatory requirements, including detailed prudential investment requirements.
Broadly speaking, foreign collective investment schemes may not be marketed to members of the public in South Africa unless the applicable scheme has been approved by the FSB.21 The requirements for approval, which were replaced at the end of 2013, include that the foreign jurisdiction in which the foreign collective investment scheme is domiciled has a regulatory regime for collective investment schemes of at least the same standing as that of South Africa, that the foreign scheme must either open a representative office in South Africa or appoint a South African manager approved in terms of CISCA as its representative, and that investment in the scheme must be promoted in South Africa to the same type of investors under the same or substantially similar requirements and conditions relating to the type of investors as in the jurisdiction in which the scheme has its principal registration.22
The FSB introduced new requirements for the marketing of both South African and foreign collective investment schemes during 2014, which came into effect in the first half of 2015.23
ii Linked policies
A well-known financial product used for investment purposes is a linked policy issued by a long-term insurance company. A linked policy is a long-term policy of which the amount of the policy benefits is not guaranteed by the long-term insurer, but is to be determined solely by reference to the value of particular assets or categories of assets that are specified in the policy and are actually held by or on behalf of the insurer specifically for the purposes of the policy.24 Given the circumscribed nature of the insurer’s liability under such a linked policy, assets in which a linked policy is invested need not be spread in accordance with the prescribed prudential investment requirements for insurance companies.25 The policyholder or its investment manager usually specifies the assets or types of categories of assets (which are often unlisted) to be held by the insurer for the purposes of the policy. Use of an insurance policy in the above circumstances is often referred to as making use of a ‘life wrapper’. Linked policies are a useful way in which institutional investors may gain exposure to infrastructure project investments without the need to become party to the extensive contractual arrangements that are typical for such projects.
iii Other structures
One of the most significant new trends in the South African asset management sector has been the growth in passively managed funds, with exchange-traded funds listed on the Johannesburg Stock Exchange (JSE) becoming more prevalent as an asset class. Exchange-traded funds could in certain circumstances fall to be regulated as collective investment schemes, and would otherwise typically fall to be regulated by the Companies Act26 and the JSE.
We discuss a common vehicle used for private investment structures, namely the en commandite partnership, in our discussion of private equity funds in Section VI, infra.
We discuss favourable tax treatment given to investors in qualifying venture capital companies in Section VII, infra.
IV MAIN SOURCES OF INVESTMENT
i Capital markets
The JSE is the largest exchange by market capitalisation in Africa and the 19th-largest exchange in the world.27 The JSE operates equity, interest rate and derivatives markets.28 Foreigners are significant investors in JSE securities.
ii Assets under management
According to the FSB,29 in March 2015, long-term insurers (excluding reinsurers) registered in South Africa had assets of 2.6 trillion rand and short-term insurers (excluding reinsurers) had assets of 135 billion rand. In December 2014, public and private pension funds had assets of 3.2 trillion rand.30
According to the Association for Savings and Investment South Africa,31 South Africa’s collective investment schemes industry had approximately 1.78 trillion rand under management as at 31 March 2016.
The private equity industry had an estimated 165.3 billion rand (including undrawn commitments of 40.6 billion rand) under management as at 31 December 2015.32 The hedge fund industry had an estimated 62 billion rand under management as at the end of June 2015.33
V KEY TRENDS
i Regulation of previously unregulated participants and investments
The government has taken significant steps in recent years to close perceived regulatory gaps and to exercise regulatory control over key players in the asset management industry. Examples include the following:
- a Parliament is considering legislation introducing new regulatory requirements for systemically important financial institutions, financial conglomerates and holding companies of financial conglomerates;34
- b the Credit Ratings Services Act created a regulatory framework administered by the FSB for the registration of credit rating agencies and the provision of credit rating services in South Africa;
- c the government is in the process of establishing a detailed regulatory framework for over-the-counter (OTC) derivatives (see subsection iii, infra);
- d hedge funds are since 2015 regulated directly by the FSB and will be required to register as collective investment schemes under CISCA (see Section III, supra);
- e the FSB indirectly regulates private equity funds through conditions for investment by pension funds in private equity funds35 and by requiring private equity fund managers to be licensed under the FAIS Act; and
- f the Registrar of Securities Services issued a directive in July 201436 in respect of unlicensed exchanges that had been operated for years by share issuers in relation to their own securities, clarifying that each such exchange must apply for either approval as an exchange under the FMA or exemption from the requirements of the FMA.
ii Reforms aimed at ensuring improved outcomes for clients
The FSB is in the process of developing a ‘treating customers fairly’ programme for regulating the market conduct of financial services firms.37 This programme will seek to ensure that fair treatment of customers is embedded in the culture of financial firms, and it will be based on a combination of market conduct principles and explicit rules coupled with regular review of market conduct by the FSB. It is anticipated that the programme will be gradually included in the regulatory and supervisory framework applied by the FSB, and many firms are already evaluating their practices against the applicable outcome-based principles.38
In addition, the FSB is conducting an industry-wide ‘retail distribution review’ in terms of which the FSB proposes far-reaching reforms to the regulatory framework for distributing retail financial products to customers in South Africa with the aim of addressing poor customer outcomes and the mis-selling of financial products.39
With respect to the retirement industry, the government is engaging in ongoing reforms and discussions with relevant stakeholders in order to achieve a number of objectives, including lowering fees and charges, encouraging the preservation of retirement savings until retirement, encouraging the conversion of retirement savings into annuity income after retirement, and improving the governance of retirement funds.40
In relation to the governance of pension funds, the PFA has been amended to require all pension fund trustees to undergo training, and to clarify that trustees owe fiduciary duties not only to the pension fund but also directly to members and beneficiaries of the pension fund.41
iii Increasingly sophisticated regulatory measures and emulating offshore developments
An example of the increased sophistication in the regulatory oversight exercised by the FSB and its emulation of offshore developments is the Solvency Assessment and Management framework (SAM framework), which is being developed by the FSB for the purposes of establishing a risk-based supervisory regime for the prudential regulation of both long-term and short-term insurers in South Africa (including reinsurers). The SAM framework is intended to align the South African insurance industry with international standards, specifically the Solvency II regime implemented for European insurers and reinsurers. In addition, the legislative framework for insurers is undergoing a complete overhaul with the consideration in Parliament of the Insurance Bill.42
Another example of this trend is the publication in July 2016 of updated draft regulations to the FMA together with various draft FSB notices aimed at regulating the OTC derivatives markets in South Africa.43 These documents aim to give effect in South Africa to ambitious regulatory objectives articulated by the G20 and the Financial Stability Board following the 2008 financial crisis. The proposed South African regulatory framework, intended to come into effect in 2017 and 2018, includes the licensing and regulation of:
- a persons (called OTC derivative providers) who as a regular feature of business and transacting as principal originate OTC derivatives or make a market in them;
- b clearing houses who act as central counterparties in transactions relating to OTC derivatives; and
- c trade repositories, who will collect data on OTC derivative transactions, collate such data and report it to regulators, as may be required.
The FSB has established an International and Local Affairs Unit whose role is to research and monitor local, regional and international developments and coordinate with foreign regulators. It can be expected that this, together with South Africa’s membership of various international bodies such as the G20, will lead to the increased influence of offshore regulatory developments on the South African policy framework.
VI SECTORAL REGULATION
The South African insurance industry is split between the long-term insurance industry (otherwise known as life insurance) and the short-term insurance industry (typically termed general insurance in other countries).
Although draft legislation has been published that will change the position (see Section V, supra), South Africa’s long-term insurance industry is regulated by the LTIA, while the short-term insurance industry is governed by the STIA. There is no bespoke legislation in place for the reinsurance industry, which is currently regulated by the LTIA and the STIA.
South African insurers have an obligation to ensure that they are always able to meet their liabilities and their capital adequacy requirements, as determined by the insurer’s statutory actuary.44 To this extent, insurers have to adhere to specific prudential spread requirements, which set out the maximum permitted holdings in particular kinds of assets.45 Compliance with both the capital adequacy and prudential requirements are verified through the submission to the FSB of unaudited quarterly returns and audited annual returns. In order to protect their assets, insurers are prohibited from encumbering their assets, borrowing any asset and giving security in relation to obligations between other persons.46 Insurers may furthermore only invest in derivatives for the purpose of reducing investment risk or for efficient portfolio management, and securities lending is subject to specific requirements, including the holding of adequate collateral in the form of cash or securities, or both.47
We have noticed an increased interest in offshore and local investment offerings to South African high-net-worth individuals and institutional investors through policies (including linked policies) issued by long-term insurance companies. We have also noted that private sector pension funds are becoming increasingly interested in outsourcing their pensioner liabilities to long-term insurers.
South African pension funds that are registered under the PFA are regulated in terms of the PFA by the FSB.48 Previously, all investment managers to pension funds were required to obtain a separate approval under Section 13B of the PFA, but this requirement was abolished in 2014.49 The prudential investment limits applicable to pension funds are commonly referred to as Regulation 28.50
Overview of Regulation 28
The board of trustees of a pension fund has a fiduciary responsibility to act in the best interests of the members of the fund, whose benefits depend on the responsible management of the pension fund’s assets. In the FSB’s view, there is a general lack of investment expertise among trustees of pension funds, and therefore Regulation 28 is primarily rules-based.51 Regulation 28 specifies that a pension fund may appoint specialist advisers such as asset managers, asset consultants and risk consultants to assist with investment decisions, but the board of the pension fund ultimately remains responsible for the management of the pension fund’s assets.52
A pension fund may only invest in the kinds of assets specified in Regulation 28, and within the relevant issuer and aggregate limits that are defined per asset class. By way of example, Regulation 28 limits the maximum exposure of a pension fund to equity securities to 75 per cent of the aggregate fair value of the total assets of a fund,53 and provides that (in addition to relevant sub-limits) the total exposure of a pension fund to unlisted debt instruments, unlisted shares, unlisted interests in property companies, hedge funds, private equity funds and any other asset not specifically referred to in the relevant schedule may not exceed 35 per cent of the aggregate fair value of the total assets of a pension fund.54 Should a pension fund be of the opinion that it would be prudent to exceed any of the prescribed limits, it can approach the FSB for a possible exemption.55
The look-through principle
When determining the asset class of a specific asset for the purposes of determining compliance with Regulation 28, a pension fund must apply the look-through principle. In terms of this principle, which is intended to prevent the circumvention of the prescribed limits, a pension fund must always disclose and report on the underlying assets to which it has economic exposure if the instrument directly held by the pension fund merely provides a conduit to such exposure.56 The principle does not apply to investment by pension funds in private equity and hedge funds that conform to the conditions prescribed in Regulation 28.57
A pension fund may only borrow for bridging purposes to maintain sufficient liquidity for its operational requirements.58
A pension fund may engage in securities lending subject to certain prescribed conditions under Board Notice 2 and 4 of 2012 (Securities Lending Notice). Any securities that are subject to a securities lending transaction remain the assets of the pension fund (and therefore subject to the Regulation 28 prudential spread limits) and must be disclosed in the annual financial statements of the pension fund as assets of the pension fund.
Pension funds may only conclude securities lending transactions in terms of a legally binding written agreement with the counterparty that complies with the definition of a master agreement as contemplated by Section 35B of the Insolvency Act,59 and such agreement must furthermore comply with certain requirements set out in the Securities Lending Notice.60 Post-insolvency set-off is, as a general rule, not permitted under South African law, but Section 35B of the Insolvency Act allows for netting and set-off provisions contained in such master agreements to be enforced post-insolvency of a party to such an agreement.
Regulation 28 allows pension funds to invest in derivative instruments subject to certain prescribed conditions. As of July 2015, these conditions have not yet been finalised.
A growing trend has been the implementation of a number of liability matching strategies by South African pension funds. These can take a number of forms, including structured bank deposits, swap and bond transactions, long-term policies, outsourcings and active mandates. Central to many of these cash-flow matching transactions is the hedging of inflation-related risks.
iii Real property
Insurance companies and pension funds are significant investors in commercial property. Other types of South African institutional investors who invest in commercial property are property unit trusts and listed real estate investment trusts (REITs) (as discussed below). Property unit trusts are collective investment schemes in property regulated as collective investment schemes by the FSB. In terms of recent amendments to the tax legislation and the JSE listings requirements, the internationally recognised REIT framework has been introduced in South Africa. Broadly speaking, to qualify as a REIT, an entity must be listed with the JSE and classified by the JSE as a REIT.
iv Hedge funds
See the discussion in Section III, supra.
Pension funds are significant investors in hedge funds. Under Regulation 28, pension funds are permitted to invest up to 10 per cent of their assets in hedge funds, subject to such conditions as the FSB may prescribe. The FSB has not yet finalised any such conditions.
A possible knock-on effect of the regulation of South African hedge funds under CISCA will be that the FSB may be more favourably disposed toward approving the marketing of foreign collective investment schemes who make use of leverage. To date the FSB has refused to approve such portfolios for marketing in South Africa under Section 65 of CISCA.
v Private equity
At present, provided that private equity funds are not offered to members of the public, the structures in which private equity funds are housed are not directly regulated by the FSB. For various reasons, the investment structures in which the majority of South African private equity funds are typically housed in are en commandite partnerships or, less frequently, in bewind trusts.
En commandite partnerships are regulated by common law. The main advantage of this type of partnership is that a commanditarian, or limited partner, is not liable for the debts of the partnership in an amount greater than its investment commitment to the partnership (provided applicable common law requirements are met).61 The managing partner (also known as the general partner) has unlimited liability for the debts of the partnership.
A bewind trust is a type of trust vehicle registered under the Trust Property Control Act,62 in terms of which the applicable assets that are subject to the trust arrangements are owned by the beneficiaries of the trust, but the trustees of the trust hold and manage those assets.63 In the context of a private equity vehicle structured as a bewind trust, the cash contributions of the investors to the trust form the initial assets of the trust. Each investor is a beneficiary of the trust, and the investors own the assets of the trust jointly in undivided shares in proportion to their respective contributions.
Pension funds are significant investors in private equity funds. Under Regulation 28, pension funds are permitted to invest up to 10 per cent of their assets in private equity funds, subject to such conditions as the FSB may adopt. The FSB has issued binding conditions for investment by a pension fund in a private equity fund.64
In the past few years, there has been increasing interest in the listing on the JSE of investment entities and special purpose acquisition companies. Over time, these vehicles could become significant entry points for private equity investment.
vi Other sectors – the Public Investment Corporation (PIC)
The PIC is the principal asset manager for South Africa’s public sector (including the Government Employees Pension Fund) and has, as an additional mandate, the obligation to contribute to economic development. The PIC is wholly owned by the government. It is regulated by its own statute, the Public Investment Corporation Act,65 and as a public entity is bound to comply with the financial management and governance provisions of the South African Public Finance Management Act.66 As at 31 March 2015, it reported assets of 1.8 trillion rand under management.67
The PIC has allocated 5 per cent of its funds under management for investment in Africa other than in South Africa, and 5 per cent of its funds in offshore investments other than in Africa.68 It also allocates a portion of its assets under management to developmental investments through its Isibaya fund, which focuses on social and economic infrastructure development, environmental sustainability, job creation, enterprise development and broad-based black economic empowerment.69 Furthermore, it is active in promoting environmental, social and governance issues in the South African marketplace, and is one of the key supporters of the recently drafted Code for Responsible Investing in South Africa.70
VII TAX LAW
South African tax legislation has undergone several significant developments lately, some of which impact the asset management industry. We briefly discuss some of these changes below.
i Dividends tax
With effect from 1 April 2012, dividends tax is levied upon any dividend paid by a resident company or a non-resident company if the shares are listed on the JSE at a rate of 15 per cent. Dividends tax is a withholding tax on cash dividends, meaning that the tax will be withheld and paid by the company declaring and paying the dividend or a regulated intermediary (which includes, inter alia, a portfolio of a hedge fund collective investment scheme), as the case may be, to the South African Revenue Service on behalf of the person who is the beneficial owner of the dividend. Dividends tax so withheld should constitute a tax credit for a foreign shareholder in that shareholder’s jurisdiction. However, in respect of a dividend that constitutes the distribution of an asset in specie, the company declaring the dividend will be liable for the dividends tax. Anti-tax avoidance provisions also exist that deem certain persons to be the beneficial owners of a dividend or reclassify certain payments as dividends, most notably payments in respect of listed shares borrowed after a dividend has been announced or declared.
ii Interest withholding tax
Although non-residents are generally exempt from tax on South African sourced interest that is not effectively connected to a permanent establishment of such non-resident in South Africa, with effect from 1 March 2015, a withholding tax is levied at a rate of 15 per cent on South African sourced interest that is paid by any person to or for the benefit of any non-resident. With effect from 1 March 2016 the definition of ‘interest’ for purposes of the interest withholding tax provisions has been defined as ‘interest’ as contemplated in paragraph (a) or (b) of the definition of ‘interest’ in Section 24J(1) of the Income Tax Act (Act 58 of 1962) (Income Tax Act). Any person who makes payment of any amount of interest to or for the benefit of a non-resident must withhold the tax. Tax so withheld should generally constitute a tax credit for such a non-resident in its jurisdiction. An additional exemption from the interest withholding tax has recently been introduced with effect from 1 March 2015 in terms of which South African sourced interest paid to a non-resident in respect of a debt owed by another non-resident is exempt from this withholding tax provided that the exclusions to the exemption do not apply. Furthermore, certain types of interest, including interest received by a non-resident from any bank or the government, or in respect of a listed debt instrument, are exempt from this withholding tax. It has been proposed in terms of the draft Taxation Laws Amendment Bill of 2016 (Draft TLAB) that South African sourced interest paid to specified financial institutions such as, inter alia, the African Development Bank, the World Bank, etc., should also be exempt from the interest withholding tax.
iii Limitation of interest deductions
New provisions have recently been introduced in respect of the deductibility of interest, limiting the deduction of interest incurred in respect of debts applied to finance certain restructure transactions. In terms of these rules, the amount of interest deductible is calculated by way of the application of a formula contained in the provisions. In terms of the Draft TLAB, it is proposed that an amendment be made to these provisions to clarify the position that such provisions do not apply to any interest incurred by an acquiring company in respect of a debt where that interest is incurred in respect of a linked unit in the acquiring company and that interest accrues to a pension fund, a provident fund, a REIT, a long-term insurer or a short-term insurer if they meet certain stipulated requirements.
Furthermore, with effect from 1 January 2015, new rules have also been introduced pursuant to which the amount of interest that can be deducted by a taxpayer is limited in respect of debt where there is a ‘controlling relationship’ between the debtor and the creditor, and the creditor is not subject to tax in South Africa. In terms of these new rules, the amount of interest that may be deducted is limited to an amount determined in accordance with a prescribed formula.
iv Hybrid debt and hybrid interest
Interest on debt instruments that contain equity-like characteristics (e.g., the obligation to pay an amount in respect of that instrument is conditional upon the market value of the assets of the payee company not being less than the market value of the liabilities of that company) will be treated as dividends in specie for South African income tax purposes and will not be deductible by the company incurring such interest, and may be subject to dividends tax.
Furthermore, amounts that constitute ‘hybrid interest’ (e.g., interest where the amount is not determined with reference to a specified rate of interest, or is not determined with reference to the time value of money) will also be treated as dividends in specie for South African income tax purposes, and may be subject to dividends tax.
In terms of the Draft TLAB, it is proposed that these anti-avoidance rules should only apply in the following instances, namely, where the issuer of the debt instrument is a resident company, where the issuer is a non-resident company and the interest incurred in respect of that debt instrument is attributable to a permanent establishment of that non-resident company in South Africa, or where the issuer is a controlled foreign company and the interest incurred in respect of that debt instrument must be taken into account in determining the net income of that controlled foreign company as contemplated in Section 9D of the Income Tax Act.
v Securities transfer tax
Securities transfer tax (STT) at a rate of 0.25 per cent is levied on the transfer of the securities issued by a company incorporated in South Africa or listed on the JSE. STT is also levied on the reallocation of securities from certain accounts by members of the JSE. Certain exemptions from STT are available. For example, a transfer of securities from a lender to a borrower, or vice versa, in terms of a ‘lending arrangement’ is exempt from STT provided specific requirements are complied with.
With effect from 1 January 2016, the transfer of a listed share by a transferor to a transferee, or vice versa, in terms of a ‘collateral arrangement’ entered into on or after that date, is exempt provided specific requirements are complied with.
In order to constitute a qualifying ‘collateral arrangement’, it is a requirement that, inter alia, the identical shares be returned by the transferee to the transferor within 12 months from the date that the collateral arrangement was entered into. The Draft TLAB proposes to extend this period from 12 months to 24 months. This amendment will, once promulgated, apply to any collateral arrangement entered into on or after 1 January 2017.
A REIT is exempt from capital gains taxation on the disposal of certain of its assets, such as immoveable property and shares or linked units in a company that is a REIT or a property company, as defined in the Income Tax Act. With effect from 1 January 2016 and applicable in respect of years of assessment commencing on or after that date, for purposes of calculating the taxable income in respect of a year of assessment of a REIT, deductions are allowed in respect of foreign taxes paid by a foreign vesting trust, foreign withholding taxes on distributions made by a foreign vesting trust and Section 18A donations made by a REIT, provided certain requirements are met. In addition, qualifying distributions in respect of a year of assessment by a REIT are deductible from the income of that REIT. A qualifying distribution is, inter alia, any dividend paid or payable by a REIT if, during a particular year of assessment, at least 75 per cent of the gross income of that REIT consists of rental income. Rental income will include, inter alia, amounts received by or accrued to the REIT in respect of the use of immoveable property, or amounts received by or accrued to that REIT by way of a dividend from another REIT. Such dividends distributed by a REIT will not qualify as exempt dividends in the hands of the investors and will therefore be taxable in the hands of the investors in the REIT, in accordance with the tax dispensation applicable to them.
vii Hedge funds
Once hedge funds comply with the regulatory framework of collective investment schemes, the tax provisions applicable to collective investment schemes will apply to such hedge funds. Collective investment schemes are exempt from capital gains tax. Amounts (other than amounts of a capital nature) that are distributed by the collective investment scheme to the holders of participatory interests by no later than 12 months after its accrual (or its receipt in the case of interest) by the collective investment scheme are deemed to have accrued directly to the holders for tax purposes on the date of the distribution.
Furthermore, where a portfolio of a hedge fund collective investment scheme is constituted as a partnership, any amount allocated by the portfolio to the partners must (for purposes of determining whether the amount accrues to the holders by virtue of its distribution within 12 months) be treated as having been distributed to the partners by virtue of the partners being holders of participatory interests in the portfolio.
Redemptions or disposals of participatory interests in collective investment schemes are treated in accordance with ordinary principles (i.e., capital gains tax if the participatory interests are held as capital assets or income tax if the participatory interests are held as revenue assets). To the extent that participatory interests are held for more than three years, they will be deemed to be capital assets.
In order to mitigate the tax implications arising from the transition as unregulated vehicles to regulated collective investments schemes, certain amendments were made to the Income Tax Act in order to address such consequences and to assist the hedge fund industry’s transition to a new regulated tax regime. Specifically, amendments were made to Sections 41 and 42 of the Income Tax Act to allow for the tax neutral disposal by the holder of an interest in a hedge fund to a hedge fund collective investment scheme in terms of an ‘asset-for-share transaction’. In addition, amendments were made to Section 44 of the Income Tax Act in order to allow for the tax neutral amalgamation of two portfolios into a single portfolio. These provisions apply retrospectively from 1 April 2015.
It is noted that the 2016 Budget Review stated that there are, however, certain instances where the aforementioned tax relief provided is limited and inapplicable to certain hedge fund trust structures. It was accordingly proposed in the 2016 Budget Review that these tax measures be considered further to address such cases. The Draft TLAB does not, however, contain any proposed amendments in this regard.
viii Tax-free investments
With effect from 1 March 2015, a new non-retirement savings tax incentive came into operation. In terms of this incentive, any amounts received by or accrued to a natural person or deceased estate or insolvent estate of that person in respect of a ‘tax-free investment’ are exempt from normal tax, and any capital gain or loss in respect of the disposal thereof should be disregarded. A ‘tax-free investment’ is any financial instrument or policy as defined in Section 29A of the Income Tax Act that is administered by designated product providers (e.g., banks, long-term insurers, managers of collective investment schemes, authorised users, administrative financial service providers) and that complies with the requirements of the regulations issued in this regard. These regulations impose certain obligations on product providers, and also set out the requirements for a tax-free investment, including that such a financial instrument or policy may only be issued by, inter alia, a bank, a long-term insurer or a manager of a collective investment scheme.
Taxpayers may only contribute up to an amount of 30,000 rand into tax-free investments annually and 500,000 rand in aggregate. Where a taxpayer contributes in excess of the aforementioned limitations in any year, 40 per cent on the amount of the excess contribution will be deemed to be an amount of normal tax payable.
ix Venture capital companies
Section 12J of the Income Tax Act offers tax relief to investors investing into approved venture capital companies. One of the requirements is that the venture capital company must be authorised as a financial services provider under the FAIS Act. The main purpose of the tax incentive is to stimulate the supply of private sector venture capital funding. In summary, Section 12J permits an investor into an approved venture capital company to deduct 100 per cent of the capital invested from the investor’s income in the year during which the investment was made, provided that the investor is not a ‘connected person’ (as defined) to the venture capital company. Provided that the investor holds his or her shares for a minimum of five years, there will be no income tax recoupment of the amount deducted when the investment is realised. There will, however, be a reduction of base costs for the purposes of capital gains tax. This tax incentive is available to any South African taxpayer. The effect of the tax regime is to significantly enhance the potential investment return. The draft TLAB proposes certain changes to the venture capital company regime.
Significant new developments in the next couple of years are:
- a the finalisation and implementation of the ‘twin peaks’ financial sector regulatory reform contemplated in the Financial Sector Regulation Bill;
- b new regulatory requirements for systemically important financial institutions, financial conglomerates and holding companies of financial conglomerates;
- c the introduction of regulation in respect of OTC derivatives;
- d the introduction of the SAM framework and of new legislation for insurers;
- e ongoing reforms flowing out of the retail distribution review; and
- f the introduction of changes to ‘know your client’ requirements under anti-money laundering legislation.
In addition, reform of the retirement industry and the government’s ambitious infrastructure development programme (which will be part-funded by the private sector) may have a marked impact on the South African asset management industry.
1 Johan Loubser and Magda Snyckers are directors at ENSafrica. The authors wish to acknowledge the contribution of Arabella Bennett to the original version of this chapter.
2 Section 3(a) of the Financial Services Board Act (Act 97 of 1990).
3 See, for example, the Collective Investment Schemes Control Act (Act 45 of 2002) (CISCA), Financial Advisory and Intermediaries Services Act (Act 37 of 2002) (FAIS Act), Friendly Societies Act (Act 25 of 1956), Long-term Insurance Act (Act 52 of 1998) (LTIA), Pension Funds Act (Act 24 of 1956) (PFA), Short-term Insurance Act (Act 53 of 1998) (STIA), Financial Markets Act (Act 19 of 2012) (FMA) and the Credit Ratings Services Act (Act 24 of 2012) (Credit Ratings Services Act).
4 See Section 10 of the South African Reserve Bank Act (Act 90 of 1989).
5 ‘Implementing a twin peaks model of financial regulation in South Africa’, published on 1 February 2013 for public comment by the Financial Regulatory Reform Steering Committee, and the draft Financial Sector Regulation Bill, 2013. The third draft of the implementing legislation, the Financial Sector Regulation Bill, was published for comment in July 2016.
6 Financial Services Ombud Schemes Act (Act 37 of 2004).
7 Sections 5 and 6A of the Act.
8 Section 69 of the Banks Act (Act 94 of 1990).
9 Section 45(1)(a)(i) and (ii) of the FAIS Act provides that any authorised user, clearing house, central securities depository or participant as defined in Section 1 of the FMA, and a manager as defined in Section 1 of CISCA, shall be exempt from the application of the FAIS Act to the extent that the rendering of financial services is regulated by or under those Acts respectively.
10 Determination of Fit and Proper Requirements for Financial Services Providers, 2008, Paragraphs 6 and 10.
11 Board Notice 166 of 2011.
12 Paragraph 9 of Board Notice 106 of 15 October 2008.
13 Sections 4 and 5 of CISCA.
14 Sections 68 and 69 of CISCA.
15 Section 97 of CISCA.
16 Parts IV, V and VI of CISCA read with Government Notice 141 of 2015 in terms of which the Minister of Finance declared hedge funds to be collective investment schemes.
17 The FSB website lists only six approved collective investment schemes in property and three in participation bonds (www.fsb.co.za, accessed on 21 July 2016).
18 Paragraph 3(2)(a) and Paragraph 3(8)(c) of BN90.
19 Board Notice 140 of 2015.
20 Board Notice 52 of 2015.
21 Section 65(3) of CISCA.
22 Board Notice 257 of 2013: Conditions in terms of which foreign collective investment schemes may solicit investments in the Republic.
23 Board Notice 92 of 2014.
24 See the definition of linked policy in Section 1 of the Long-term Insurance Act (Act 52 of 1998) read with Directive 146.A.i of 30 June 2010.
25 Section 31(1) of the LTIA.
26 Act 71 of 2008.
27 See www.jse.co.za/about/history-company-overview, accessed on 21 July 2016.
28 See www.jse.co.za/about/history-company-overview, accessed on 21 July 2016.
29 See the FSB Quarterly Report on the Result of the Long-Term Insurance Industry for the period ended 31 December 2015, p. 5, and the FSB Quarterly Report on the Result of the Short-Term Insurance Industry for the period ended 31 December 2015, p. 6.
30 Annual Report of the Financial Services Board for the year ended 31 March 2015, p. 25. The long-term insurers’ assets include assets of pension funds managed by insurance companies.
31 Association for Savings and Investment South Africa, asisa.org.za/en/statistics, last accessed on 21 July 2016.
32 KPMG and SAVCA, Venture Capital and Private Equity Industry Performance Survey of South Africa covering the 2015 calendar year (June 2016): www.savca.co.za, last accessed on 2 August 2016.
33 Novare Investments South African Hedge Fund Survey (2015): www.novare.com/uploads/files/NovareInvestmentsSAHedgeFundSurvey2015.pdf, last accessed on 21 July 2016.
34 See Financial Sector Regulation Bill published in July 2015.
35 Notice No. 1 of March 2012: Conditions for Investment in Private Equity Funds, Approval in Terms of Section 5(2)(e) of the PFA.
36 Board Notice 68 of 2014.
37 FSB: Treating Customers Fairly: The Roadmap (31 March 2011) and see further policy documents at www.fsb.co.za/Departments/MCS/TCF/Pages/DownloadDocuments.aspx, last accessed on 21 July 2016.
38 TCF – Guidance for Small FSPs/ Independent Financial Advisers (FSB 11 November 2013), p. 2. (www.fsb.co.za/Departments/fais/Documents/TCF%20Small%20FSP%20Guide.pdf, last accessed on 21 July 2016).
39 FSB: Retail Distribution Review 2014, www.fsb.co.za/Departments/MCS/TCF/Pages/DownloadDocuments.aspx, last accessed on 21 July 2016.
40 See National Treasury 9 July 2014 Press Release and 2013 Retirement reform proposals for further consideration and other policy documents (www.treasury.gov.za/publications/RetirementReform, last accessed on 21 July 2016).
41 See amendments to Section 7A and 7C of the PFA effected by the Financial Services Laws General Amendment Act (Act 45 of 2013).
42 FSB: Solvency Assessment and Management, Update, 10 May 2016, https://www.fsb.co.za/Departments/insurance/Documents/SAM%20Newsletter%2018.pdf, last accessed on 2 August 2016.
43 See www.fsb.co.za/Departments/capitalMarkets/Pages/Documents-for-Consultation.aspx, last accessed on 2 August 2016.
44 Section 28 of the STIA and Section 29 of the LTIA.
45 Section 29 of the STIA and Sections 30 and 31 of the LTIA.
46 Section 33(1) of the STIA and Section 34(1) of the LTIA.
47 Section 33(2) of the STIA and Section 34(2) of the LTIA.
48 Section 3 of the PFA read with Sections 1 and 13 of the Financial Services Board Act (Act 97 of 1990). Certain South African pension funds have been established under their own statute and do not fall to be regulated by the FSB, and are not subject to the provisions of the PFA (unless the latter has been specifically incorporated by reference in the pension fund’s constitutional framework).
49 See amendment to Section 13B of the PFA set out in the Financial Services Laws General Amendment Act (Act 45 of 2013).
50 So named because the requirements are contained in Regulation 28 of the Regulations to the PFA.
51 Final Regulation 28 Explanatory Memorandum, p. 7.
52 Regulation 28(2)(d).
53 Item 3.1 of Table 1 of Regulation 28.
54 Regulation 28(3)(f).
55 Regulation 28(9).
56 Regulation 28(4).
57 On 15 March 2012, the FSB published conditions for investment by pension funds in private equity funds under Notice No. 1 of 2012.
58 Regulation 28(5).
59 Act 24 of 1936.
60 The market practice in South Africa is to conclude securities lending transactions in terms of a global master securities lending agreement as published by the International Securities Lending Association, together with a South African schedule thereto as published by the South African Securities Lending Association.
61 Law of South Africa, 2nd ed., Vol. 19: ‘Partnership’ by JJ Henning, Paragraph 258; Joubert and Faris (editors).
62 Act 57 of 1988.
63 Law of South Africa, 2nd ed., Vol. 31: ‘Trusts’ by MJ De Waal and others, Paragraph 545; Joubert and Faris (editors).
64 Notice No. 1 of 15 March 2012: Conditions for Investment in Private Equity Funds.
65 Act 23 of 2004.
66 Act 29 of 1999.
67 PIC Integrated Report 2015, p. 41.
68 Ibid, p. 12.
69 Ibid, p. 47.
70 Ibid, p. 48.