Fund management regulationRegulatory framework and authorities
How is fund management regulated in your jurisdiction? Which authorities have primary responsibility for regulating funds, fund managers and those marketing funds?
The Financial Sector Conduct Authority (FSCA) and the Prudential Authority (located within the South African Reserve Bank (SARB)) have recently replaced the Financial Services Board. This marks the formal implementation of the twin peaks model of financial sector regulation that has been under discussion in South Africa for some time. The Prudential Authority regulates the financial soundness of financial institutions and the FSCA regulates the market conduct of financial institutions. Other regulators include the Financial Intelligence Centre (responsible for administering the anti-money laundering and related requirements of the Financial Intelligence Centre Act) and the SARB (responsible for setting monetary policy and administering exchange control rules).
The Conduct of Financial Institutions Bill (COFI) was published for comment in late 2018, and once enacted will move away from the current sectoral licensing model followed in South Africa to a centralised, activity-based licensing model. The new licensing regime that will be outlined in COFI will focus on the activities that a prospective licensee wishes to perform, rather than on particular sectors of the market. COFI will replace existing sector-specific legislation.
Currently, the following legislation applies:
- the Collective Investment Schemes Control Act (CISCA) regulates collective investment schemes in, respectively, securities, property and participatory bonds, and collective investment schemes that are hedge funds;
- the Financial Advisory and Intermediary Services Act (the FAIS Act) regulates the provision of financial services by, for example, investment advisers, asset managers and persons who provide financial product platforms;
- the Financial Markets Act regulates the Johannesburg Stock Exchange (JSE), other South African exchanges and related service providers, such as stockbrokers, depositories and clearing houses; and
- the Financial Sector Regulation Act (FSRA) creates the regulatory framework within which the FSCA and the Prudential Authority exercise their regulatory powers.
Exchange-traded funds and real estate investment trusts (REITs) listed on the JSE are regulated by the FSCA if they are also collective investment schemes.
Special-purpose acquisition vehicles listed on the JSE are regulated by the JSE.
Venture capital companies (VCCs) benefiting from the tax incentives introduced by section 12J of the Income Tax Act 1962 and investing in small enterprises defined as ‘qualifying companies’ are regulated by the Income Tax Act, the Companies Act and the FAIS Act.
Private equity funds are, generally speaking, not currently regulated by the FSCA, although service providers to such structures may fall to be regulated under the FAIS Act. COFI proposes to regulate private equity funds as ‘alternative investment funds’. These are currently defined as:
a collective investment undertaking, including investment compartments of a collective investment undertaking, excluding a collective investment scheme, constituted in any legal form, including in terms of a contract, by means of a trust, or in terms of a statute, which (a) raises capital from one or more financial customers to facilitate the participation or interest in, subscription, contribution or commitment to, a fund or portfolio, with a view to investing it in accordance with a defined investment policy for the benefit of the financial customers; and (b) the financial customers share the risk and the benefit of investment in proportion to their participation or interest in, subscription, contribution or commitment to, the fund.
This definition would include many private equity funds.
As of 1 April 2015, hedge funds that invite or permit members of the public (as defined in CISCA - see question 26) to invest money or other assets have been regulated as collective investment schemes in hedge funds in South Africa. Private arrangements and segregated portfolios using hedge fund strategies remain unregulated (subject to the comment above regarding future regulation of any arrangement that may meet the definition of an alternative investment fund as currently expressed in COFI).
Two types of hedge funds may be registered: qualified investor funds and retail funds. Qualified investor funds are hedge funds that 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 initially 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.Fund administration
Is fund administration regulated in your jurisdiction?
Yes. As a consequence of the wide definition of ‘intermediary services’ in the FAIS Act, fund administrators are generally required to obtain authorisation from the FSCA under the FAIS Act to provide non-discretionary intermediary services (a Category I licence or, where the administrators make use of aggregated or bulked investment and disinvestment orders, a Category III licence). As per the above, COFI will amend the licensing regime once promulgated.Authorisation
What is the authorisation or licensing process for funds? What are the key requirements that apply to managers and operators of investment funds in your jurisdiction?
Five categories of collective investment schemes are currently permitted by CISCA, namely the following:
- collective investment schemes in securities;
- collective investment schemes in property;
- collective investment schemes in participation bonds;
- retail hedge funds; and
- qualified investor hedge funds.
In this section, only the position relating to obtaining authorisation under CISCA for a collective investment scheme in securities, which is the most common scheme, will be discussed.
CISCA and the relevant notices made thereunder have requirements in relation to the authorisation of both the manager (who administers the scheme) and the trustee or custodian (who holds the assets and oversees compliance with applicable requirements), the formation of the collective investment scheme (being the legal structure created to house the investments) and the creation of particular portfolios (each portfolio constituting a fund in which investors can invest). Prior approval from the FSCA is required to establish a collective investment scheme or to form a new portfolio.
With respect to the manager, the following should be noted:
- only companies registered under the South African Companies Act as ring-fenced companies qualify for authorisation;
- the manager’s board must consist of at least four directors approved by the FSCA of whom all executive directors must be resident in South Africa and must include independent directors;
- the manager is required to maintain prescribed minimum capital (in practice, consisting of seed investments in portfolios while they have low value and the maintenance of capital equal to at least 13 weeks of fixed costs of the manager); and
- the manager must satisfy the FSCA of the adequacy of its operational capacity, management systems, risk management and complaint resolution system.
A draft notice was published in 2015 that seeks to amend the conditions for registration of managers of collective investment schemes and the determination of fit and proper requirements for directors and management of such managers. This, however, remains in draft form.
With respect to the trustee, public companies registered under the South African Companies Act, branches of foreign banks and South African insurers qualify to play this role, provided that they have capital of more than 10 million rand and have been registered by the FSCA as a trustee or custodian. The trustee may not be a holding company or subsidiary of a manager. The FSCA may only register a trustee if it is satisfied that the general financial and commercial standing and independence of the relevant applicant is such that it is fit for performing the functions of trustee or custodian and that the company or institution is, by reason of the nature of its business, sufficiently experienced and equipped to perform such functions. In practice, this last requirement sets the bar quite high and only a handful of trustees (which are all affiliated with large financial institutions) have been registered.
With respect to the deed of the collective investment scheme, it should be noted that although CISCA potentially permits a variety of legal structures, in practice, collective investment schemes in securities are housed in unit trust-type schemes whose trust deeds follow model wording approved and published by the FSCA. The consideration and approval of a trust deed forms part of the approval process of the manager.
It is also possible to establish a co-named portfolio, which in effect is a joint venture between a company licensed as a manager of a collective investment scheme that will administer the co-named portfolio, and an asset manager, which will provide the asset management services to the portfolio. The portfolio will bear the name of both the manager and the asset manager.
Portfolios are created in the trust deed of the collective investment scheme or by an amendment thereto approved by the FSCA.
There are currently no registration requirements for private equity funds housed in partnership structures or segregated portfolios, although asset managers must be appropriately licensed under the FAIS Act to provide services to such funds. Under COFI, private equity funds housed in partnership structures may be required to be licensed by the FSCA if they fall within the definition of alternative investment funds.
REITs, exchange-traded funds, exchange-traded notes and special-purpose acquisition vehicles seeking a listing on the JSE must comply with the JSE Listings Requirements.Territorial scope of regulation
What is the territorial scope of fund regulation? Can an overseas manager perform management activities or provide services to clients in your jurisdiction without authorisation?
CISCA applies to the administration of a collective investment scheme within South Africa.
Administration has a broad definition in CISCA as:
[A]ny function performed in connection with a collective investment scheme, including the management or control of a collective investment scheme; the receipt, payment or investment of money or other assets including income accruals in respect of a collective investment scheme; the sale, repurchase, issue or cancellation of a participatory interest in a collective investment scheme and the giving of advice or disclosure of information on any of those matters to investors or potential investors; and the buying and selling of assets or the handing over thereof to a trustee or custodian for safe custody.
Only persons registered as managers under CISCA or persons who are authorised agents of the manager may perform such administration services (section 5(1) of CISCA). Generally speaking, before a manager may delegate any function listed in the definition of administration to any person, it must obtain the approval of the FSCA (section 4(5) of CISCA). Accordingly, an overseas manager may not perform management activities for South African collective investment schemes without prior authorisation (and would need to hold an appropriate licence in South Africa to authorise it to carry out any outsourced services in South Africa). It should be noted that the outsourcing of functions of administration is currently under review by the FSCA.
The FAIS Act prohibits any person from providing, as a regular feature of business, in relation to financial products, intermediary services for product suppliers or intermediary services or advice to clients without authorisation under the FAIS Act. In accordance with ordinary principles of statutory interpretation, the FAIS Act applies to such services rendered in South Africa. In addition, regulation 3 of the regulations made under the FAIS Act prohibits any person from canvassing for, marketing or advertising any business related to the rendering of financial services by any person who is not an authorised financial services provider or a representative of such a provider. Accordingly, foreign service providers may not render financial services in or into South Africa without a FAIS licence and no person may canvass for, market or advertise any South African or foreign financial services business in South Africa unless such business is licensed under the FAIS Act. It should also be noted that the FSRA has introduced a wider definition of ‘financial service’. This wider definition has closed potential loopholes that may previously have allowed foreign service providers to undertake activities in South Africa that fell short of the definition of financial service in FAIS.Acquisitions
Is the acquisition of a controlling or non-controlling stake in a fund manager in your jurisdiction subject to prior authorisation by the regulator?
In terms of the FAIS Act, a licensed financial services provider (an asset manager in South Africa will have a Category II licence) is required to notify the FSCA within 15 business days of a change in its shareholders or its board of directors. Section 8(10)(b) of the FAIS Act provides that if the FSCA is satisfied that the new director, member, trustee or partner does not comply with personal character qualities of honesty and integrity, the FSCA may suspend or withdraw the licence of the financial services provider. A change in the name of a financial services provider effectively requires prior consent as a financial services provider may not carry on financial services business under its new name until the FSCA has issued it with a new licence in its new name. It should also be noted that a licence in terms of the FAIS Act is non-transferable.
Pursuant to CISCA and the regulations thereunder, the prior consent of the FSCA is required for any change in shareholding of the manager of a collective investment scheme, a change of its directors or a change of its name. In practice, the FSCA usually also requires that this limitation be included in the constitutional documents of the manager of a collective investment scheme, as a restriction on such company’s corporate powers. In terms of the FSRA, a person cannot enter into any arrangement that will result in that person becoming a significant owner of a manager of a collective investment scheme without prior written approval of the FSCA. The FSRA defines a significant owner as someone who has the ability to control or influence materially the business of a financial institution.Restrictions on compensation and profit sharing
Are there any regulatory restrictions on the structuring of the fund manager’s compensation and profit-sharing arrangements?
The fee arrangements of the manager of a collective investment scheme are subject to approval by the FSCA as part of the general oversight exercised over collective investment schemes. Furthermore, care should be taken when setting out the agreed fee arrangement, as only the agreed and disclosed fee of the manager may be deducted from the portfolio.
In addition, consideration should be given to the tax implications of any structuring. Generally speaking, managers’ compensation is often structured as a fixed percentage of the value of assets under management plus a performance fee. It should be noted that the FSCA has indicated that, in future, legislative amendments will be made to ensure that managers do not pay a portion of this fee to advisers in the form of commission. The ongoing Retail Distribution Review has suggested that any fee payable to an adviser placing a client’s funds in a collective investment scheme should be paid by the client to the adviser (although a client may authorise the deduction of such fee from its portfolio). This has triggered a move to ‘clean pricing’ by collective investment schemes in South Africa.
A person (whether a juristic person or an individual) authorised to provide advice under the FAIS Act may not receive a sign-on bonus, save if such person is a new entrant to the market (Board Notice 146 of 2014).
There are detailed restrictions and disclosure requirements relating to fees and remuneration in the conflict of interest and other provisions of the General Code of Conduct for Authorised Financial Services Providers under the FAIS Act. These provisions impact the design of compensation and profit-sharing arrangements relating to financial services providers and must accordingly be considered when structuring the fund manager’s compensation and profit-sharing arrangements.
It should also be noted that the FSCA is currently engaged with a Retail Distribution Review, as part of which it is considering far-reaching reforms to the regulatory framework for distributing financial products to customers. The outcome of this review will affect the remuneration of certain financial services providers, most notably financial advisers (Category I financial services providers). COFI, as currently drafted, suggests that conduct standards will be issued by the FSCA to regulate the remuneration arrangements of financial institutions.
Does the marketing of investment funds in your jurisdiction require authorisation?
Yes. See question 8.
What marketing activities require authorisation?
A participatory interest in a collective investment scheme constitutes a ‘financial product’ as contemplated in the FAIS Act. The marketing of financial products may only be performed as a regular feature of business by persons having an appropriate licence under the FAIS Act (ordinarily a Category I licence is required).
In addition, section 65 of CISCA prohibits any person from ‘soliciting’ (defined as any act to promote investment by members of the public in a collective investment scheme) investments in a foreign collective investment scheme that is not approved by the FSCA. Accordingly, a foreign collective investment scheme may only be marketed to members of the public in South Africa if it has been approved for such purpose by the FSCA.
Board Notice 92 of 2014, effective from 1 May 2015, introduced comprehensive new requirements relating to the documentation used to market collective investment schemes. In terms of this notice, a manager of a South African collective investment scheme (or of a foreign collective investment scheme approved in terms of section 65 of CISCA) must lodge with the FSCA copies of all advertisements and marketing material, fund fact sheets (with prescribed information) and relevant investor application forms before publication or use of the material. Furthermore, in terms of these requirements, South African collective schemes as well as foreign collective investment schemes that are approved in terms of section 65 of CISCA, are required to prepare (and update on a quarterly basis) minimum disclosure documents (similar, in principal, to the key investor information document required in terms of undertakings for collective investment in transferable securities legislation). In 2017, the FSCA published proposed amended marketing disclosure requirements for collective investment schemes for public comment.Territorial scope and restrictions
What is the territorial scope of your regulation? May an overseas entity perform fund marketing activities in your jurisdiction without authorisation?
The regulatory provisions set out in question 8 apply to marketing activities in South Africa.
If a local entity must be involved in the fund marketing process, how is this rule satisfied in practice?
Foreign financial services providers qualify for licences under the FAIS Act and a substantial number of foreign entities hold Category I FAIS licences. However, it should be noted that, in order for a foreign financial services provider to qualify for a Category I FAIS licence, its key individuals and representatives will be required to demonstrate their ability to comply with the South African fit and proper requirements published under the FAIS Act, which includes, if they render financial advice, the completion of regulatory exams in respect of the relevant South African legislation. Examination sittings are held from time to time in South Africa and in London. The fit and proper requirements under FAIS have recently been amended. At the time of writing, the FSCA is considering whether or not to require that foreign financial services providers must keep an office in South Africa and register as external companies under the Companies Act.
One of the requirements relating to approval of a foreign collective investment scheme under section 65 of CISCA is that the manager or operator of the foreign scheme must, for purposes of interacting with the regulator, either open or appoint a South African office (capitalised with at least 2 million rand) or appoint a South African manager authorised under CISCA to act, for a fee, as its representative in relation to regulatory affairs.Commission payments
What restrictions are there on intermediaries earning commission payments in relation to their marketing activities in your jurisdiction?
Intermediaries subject to the FAIS Act may earn fees expressed as a percentage of the net value of a financial product (such as an investment in a collective investment scheme) upon condition that if such fees are deducted from the investment, then the client must specifically agree thereto in writing and must have the power to stop the payment of fees. In practice, many managers of collective investment schemes or financial product platform providers stipulate maximum fee levels that they would be willing to administer by way of deduction from the client’s investment. The type and level of commission that may be earned in relation to insurance products (such as linked policies referencing investments in a collective investment scheme as the underlying asset) are subject to regulated upper limits. The ongoing Retail Distribution Review may impact such fee arrangements going forward.
Retail fundsAvailable vehicles
What are the main legal vehicles used to set up a retail fund? How are they formed?
Retail funds are housed in collective investment schemes registered under CISCA. Such schemes are formed by a trust agreement entered into between an authorised manager and a registered trustee, the deed of which is approved by the FSCA. Schemes then create portfolios, subject to approval from the FSCA, in which investors purchase participatory interests. CISCA permits other legal structures, but in practice only these unit trusts are used. See also question 3.Laws and regulations
What are the key laws and other sets of rules that govern retail funds?
The key laws are currently CISCA, the FSRA and the FAIS Act. From a self-regulatory standpoint, the industry body, the Association for Savings and Investments South Africa, has published various standards that are influential, such as a standard on the calculation of the net asset value of portfolios, a standard on the calculation of total expense ratio and transaction costs, a standard on the classification of funds and a standard on performance fees.
The key laws and requirements in relation to exchange-traded funds, special-purpose acquisition vehicles and REITs are the relevant listings requirements of the JSE, the Companies Act and the Income Tax Act.Authorisation
Must retail funds be authorised or licensed to be established or marketed in your jurisdiction?
Yes, a South African collective investment scheme may only be marketed to members of the public if registered under CISCA. A foreign collective investment scheme may only be marketed to members of the public if approved under section 65 of CISCA.Marketing
Who can market retail funds? To whom can they be marketed?
South African collective investment schemes approved under CISCA may be marketed by the manager thereof and by any person having an appropriate licence under the FAIS Act. Other than in relation to qualified investor hedge funds, there are no restrictions regarding to whom the collective investment scheme may be marketed.
A qualified investor hedge fund 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 initially invest at least 1 million rand.
A foreign collective investment scheme approved under section 65 of CISCA may be marketed by any person having an appropriate FAIS licence. The scheme may only be marketed 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 its domicile of registration (Board Notice 257 of 2013).Managers and operators
Are there any special requirements that apply to managers or operators of retail funds?
The managers of hedge funds classified as retail funds will be subject to greater disclosure requirements and prudential investment limits than hedge funds classified as qualified investor funds (see question 1).Investment and borrowing restrictions
What are the investment and borrowing restrictions on retail funds?
Collective investment schemes in securities may not borrow any funds, save where the manager must repurchase participatory interests but insufficient liquidity exists in a portfolio or assets cannot be realised. In such circumstances, the manager may borrow the necessary funds for such repurchase (and grant security over the assets of the portfolio in question) from registered financial institutions at the best commercial terms available, provided that the maximum amount borrowed does not exceed 10 per cent of the market value of such portfolio at the time of borrowing. In addition, collective investment schemes may enter into eight-day loans for purposes of bridge funding in order to acquire assets.
Collective investment schemes in securities are subject to detailed prudential investment restrictions contained in Board Notice 90 of 2014. The restrictions distinguish between standard portfolios, money market portfolios, fund of funds portfolios and feeder fund portfolios. Notable restrictions relating to standard portfolios include the following:
- limitations on the maximum exposure of a portfolio to equity securities issued by any one entity, calculated with reference to the value of the portfolio and the weighting of the applicable security in applicable indices;
- limitations on the maximum exposure to listed or unlisted non-equity or debt securities, based on who the issuer or guarantor is (eg, maximum exposure to the debt of an unlisted issuer is 5 per cent of the value of the portfolio);
- a requirement that at least 90 per cent of the market value of a portfolio must consist of the following:
- securities listed on an exchange that is a full member of the World Federation of Exchanges;
- securities acquired by the manager pursuant to the exercise of rights attaching to securities listed on an exchange; and
- permissible unlisted non-equity securities and derivatives; and
- derivatives, such as listed futures, option contracts, warrants or index tracking certificates and unlisted swaps (relating to exchange rates, interest rates of indices) may not be used to leverage or gear the portfolio and exposures must be covered at all times (Chapter V of Board Notice 90 of 2014).
Applicable restrictions apply to other types of retail funds.Tax treatment
What is the tax treatment of retail funds? Are exemptions available?
In general, collective investment schemes in securities are treated as conduit vehicles in relation to income amounts, and accordingly, if the income amounts are distributed within 12 months of their accrual, such amounts are taxed in the hands of the investors in accordance with their tax profile. Amounts so distributed retain their nature for tax purposes and any exemptions available in relation to particular income amounts (eg, the local dividend exemption or the individual interest exemption) are accordingly generally available to the investors in respect of such amounts. Capital gains are exempt in the hands of a collective investment scheme in securities. A disposal of participatory interests in a collective investment scheme is taxable in the hands of the investor disposing of the participatory interest as either revenue or capital depending on whether the participatory interests are acquired as part of a scheme of profit making or as capital assets. Where participatory interests were held for at least three years before their disposal, they will be deemed to be capital in nature for tax purposes.Asset protection
Must the portfolio of assets of a retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?
Yes. The portfolio of a collective investment scheme must be held by an approved trustee or custodian. In addition, the assets of the collective investment scheme are protected by the following regulatory provisions:
- section 2 of CISCA provides that the assets of a portfolio must at all times be properly protected by application of the principle of segregation and identification (eg, section 105 of CISCA requires that the manager must, within one business day of receiving cash from investors, deposit such amounts in a trust account controlled by the trustee);
- section 71 of CISCA provides that any money or other assets received from an investor and assets of a portfolio are regarded as being trust property for the purposes of the Financial Institutions (Protection of Funds) Act (with the effect, for example, that the manager may not derive improper advantage from the investment activities of the portfolio and must declare relevant conflicts of interest) and a manager, its authorised agent, a trustee or custodian must deal with such money or other assets in terms of CISCA and the applicable deed and in the best interests of investors;
- section 93 of CISCA provides for a closed list of permissible deductions against the portfolio for fees, charges and so forth; and
- section 104 of CISCA provides that the assets of a portfolio are not available to satisfy third-party claims against the manager or trustee.
What are the main governance requirements for a retail fund formed in your jurisdiction?
See questions 3 and 21. In addition, the trustee or custodian of the collective investment scheme is required to:
- ensure that the selling or repurchase price of participatory interests is calculated in accordance with CISCA and the applicable deed;
- enquire into and prepare a report on the administration of the collective investment scheme by the manager during each annual accounting period and send the report for submission by the manager to the FSCA together with the manager’s annual compliance report;
- ensure that appropriate internal control systems are maintained and that records clearly identify the nature and value of all assets under custody, the ownership of each asset and the place where documents of title pertaining to each asset are kept; and
- report any irregularity or undesirable practice concerning the collective investment scheme of which it becomes aware to the FSCA.
What are the periodic reporting requirements for retail funds?
Managers of all collective investment schemes must report to investors on a quarterly basis, at a minimum.
Managers are required to make quarterly reports relating to all assets in the portfolios administered by them to the FSCA (regulation 3 of the regulations under CISCA) and must annually submit to the FSCA their audited financial statements together with audited financial statements for each portfolio, a compliance report and prescribed information (such as the manager’s income derived from all sources in the operation of the collective investment scheme and a list of all securities lent by the portfolio and the value of the collateral thereof) (regulation 2 and paragraph 10 of Government Notice 910 of 2010). Managers of retail and qualified investor hedge funds must also submit quarterly and annual reports to the FSCA (Board Notice 52 of 2015).Issue, transfer and redemption of interests
Can the manager or operator place any restrictions on the issue, transfer and redemption of interests in retail funds?
The terms of issue and repurchase contained in the deeds of South African domiciled collective investment schemes tend to be uniform, with collective investment schemes in securities permitting daily dealing. Retail hedge funds must offer at least monthly dealing and qualified investor hedge funds at least quarterly dealing. From time to time, managers enter into contracts with large institutional investors relating to the redemption of participatory interests, providing, for example, for longer periods of notice than provided for in the deed. Where a manager receives redemption notices of more than 5 per cent of the market value of the portfolio with prior notice of less than 10 business days, the manager may, with the consent of the trustee, suspend the repurchase of participatory interests for up to 20 business days. After the 20 days, it must tender redemption through the transfer of assets in kind (unless the investor agrees to a further extension) (Government Notice 573 of 2003).
Non-retail pooled fundsAvailable vehicles
What are the main legal vehicles used to set up a non-retail fund? How are they formed?
Many South African private equity funds are housed in en commandite partnerships. En commandite partnerships are regulated by common law and are formed by agreement between the partners. 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). The managing partner (also known as the general partner) has unlimited liability for the debts of the partnership.
Another type of structure sometimes used in the private equity context is a bewind trust. A bewind trust is a type of trust vehicle registered under the Trust Property Control Act, in terms whereof the applicable assets that are subject to the trust arrangements are owned by the beneficiaries of the trust, but the trustee of the trust holds and manages such assets. 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. A bewind trust is formed by agreement between the investors as beneficiaries and the trustee.
Lastly, insurance companies may market investment exposure to portfolios owned by them to investors through the issue of linked investment policies. This type of investment policy is widely used by pension funds to obtain exposure to both listed and unlisted investments. The investment return on the policy is determined by the investment return of assets held by the insurance company and specified in the policy.
In certain instances, notably if investors are willing to receive returns on an after-tax basis, closed-ended portfolios can also be housed in companies established under the Companies Act.Laws and regulations
What are the key laws and other sets of rules that govern non-retail funds?
Fund managers and other financial service providers to non-retail funds are currently governed by the FAIS Act. Private equity funds set up as limited or en commandite partnerships are governed by the common law and those set up as bewind trusts are governed by the common law and the Trust Property Control Act. Long-term insurance companies are currently governed by the Long-Term Insurance Act and the Insurance Act, which came into effect on 1 July 2018.Authorisation
Must non-retail funds be authorised or licensed to be established or marketed in your jurisdiction?
No authorisation or licensing is currently required to form private equity funds housed in limited or en commandite partnerships or bewind trusts. However, in the current draft of COFI, alternative investment funds will be required to be licensed under COFI, and private equity funds may well meet this definition. Bewind trusts must be registered with the Master of the High Court, and the appointment of trustees is subject to approval by the Master of the High Court before they may act as such, but these are administrative requirements that apply to the formation of all trusts. Registered insurance companies are free to write linked investment policies without prior approval.Marketing
Who can market non-retail funds? To whom can they be marketed?
Non-retail funds may be marketed by any person having an appropriate licence under the FAIS Act.
However, save if sold through a linked investment policy by a long-term insurer, such funds are prohibited under CISCA if marketed to members of the public. ‘Members of the public’ is defined in section 1 of CISCA to include:
[M]embers of any section of the public, whether selected as clients, members, shareholders, employees or ex-employees of the person issuing an invitation to acquire a participatory interest in a portfolio, and a financial institution regulated by any law [such as a pension fund, insurance company, stockbroker, financial services provider, or a bank], but excludes persons confined to a restricted circle of individuals with a common interest who receive the invitation in circumstances which can properly be regarded as a domestic or private business venture between those persons and the person issuing the invitation.
In our view, ‘members of the public’ must be given the meaning it has in ordinary usage, save that the statutory definition serves to broaden the concept to include ‘any section of the public’ and (only where the circumstances of the applicable offer is such that it can properly be described as a public offer) financial institutions.
Media advertising, press releases, presentations to third parties, providing sale and promotional materials and advertising through electronic media such as television, email, the internet or a website are not permitted.Ownership restrictions
Do investor-protection rules restrict ownership in non-retail funds to certain classes of investor?
There are no investor-protection rules other than for the requirement that the funds may not be marketed to members of the public, as defined in question 26. A qualified investor hedge fund 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 initially invest at least 1 million rand.Managers and operators
Are there any special requirements that apply to managers or operators of non-retail funds?
What is the tax treatment of non-retail funds? Are any exemptions available?
In general, partnerships and bewind trusts are essentially disregarded for tax purposes (with the exception of value added tax, in which case a partnership or bewind trust may constitute a separate value added tax vendor), with the tax implications of the underlying investments arising in the hands of the partners or beneficiaries, respectively, as if they held the underlying investments directly. The entry or exit of partners or beneficiaries generally has tax implications.Asset protection
Must the portfolio of assets of a non-retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?
There are no specific custody requirements in relation to partnerships and trusts, and the general partner or trustee, as the case may be, normally holds the relevant assets. Trust property does not form part of the estate of the trustee except insofar as the trustee is a beneficiary (section 12 of the Trust Property Control Act).
Where a pension fund is invested in a private equity fund, conditions relating to the pension fund require it to procure that a script count is performed by the private equity fund’s auditors every six months (see question 31).Governance
What are the main governance requirements for a non-retail fund formed in your jurisdiction?
There are no fund-specific governance requirements prescribed by law. It is usual for non-retail funds to be audited on an annual basis and to be managed by a fund manager licensed under the FAIS Act.
The FSCA published conditions for investment in private equity funds (the Conditions) in March 2012 that stipulate requirements in order for a private equity fund to qualify for investment by a pension fund. Although the applicable requirements do not bind private equity funds, pension funds are significant investors and private equity funds therefore have a strong incentive to comply. The most significant requirements contained in the Conditions are the following:
- fund managers must be members of the South African Venture Capital Association and are required to be authorised as discretionary financial services providers under the FAIS Act;
- the auditors of the private equity fund must verify the assets of the fund on a biannual basis and the fund must produce audited financial statements complying with international financial reporting standards within 120 days of the end of its financial year; and
- the private equity fund must have clear policies and procedures for determining the fair value of the assets of the fund in compliance with the International Private Equity Valuation Guidelines, and any valuations must be verified at least annually by a third party.
The FSCA published a draft notice, ‘Conditions for Pension Fund Investment in Hedge Funds’, in February 2017 for comment. If such notice is adopted in its current form it will permit South African pension funds to invest in foreign hedge funds (as defined) only if the foreign hedge fund is approved for marketing to members of the public in South Africa under section 65 of CISCA (see question 8).
In March 2018, the FSCA published draft legislation that will, once promulgated, require pension funds to consider environmental, social and governance factors when considering an investment.Reporting
What are the periodic reporting requirements for non-retail funds?
The reporting periods are agreed contractually. Such funds typically report on a monthly or quarterly basis.
Separately managed accountsStructure
How are separately managed accounts typically structured in your jurisdiction?
These are commonly referred to as segregated mandates and are typically structured as investment management agreements concluded between the investor and the asset manager. The asset manager will either hold a Category II licence under the FAIS Act or, in cases where the underlying assets are listed, could be a stockbroker authorised to act as such by the JSE. The investor is the owner of the assets managed by the asset manager.Key legal issues
What are the key legal issues to be determined when structuring a separately managed account?
Paragraph 5 of the Code of Conduct for Discretionary Financial Services Providers made under the FAIS Act sets out a checklist of matters to be dealt with in a discretionary investment mandate concluded by an asset manager with a Category II licence under the FAIS Act. In addition, the Code requires asset managers to submit their standard form investment management agreements for prior approval by the FSCA.
From a commercial perspective, the key issues to be agreed upon are typically the following:
- duration of the appointment;
- investment objectives and restrictions;
- termination arrangements;
- reporting arrangements;
- custody arrangements;
- remedial steps in the event of a mandate breach; and
- exclusion or limitation of liability of the asset manager in certain circumstances.
Is the management or marketing of separately managed accounts regulated in your jurisdiction?
Only asset managers licensed under the FAIS Act or, in the case of listed assets, stockbrokers authorised by the JSE, may market and perform fund management services on the basis of a segregated mandate.
Are there proposals for further regulation of funds, fund managers or marketers of funds in your jurisdiction?
Yes. The introduction of COFI, and the ongoing Retail Distribution Review, may have a fundamental impact on the above matters.Public listing
Outline any specific requirements for stock-exchange listing of retail and non-retail funds.
With respect to retail funds, collective investment schemes in property are required to be listed on the JSE, as are REITs generally. To achieve REIT status under the listings requirements of the JSE, the issuer must, among other things, be primarily engaged in activities in respect of immovable freehold or leasehold property for retention as investments and distribute at least 75 per cent of its total distributable profits to holders of its listed securities on an annual basis.
In 2013, the JSE introduced new listing requirements permitting the listing of special-purpose acquisition companies. Such a company may not carry on any commercial or business operations at the time of its application for a listing, but must, within 24 months of the date of its listing, acquire assets meeting the qualifying criteria of the main board or the alternative exchange (AltX) of the JSE. The JSE Listing Requirements were amended in 2017 to the effect that a special-purpose acquisition company that does not acquire these assets within 24 months will have its listing suspended and subsequently will be removed. In order to list on the main board of the JSE, an applicant must raise at least 500 million rand through the issue of shares. A minimum of 50 million rand must be raised for a listing on the AltX. All capital raised must be held in escrow with an escrow agent until acquisitions of qualifying assets are made. It is anticipated that this type of vehicle may, in future, be used as an alternative to the more traditional private equity fund structures discussed in question 25.
The JSE listing requirements permit exchange-traded funds investing in securities to list, subject to the overarching requirements that the persons responsible for managing the investments must have appropriate experience, there must be an adequate spread of portfolio risk and the fund must not, to a significant extent, speculate in securities. Exchange-traded funds are required to be registered as collective investment schemes in securities under CISCA.
The listings requirements also permit the listing, on the debt market, of exchange-traded notes backed by assets such as gold, platinum or silver.Overseas vehicles
Is it possible to redomicile an overseas vehicle in your jurisdiction?
Generally speaking, this would not be possible for collective investment schemes and non-retail fund structures. There are provisions in the Companies Act that permit a foreign company to redomicile in South Africa.Foreign investment
Are there any special rules relating to the ability of foreign investors to invest in funds established or managed in your jurisdiction or domestic investors to invest in funds established or managed abroad?
Foreign investors are, in general, required to acquire any South African investments at market value. Where shares are acquired by foreign investors, the share certificates must be endorsed as ‘non-resident’, or an entry to this effect must be made in the records of the central securities depository participant or broker in the case of listed shares. Foreign investors may not introduce loan funding into South Africa without obtaining exchange control approval. Individual South African investors may make foreign investments utilising the following:
- their 10 million rand annual foreign investment allowance;
- their 1 million rand annual single discretionary allowance (to the extent that the same has not already been used for travel purposes); or
- authorised foreign assets.
South African companies may only make foreign investments subject to obtaining exchange control approval for such investment. South African institutional investors (including retirement funds, long-term insurers, collective investment scheme management companies and investment managers) may make foreign investments up to certain limits.Funds investing in derivatives
Are there any special requirements in your jurisdiction relating to funds investing in derivatives?
Yes. Collective investment schemes in securities may not use derivatives to leverage or gear the portfolio, and exposures must be covered at all times. Collective investment schemes that are hedge funds may only enter into over-the-counter derivatives with certain regulated counterparties.