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.