Retail funds

Available 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.
Governance

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.
Reporting

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).