Snapshot: fund management regulation in South Africa

Fund management regulation

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 (the Prudential Authority being located within the South African Reserve Bank (SARB)) have recently replaced the Financial Services Board. 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), the SARB (responsible for setting monetary policy and administering exchange control rules) and the National Credit Regulator (responsible for regulating the provision of credit by credit providers in South Africa).

The Conduct of Financial Institutions Bill (COFI) was published for comment in late 2018 and substantial comment was received from stakeholders in South Africa. Once enacted, COFI will signal a move away from the current sectoral licensing model followed in South Africa to a centralised, activity-based licensing model. The new licensing regime outlined in COFI will focus on the activities that a prospective licensee wishes to perform, rather than on particular sectors of the market, and licensees will be granted a single licence authorising all regulated activities that they undertake. COFI will replace existing sector-specific legislation and will amend other sector-specific legislation to achieve alignment and harmonisation.

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, fund 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. It should be noted that the section 12J tax incentive regime that creates the environment in which VCCs operate currently comes to an end on 30 June 2021. There is, however, an industry lobby for this regime to be extended.

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 (1) 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 (2) 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 and may also include unlisted property funds.

As of 1 April 2015, hedge funds that invite or permit members of the public (as defined in CISCA) 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 with such knowledge) and who initially invest at least 1 million rand. A retail fund does not have such restrictions. Generally, retail funds must comply with more detailed regulatory requirements, including detailed prudential investment requirements.

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). The FSRA also includes within its wider definition of ’financial services’ that are regulated any service provided to a financial institution through an outsourcing arrangement and, in our experience, this would almost always include fund administration provided to financial institutions. As per the above, COFI will amend the licensing regime once promulgated.

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);
• the manager must satisfy the FSCA of the adequacy of its operational capacity, management systems, risk management and complaint resolution system; and
• delegation by the manager is subject to regulatory requirements.

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 deeds follow model wording approved and published by the FSCA. The consideration and approval of a 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 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, although asset managers must be appropriately licensed under the FAIS Act to provide services to such funds. Under COFI, private equity funds may be required to be licensed by the FSCA if they fall within the definition of alternative investment funds.

REITs, exchange-traded funds, issuers of exchange-traded notes and special-purpose acquisition vehicles seeking a listing on the JSE must comply with the JSE Listings Requirements.

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, 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) and any such delegation will be subject to the Conduct Standard: Delegation of Administration functions by CIS Managers. 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).

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 closes the door on some interpretations that may previously have allowed foreign service providers to undertake activities in South Africa without a licence.

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. 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, or increase or decrease such significant ownership, without prior written approval of the FSCA. The FSRA defines a significant owner as someone who (directly or indirectly, alone or together with a related or inter-related person) has the ability to control or influence materially the business of a financial institution. A person will be deemed to have such ability if it has the power to appoint or remove 15 per cent of the members of the governing body of the financial institution or holds a qualifying stake (which is defined in the FSRA to include the holding of 15 per cent of the issued securities of a financial institution). A joint standard on fit and proper requirements for significant owners of financial institutions and financial institutions was published on 1 June 2020. This standard sets out the fit and proper requirements applicable to significant owners of financial institutions (like collective investment scheme managers), but certain financial institutions have been exempted, such as fund managers. The standard also determines, for purposes of the notification to be made in respect of a change in significant ownership by a manager of a collective investment scheme, that any variation of 5 per cent (either in shareholding or with regard to the power to appoint or remove members of the governing body) will be considered notifiable.

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.

Generally, management fees are often structured as a fixed percentage of the value of assets under management plus a performance fee. 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, except 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 a 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.

Law stated date

Give the date on which the information above is accurate.

8 June 2020.