SOUTH AFRICAN PENSION FUNDS SEEKING TO INVEST IN FOREIGN PRIVATE EQUITY REMAIN IMPEDED
From a Financial Advisory and Intermediary Services Act, 2002 (FAIS) perspective, foreign fund/asset managers looking to offer discretionary financial services to South African-resident investors are only required to obtain a Category I financial services provider (FSP) licence, provided that the discretion in question is exercised (ie the investment decision is taken) offshore. Under these circumstances, the Category I FSP licence then covers the foreign manager’s proactive engagement and marketing activities in relation to South African-resident investors, and a Category II (discretionary) FSP licence is deemed unnecessary given that the discretionary service is not being performed in South Africa. This is a position long-held by the FAIS Department of the Financial Services Board (FSB).
Investments by South African pension funds, however, as institutional investors, are subject to the prescripts of the Pension Funds Act, 1956 (PFA) and are specifically regulated by Regulation 28 of the Regulations to the PFA (Regulation 28). Regulation 28 significantly limits the extent to which a pension fund may invest in certain categories of assets, including private equity funds. Regulation 28 defines a “private equity fund” as:
“a managed pool of capital that-
- is managed by a person licensed as a discretionary Financial Services Provider as defined in the Code of Conduct for Administrative and Discretionary Financial Service Providers, 2003, or if a foreign private equity fund, managed by a person licensed as a Category I Financial Services Provider that is authorized to render financial services on securities and instruments as defined in the Determination Of Fit And Proper Requirements For Financial Services Providers, 2008; and
- is subject to conditions as may be prescribed”. (emphasis added)
From the definition of a “private equity fund”, it is apparent that in order for a South African pension fund to invest in a foreign private equity fund, that fund must be managed by a person who holds a Category I FSP licence. This position is in line with the long-held position of the FSB, as outlined above.
Subsequent to the coming into effect of Regulation 28, however, the Registrar of Pension Funds published Board Notice 1 of 2012, entitled “Conditions for Investment in Private Equity Funds” (Conditions). These Conditions are the conditions contemplated in paragraph (d) of the definition of a “private equity fund”. Contrary to Regulation 28, item 3 of the Conditions (Condition 3) provides that a pension fund may invest in a private equity fund only on the condition that any person rendering financial services, whether discretionary or otherwise, to that private equity fund, whether local or foreign, is a Category II FSP or a representative of a Category II FSP.
By stipulating the need for a Category II (discretionary) FSP licence under these circumstances, Condition 3 not only directly contradicts Regulation 28’s definition of a “private equity fund” but also undermines the view long-held by the FSB, as outlined above.
While the clear contradiction between Regulation 28 and Condition 3 has been acknowledged by the FSB in the past, the matter remains unresolved to date and, in the meantime, Condition 3 is binding on and enforceable against South African pension funds. The lack of resolution places local pension funds in somewhat of a dilemma, with most insisting on compliance with Condition 3’s Category II FSP licence requirement in relation to any potential foreign private equity investment. Exacerbating the position in respect of foreign fund managers is the FSB’s reluctance (read: refusal) to grant a Category II FSP licence to an offshore applicant that has no local presence (and also no desire to establish such a presence). This position, against the backdrop of Condition 3, effectively excludes foreign private equity fund managers, who operate on a cross-border basis, from securing investment from local pension funds.
In general, a foreign fund/asset manager rendering financial services to a foreign private equity fund (in which a local pension fund may seek to invest) will not render such services to the private equity fund in South Africa, but solely offshore. The South African legislature does not have general jurisdiction over foreign legal subjects and what those subjects do outside of South Africa’s borders, as this would offend against the ‘doctrine of effectiveness’ (ie the ability to enforce or give effect to an order in relation to such conduct). This is a well-developed principle of our common law and it highlights the need for resolution of this issue.
By: Francisco Khoza and Bright Tibane.