Global regulators have increasingly focused on the regulation of investment managers. As we’ve learnt throughout the regulatory reform process in South Africa, the past repeats itself and regulation in Europe, the UK and Australasia will, in similar form, flow through to the South African financial sector.
The reformed regulatory oversight of investment managers in South Africa is fast taking shape with the developments on COFI and the anticipated increased prudential oversight by the Prudential Authority. We’ve provided a non-exhaustive list of key drivers for the coming year, which investment managers should be looking at in terms of compliance, governance and strategy:
Third party risk management/mitigation
The operating models of investment managers range from fully outsourced to largely insourced but, in general, managers rely on third party service providers for a variety of services. If a service failure results in a loss for a fund or for its shareholders, it is the investment manager who remains responsible. Managers therefore need to ensure that all third-party risks are identified, prioritised and included in a comprehensive risk management framework to mitigate regulatory breaches and service failures.
Distribution and fee transparency
Banks, insurance companies and asset managers remain the main distribution channels to retail investors. An equivalent of the UK’s Retail Distribution Review (RDR) legislation has been proposed in South Africa. The introduction of the RDR is likely to introduce significant changes locally. The Independent Financial Advisor (IFA) market is expected to contract, while direct consumer investment is expected to increase, largely due to increasing levels of connectivity and consumer sophistication.
The aim of RDR is to ensure more transparency and fairness for investors by simplifying fund investment costs. Costs carried by the investor will be clearer and financial advisors can no longer bundle fund and advice to generate an extra layer of revenue at the fund level. Customers get the benefit of clear fees and easy to understand advice charges.
Advisers will be prevented from using complex integrated investment structures. RDR will require financial advisors to charge a pre-negotiated fee for their service, shifting the negotiating power to the investor. The motivation is now to focus on the investor’s needs instead of selecting the product provider with the greatest financial benefit to the adviser.
Additionally, instead of IFAs and “tied advisors”, the FSCA is proposing the terms Registered Financial Advisor (RFA) and Product Supplier Agent (PSA) respectively, which will help consumers determine whether or not their advisor is truly independent.
The Protection of Personal Information Act (POPIA) is South Africa’s data protection law. The purpose of the POPIA is to protect people from harm by protecting their personal information and to curb incidents of money being stolen and identity theft, as well as to protect the fundamental human right to privacy. To achieve this, POPIA sets conditions for when it is lawful for someone to process someone else’s personal information.
POPIA will undoubtedly play a major part in the operations of all managers and their contracted third party providers over the coming year. The POPIA commencement date was 1 July 2020 which makes a deadline of 1 July 2021 for organisations to comply.
Financial Consumer Education Initiatives
The FSR Act extended the jurisdiction of the FSCA to protect financial customers by providing financial customers with financial education programmes and to promote financial literacy and sound financial decision making.
On 29 June 2020, the FSCA published a Discussion Document containing proposed policy interventions to ensure the appropriateness of the financial education (FE) initiatives provided by financial institutions. The proposals relate to the FSCA’s consumer education mandate. Institutions providing FE initiatives will need to adhere to these requirements, including monitoring and evaluating effectiveness, efficiency and appropriateness of these FE initiatives.
The proposals require all financial institutions to take reasonable steps to ensure appropriate standards of behaviour, governance and oversight when developing content, implementing, monitoring, evaluating and reporting on FE activities or interventions.
The FSCA believes that the proposals will contribute to increasing the effectiveness of national strategies for financial education, and ultimately assist individuals and households to navigate the challenges and opportunities of today’s financial markets and products offered in the financial sector in general, thereby improving overall financial wellbeing.
Environmental, Social and Governance (ESG)
Regulators globally are increasingly requiring institutions to act like responsible corporate citizens, taking ownership of their Environmental, Social and Governance (ESG) responsibilities.
This expectation is no different in the South African landscape. Regulations of the Pension Funds Act require all retirement funds to have an investment policy statement considering ESG factors before investing in an asset. In the South African context, and specifically in respect of assets located in SA, these factors include the manner in which broad-based black economic empowerment is advanced.
The FSCA has affirmed its commitment to refining the regulatory framework relating to issues of sustainability in consultation with industry players. The expectation is that the final set of requirements will be incorporated into prudential and/or conduct standards in future.
The magnitude of new and proposed regulatory and governance requirements imposed on asset managers will, in no uncertain terms, continue to add to the revenue and cost challenges faced in the sector. As management fees come under pressure and scrutiny there is an inevitable contraction in margin. The need to stay on top of, and ahead of, regulatory requirements adds a significant cost layer to managers. There is, however, cause for optimism as the regulatory proposals and larger reform will improve the attractiveness of South Africa as an investment management hub, both locally and for foreign investment into Africa. A comprehensive all-encompassing regulatory framework of sound prudential supervision and effective market conduct oversight will serve to benefit all market stakeholders in the long term.
South African asset managers are facing the daunting, yet attainable, challenge of ensuring that they remain equipped for the developments of the 21st century. This means being primed for the anticipated levels of governance and compliance oversight, a greater drive towards sectoral transformation, improved consumer protection, transparency in fees and operations, all while efficiently managing cost.