It is exactly a year since we last provided a comprehensive update on the policy reform process impacting the investment industry broadly, and retirement funds specifically. In April 2013 we wrote that National Treasury intended to take all the various proposals to white-paper stage within the following 12 months. As is inevitable in these processes, there has been some slippage, with most of the detailed proposals still outstanding. There has, however, been no change to government’s intent to comprehensively reshape the industry landscape. Much of the process is aimed at achieving greater structural efficiencies through a more consolidated, better governed, workplace-led retirement system.
Completed reforms: Harmonisation of tax breaks, compulsory annuitisation and stronger governance framework
The tax break on contributions to retirement funds will be harmonised across different fund types and capped at the lowest of 27.5% of taxable income or R350 000 from 1 March 2015 (as anticipated). In addition, the requirement to annuitise at least two-thirds of retirement capital will also apply to all new contributions made to provident funds after this date by fund members younger than 55 at the time. The tax-free lump sum that can be taken at retirement has been increased to R500 000, while retirement pots of less than R150 000 can now be taken as a lump sum in full, effective March 2014.
The Pension Funds Act was amended to criminalise withholding of contributions to funds by employers, and to enable the introduction of tougher governance standards for funds. As a result, the Financial Services Board (FSB) has been tasked with updating PF130, the circular dealing with retirement fund governance. It is still intended to extend fit and proper as well as compulsory training requirements to trustees, but the detailed regulations are only expected to be available for consultation towards the end of 2014.
Current work programme
Last month, National Treasury released two papers updating its position on the retirement reform process and confirming the intent to proceed with the introduction of tax-free discretionary savings accounts (TFSAs). The currently communicated timeline is for the remaining reform consultation processes to be conducted through 2014 and 2015, in the order set out below:
Retirement fund defaults
National Treasury’s emphasis on requiring trustees to provide default strategies has become stronger. Legislated requirements to provide default investment portfolios for contributing members, default annuities for retiring members and default preservation options for departing members will be required. Members should face no unreasonable obstacles to opt out of the defaults, and it is still proposed that funds will be obliged to provide financial counselling at the point of retirement to guide members through their retirement income options. National Treasury is also hoping that preservation of accumulated benefits will be significantly enhanced by requiring funds to retain previous employees as members, and to automatically transfer preserved benefits of new members into the fund, where applicable.
While we are broadly supportive of a stronger emphasis on defaults, we believe that the regulations should emphasise trustee discretion to provide appropriate options for their members, rather than create overly prescriptive rules-based constraints. The new concept of financial counselling and how it interacts with the existing definitions of individualised advice and guidance, together with appropriately allocating the costs of this additional guidance to benefiting members, require further consideration.
Retail Distribution Review (RDR)
The long-awaited discussion paper on eliminating remaining conflicts of interest in distribution arrangements is now slated for release in May 2014. We still expect a ban on the payment of commissions to advisors and rebates to investment platforms for most forms of investment business. The scope of this review has been extended to include hard and soft commissions payable on risk products.
The fund management industry has been anticipating the changes that will likely be required as a result of the RDR, and has to a large extent already adjusted business practices in anticipation of the pending regulatory changes. It is therefore unlikely that the outcome of this review will require dramatic changes to current investment industry best practice, where advisors earn clearly disclosed fees as agreed to by clients. The majority of investments in funds placed via platform arrangements are also already conducted on the basis of these rebates being applied to the benefit of the client, avoiding the situation where an investor pays twice for administration and reporting services. The use of clean fund classes, where rebates to platforms are replaced with a discounted fund fee, is also becoming more prevalent.
Stronger regulation and supervision
The regulatory intent is to introduce tougher professional standards for trustees, more nudges and prods to incentivise fund consolidation and, eventually, tougher entry requirements to become a fund service provider. Expect draft regulations available for comment from late 2014 onwards.
Tougher professional standards include better training to ensure a clear understanding of fiduciary responsibilities, higher probity standards and clearer prohibitions on service provider activity that can create conflicts of interest. Our experience with the introduction of similar requirements for financial services providers over the last decade is that, despite the additional compliance and personal commitment costs, the interventions have led to industry behaviour that is much more aligned with ensuring good client outcomes.
Compulsory charge disclosure for retirement funds
National Treasury wants to introduce the requirement for all retirement funds to provide full and comprehensive disclosure of total charges incurred, together with a clear indication of who benefits from these charges, in a comparable format available in the public domain. The idea is that this form of disclosure will enable fund members and fiduciaries alike to benchmark their cost structures against the full range of options available in the market.
We are supportive of more transparency across the value chain as it makes it easier to assess the value-add of incumbent service providers. The proposed disclosure requirements for retirement funds are similar to the approach historically adopted in the unit trust industry, which provides a template of how this form of disclosure will work. The key unintended consequence that should be guarded against is an environment where trustee responsibility is equated solely with minimising costs rather than optimising value. We believe that balanced disclosure between costs and benefits, together with appropriately defined trustee duties, will mitigate this risk.
Preservation of accumulated benefits pre-retirement
National Treasury has not yet been able to build consensus across all stakeholders for reducing the full ‘accidental’ access to retirement benefits that arise when fund members change jobs before retirement. In addition to the previous concession of protecting full vested rights and a 10% p.a. withdrawal that can be carried forward when not used, the current proposal extends to allowing a de minimus withdrawal of amounts up to R150 000. The proposals remain the subject of consultation, and progress towards implementation remains unclear.
The politicisation of this issue is unfortunate, as all retirement experts would agree that lack of preservation is the number one reason why middle and high income earners retire with inadequate capital. The proposed requirement to change the default at termination of membership to preservation, rather than encashment referred to earlier, remains the only progress achieved as a result of the current process in this regard.
Auto-enrolment and/or mandatory contribution
Government has for the first time clearly stated its firm intention to, ‘over the medium term’, make retirement saving compulsory for all formally employed workers. National Treasury argues that a fundamental change to the infrastructure of the market is required to achieve this, primarily through the provision of some form of simple, robust and low-cost default product architecture for those unwilling, or unable, to take advice on the optimal solution for their requirements.
While we are supportive of attempts to deepen the savings pool and enhance the wellbeing of more households, we are wary of unintended consequences. The nature of compulsion will place a larger responsibility on both government and industry participants to ensure that fund members forced into savings perceive fairness in the system. We continue to hold that compulsory systems only achieve this fairness objective in a democracy when individuals retain as close to unfettered control over their own money as is practically achievable. We will therefore continue to oppose any proposals that may lead to the unintended consequence of a retirement marketplace that becomes too restrictive or too prone to government intervention.
Product simplicity and portability regulations
The bugbear in the institutional market relates primarily to umbrella funds, where National Treasury contends that fund rules often create arbitrary restrictions on moving funds from one provider to another. In the retail market the issue relates to underwritten or old-generation retirement annuities, which are subject to early termination penalties. Expect ongoing pressure to move the market closer to full and easy portability between providers.
There is little fault to find with the principle of allowing customers to vote with their feet when they are unhappy with the value provided by their existing service providers. We also take comfort from the fact that National Treasury acknowledged that the move towards greater portability should be gradual enough in nature to avoid systemic risks as a result of unmanageable disruptions in historic business models.
While National Treasury agrees that consolidation of funds will require more use of umbrella funds, it is worried that governance in these multi-employer arrangements are too weak. One of the big issues to be debated is whether the product provider that sponsors the umbrella fund should still be able to tie fund members to only buying services from particular service providers.
The key risk here is that a costly layer of additional governance is added into commercial arrangements without any improvement in the protection of member rights. We think a better approach will be to fix the constraints to portability described above, while allowing the professional and regulated fiduciaries to get on with it. The way the unit trust industry works is instructive: If you decide to invest in a Coronation fund, it is probably fair to assume that you expect Coronation to manage it. While you remain invested, we are subject to the oversight of professional trustees who primarily take responsibility for custody of your money, while allowing us to focus on managing it. When you want to divest, you simply let us know and we return your funds within two business days.
Extending retirement system coverage
The sobering fact remains that roughly six million working South Africans are not currently contributing to a retirement fund. Many of these ‘missing savers’ are in so-called vulnerable employment in industries such as construction, household and hospitality services. The idea is to create highly standardised default-type arrangements, with an emphasis on efficient distribution mechanisms that will make it possible to extend auto-enrolment or mandatory contribution to a larger component of the formally employed population. Expect a policy paper towards the end of 2014. We are very supportive of extending the dignity of an adequate income in retirement to more working South Africans. The design challenges are significant though, and deserve careful consideration to ensure appropriately calibrated benefits and incentives that are perceived to be valuable by the target audience, and delivered by a competitive and well-functioning marketplace. This is possibly the only area in the retirement system where well constructed public-private-community partnerships that still allow some choice of provider are the appropriate delivery model.