29th November 1999
Since the beginning of August 1998 companies running offshore mutual funds have not been allowed to promote such funds in South Africa, unless they were approved by the Financial Services Board in South Africa (the "FSB"). This was due to the introduction of section 37A of the Unit Trusts Control Act No 54 of 1981 (the "Act") which came into operation on 1 August 1998. Since then, a number of foreign collective investment schemes have been approved by the FSB to promote their business in South Africa. A list of the schemes that have been approved is available on the FSB's website at http://www.fsb.co.za/unit.htm.
The FSB's stated aim in introducing section 37A of the Act is that of investor protection, i.e. to protect local investors against foreign funds which may be less well regulated than South African schemes. There is also an element of protecting the local unit trust market, in that the FSB has indicated that the legislation is intended in addition to ensure that offshore schemes are not able to offer products that South African funds cannot offer.
The first legislation for the regulation and supervision of the unit trust industry in South Africa was promulgated in 1947 and has been amended several times in an attempt to keep abreast of developments within the industry and to cater for the changing needs of investors. The FSB has recently published a draft Collective Investment Schemes Control Bill (the "Bill") which is intended to replace the Act in its entirety. The full text of the Bill, followed by a memorandum on the objects of the Bill, is published on the FSB's website at http://www.fsb.co.za/ciscb.htm. The explanatory memorandum contains a useful summary of all the clauses of the Bill, together with reasons for the inclusion of certain provisions. The memorandum to the Bill makes particular mention of the specialist input that has been provided by Maitland & Co.
This note comments on the draft of the Bill dated 27 August 1999. It is important to note that even though this draft of the Bill has been submitted for approval by cabinet, the Bill is still only in draft form and consequently may be subject to change.
Section 37A of the Act aims to regulate the operations of non-South African funds in South Africa. The substantive provision is section 37A(1), which is in the following terms:
No person may:
(a) publish, cause or permit to be published any price list, advertisement, brochure or similar document; or
(b) perform any other act,
to promote the business of or solicit investments in a collective investment scheme carried on outside the Republic unless such scheme -)
(i) has, after an application for approval accompanied by the prescribed fee, been approved by the Registrar; and
(ii) complies with the conditions that the Registrar may determine by notice in the Gazette.
It can be seen that the terms of section 37A(1) are extremely broad. Neither the Act nor the conditions referred to in section 37A(1)(b)(ii) contain any exemption for sales or marketing to sophisticated investors or for private placements.
The effect of the section is that an investment manager in South Africa would not, for example, be able to mention the name of an unapproved foreign scheme as an additional investment opportunity to its existing clients. It is, however, possible for a registered investment manager to invest in unapproved foreign schemes in the exercise of the manager's discretion under a discretionary mandate. A discussion of the ambit of the legislation regulating domestic and foreign investment managers is beyond the scope of this note.
The Registrar of Unit Trust Companies (the "Registrar") has by notice in the Government Gazette in terms of section 37A(1)(b)(ii) of the Act promulgated conditions governing the promotion of foreign collective investment schemes in South Africa (the "Conditions"). Some of the more significant requirements of the Conditions are set out below:
- Each foreign collective investment scheme approved under the Act is required either to establish a representative office in the Republic (being a South African public company with a minimum share capital of R2 million invested in liquid assets) or to enter into a representative agreement with a management company of a South African unit trust scheme.
- The Conditions provide that no scheme will be approved unless it is carried on in a regulatory environment of at least the same standing as the South African regulatory environment.
- The Conditions provide for various information which must be disclosed in the prospectus and other marketing material relating to the foreign scheme.
- Under paragraph 6 of the Conditions, the Registrar may refuse to approve the scheme:
- unless the applicant satisfies the Registrar that the investments which the scheme proposes to offer for sale in the Republic have a risk profile which is not significantly higher when compared to the risk profile of similar investments in South African unit trusts; or
- if investments are offered for sale under the scheme which may not in terms of the Act be offered for sale by any management company of a South African unit trust scheme.
The significance of the Registrar's rights in terms of paragraph 6 of the conditions is that the types of assets in which South African unit trusts are permitted to invest are quite narrowly prescribed. In practice, the FSB has applied this condition such that, for example, any foreign schemes or sub-funds which may invest in over-the-counter derivatives will not be approved, nor will schemes or sub-funds be approved which are permitted to invest in shares which are not listed on one of the exchanges recognised by the International Federation of Stock Exchanges (FIBV), in each case on the basis that South African schemes are not permitted to invest in such assets.
The other key aspect of the current legislation to note is that, in terms of the Act, the only recognised form of collective investment scheme is a unit trust scheme. This has led to some difficulties for foreign schemes that are not trust-based, in particular open-ended investment companies such as the Luxembourg SICAV. Investors acquire shares - as opposed to units as trust beneficiaries Đ in such foreign corporate schemes.
As a result, the marketing and sale of such investments is theoretically also governed by the provisions in the South African Companies Act No 61 of 1973 ("the "Companies Act") relating to offers of shares to the public. The Act only recognises unit trust schemes, and does not exclude the application of the Companies Act provisions. Consequently, foreign schemes in corporate form, even if approved under the Act, would still in theory need to comply with the Companies Act requirements, which involves amongst other things the preparation of a prospectus in the prescribed form and the registration of such prospectus with the Registrar of Companies. In practice, the Registrar of Companies does not enforce the provisions of the Companies Act relating to offers of shares to the public against foreign open-ended investment schemes approved in terms of the Act, but there is no guarantee that this informal exemption will continue. It is in any event debatable whether the Registrar of Companies has the power to exempt foreign schemes from complying with the Companies Act provisions.
Against this background, the FSB has published the Bill. The Bill will replace the Act in its entirety, and provide for the control, regulation and supervision of all foreign and local collective investment schemes (including unit trust schemes) which seek to carry on business within the Republic.
The first point to note is the significance of the change in name of the legislation from the Unit Trusts Control Act to the Collective Investment Schemes Control Act. This highlights the movement away from the unit trust regime to permit other types of schemes and provide flexibility for future types of schemes. The explanatory memorandum to the Bill refers to the international acceptance that innovation is not possible within a trust-based format. Open-ended investment company schemes should allow much greater innovation in the collective investment scheme arena. The memorandum also acknowledges that many such products already exist internationally, are sold to South African investors and are offered offshore by South African companies. The FSB considers that it would be beneficial to South Africa's balance of trade and employment prospects if these products could be designed locally and sold in the domestic and foreign markets. The Registrar of Unit Trust Companies will be re-titled the Registrar of Collective Investment Schemes.
The Bill excludes certain provisions of the Companies Act, thus largely overcoming the problems referred to above in respect of compliance by corporate schemes with the Companies Act provisions in relation to offers of shares to the public.
Although the main purpose of this note is to highlight the provisions applicable to the marketing of foreign collective investment schemes in South Africa, it is useful to note the other main areas provided for in the Bill:
- the control, regulation and supervision of all collective investment schemes including unit trust schemes and all foreign and local collective investment schemes which seek to carry on business within the Republic of South Africa;
- the procedure for an existing South African unit trust scheme to convert to another approved form of scheme;
- the appointment of a representative advisory committee to advise the Minister and the Registrar on the business and the supervision of collective investment schemes;
- the recognition of an industry association(s) which may be entrusted with duties and powers for the self-regulation of the conduct of its members;
- risk-based capital requirements for the managers of collective investment schemes;
- comprehensive disclosure and additional requirements to protect investors further; and
- independent custodianship of the assets representing the interests of investors.
Definition of "collective investment schemes"
The Act does not contain a definition of "collective investment schemes", although a definition of this term is contained in the Conditions. The definition from the Conditions has been expanded and incorporated into the Bill. This key term is defined as follows:
... a scheme, in whatever form, in pursuance of which members of the public are invited or permitted to invest money or other assets in a portfolio, and which scheme has the following characteristics:
(a) two or more investors contribute money or other assets to and hold a participatory interest in a portfolio of the scheme through shares, units or any other form of participatory interest; and
(b) the investors share the risk and the benefit of investment in proportion to their participatory interest in a portfolio of a scheme or on any other
basis determined in the deed,
but excludes a collective investment scheme authorised by any other act
Part VI of the Bill permits different types of schemes to be declared lawful by the Minister in the future. The definition of "collective investment schemes" is consequently deliberately drafted in wide terms to allow for future flexibility.
The inclusion of the phrase "members of the public" in the definition of "collective investment schemes" is considered below, under the analysis of the practical implications of the Bill on the activities of foreign collective investment schemes in South Africa.
Regulation of foreign collective investment schemes in terms of the Bill
Part VII of the Bill deals with foreign collective investment schemes and contains three sections that will now be focused upon.
(i) Approval of foreign schemes (section 45)
Section 45(1) of the Bill is the replacement to section 37A of the Act and is in the following terms:
The registrar may –
(a) on application, in the form prescribed by the registrar, by a manager or operator of a collective investment scheme which is carrying on business outside the Republic;
(c) if a copy of the approval or registration by the relevant foreign jurisdiction authorising the foreign collective investment scheme to act as such, is submitted;
(d) if the foreign collective investment scheme can comply with the conditions prescribed by the registrar by notice in the Gazette or any other conditions imposed by the registrar; and
(e) on payment of the fee prescribed by the registrar,
approve such an application to solicit investments by members of the public in the Republic in such a foreign collective investment scheme in terms of this Part
The Bill defines the word "solicit" as meaning "any act to promote or encourage or persuade members of the public to invest in a collective investment scheme".
Section 45(1) refers to applications for approval being made in the form prescribed by the registrar. Under the Act there is no prescribed form for application, although since the Act came into force, the FSB has established internal guidelines as to the format of the information required to be submitted in support of any application. The prescribed form referred to in the Bill has not yet been published.
Section 45(2) states that a person who solicits investments in a foreign scheme which is not approved in terms of the Act, is guilty of an offence with the penalty being a fine or a term of imprisonment for up to five years, or both a fine and such term of imprisonment.
(ii) Reciprocity (section 46)
Section 46 provides for a new concept of reciprocity. The section provides that if the jurisdiction of the foreign scheme discriminates against management companies of South African schemes in such jurisdiction, the registrar may suspend, disqualify or restrict the business of a foreign scheme operating from such jurisdiction in South Africa.
(iii) Withdrawal of approval (section 47)
Section 47 is another new provision and sets out the grounds on which the registrar may withdraw an approval given under section 45(1). These grounds are:
- the registrar considers it to be desirable or in the interest of investors or potential investors to do so;
- the manager of the foreign scheme has submitted inaccurate or misleading information in its application; or
- any of the conditions referred to in section 45(1)(c) are no longer met.
As there is no materiality in the provision relating to inaccurate or misleading information, care will clearly need to be taken by schemes in preparing their applications for approval.
PRACTICAL IMPLICATIONS OF THE BILL FOR FOREIGN COLLECTIVE INVESTMENT SCHEMES
The conditions proposed to be issued as referred to in section 45(1) of the Bill have not yet been published, so it is difficult at this stage to assess whether the Bill will provide for a more lenient or less lenient regime from that applicable under the Act.
In particular, it is uncertain whether the FSB will still require a foreign scheme to maintain a representative office or enter into a representative agreement. However, the purpose of the current requirement is to provide an entity within South Africa against whom the FSB can enforce compliance with the provisions of the Act and regulations issued thereunder and, for these reasons, the FSB has indicated that it is its intention to retain this requirement.
Regulatory environment and risk profile
Under the current legislation, two of the most difficult requirements for foreign collective investment schemes to comply with have been proving, firstly, that the regulatory environment of the foreign scheme is similar to the South African regime, and secondly, that the risk profile and type of investments offered under the scheme are similar to those which may be offered in terms of the Act by South African unit trust schemes.
The second of these requirements has caused difficulties for foreign schemes, as the type of assets in which South African unit trust schemes are permitted to invest is generally more restrictive than the assets in which foreign schemes are permitted to invest. The type and spread limits of assets in which South African unit trust schemes are permitted to invest is largely set out in section 6 and the definition of "securities" in section 1 of the Act. These provisions have been largely replaced in the Bill by section 77. However, section 77 does not contain any substantive provisions, but instead refers to conditions that may from time to time be issued by the registrar. Whilst this may indicate that a more flexible regime will be adopted for South African schemes, until such conditions are published, it is not possible to assess whether the South African regime will be relaxed, making it easier for foreign funds to comply with this requirement.
The Bill does provide for some relaxation of certain restrictions currently applicable to South African schemes. Sections 86 and 87 of the Bill, for example, provide for a relaxation on the current restriction on borrowing by a manager, to bring the South African approach to this issue in line with international practice. Under section 86(2), a manager of a scheme will be permitted to borrow money for the account of a portfolio, subject to such borrowing being for a purpose and in accordance with conditions to be prescribed by the Registrar. Section 87 will permit a manager of a scheme to borrow funds of up to 10% of the market value of the portfolio to meet the scheme's obligations to repurchase or cancel participatory interests, where there is insufficient liquidity in the portfolio to meet such obligations. Costs will be for the account of the portfolio, but the amendment should nonetheless benefit investors as the scheme will not have to sell quality investments when the market is low, simply to meet repurchase obligations. Funds may only be borrowed from registered financial institutions and then only on the best commercial terms available.
Definition of "members of the public"
As noted above, the existing legislation does not provide for any exemption from the registration requirements for private placements or sophisticated investors, making the ambit of the provisions all-encompassing.
It is therefore significant to note in the definition of "collective investment scheme" in the Bill (as set out above) a reference to "members of the public". The effect of the inclusion of these words is that any collective investment schemes which are not offered to members of the public (as defined) will not fall within the application of the Bill and will thus not require the prior approval of the registrar if the activities are limited to sales to persons not deemed to be "members of the public".
Consequently the definition of "members of the public" contained in the Bill is extremely important. It is drafted in the following terms:
"members of the public" includes –
(a) members of any section of the public, whether selected as clients, members, shareholders, employees or ex-employees of the person issuing an invitation to acquire a participatory interest in a collective investment scheme; and
(b) a financial institution regulated by any law,
but excludes persons confined to a restricted circle of individuals with a common interest who receive the invitation in circumstances which can properly be regarded as a domestic or private business venture between those persons and the person issuing the invitation
This is not an easy definition to interpret. Firstly, the use of the word "includes" in the preamble adds uncertainty. Secondly, the terms of the definition are very wide, with the result that the application of the definition could in practice be almost all-encompassing, as it is difficult to conceive of any category of persons who would fall outside it.
The reference to "financial institution" in paragraph (b) of the definition indicates that no "sophisticated investor" exemption will be permitted. In addition, if a foreign scheme decided it only wished to market itself to a single financial institution (for example, Old Mutual), then the FSB has indicated that the scheme would still require the approval of the Registrar. The term "financial institution" is not defined in the Bill. However, there is a definition of "financial institutions" in the Financial Services Board Act No 97 of 1990. That definition includes, for example, pension funds.
Consequently it can be seen that the ambit of persons who are not "members of the public" is extremely limited, and that foreign collective investment schemes will need to exercise caution if they wish to avail themselves of the exemption from registration on the basis that they are not marketing their funds to "members of the public".
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WEBBER WENTZEL BOWENS
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