Tuesday, July 31, 2012

Private equity fund managers and pension funds that invest in private equity funds have been through some rough times in recent years.
In 2010 the registrar of pension funds indicated that he was about to issue a notice declaring all investments by pension funds in private equity funds unlawful because the custodians of the assets of those schemes were not authorized by section 5(2) of the Pension Funds Act, 1956, (the PFA) to hold pension fund assets on their behalf.
If the registrar’s interpretation of section 5(2) was correct, pension funds could have been compelled to terminate their investments in private equity schemes prematurely and to suffer the considerable penalties that would have been applicable as a result.
The Southern African Venture Capital and Private Equity Association (SAVCA) argued that the assets of a private equity fund were not the “assets of a pension fund” but this did not persuade the registrar.
Fortunately, however, the registrar did not issue his notice.
Instead, the new regulation on “asset spreading requirements” (regulation 28), promulgated with effect from June 2011, made it clear that, subject to conditions to be determined by the registrar, a pension fund could invest up to 10% of its assets in private equity funds with a maximum of 2,5% in any single private equity fund.
The regulation defines the term “private equity fund” as follows:
“private equity fund” means a managed pool of capital that —

has as its main business the making of equity, equity-orientated or equity-related investments in unlisted companies to earn income and capital gains;
is not offered to the public as contemplated in the Companies Act, 2008 (Act No 71 of 2008);
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;
is subject to conditions as may be prescribed [by the registrar];

The registrar recently published conditions for pension fund investments in private equity schemes (“the Conditions”). He has also indicated that a private equity fund complying with the Conditions that he publishes will be automatically approved by him as a person or entity which may hold assets on behalf of a pension fund.
The only private equity funds that will qualify will be those that are structured in such a way as to ensure that pension funds that invest in them —

are co-owners of the private equity fund assets (that is, are beneficiaries of bewind trusts or limited partners of en commendite partnerships) or are shareholders in a company comprising the private equity fund; and
will never be at risk of losing more than they have undertaken to invest,

The private equity funds will have to belong to an industry association approved for the purpose by the registrar of pension funds, provide their pension fund investors with regular reports on their activities and performance, subject their assets to regular ‘scrip counts’ and valuations in accordance with applicable international standards and subject their financial statements to audit in accordance with IFRS accounting standards.
The Conditions will come into effect on 30 September 2012 which means that private equity funds that do not now comply with the Conditions have some time to do what they can to comply by then
There are several problems in the definition of “private equity fund” and in the Conditions.
The first is that one of the criteria for qualification as a “private equity fund” is that it must be managed by a person licensed in terms of the Financial Advisory and Intermediary Services Act, 2002, (FAIS) to act as a “Discretionary FSP” as defined in the Code of Conduct for Administrative and Discretionary FSPs issued in terms of FAIS.
Fair enough, you might think. After all, the managers of private equity funds are usually empowered to exercise discretion in the selection, acquisition and disposal of assets on behalf of the fund as contemplated in the definition.
However, the Conditions indicate that the registrar believes private equity fund managers must have “Category II” licenses, which means that their “representatives” and “key individuals” must write the exams and have the qualifications applicable to those who provide asset management services to pension funds.
However, SAVCA and the registrar appear to accept that it would be appropriate for a special category of FAIS license to be determined for private equity fund managers and the Conditions changed to reflect it when this is done
This will not, however, solve the problem for the managers of foreign private equity funds.
While a foreign private equity fund may not be able to comply with the Conditions, this will not mean that, because it is not “approved” in terms of section 5(2), a pension fund may not invest in it. It simply means that the investment will be counted as an investment in a private equity fund for the purposes of assessing compliance by the fund with PFA regulation 28.
This means that, SA-domiciled pension funds will not be able to invest, in aggregate, more than 2,5% of their assets in:

foreign private equity funds without managers with Category II FAIS licenses; and
all other assets not specified in the schedule to regulation 28.