This presentation serves as study notes for the e-learning material titled: "South African Hedge funds and international developments" These notes focus on the amended Regulation 28 South Africa and its Impact on the Hedge Fund Industry. http://www.hedgefund-sa.co.za/regulation-28

1. Regulation 28
Study Notes

2. Objectives
• to protect investors of retirement funds from
– Effects of poorly diversified portfolios
– Over exposure to higher-risk asset types
• Ensure that retirement contributions are
invested in a prudent manner
– Protecting investor
– Channelling economic development and growth
• Insurance policy assets must meet Reg 28
requirements

3. DEFINITION
A hedge fund is an asset which uses any strategy
or takes a position that could result in the
portfolio incurring losses greater than its fair
value at any point in time and which strategies
or positions include but are not limited to
leverage and net short positions
• Managed by a licensed hedge fund Financial
Services Provider
• Subject to any prescribed conditions

4. background
• Many amendments since inception in 1998
• Reasons for amendments
– Inconsistencies in the regulations eg definitions
– Loopholes which allowed retirement funds to avoid
regulatory rules
– Ability for retirement funds to invest in assets
exposing them to unacceptable risk levels
– Credit risk issues
– No provision for Islamic compliant retirement funds

5. Current regulation
• Prescribes maxima for certain types of
investments
• No restrictions bank-issued money markets
and government bonds
• No guidance on use of derivatives
• Registrar may exempt funds from certain
maxima

6. process
• Public consultation
• Key issues brought up
– False mordenisation of market
– Limit on debt too strict
– Restrictions on alternative investments may hinder
economic growth
– Investments in Africa may promote development of
South Africa
• After feedback amendments made to the current
regulation

7. amendments
• Greater accountability for trustees
• Sturdier markets for corporate debts
• Greater protection of investors
• Greater use of alternative investments
• Expansion into foreign markets done
responsibly

8. Explanation of new regulation
• Refining of definitions to mitigate risk of
avoiding regulation
• Tighter definitions to reflect risk-return profile
of investments
• References updated to reflect changes in
exchange environment

9. Preamble and principles
• Preamble frames regulation
• Retirement fund board must invest savings in a
manner that
– promotes long term sustainability of asset values
– takes into account environment, social and
governance issues
• Better guidance to trustees investment strategy
• Recognise that a too conservative approach can
be damaging to long term savings in the same
way a too risky approach is

10. Preamble and principles
• Strengthen investment process
• Improve transparency
• Improved accountability of trustees to the
Registrar
• Principles captured in Investment Policy
Statement (IPS)

11. Investment policy statement
• Inform a fund’s investment approach on aspects
identified in the regulation including:
– Promoting relevant education of trustees
– Monitoring compliance of the fund and its agents
– Asset-liability matching
– Performing appropriate due diligence on investments
– not relying heavily on credit-ratings from credit
rating agencies
– Long term sustainability of fund
– Any other relevant details

12. Asset limits
• Investments done within the limits of the
regulation
• Provisions made for breaches beyond the control
of the board
• Board should make investment decisions based
on what is best for the fund and its investors
• Asset limits should not prevent fund from
reaching optimal investment
• Board may apply for a breach of limit from the
Registrar

13. Asset limits
• Mindful of the importance of individual member
protection and fund sustainability
• Exceptions for certain existing individual contract
arrangements
• Allowance outside Reg 28 until such a time they may
be changed
• Some asset definitions are narrow
• Anything outside definitions may fall under debt
• Exceptions – hedge funds
- private equity
- alternative investments

14. cash
• Instruments collectively used for liquidity
management
• Includes money market instruments
• Concern over maturity transformation in
money market funds
• Strengthening needed to protect investors and
safeguard against future financial instability

15. Debt instruments
• Improved diversification
• Reduce regulatory induced distortions
• Better support to corporate debt instruments
• Lack of transparency leading to information
asymmetry between investor and issuer
• Aggregate limit for debt raised to 75%
• Stricter limits across issuer sub-categories for
unlisted debt instruments
• Credit ratings may be used for broad due
diligence

16. Equities
• Asset class
• Include preference and ordinary shares only
• Aggregate limit of 75%
• Limits on issuer sub-categories
• Limits checked for inflationary pressures and
updated accordingly
• Limit on unlisted equity 15% subject to
diversification and valuation requirements

17. Immovable property
• Unlisted property may have significant risk
management implications
• Limits on exposure
• Limits on sub-categories as well
• Limits checked and tested by Registrar over
time and updated accordingly
• Debt instruments backed by property listed as
debt

18. commodities
• Have hedging potential
• Fund can invest in listed commodities
– Max 10% gold
– Max 5% other commodities
– Combined maximum of all commodities of 10%

19. Other assets and alternative
investments
• Hedge funds and private equity defined
• Prevents these products from being reported as
the linking structure
• Guidance to investments activities
• Hedge fund defined as such and no other
products hiding under hedge fund disguise
• Accessing hedge funds and private through funds
of funds providing extra layer of due diligence
and diversification
• Registrar impose extra requirements

20. Foreign assets and regional
development
• Foreign assets currently defined
• Recognised foreign exchange falls away
• To be considered as listed an exchange must be listed
on an exchange that is a full member World Federation
of Exchanges
• Allows exposure of retirement funds to foreign assets
through a suitably regulated vehicle
• Inward or dual listed securities on an SA exchange
treated as listed
• Subject to limits - 75% equities – 50% dent
• Foreign markets have access to South African capital

21. Look through
• Use of hedge funds as loophole to hold risky
assets in the past
• Funds may not use asset structure to avoid asset
limits
• Disclose underlying assets
• Exceptions are private equity and hedge funds
• Definitions ensure that look-through is not
abused
• De minimis rule applied to lessen far-reaching
disclosure requirements

22. borrowing
• Funds may never borrow funds for purposes
of investing borrowed funds
• Only allowed to borrow when acing liquidity
problems in paying members leaving the fund
• Limit on the amount borrowed and time
constraint
• Stay away from exploitative arrangements and
inappropriate loan terms

23. Reporting, exclusions and exemptions
• Not all funds used in calculation of percentage
limits
• An FSB regulated entity offering a Reg 28
compliant product excluded from limit
calculations
• Funds may apply for exemption for a given time
and certain limits
• Funds should act in best interests of stakeholders
which may be in conflict with Reg 28
• Funds may engage Registrar and apply for
exemption based on these grounds

24. implemantation
• Effective from 1 july 2011
• Contracts before 1 April 2011 exempt
• No contracts that are not Reg 2 compliant may
be sold
• Warning against exploiting the exempt
contracts

25. Conclusion
• Reg 28 now rigorous, flexible and fair
• Suitable to the South African context
• Challenges may arise in implementation and
funds may engage the Registrar in this regard