FSCA withdraws proposed hedge fund conduct standard

FSCA withdraws proposed hedge fund conduct standard

The FSCA has withdrawn a proposed conduct standard for retirement fund investments in hedge funds, saying subsequent events have made the standard unnecessary.

The draft standard was published by the erstwhile Financial Services Board for public comment in 2015. The FSCA published a revised draft in October 2020.

The draft standard proposed that retirement funds be permitted to invest in hedge funds subject to three conditions.

The FSCA said it considered the submissions from four industry stakeholders on the draft conduct standard. Earlier this year, the FSCA had “targeted engagements” with some of the commentators to understand their concerns.

In its communication this month, the FSCA explained why there was no longer “a critical need” to impose the conditions.

Condition 1

A retirement fund may invest in a hedge fund if the fund is administered by a registered manager as referred to in paragraph 2(2) of Board Notice 52 of 2015.

The FSCA said this condition may no longer be necessary because of the impending change to the definition of “hedge funds” in regulation 28 of the Pension Funds Act (PFA). The revised definition will be linked to a hedge fund regulated under the Collective Investment Schemes Control Act (Cisca) and be administered by a registered manager in accordance with section 42 of Cisca. This means that, by definition, retirement funds will be able to invest only in Cisca-regulated hedge funds and will only be able to use registered managers for members’ investments.

Condition 2

A retirement fund may invest in a hedge fund only if the hedge fund manager contractually undertakes to disclose whether the hedge fund’s exposure to embedded derivatives in the fund exceeds 100% of such derivatives.

The FSCA said regulation 28(3), which prohibits investment in an asset where the potential loss exceeds the value of the investment, is already sufficient. Specifically, a fund must not invest or contractually commit to invest in a hedge fund where the fund may suffer a loss in excess of its investment or contractual commitment in the asset.

Regulation 28(3) prohibits investment in an asset where the potential loss exceeds the value of the investment, so requiring a hedge fund manager to disclose an investment in embedded derivatives in a hedge fund exceeding 100% of such derivative is superfluous: the fund may not invest in such a type of investment in the first place.

Regulation 28(3)(d) has an added protection measure that requires a hedge fund to hold liability exposure in a limited liability structure, the FSCA said.

Condition 3

Where the board of a retirement fund lacks the expertise to make investment choices, the fund must, before it invests in a hedge fund, obtain expert advice as required in terms of section 7D(1)(e) of the PFA to enable it to make the most suitable investment decisions in relation to investing in a hedge fund.

The FSCA said it agreed with commentators’ views that section 7D(1)(e) of the PFA obliges boards of retirement funds to “obtain expert advice on matters where board members may lack sufficient expertise”. As such, it is not necessary to retain this condition in a conduct standard as well.

It said the “wide and principles-based” wording of section 7D(1) can be applied in the context of hedge fund investments. If the FSCA found that this principle was not being adhered to, it will communicate this to the industry in, for example, a guidance notice.

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