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NT: Mcebisi Jonas: Address by Deputy Minister of Finance, at the 5th Annual Audit Committee Conference, at the Sandton Convention Centre, Johannesburg (03/08/2015)

NT: Mcebisi Jonas: Address by Deputy Minister of Finance, at the 5th Annual Audit Committee Conference, at the Sandton Convention Centre, Johannesburg (03/08/2015)

4th August 2015

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I am pleased to be addressing you this morning. Thank you for the invitation.

Pension funds play an important role in the national economy. Given South Africa’s low savings rate and the present twin fiscal and current account deficits, pensions are even more important for economic development. They pool funds from both employers and employees with the aim of providing retirees and their beneficiaries with income upon the retirement, death or disability of a member. This guards against poverty in old age and reduces the potential dependency on the government.

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When smartly invested, pension funds provide a mechanism for unlocking savings, stimulating economic growth and ensuring that pensioners are provided for in retirement.

The collapse of a pension can therefore, profoundly damage the future of pension funds members and also undermine the certainty and incentives of the savings regime. The protection of funds invested by people in pension funds is paramount for these reasons; pension funds require good prudential and member protection oversight.

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Pension fund reform has now become a topical issue in most countries including South Africa. The financial crisis highlighted the importance of a review of the financial sector regulatory system, a process we had already started prior to the crisis.

This review was captured in a National Treasury publication in 2011, titled A safer financial sector to serve South Africa better. It proposes a Twin Peaks Model for our supervisory regime, which will see the South African Reserve Bank (SARB) focusing on prudential supervision, while the Financial Services Board (FSB) dedicates itself to market conduct supervision. This financial architecture reform is more focused on enhancing and strengthening the current system.

Part of the review discussed in this publication, includes the reform of the pension funds industry, which will be the focus of my speech today. South Africa recognises the important role played by retirement funds in the economy, especially as a form of saving that achieves very important goals both at an individual and country level.

The key drivers behind these reforms include fiscal pressure, ageing population, market imperfections lack of consumer protection and low levels of financial literacy, low savings, investment risks and the shortage of knowledgeable professional trustees.

Pension reforms to boost saving

Besides the above-mentioned reasons, South Africa has embarked on pension reform to boost the national savings rate to support investment and economic growth. We have a worryingly low saving rate when compared to other developing and emerging market economies.

The country experienced a decline in the national savings rate over the past decades. Gross savings declined from a peak of 33.6 per cent of GDP in 1980 to 18.9 per cent in 1990, declining further to a level of 14.9 per cent in 2014.

Another key reason for pension reform is to ensure that individuals have adequate retirement provision, and do not default to the State after having had an opportunity to work. Households or individuals generally do not save! The net household savings as a percentage of GDP has declined sharply over the past decades, from an average of 2.8 per cent during the 1980s to 1.6 per cent in the 1990s and is now at a disturbing negative 1.4 per cent in 2014.

Governance of pension funds

South Africa relies on the system of trustees to manage and govern retirement funds, with assets worth over R3 trillion as at 2013, according to the FSB. It is, therefore, imperative that retirement funds be governed and run by sufficiently trained and skilled trustees, who are able to properly manage conflicts of interest and take decisions which benefit the members of the funds. Government recognises trustee education as a key aspect in the governance of pension funds.

According to PwC’s 2014 Retirement Fund Strategic Matters and Remuneration Survey, the sheer scale of pension fund investments, coupled with the relevant economic, political and administrative risks, places an enormous responsibility on board members to govern these arrangements wisely. Not only do trustees have almost unlimited fiduciary responsibilities placed upon them by law, but they also have a moral obligation to act in the best interest of fund members. As expected, professional trustees are the most experienced and highly educated, with 94 per cent having more than five years’ and 53 per cent having more than 10 years’ experience.

There is, therefore, a statutory requirement that trustees be ‘fit and proper’ with certain minimum qualifications. To enable this, we amended the Pension Funds Act in 2013, to introduce measures that ensure that trustees are well trained within six months of assumption of duties, and continue to be trained while they remain trustees.

Other proposals seeking to strengthen governance of pension funds contained in the amended Pension Funds Act include:

  •     Whistle-blowing protection for board members (i.e. trustees), valuators, principal/deputy officers, and employees who disclose material information to the Registrar of pension funds;
  •     Extending personal liability to employers in respect of non-payment of pension contributions to a pension fund;
  •     Protection for board members from joint and several liability, if they act independently, honestly, and exercise their fiduciary obligations; and
  •     Require pension funds to register or be provisionally registered prior to commencing the business of a pension fund.

The role of trustees in pension fund governance is also captured as one of the most important principles in the new Regulation 28. Regulation 28 is a prudential instrument which limits the amount and extent to which retirement funds can invest in particular assets or categories of assets.

Part of Regulation 28 is to ensure that the savings South Africans contribute towards their retirement are invested in a prudent manner that not only protects the member but are channelled in ways that achieve economic development and growth. This meant that the revised Regulation 28 had to move away from a rules-only based approach to one that also has an overlay of principles. Principles have been introduced into the Regulation to strengthen the investment decision making processes and improve transparency and accountability to fund members and the Registrar.

Regulation 28 is very much aligned to the global thinking and developments with regard to revamping the regulatory and supervisory framework. Regulation 28 is designed to reduce excessive risk taking and excessive leveraging, which were common factors in the run up to the crisis.

Improvement in market conduct

Current law gives trustees of retirement funds substantial duties to protect the interests of members. However, in many instances, trustees appear to have given insufficient emphasis to simple initiatives which would substantially improve the retirement outcomes of members of their funds.

In order to remedy this, the Minister on 22 July 2015 issued draft default regulations for public comment. These regulations seek to clarify the duties of trustees in order to deal with the following observed shortcomings:

  •     Members being automatically enrolled into excessively complex, unreasonably expensive or otherwise inappropriate default investment portfolios;
  •     Trustees’ failure to implement initiatives that facilitate preservation and portability of retirement savings between funds. The de facto default for most funds appears to be that retirement benefits are paid automatically, in full and in cash when members leave the employment of the participating employer; and

    Trustees seemingly ignoring their responsibilities to ensure that fund members are able to convert their accumulated fund credits into an income when they retire in the most efficient, transparent and cost-effective way.

The draft regulations, when adopted, will require all retirement funds to operate a set of default policies that are in the long-term interests of members rather than of service providers. The regulations will prescribe the conditions that require trustees to have default investment portfolios for the investment of retirement savings, default annuity strategies for members upon their retirement, and default preservation rules for members on termination of membership before retirement.

Role of auditors

Although it is the ultimate responsibility of board members to ensure proper execution of their duties and compliance with the Pension Funds Act legislation and the Rules of the Fund, there is also a need for an independent person to ensure the validity and legality of financial records.

This is in addition to a variety of activities, which include:

  •     ensuring that assets are safeguarded;
  •     gauging levels of financial risk within organisation;
  •     checking that financial reports and records are accurate and reliable;
  •     identifying if and where processes are not working as they should and advising on changes to be made;
  •     providing unbiased information about operational activities;
  •     ensuring procedures, policies, legislation and regulations are correctly followed and complied with; and
  •     Whistle blowing

Risk management, compliance and monitoring, are therefore key elements of auditing. With a wide social coverage of millions of members and beneficiaries, involving the participation of a range of different players, the performance of the persons and entities involved in the operation and oversight of the pension fund should be assessed regularly.

Due to the important nature of their tasks, the compliance and auditing function must be staffed with competent, well trained individuals who have a clear understanding of their role and responsibilities.

Conclusion

Auditors owe a fiduciary responsibility to members of funds, as well as the Registrar of pension funds; to identify the most critical risks that face each pension fund, assess the pension fund’s management of those risks and the pension fund’s financial vulnerability to potential adverse experience.

Where there are glaring and common problems that auditors come across in their work, they have a moral duty to report these to the Registrar. It is sad indeed when anomalies are detected long after a lot of damage has been done to retirement funds – these are monies people set aside for retirement and often it is impossible for defrauded members and beneficiaries to get their monies back after the effect (e.g. Fidentia case).

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