1. Licensing of asset managers
South African asset managers must register as financial service providers (FSPs) with the Financial Services Board (FSB) – now the Financial Sector Conduct Authority (FSCA) – under the Financial Advisory and Intermediary Services (FAIS) Act. Any person carrying on asset management business in South Africa, or from abroad directed at South African clients, whether in a discretionary or non-discretionary capacity, must be licensed as an FSP under the FAIS Act.
2. Licensing of alternative fund managers
A category of FSP licence tailored specifically for hedge fund managers (category IIA) was introduced in 2007.
The FSCA is seeking to introduce a category of FSP licence tailored specifically for private equity managers.
The preliminary draft of the Code of Conduct for Private Equity Managers borrows a number of concepts from the European Union’s Alternative Investment Fund Managers Directive. In particular, significant emphasis is placed on conflicts of interest, as well as remuneration and reward of personnel. There is also a proposed restriction on the leverage that can be employed by private equity funds.
Further exemptions to the fit and proper requirements for financial services providers under the FAIS Act have been applied for by the South African Venture Capital and Private Equity Association relating to the practicality of specific sections contained in the requirements in respect of the private equity industry.
3. Regulation of retail funds
South African retail investment funds, such as unit trust funds and exchange traded funds, are known as collective investment schemes (CISes) and are regulated under the Collective Investment Schemes Control Act (Cisca). There are different types of collective investment scheme, including a CIS in securities, a CIS in property and a CIS in participation bonds. Cisca places significant restrictions on the asset classes in which a CIS can invest, as well as concentration limits on CIS portfolio exposure. The manager of a CIS must be approved and regulated as a CIS manager under Cisca.
4. Minimum capital for asset managers
Fit and proper requirements under the FAIS Act require different categories of FSPs to maintain specified minimum levels of capital. For example, category I FSPs (essentially, non-discretionary FSPs) must maintain liquid assets equal to or greater than 4/52 weeks of annual expenditure.
An asset manager appointed as a registered manager of a CIS under Cisca is also required to maintain a certain minimum amount of capital, which varies according to the type of CIS.
5. Registration of foreign funds
It is possible for foreign investment funds to register as foreign CISes under Cisca. A foreign investment fund that is so registered may be marketed publicly in South Africa.
In order to qualify for South African registration, a foreign fund must have an investment policy that is consistent with the requirements set out under Cisca.
However, Cisca has significantly more restrictive prudential requirements than, for example, the European Undertakings for Collective Investment in Transferable Securities (UCITS) regime. In particular, under Cisca, a CIS may use derivatives only for limited hedging purposes. Consequently, many UCITS funds do not qualify for registration in South Africa.
6. Alternative investment funds
Alternative investment funds, including private equity funds (but excluding hedge funds), are unregulated in South Africa. Accordingly, such funds need to be carefully structured to ensure they are not inadvertently regulated by Cisca’s broad provisions.
The FSCA and National Treasury introduced a regulated regime for hedge funds in South Africa under the auspices of Cisca. The regime introduced two categories of regulated hedge funds: qualified investor hedge funds, which are limited in their membership to private arrangements among qualified investors, and retail investor hedge funds, which may be marketed to the public but are subject to a stricter regulatory regime.
7. Marketing foreign funds
South Africa is an extremely restrictive jurisdiction regarding the marketing of foreign investment funds. In essence, fund promoters, both foreign and local and whether or not they are registered as CIS managers under Cisca, are not allowed to solicit investments in funds that are not registered under Cisca from members of the public in South Africa.
The concept “members of the public” is widely interpreted to include individuals, parastatals and institutions.
Unlike many other jurisdictions, South Africa does not have a more permissive private-placement regime for sophisticated or high-net-worth investors.
It is permissible for a South African investor to invest in an unregulated foreign fund where the investor makes the initial enquiry (a so-called “reverse solicitation”).
8. Exchange control and investments into Africa
Previously, South African private equity funds were required to obtain exchange control approval from the South African Reserve Bank (Sarb) on a case-by-case basis for investments outside of South Africa.
In late 2010, following significant lobbying from the industry, the Sarb introduced a new exchange control dispensation for private equity funds. Domestic private equity funds mandated to invest into Africa can now apply for upfront exchange control approval to invest all of their commitments. The approval is usually issued subject to a number of ongoing reporting requirements and, in some cases, requires renewal every three years. The applicant fund is also required to acquire at least 10% of the equity capital of each foreign target company in which it invests.
9. Tax residency of foreign investment funds
A South African asset manager of an offshore investment fund faces a significant risk of dragging that fund onshore – that is, of the fund being deemed to be resident in South Africa for tax purposes.
However, under the Income Tax Act, certain services provided by a South African manager to a foreign investment fund are now disregarded for the purposes of determining whether that fund is tax resident.
The carve-out has a number of requirements. Most notably, the offshore fund’s portfolio must comprise solely of cash, government bonds, listed instruments and regularly traded unlisted instruments. As a consequence, private equity funds generally do not qualify for the carve-out.
A further requirement of the carve-out is that South African residents may not directly or indirectly own more than 10% of the value of the offshore fund.
10. Pension fund investment into alternative funds
Prudential rules for South African pension funds are set out in regulation 28 under the Pension Funds Act. Regulation 28 was revised in February 2011 to introduce many new investment categories for pension funds, including “private equity fund” and “hedge fund” categories.
Under the new regulation 28, a pension fund can, subject to certain requirements, invest up to 15% of its assets in hedge funds and private equity funds, whether local or foreign.
Shawn Barnett is a banking and finance lawyer based in Johannesburg and is a director of law firm Norton Rose Fulbright. This article first appeared in Norton Rose Fulbright’s banking newsletter on March 18. It is reproduced with permission.