Key issues in the new draft default legislation
Treasury has made numerous amendments to the first draft of their retirement funds default regulations released on 9 December 2016. Denver Keswell, Senior legal advisor at Nedgroup Investments has commented extensively on the first draft of the retirement funds default regulation and believes that this latest shows clear commitment by Treasury to improve the long-term savings position of South Africans.
“Whilst Treasury has made many amendments to their initial draft, it is encouraging to see that Treasury has, in line with its commitment to act in member’s best interests, considered the industries views with regards to the draft. It is also encouraging to see that Treasury are willing to introduce legislation to ensure that retirement fund members are in a much better position when they get to retirement, to actually afford to retire,” he says.
Whilst many interesting issues were raised in the second draft, the regulation can be broken down into 10 key issues:
- Definition of “annuity strategy
- Retirement benefit counsellor
- Characteristics of members
- The active vs. passive debate
- Performance fees and guarantees
- Default preservation and portability
- Unclaimed benefits
- In-fund vs. out-of-fund annuities
- Retail funds vs. employment funds
Definition of “annuity strategy”
The definition of annuity strategy has been amended to an “opt-in” instead of an “opt-out” strategy. An important understanding of the first draft default regulations was that the intention was not to force retirement fund members into default options. Members would always have the option to opt-out of the default fund should the default be inappropriate for the specific need.
However, the first draft default regulation was structured so that annuitants with a default conventional annuity would not be able to opt-out. This is because the characteristic of a conventional annuity does not allow one to transfer out. Therefore, in the second draft, Treasury has amended the definition of a “default annuity” so that an annuitant has the option to “opt-in” instead of automatically being transferred into the default (as is done for both the default investment portfolio and default preservation strategies). This proposed change is a sensible one as it allows a retiring member to opt-in to a default annuity strategy that may be appropriate for their need - as well as being cost effective.
Retirement benefit counsellor
The definition of “retirement benefits counsellor” has been amended to “retirement benefits counselling”.
This amendment puts to bed some confusion around whether every retirement fund must have a FAIS approved individual to provide advice to every single retirement fund member. The new definition clarifies that the fund itself is able to decide how information (and not advice) is provided to its members.
Characteristics of members
Section 37(2) of the second draft of the Retirement Funds Default Regulation requires that a default investment portfolio be appropriate for members. Whilst this is still a requirement in the second draft, Treasury has removed the requirement that every default investment portfolio must as far as possible take account of “the likely characteristics and needs of that category of members”. The requirement that a retirement fund consider each members “risk and return”, “future term of membership”, “financial sophistication” and “their ability to access individual financial advice” was far too onerous and this amendment will be welcomed by retirement funds.
The active vs. passive debate
The initial draft required that retirement fund board members must be able to show that “they considered the passive or enhanced passive investment of listed assets” when they design their default investment portfolio.
Treasury is of the view that passive funds could be used where appropriate to lower member’s costs. Currently the majority of retirement funds have elected active investment strategies for their members - with very few considering passive investments. The second draft regulation requires that “boards should consider both passive and active investment strategies as part of the default investment portfolio”.
Performance fees and guarantees
Treasury has indicated in the recent past that they do not support performance fees. In the initial draft as well as with the introduction of tax-free investment products Treasury indicated that they will not allow performance fees. Whilst performance fees are still not allowed on tax-tree investment products, Treasury revised their decision to disallow performance fees in the second draft. They do indicate that they would like to see stricter compliance and monitoring of performance fees and will revisit this decision if necessary.
It seems that Treasury has done a similar U-turn on the requirement that the default investment portfolios should be purely for investment purposes only.
Currently many retirement funds offer their own “default funds” which are not in line with the proposed default regulations. Even though the initial draft did not specifically require it, concerns were raised regarding the potential consequences of forcing current default funds to either change their structure to meet the current proposals or transfer into new regulated default funds. Treasury has indicated in their explanatory memorandum on the draft default regulations that existing default funds will be exempt from the final default regulations. All new members going into default funds will have to be invested in the regulated default funds.
Default preservation and portability
In the first draft of the regulation, there was some concern that the initial draft required that the “pot must follow the member”.
Treasury has now clarified that the transfers from the default preservation fund will only be allowed if the member elects to do so. This applies to transfers to both outside retirement funds as well as the current retirement funds’ default fund. Members will always have the option to either transfer out of the default preservation fund or withdraw any allowable cash.
Unclaimed benefits is an issue that the Financial Services Board as well other industry bodies have been trying resolve for a while now. Treasury would like the paid-up certificates issued to members to be deposited in a centralised database. The new retirement fund that a member joins should then enquire as to whether the member has a paid-up certificate. This should assist in future with tracking members/dependants with unclaimed benefits.
In-fund versus out-of-fund annuities
There were some concerns that the first draft of the regulation only made provision for in-fund living annuities. Furthermore, there was a concern that that many of the smaller retirement funds were not in the business of providing in-fund living annuities and would therefore resort to guaranteed annuities as their defaults. The second draft makes it clear that both in-fund and out-of-fund living annuities can be used as default annuities provided all the proposed requirements are met.
Retail funds versus employment funds
In their explanatory memorandum, Treasury indicates that the proposed default investment portfolios will not apply to retirement annuities as it is usually a condition of these funds that a new member selects their fund choice at on boarding. Retirement annuities will also be excluded from the default preservation strategy as membership is not based on an employer-employee relationship and therefore a member is unable to resign. What is interesting though is that Treasury has indicated that the proposed default annuity strategy will apply to retirement annuities as a member is required to annuitise their benefits at retirement. It is assumed that the member will be able to opt-in at any stage after they reach age 55 as a retirement annuity member is able to retire from age 55 onwards.
Treasury has specifically addressed retirement annuities in the retail space but has been silent on retail preservation funds. It would however make sense that the same concept that would apply to retirement annuities will apply to preservation funds.
We will be keeping a close eye on the developments in this regard as well as any impacts they may have on the industry going forward.