Collective Investment Schemes Control Bill: finalisation

Meeting report

FINANCE PORTFOLIO COMMITTEE
16 August 2002
COLLECTIVE INVESTMENT SCHEMES CONTROL BILL: FINALISATION

Chairperson: Ms B Hogan (ANC)

Relevant documents
Collective Investment Schemes Control Bill [B28-2002]
Proposed amendments from Edward Nathan & Friedland Attorneys (Appendix 1)
Standard Executors and Trustees Limited proposed amendments (Appendix 2)

SUMMARY
Concern was raised with the discretion granted to managers to decide on the information to be made available to investors under Clause 3, and an amendment was proposed to resolve this. The extent to which Clause 46 encourages consultation between the registrar and the industry was discussed, and an amendment was proposed to ensure such consultation. The FSB expressed concern with enacting a similar amendment to Clause 67 as it needs to act swiftly and efficiently in such cases, and it was suggested that the current formulation of the provision be retained. The reason for specifically including a "public company" alone and not other types of companies in Clause 69 was discussed, and the concerns raised by Standard Executors and Trustees Limited with regard to Clause 70 were considered.

The concerns raised by Edward Nathan & Friedland Attorneys regarding Clause 99(3)(c) and the consent required from unit holders was discussed, as well as the extent to which this clause differs from the former Section 24(4) of the Unit Trust Control Act and whether a quorum or majority response requirement should be adopted. The second concern raised by Edward Nathan & Friedland Attorneys regarding the possible registration of linked investment service providers (LISPs) as managers as well was discussed, and the FSB assured the Committee that this could not occur in practice.

MINUTES
The Chair suggested that the Bill be considered by Members on a chapter-by-chapter basis, rather than clause-by-clause.

Part 1: Collective Investment Schemes
Clause 3: Disclosure of information
Concern has been raised with Clause 3(b) and the type of information that the manager considers necessary, because it presupposes knowledge of what the investor might feel is necessary. Should it not be amended to read "information that is necessary to enable the investor to be informed"?

Mr Rob Barrow, Deputy Executive Officer/Deputy Registrar: Investment Institutions of the FSB, replied that Clause 3(b) has to be read together with Clause 100, which details the full requirements for such disclosure.

The Chair reiterated that Clause 3(b) leaves it to the discretion of the manager as to which information should be made available to investors, and perhaps the amendment proposed should be enacted.

Mr Barrow replied that he has no problems with including the amendment.

The Chair noted that the proposed amendment is agreed to by Members.

Part IV: Collective Investment Schemes in Securities
Clause 42: Procedure for registration of manager of collective investment scheme in securities
The Chair asked Mr Barrow to explain the reason for requiring managers alone to register.

Mr Barrow responded that the structure of the scheme is such that only the managers operate the portfolios, and the manager of the management company is therefore licensed to carry out the business of the scheme, such as repurchasing of interests or holding prudential capital. One could then say that the management company is the scheme per se.

The Chair asked whether this means that when the manager registers it is therefore the management company or the scheme itself which is registering.

Mr Barrow answered in the affirmative, and added that the management company would then have to register each individual scheme or portfolio.

Clause 46: Limitation on investment in portfolio
Ms R Taljaard (DP) referred to the regulatory power granted to the registrar by this clause, and asked for clarity regarding the degree of consultation it encourages between the registrar and the industry. This is an important concern because it creates the potential for a very prescriptive regulatory power, apart from the fact that the registrar can be relied on to exercise discretion with the requisite degree of circumspection. The current wording of the provision does not provide for this consultation.

Mr Barrow replied that he is pleased that Ms Taljaard phrased it is "degree of consultation" because this matter has been bandied about with the industry for the last three years. This is a tricky area and the most likely to change rapidly. It has been discussed and debated very extensively, and the advisory committee serves as the check and balance here. No regulation may be issued unless it has first been approved by that committee. The benchmark in this regard is the European Union standard, which may not be the best standard but is the accepted practice.

Ms Taljaard suggested that this makes her concern even more significant because this provision is the key determinant of the pace of the industry. The role of the advisory committee as explained by Mr Barrow is accepted, but the provision has to be tightened up. A possible solution could be to refer to the role of the advisory committee by inserting the phrase "after/in consultation with the advisory committee". Mr Barrow has indicated that it is included in the process operates in practice, and it should thus be included in the provision in principle.

Mr Barrow replied that it would not be problematic to effect this amendment.

Ms Taljaard suggested that the same phrase would be inserted between the words "may" and "determine" in both Clause 46(1) and (2).

The Chair noted that this proposed amendment is agreed to.

Part V: Collective Investment Schemes in Property
Clause 49: Foreign country in which collective investment scheme in property may invest
The Chair requested the reason for including an investment grade in this clause.

Ms R Joemat (ANC) informed the Chair that this matter has since been resolved.

Part VIII: Foreign Collective Investment Schemes
Ms Taljaard stated that the same concerns apply here as those she raised regarding Clause 46, but cannot recall the specific clause.

Mr Barrow replied that this could refer to Clause 67, and the identical amendments to those effected under Clause 46 could be added here.

The Chair agreed, and noted that the Committee approved of these amendments.

Mr Barrow stated that the phrase "after/in consultation with the advisory committee", as suggested earlier by Ms Taljaard, can be inserted in Clause 65(1) before the word "approve".

The Chair asked whether the same could be done for Clause 67.

Mr Barrow replied that it would be problematic to effect those same changes in Clause 67, because requiring the registrar to consult with the advisory committee as to whether approval should be granted does make things difficult for the FSB. The only time the registrar would withdraw approval under Clause 67 would be when there is a problem and it stops the particular fund from marketing its product. In such cases the FSB needs to act swiftly, and requiring it to first consult the advisory committee would compromise this efficiency.

The Chair agreed that the FSB needs to act quickly in such cases.

Mr Barrow added that the current FSB Act requires the licensing committee to clear all licensing approvals. This body consists of one representative from the FSB and four or five members are independent of the FSB. They have to clear the licensing approvals, and this is the check and balance put in place by the Bill.

The Chair agreed with this structure, and recommended that Clause 67 then contain a reference to the relevant provisions in the FSB Act in this regard.

Ms Taljaard stated that she does not have a problem with including such a reference in Clause 65, but it does depend on how the advisory committee plans on registering the other types of funds.

The Chair contended that to include a proper reference to the FSB Act and to enable this Committee to properly understand that Act, it should be included in this provision. It would, however, be too complicated to do so at this stage of proceedings.

Ms Taljaard agreed, and stated that it has to be ensured that this Bill does not "overreach" the FSB Act. Sufficient checks and balances have to be put in place here.

Ms L Mabe (ANC) agreed that, if the registrar has to act as swiftly as possible, this has to be reflected in the Bill that no restrictions can be imposed on the registrar here. Therefore the current formulation of the Clause 67 should be retained.

The Chair informed Ms Mabe that her assertions relate to Clause 67, whereas the current discussion concerns Clause 65. Her concerns have thus been covered by the discussion on Clause 67.

Part IX: Trustee or custodian
Clause 69: Appointment and termination of appointment of trustee or custodian
The Chair asked Mr Barrow to explain why Clause 69(1)(a) specifically includes a "public company", and not other types of companies as well. She does not have any objections with its inclusion in principle, because the Committee has been informed that its inclusion is in line with international practice, but clarity is merely requested on the reason for its inclusion.

Mr Barrow replied that this wording is identical to the corresponding provision in the current legislation. This matter was debated extensively by the drafting committee and the decision was taken to include a "public company" and not other types of companies because, as he understood it, public companies this clause requires that it has to be an entity that is required to file its documents in the public arena. It does not have to be a listed company, but must be of a public nature so that the public can have access to its documents. The Companies Act contains a number of provisions which exclude some non-public companies from having to disclose information, and it was therefore decided the provision should specifically include a "public company" so that these exemptions would not apply in this clause.

Clause 70: Duties of trustee or custodian
The Chair requested Mr Jurgen Boyd, Head of the Collective Investment Schemes Department: FSB, to respond to the letter received from Standard Executors and Trustees Limited (SETL) [see document above].

Mr Boyd replied that he has not yet had time to adequately consider it but Mr Klaas Badenhorst, the FSB legal advisor, has replied to the letter on his behalf, and he thus agrees with the answer provided by Mr Badenhorst.

The Chair asked Mr Boyd whether he agrees with SETL that Clauses 70(1)(a) and (b) needs clarity.

Mr Boyd answered in the affirmative, as the current formulation could be widely interpreted. Furthermore, the verification exercise is conducted by the management company in any event.

The Chair stated that this matter would be considered later.

Mr Barrow stated, having considered this matter with the FSB legal advisor, it appears that SETL have offered a strict interpretation of the word "verify" to mean that the trustee would then have to reperform and check every transaction. Clauses 70(1)(a) and (b) could be amended by replacing the "verify that" with the phrase "ensure that the basis on which". This would make the trustee responsible for ensuring that the procedures of the management company reach the desired result.

The Chair noted that all agreed to this amendment.

Part XII: General
Clause 99: Amalgamation of business of collective investment schemes or portfolios and cession, transfer or take-over of rights of investors
The Chair drew Members' attention to the letter from Edward Nathan & Friedland Attorneys (ENF) [see document above] which raises concern with this clause 99. The concerns raised do make sense, because if the management company has to wait for a response from investors before proceeding, the matter would never be resolved.

Mr Barrow replied that the ENF reading of Clause 99 misunderstands the true intention, because it provides that the registrar has to obtain the consent of the majority of unit holders.

The Chair stated that ENF is asking how the registrar will proceed should it not get a response or a majority of unit holders.

Mr Barrow replied that in this case the amalgamation could not proceed and is thus the same as any consent-type transaction, because a certain element of support is needed. The FSB has difficulty in saying that, should the investors not respond, they would effectively lose their rights here, because these rights of investors have to be protected.

Ms Mabe contended that this is part of the marketing process, and if the management company wants to effect an amalgamation it has to address the passivity of the investors.

The Chair asked how difficult it would be to elicit a response.

Ms Joemat replied that the investors would usually receive a letter stating that their failure to respond would allow the management company to assume that they agree with the amalgamation.

The Chair stated that this is the position under the former Unit Trusts Act, but it is not included in the Bill. The Bill does however provide that the management company has to get a response from the majority of shareholders.

Ms Taljaard requested that Members be provided with copies of Section 24(4) of the Unit Trusts Act.

The Chair stated that this could be done, but encouraged Members to "take it as the truth" that that section says exactly what the ENF letter says it does.

Mr Barrow read out Section 24(4).

The Chair stated that this section is clearly different to Clause 99, because it provides that investors are deemed to agree. The position in the Bill is therefore preferable. But does Clause 99 include the process outlined earlier by Ms Joemat?

Mr Barrow replied that Clause 99 requires the management company to secure a majority response.

Mr David Stronach of the Association of Unit Trusts informed Members that current practice requires the management company to write to all the investors, and a quorum of 25% of the number of units in issue is required. A majority response is needed, and if the management company cannot secure a quorum it has to be reballotted. A simple majority would then be sufficient at the re-ballot.

The Chair stated that this does make sense, because the quorum at least allows those opposed to the amalgamation to voice their disapproval. It also does not allow a simple walkover for the management company. Thus the present system has to be retained, and the question then is whether the Bill accurately reflects this current practice.

Mr Stronach replied that this does not seem to be the case.

The Chair contended that the reason could be that the Bill requires a majority, whereas the current system requires a quorum.

Mr Stronach responded that it does seem as though a majority is needed here.

Mr B Mnguni (ANC) asked whether the Bill protects investors.

The Chair contended that the investors could in fact be better protected by an amalgamation. A quorum is needed so that those investors who feel strongly enough about it can stop the amalgamation. It has to be made possible to stop an amalgamation, but an amalgamation cannot be allowed to happen just because of the passivity of investors.

Ms Mabe stated that the current majority requirement is fine. It is important that investors have information which is as straightforward as possible so that it stimulates investors to respond. In most cases the investors do not respond because of the manner in which the correspondence is drafted.

The Chair stated that it became evident during the hearings and training sessions that a vast number of people are involved here, and if the majority requirement were to be adopted the administrative costs that would have to be incurred by the management company in notifying these investors to secure the amalgamation would be huge. This is not one of the most serious investments an investor could make because this clause only deals with an amalgamation, and it would be easier to stop an amalgamation via a quorum than a majority. It is thus suggested that the quorum requirement be maintained so that flexibility is granted either way.

Ms Joemat agreed that a quorum be adopted because should a majority be accepted with the current culture of "non-response", the hands of investors could be tied.

Ms Taljaard agreed with the Chair and the issues of practicality and speed highlighted in her reasoning. This legislation should also not be seen to favour amalgamations, but should instead be sensitive to both scenarios.

The Chair asked whether Mr Barrow has formulated an amendment that includes the quorum.

Mr Barrow, having requested some time to consult the FSB legal advisor on this matter, stated that he has been informed by the legal advisor, who was part of the team that drafted the Bill, the Bill replaces the negative formulation of the previous legislation with a positive one. There is also a presumption that a failure to respond amounts to an acceptance of the situation. It is therefore proposed, in an attempt to clarify the situation, that wording similar to the previous section be used. The phrase "consented to the proposed transaction" in Clause 99(3)(c) will be replaced by wording - the gist of which reads: not been informed by the manager in writing on or before a date to be determined by the registrar and disclosed by the manager in writing to every such holder that they refused consent to the proposed transaction.

Mr B Kannemeyer (ANC) asked how this formulation reflects the current position outlined earlier by Mr Stronach, because the proposed formulation implies that the amalgamation would go through if no shareholder responds.

Mr Barrow replied that the procedure outlined by Mr Stronach relates to the standard deed and a ballot is required to amend the trust deed. This is, however, a different situation and provides that an amalgamation needs something different if the investors do not respond.

Mr Stronach stated that a distinction has to be maintained between a simple amalgamation of a scheme and the situation where the amalgamation rights of investors are changed. The latter requires a ballot procedure, and a quorum is used to amend the deed which does not necessarily involve an amalgamation.

Mr Barrow stated that the new Clause 99(3)(c) does not include a quorum requirement, and it would then use a majority.

The Chair moved on to the second concern raised by ENF regarding the possible classification of linked investment service providers (LISPS) as managers as well.

Mr Barrow replied that the same entity cannot be granted both a LISP and unit trust investment license.

The Chair stated that Mr Barrow's reply assumes regular communication between the registrars of each.

Mr Barrow responded that the same registrar licenses both the LISP and unit trust investment scheme. Furthermore, the two are distinct as the LISP invests on behalf of people, whereas the management company offers the investment product itself. Therefore the concern raised by ENF would never come to pass.

The Chair asked whether it was ever the intention of the drafters of the Bill that this be allowed.

Mr Barrow replied that this was never the intention.

The Chair requested Mr Barrow to reduce the actual intention to writing.

Mr Barrow agreed, and added that LISPS and management companies could very well exist within the same group, as is done by Investec, but the nature of business conducted by a LISP precludes it from functioning as a management company.

The Chair noted that all the proposed amendments were agreed to and read the Motion of Desirability. There were no further questions or comments and the meeting was adjourned.

Appendix 1

COLLECTIVE INVESTMENT SCHEMES BILL

I have recently reviewed certain provisions of the Collective Investment Schemes Bill ("the bill") and there are two aspects on which I wish to express a view.

Section 24(4) of the Unit Trust Control Act ("the UTC Act") is not repeated in section 99 of the Bill. As you know, both section 24 of the UTC Act and section 99 of the bill deal with the amalgamation of unit trust schemes or collective investment schemes. Both these sections require the consent of both the registrar and the majority in value of the investors to amalgamated; and the registrar is required to be satisfied that the investors have been able to make an informed decision and that their rights are not jeopardised by the scheme.

Section 24(4) of the UTC Act is particularly important because it provides essentially that the consent of investors to the amalgamation of a scheme is deemed to be given if they do not object. Investors are notoriously passive, and if this provision (section 24(4) of the UTC Act) is not repeated in the bill then it will have the effect of making the amalgamation of a collective investment scheme considerably harder than was the case in terms of the UTC Act.

I would urge you to consider inserting the provisions of section 24(4) of the UTC Act in the bill for the following reasons;-

1. The protection of the investor as an underlying principle of the bill is to be commended, and for what it is worth I agree with all the provisions of the bill to that effect. However, as stated above, investors are notoriously passive and find it far more difficult actually to give their consent to something, particularly when such amalgamation schemes may be complex and the rationale for it not easy to understand the registrar effectively acts as a watchdog for the interests of the investor in the amalgamation of such schemes, and as investors in any event always have the right to object to any scheme, I submit that the interests of investors would be sufficiently protected if the provisions of section 24(4) of the UTC Act were to be repeated in the bill.

2. If the provisions of section 24(4) are not repeated in the bill then, as stated above, it will effectively be much harder to amalgamate collective Investment schemes. If investors would be sufficiently protected despite the inclusion of section 24(4) in the bill, it is difficult to understand the rationale for making it harder for schemes to merge. It Is a settled fact that the collective Investment schemes industry, at least In the equity portfolios, is in need of some ratlonalisation; and if there are mergers at manager level It would not enhance competition for a manager to have to operate identical schemes with the inefficiencies that flow from duplication merely because the amalgamation of collective investment schemes has been made more difficult. One of the effects of making the amalgamation of schemes more difficult could well be to decrease competitiveness and this would not be in the interests of the investor nor is it one of the purposes of the bill.

The other aspect of the bill about which I have a comment is that although it is not apparent from the bill itself understand that it is intended in terms of the proposed draft regulations (which I have not yet seen) that it will be easier for companies to obtain the requisite authority to operate as a manager. Whilst there is nothing wrong with that in principle, I do not think that linked investment service providers should be permitted to operate as a manager because, whether effectively or not, LISPs do fulfil a watchdog role by monitoring the buying and selling and valuation functions of managers; and if the same entity were to provide both functions (that of a manager and a LISP) the apparent benefit of this would be lost.

The views expressed above are mine personally and do not necessarily reflect those of my firm.

Yours truly
JWT MORT

Appendix 2

14 August 2002

Collective Investment Schemes Control Bill

We refer to the conversation with the writer on 1 August 2002 during which you requested us first refer the interpretation of section 70 (1) (a) (b) of the Bill to the Registrar of Unit Trusts before a written submission is addressed to the committee. We have adhered to your request and quote both the submission and the response from the representative of the FSB:

"Dear Mr Boyd

We refer to the Collective Investment Schemes Control Bill 2002 published in the Government Gazette No.23253. More particularly the interpretation of section 70(1) (a) and (b) of the Bill.

Section 70 (1) (a) and (b) stipulates that:

A trustee or custodian must-

"(a) verify that the sale, issue, repurchase or cancellation, as the case may be, of participatory interests effected by or on behalf of a collective investment scheme is carried out in accordance with this Act and the deed,

"(b) verify that the selling or repurchase price of participatory interests is calculated in accordance with this Act and the deed",

As you know, to date the trustee or custodian had no formal duties relating to the pricing of units.

Whilst preparing ourselves for the promulgation of the Act the question arose as to how the

abovementioned sections should be interpreted. That is, especially bearing in mind that certain interpretations could have significant cost implications for the trustee. The Bill places the trust custodian under the duty to "verify" the pricing of the units. According to the Oxford dictionary the term verify means "to establish or confirm the truth". As we see it the said subsections could be interpreted in two ways:

A The trustee or custodian must merely verify that the methodology used by the management company to price the units is in compliance with the Act and the deed.

B In addition to verifying the methodology used, the trustee or custodian must also obtain, from an independent source, the value of the underlying assets of the unit portfolios and do a complete duplicate pricing of the units to verify that it is in compliance with the Act and the deed. Bearing in mind that the trustee or custodian does not have any records of unitholders, the trustee would have to rely on certain information provided by the management company to do the pricing of the units. The management company and the trustee would also have to agree on the exact time the respective unit portfolios will be priced on a daily basis.

The question also arises as to the frequency with which the trustee will be required to verify the pricing of units. In terms of the Act and the deed the management companies are required to price the units on a twenty-four hour basis. It could consequently be argued that, if the management companies are required to price the units of the unit portfolio on a daily basis, the trustee or custodian would be required to verify the pricing on a daily basis. If the interpretation mentioned under B above would be correct, the daily verification of pricing, combined with the other compliance duties of the trustee, would indeed be onerous and costly. The ad hoc verification of the pricing of the units on the other hand, say at least twice a month, would pose no difficulty at all.

I have discussed these two aspects with Mr A Hermans (Secretary to Parliament), and suggested that we first obtain clarity from you as the appropriate Regulator on the existing wording of the Bill before we submit a written representation to the committee. We shall indeed appreciate receiving your valuable comments on how the said sub -sections should be interpreted before we decide on a course of action.

Your assistance is much appreciated."

The response:

"Dear Kobus,

I refer to your letter of 01-08-02 addressed to Jurgen Boyd in connection with the interpretation of clause 70(1) (a) and (b) of the Collective Investment Schemes Control Bill.

I agree with your first (A) interpretation of paragraphs (a) and (b) of the said clause. It is, in my opinion, the carrying "out in accordance with this Act and the deed" (paragraph (a)) and the calculation "in accordance with this Act and the deed" (paragraph (b)) that must be verified. Clause 70 (1)(a) and (b) refer in general terms to a "sale", etc., and to the "selling or repurchase price of participatory interests". There is no indication that each and every sale, etc., and each and every pricing must be verified so as to confirm that the methodology prescribed by the Act and the deed is followed. Verification at intervals which are reasonably regular in the context of clause 70 will, in my opinion, be sufficient.

Kind regards

Klaas Badenhorst"

As mentioned in the submission to Mr Boyd subsection 70 (1) (b) in particular does leave itself open for more than one interpretation. In view of the response from the FSB it would be appreciated if the duties of the trustee in terms of the two said sub-sections could be described in more detail in the legislation to avoid any misunderstanding or misinterpretation in the future.

We thank you for the opportunity to put forward a submission after the deadline date, and trust that our request will be responded to favourably.

Yours faithfully

Kobus van Schalkwyk

Senior Manager: Legal