FSB refines rules for foreign CIS
Could recent legislative changes mean that we will see more foreign collective investment schemes hit our shores? RISKSA takes a closer look.
The number of foreign investment schemes directly available to South African investors has decreased dramatically over the last eight years, falling from 366 in 2006 to 308 at the end of March this year. However, changes ushered in by the Financial Services Board ( FSB) in January this year have made South Africa more accessible for foreign collective investment schemes, which include foreign exchange traded funds ( ETFs) and mutual funds. Good returns from offshore markets, as well as the depreciation of the Rand against major currencies, has boosted the value of foreign assets in Rand- denominated funds. These two factors have driven demand for Randdenominated foreign funds. Foreign exchange controls restrict asset managers to investing a maximum of 35 percent of their retail assets under management in offshore markets. Wehmeyer Ferreira, head of Deutsche Bank X- trackers, which provides exchange traded funds that track major foreign indices, says demand for foreign investments is likely to remain strong, on the back of improved economic growth in the US last year, a reduction in fears that the Eurozone will break up, the under- performance of emerging equity markets in terms of US dollars and uncertainty about the Rand. According to the 2013 annual report of the Association for Savings and Investment South Africa ( ASISA), the assets under management for foreign collective investment schemes ( CIS) last year was R217 billion.
What are the changes?
Peter Blohm, senior policy adviser at the ASISA says the biggest change was probably the addition of a clause that states that foreign collective investment schemes marketed in South Africa must also be available to similar investors under the same or substantially similar requirements in its own domicile. The conditions required by the FSB before foreign CIS will be allowed to solicit investment in South Africa include: • The regulatory environment under which the scheme operates in its domicile must offer investors the same or a similar level of protection to the protection in South Africa. • Foreign schemes have to enter into an association with a local company or open a local office. This will make it easier for investors to interact with the scheme and obtain required documentation such as tax certificates. • The FSB does not directly regulate foreign CIS schemes but is likely to only approve International Organisation of Securities Commissions ( IOSCO) schemes, or schemes based in countries where there is a multilateral understanding between our regulator ( the FSB) and theirs. • Previously, investment limits were prescribed for foreign funds – to be similar to local funds – in terms of what the portfolio can invest in, for example, equities were capped. • Under the old provisions, foreign Fund of funds was required to invest in five underlying funds. But now the focus has shifted from forcing foreign schemes to look like local schemes. The focus is now on jurisdiction.
• Previous conditions were very strict. Blohm says having an independent custodian is an arrangement that works well in South Africa in a unit trust structure. “The new conditions do require proper independent oversight but the need for an independent custodian has now fallen away,” he says. • The scheme must have sufficient liquidity to be able to pay investors out if they wish to withdraw from the investment. To this end, the local partner or representative office must have paid- up share capital and reserves of at least R2- million. This money must be invested in assets that can be liquidated within seven days. • Foreign CIS are not allowed to invest in financial instruments that will result in the scheme owning physical commodities. • Foreign funds will have to provide the FSB with a document listing the differences and similarities between the scheme and a local collective investment scheme.
Tax treatment of foreign funds a problem
Although the relaxation of rules from the FSB may attract more foreign CIS to our shores, experts say South Africa’s tax treatment of these funds remains a problem.
Shayne Krige, a director at Werksmans Attorneys and head of investment funds practice, says international investors tend to set up their holding companies and fund entities in countries that have the lowest tax rates. “South African tax considerations make it difficult for South Africa to compete as a Pan- African investment fund location,” he says. Hiring a South African investment manager has another major tax consequence for foreign funds under the current system: any profits that are deemed to have a South African source are taxable in South Africa. This may be the case if the local manager has discretion to contract on behalf of the foreign fund. “The ‘ source risk’ is one that is easier to manage in other jurisdictions, and it is difficult for a South African manager to compete for a discretionary mandate against a manager located in a country that has the exemption,” says Krige. He points to the UK as an example of a country that has created an investment management exemption in terms of which, only the investment management fees paid by a foreign fund to a manager based in the UK are taxable. “What South Africa needs is a regime that allows investment managers to conduct discretionary activities, whether under a contractual mandate or through a particular structured participation, without creating any tax risk for a foreign fund,” he says. How investors can access foreign investments If an investor chooses to invest in a foreign CIS, then he or she needs to obtain approval from the South African Reserve Bank ( SARB) to convert their single discretionary allowance or R1 million annual offshore allowance into a foreign currency. The other option investors have, is to use their annual R4 million investment allowance. If they choose the second option, they will require a tax clearance certificate from SARS as well as approval from the SARB.
“What South Africa needs is a regime that allows investment managers to conduct discretionary activities.”
The different types of foreign collective investment schemes
There are several different types of foreign CIS: 1. Unit trust funds or collective investment scheme funds – are very similar to local unit trust funds with regards to structure. Investors pool their money and fund managers then invest the money in a range of shares, bonds and other financial instruments. 2. Open Ended Investment Companies ( OEICs) – were introduced in May 1997. They are registered mainly in jurisdictions including the Channel Islands, Isle of Man and Ireland, and are regulated by the UK Financial Services Authority. Investors obtain participation rights by buying shares in the company. As new investors buy in, new shares are issued. The company has no predetermined termination or end date, which is why it is an ‘ open- ended’ company. 3. SICAVs – these are the same as OEICs but they are typically registered in French speaking countries such as Luxembourg and France. They fall under the European Directive on UCITS ( Undertaking for a Collective Investment in Transferable Securities). 4. Mutual funds – are offered in the United States and have the same structure as an OEIC. 5. Feeder funds – allow investors to invest into an underlying fund through another fund. For example, the Allan Gray- Orbis Global Equity Feeder Fund invests only in the Orbis Global Equity Fund. 6. Fund of funds – this is similar to a feeder fund but invests in a number of underlying funds rather than just one underlying fund.