Sello Alcock spoke to Rosemary Hunter on the possible implications of the proposed reforms.

Sello Alcock: The most radical aspect of the proposal, in my opinion, is the suggestion that the number of retirement funds be reduced considerably. Is this even feasible?

Rosemary Hunter: Yes it is. We must remember that the State subsidises our retirement savings by allowing deductions of contributions to, and benefits paid by, retirement funds from the income of members and employers subject to certain conditions. If those conditions are strengthened, so that the deductions are only available in relation to the contributions that are paid to, and benefits paid by, retirement funds that comply with conditions relating to size of membership, we will soon see employers and employees wanting to close down small, inefficient funds and to participate instead in accredited, larger and better run retirement funds.

Sello Alcock: One of the reasons the Treasury wants to reduce or consolidate the number of pension funds is presumably that the majority of funds are just not big enough to achieve economies of scale, which leads to higher charges. The Treasury suggests a move towards “multi-employer arrangements”. Are you convinced of this suggestion?

Rosemary Hunter: Yes. In the past few years this firm has advised an increasing number of retirement funds on the terms of the agreements that they conclude with providers of various products and services to the funds. It has been clear from this work that it is only the large funds which have significant bargaining power and are able to conclude agreements on terms that provide some measure of protection for the retirement funds and their members. The smaller funds find themselves signing agreements prepared by the providers and which include clauses designed to protect those providers against risk, such as limitation of liability clauses, minimal reporting obligations and the like.

Sello Alcock: On a practical level, I know this might be a tough ask, what would these “multi-employer arrangements” look like?
Rosemary Hunter: We already have many ‘multi-employer’ funds in this country, although we call them ‘umbrella funds’. They include:

Industry funds established by parties to industrial council agreements, for example, the Engineering Industries Pension Fund, the Metal Industries Provident Fund, and the Automakers Pension and Provident Funds;

• Union funds, that is, funds established by trade unions for the benefit of their members employed by unrelated employers;
• Funds established in terms of sectoral determinations like the Private Security Sector Provident Fund;
• Umbrella funds established by service providers such as the Alexander Forbes Umbrella Pension and Provident Funds, the Momentum FundsAtWork Umbrella Pension and Provident Funds and the Evergreen umbrella funds established by Old Mutual.
• Government has proposed measures to promote the move towards fund consolidation in large umbrella funds like these, and improvements in the way that these funds operate.

Sello Alcock: There has been talk of a move to a twin peaks financial regulation model for a while now and the policy proposal seems to suggest that this ‘super regulation model’ will be aided by consolidating existing funds. It also sounds like this new regulator will have broad powers to monitor and even issue standardised documents like fund rules, investment mandates, service level agreements and codes of practice for use by funds. Is this not essentially an encroachment on the specialised territory held by pension lawyers and financial services professionals?
Rosemary Hunter: The ‘Twin Peaks’ model of regulation being adopted by an increasing number of countries envisages two regulators for the financial services sector:

• a central bank (in our case, the Reserve Bank) with responsibility for ‘macro-prudential’ oversight and regulation to promote the health and stability of the sector; and,
• a market conduct regulator (which will replace our Financial Services Board) with responsibility for  promoting and enforcing higher standards in the provision of financial products and services including those provided by banks, insurers, the capital markets, investment funds and retirement funds.

It may be that if the use of, amongst others, standard-form rules, constitutions and agreements is encouraged or required, in the future pension lawyers will be asked less often to draft these documents. But it is not the State’s job to protect pension lawyers by ensuring that they have lots of this kind of routine work to do. Its duty is to protect the most vulnerable and, if it can do this by reducing the reliance of retirement funds on lawyers for these services, we should applaud the move. Good lawyers have nothing to fear from these changes. Transitions of this kind are always complicated and there will be lots of work for lawyers who are able to provide the State, regulators, employers, unions, members, providers of products and services and other stakeholders with the advice that they need to successfully manage the changes.

Sello Alcock: Do you think the regulator, which I assume will be the Financial Services Board, has the capacity to carry out this mammoth task?
It is the National Treasury that is making these policy proposals and, if they are to be implemented, it will prepare the draft laws required for the purpose for consideration by Parliament. Then it will be up to both the Reserve Bank and the Financial Services Board (or the new ‘market conduct’ regulator that will replace it), in consultation with the National Treasury, to ensure that the laws are complied with. I am confident that they will have, or will be able to obtain, the expertise that they need for the purpose. They will also need the assistance and support of experts working in the retirement and investment sector and indications are that this will be made available.

Sello Alcock: The other area, and perhaps closer  to home, the Treasury is looking to improve is the way funds are governed. One of the suggestions, at least as I understand it, is to use legislation to make cost-effectiveness one of the duties of members of boards of management of pension funds. Do you think this will work?

Rosemary Hunter: It is already a common law duty of the board of management of a retirement fund to use the assets of the fund in a cost-efficient and cost-effective way to fulfil the objectives of the fund. And if it cannot do that, that alone is an indication that the fund should be closed and its assets and liabilities transferred to a retirement fund that can. However, sometimes members of our boards are not aware of their common law duties and so it is helpful to set some of them out in legislation.

Sello Alcock: The Treasury also wants to change the law in order to alter the composition of management boards by including “expert” and “independent” trustees. Will this in any way enhance the governance levels of boards of management?

Rosemary Hunter: This is a controversial issue. Some unions have suggested that ‘independent trustees’ will undermine the ‘democratic’ way that the boards of many retirement funds are now comprised, with members having the right to elect at least 50% of the trustees. While the fact that members have this right has helped to improve the governance of some funds, it has not been sufficient to get standards of governance to the level required for proper member protection. There are both ‘good’ and ‘bad’ board members amongst those elected by fund members and those appointed by employers. By ‘good’ board members I mean board members who have appropriate levels of knowledge and skill and who act with integrity, vigour and vigilance and exercise their discretion independently and in the interests of the funds, taking into account the interests of other stakeholders but not being bound to promote them at all times. I do think that professional independent board members could help the boards of funds improve their standards of governance and oversight.

Sello Alcock: There is also a suggestion that these boards will be compelled to adhere to principles akin to the King III code. Are such measures, often considered ‘soft law’, not going to be toothless?

Rosemary Hunter: Many of the ‘good governance’ principles and practices reflected in the King III Code are principles and practices which, if adopted, will assist the boards of retirement funds to comply with their existing common law and statutory duties. It is the common law and statutory duties that are enforceable and they are not ‘toothless’.

Sello Alcock: The other suggestion is to formalise the role, rights and obligations of employer-level committees within funds. What are your thoughts on this?

Rosemary Hunter: One of the problems with large multi- employer or ‘umbrella’ funds is the fact that their boards cannot properly take into account the facts and circumstances of specific groups of members and their employers when making decisions. For this reason it might be appropriate for the law to require umbrella funds to have what many of them have already provided for in their rules – ‘management committees’ the members of which are drawn from members employed by a specific employer or the employer itself and which are empowered to make decisions applicable only to them. These decisions could relate to, for example, the allocation of fund assets held to provide for future benefits for the members employed or formerly employed by the employer amongst the various asset classes, the kinds of benefits that should be payable on the disablement or death of an employed member in the group, and the allocation of shares of a benefit payable on the death of a member amongst his or her dependants and nominees.

Sello Alcock: The Treasury also suggests that the complexity of some retirement and risk products are part of the reason charges are so high. Do you agree?

Rosemary Hunter: Yes I do. As you know, it can be difficult to choose which cell-phone package amongst the numerous offerings from various providers would be right for you. Imagine how much harder it is for the board of a retirement fund to decide which financial products and services would be the right ones for the fund, particularly when they are often impossible to compare. They may be able to compare the percentage of contributions which will be required to be used to provide for the fund’s expenses in relation to basic fund administration and the premiums payable to insurers for death and disability cover. But sometimes those products and services are ‘packaged’ with other products and services in a way that makes it impossible to see what you are paying for each element. And many of the costs that funds incur in relation to investment-related services such as investment consulting, asset management, asset valuation, portfolio monitoring and re-balancing, unitisation, transition management,  scrip-lending and the like are based on the value of the assets of the fund and performance measurement standards that ordinary people like you and me struggle to understand. Furthermore, because the costs are deducted from the ‘returns’ earned on the investment of the fund’s assets, the board may not realise quite how much the fund is paying for the services and so may never even apply its mind to the question of whether it is getting value for money from providers of products and services.

Sello Alcock: Intermediaries, although important, also seem to push up the charges. Is there a way around this?

Rosemary Hunter: Yes. For so long as retirement funds have to make decisions in the context of the complexities I have just described, they will need intermediaries to advise them. Unfortunately the advice of some intermediaries has been designed to maximise their own earnings rather than to serve the best interests of funds. So, in my opinion, it would be appropriate for the law to be changed to require that providers of financial products and services price those products and services and report on their performance in ways that enable the boards of retirement funds to properly compare and evaluate them. This should reduce their reliance on intermediaries. Again, the better intermediaries should have nothing to fear. There will still be a need for expert financial advice, particularly in the period of transition which is likely to last for many years. But those intermediaries who have got used to making “money for nothing” might need to consider more honest ways to earn a living in the future.