BY Jessica Blumenthal AND Johan Loubser
banking and finance
South Africa: CIS exemption relating to sale and repurchase obligations
As part of its reaction to the Coronavirus (COVID-19) pandemic, the Financial Sector Conduct Authority (“FSCA”), on 11 May 2020, issued a broad exemption to managers of collective investment schemes in securities permitting them to suspend the creation, issue, sale and repurchase of participatory interests in certain circumstances. We set out and discuss this exemption below at a high level. As at the date of this article, we are not aware of any schemes that have implemented a suspension in accordance with the exemption.
Why was the exemption adopted? According to the FSCA, the spread of COVID-19 is having an increasingly significant impact on the global economy and has also placed the local economy under immense strain. The South African financial market is currently experiencing significant volatility in the domestic bond market and listed property markets and this has impacted on liquidity in certain collective investment scheme portfolios. In the FSCA’s view, it is appropriate to provide managers with additional measures in order to manage portfolios in the best interest of all investors and the market as a whole. The FSCA is also of the view that the provisions in the Collective Investment Schemes Control Act to deal with illiquidity in portfolios “might not be applicable in current circumstances” and do not “allow for mechanisms or tools to deal with the current market conditions”.
Who qualifies for the exemption? The exemption is limited to managers of collective investment schemes in securities. It therefore applies to portfolios such as equity funds, balanced funds, feeder funds, funds of funds, money market funds and so on. It does not apply to collective investment schemes in participation bonds or property and also does not apply to retail or qualified investor hedge funds.
When does the exemption apply? The exemption is effective immediately and applies until amended or withdrawn by the FSCA.
What is the legal effect of the exemption? A manager may now temporarily suspend its obligations under the deed of the collective investment scheme relating to the creation, issue, sale and repurchase of participatory interests in a portfolio, if due to the exceptional circumstances caused by the spread of COVID-19, it is in the interest of investors in the portfolio to do so. If a manager acts pursuant to this permission, then it may not sell any participatory interests or repurchase any participatory interests for so long as the suspension is in place. Such a suspension constitutes a substantial limitation on the rights of investors, who are in ordinary circumstances entitled to place repurchase orders on any business day and can expect for such orders to be processed timeously in accordance with specified timelines set out in the deed, read with the supplemental deed. The exemption does address any contractual undertakings the manager may have given with respect to the sale or repurchase of participatory interests, but the manager may find it impossible to give effect to such undertakings if a suspension is implemented.
To trigger a suspension, what conditions must the manager comply with? The manager must:
- obtain the consent to the suspension relating to a particular portfolio from the trustees of the collective investment;
- inform the FSCA stating the reason for the suspension prior to it taking effect, and possibly provide a further notification to the FSCA with detailed reasons once the suspension takes effect;
- notify investors of the suspension, which notification must cover a number of prescribed topics, including the likely duration of the suspension (information about the likely duration must be updated from time to time on its website);
- give investors the opportunity to withdraw repurchase instructions not yet processed;
- continue to perform valuation and pricing as far as it is reasonably and practically possible;
- terminate the suspension as soon as practicable after the exceptional circumstances have ceased (and the manager and the trustee must review the suspension as regularly as the exceptional circumstances dictate, but at a minimum every 48 hours); and
- inform the FSCA and the trustee of the lifting of the suspension and immediately after the lifting must confirm this in writing to the Authority.
What are the next steps? Any issues? The FSCA noted in the exemption that it will this year be considering how current legislation can be amended to allow for managers to suspend the creation, issue, sale and repurchase of the participatory interests in a portfolio under exceptional liquidity risk and/or in stressed market conditions.
The COVID-19 crisis may necessitate a less comprehensive and more short-term approach. In that regard, it may be that, as with much of government and society’s response to COVID-19, the exemption, although in effect, is a work in progress and that we will see further amendments and refinements as experience develops.
In our view, there are a number of potential issues to consider in relation to the exemption.
- The exemption contains the following statement (in the section dealing with the applicable conditions): “A manager is not precluded from entering into arrangements to continue meeting standing income demands, including but not limited to annuity requirements, as and when reasonably and practically possible with sufficient available liquidity.” It is not clear to us what this statement is meant to authorise. It would be of concern if the manager is permitted to differentiate between types of investors with respect to repurchase orders. On what basis would the manager do so whilst giving effect to the requirement of treating customers fairly, and why should preference be given to “standing income demands”?
- Arguably, the interests of investors wishing to exit a portfolio must be balanced against the interests of investors remaining in the portfolio. The exemption is silent on the type of impact, and the severity thereof, which the exceptional economic circumstances should have on the portfolio in order to merit a suspension. This is left to the professional judgement of the manager and the trustee who are given only the rather vague direction that they must act in the interest of investors. Whereas standards and industry practice may develop with time, managers and trustees may initially find it difficult to agree on when a suspension is justified. Moreover, the exemption does not set out the basis on which the FSCA may intervene in circumstances where a suspension is not appropriate. Circumstances may arise where an investor wishing to exit contends that the decision to suspend was not appropriate. It is not clear what recourse will be available in such circumstances. Will an affected investor have to file a complaint with the relevant manager for internal resolution before escalating the matter to the FSCA? Could the FSCA direct the manager to resume repurchases, and on what basis? It is not clear what the answers to these questions are.
- The exemption is silent on the duration of the suspension other than to state that it must be temporary. Whereas suspensions of a day or two may not have a large impact, temporary suspensions could potentially be of much longer duration, which will have a bigger impact on investors who seek to disinvest.
- No requirement is imposed for a manager to formulate and publish its policy with respect to suspensions, so that relevant information will only reach investors after the fact, once a suspension has been put in place. Potential investors should arguably be entitled to this information at the time of investment.
- No guidance whatsoever is given as to the status of Government Notice 573 of 2003, which served to regulate suspensions in the past, and which contains conditions and requirements in addition to what is set out in the exemption.
- Suspensions are blunt instruments. Widespread use may undermine confidence in collective investment schemes and the financial sector. Although it is so that the Collective Investment Schemes Control Act does not expressly authorise other types of tools and processes that can be used to manage liquidity, we suspect that it is possible for the FSCA to permit managers to make use of tools and processes which have a less severe impact on entitlement of investors to require a repurchase of their participatory interests than a suspension. For example, the FSCA could encourage the use of agreed side letters which limit redemption rights or extend notice periods and help the manager to predict repurchase instructions. Also, the FSCA could authorise the creation of side pockets for problem assets. In this way, uncertainty about the value of an asset forming perhaps 5% of the value of the portfolio need not lead to the suspension of all dealing in the portfolio’s participatory interests.
Banking and Finance | Executive
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Banking and Finance | Executive
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