October 31, 2019
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In 2019, the African National Congress (ANC) expressly stated in its election manifesto that the party will “investigate the introduction of prescribed assets on financial institutions’ funds to unlock resources for investments in social and economic development”.
Understandably, this, together with various prior statements about the implementation of prescribed assets from high-ranking ANC officials, including the Minister of Trade, Industry and Development, has raised concerns among a wide range of investors, both locally and internationally. In particular, stakeholders are concerned that at some point in the future the South African government will force domestic pension and provident funds, as well as other retirement savings, to divert a significant portion of their assets into funding the public sector’s large and rapidly-growing debt burden. This would probably include the forced funding of fragile state-owned enterprises (SOEs) such as Eskom.
A substantial deterioration in government’s key fiscal parameters in recent years has led to a swift increase in public sector debt, successive credit rating downgrades, and a growing concern that the government could start to experience difficulties in raising sufficient funds in the domestic bond market. Already most SOEs are unable to raise sufficient finance directly in the bond market and have become reliant on government transfers. A further key risk to SA’s ongoing fiscal stability is the increase in state debt cost, which is now consistently one of the fastest-growing components of government expenditure.
Introducing prescribed assets: a threat?
The support for presecribed assets within the ANC is largely based on the perception that private investment does not currently support SA’s fixed investment and needs to be redirected. As the monitoring of the ANC Conference resolutions gathers pace, it is expected that work on prescribed assets may start towards the end of the year.
What the ANC will need to consider is that the fund management industry has a fiduciary obligation to manage clients’ money in a prudent and responsible manner. The preamble to Regulation 28 states that “a fund has a fiduciary duty to act in the best interest of its members”. It would be extremely difficult to align a policy of prescribed assets with the responsibilities placed on pension fund trustees under current Regulation 28, which limits the ability of government to implement prescribed assets without first amending Regulation 28.
Looking back, SA does not have a good track record. During the apartheid era, the government introduced a policy of prescribed assets, which was implemented through the Pension Funds Act and lasted about three decades, from 1956 until 1989. Prescribed asset policy at that time may have been successful in redirecting capital from the private sector into the public sector, but it had a number of severe and unintended consequences, making pension fund trustees persistently unable to act in the best interests of their members.
An extension of the prescribed assets requirement to other forms of retirement savings, as well as unit trusts, would potentially make the asset allocation to public sector debt a lot more substantial.
The reintroduction of a policy that simply prescribes a specific percentage of public sector investment could have a profound effect on ordinary South Africans, inflicting damage that goes far beyond just the obvious impact on retirement outcomes. In general, it would undermine domestic and international investor confidence, encourage foreign capital outflows, discourage discretionary savings, weaken SA’s international credit rating, and undermine the country’s ability to raise foreign finance.
Can we limit the damage?
Limiting the damage is possible. In our view government would need
to consider implementing the following key guidelines:
- Stipulate a broad and well-defined category of prescribed assets. The prescribed asset ratio should be as small as possible to prevent concentration of risk, lack of diversification and over-exposure to sovereign risk. The ratio should also be a target range, as opposed to a precise percentage, with pension funds having longer periods to reach requirements.
- Funds from prescribed assets should be used for investment in infrastructure development or similar projects, not for consumption. This limits the chance of eroding pension fund wealth and is truly developmental in nature.
- There should be strict rules on how the prescribed asset policy will be implemented, especially rules that limit the ability of government to increase the ratio arbitrarily.
Or is this an opportunity?
There are far more elegant ways to achieve similar results, including public-private partnerships (PPPs). History shows that there is in fact private sector appetite for well-conceived public investment programmes. The country already has some examples of successful programmes, such as the Renewable Energy Independent Power Producer Procurement Programme.
Another short-term solution for government would be to sell nonstrategic assets such as property, shareholdings in listed entities, nonstrategic shareholdings in SOEs and surplus cash balances in public entities.
It is clear from a very broad range of research that when government crowds out the private sector, fixed investment activity tends to languish and economic growth slows, especially if it is accompanied by policy uncertainty. The implementation of prescribed assets would have similar consequences, especially since SA has a substantial savings shortfall and has become highly reliant on foreign investment.
Very few countries have made use of prescribed assets successfully, while the major multinational organisations (IMF, OECD, BIS) would, in general, argue against their use.
Imposing prescribed assets would have far-reaching consequences, going well beyond the distortion of asset class returns and measures of risk. In particular, it would undermine business and consumer
confidence leading to increased capital outflows, while also weakening SA’s credit rating. Instead, there are many more attractive alternatives to the imposition of prescribed assets that would achieve a similar outcome, without the unintended negative consequences.
- The support for prescribed assets is largely premised on the perception that private investing in South Africa does not currently support the country’s fixed investment activity.
- If implemented, funds from prescribed assets should be used for investment in infrastructure development projects and not for consumption.
- Public private partnerships are programmes that achieve similar results to prescribed assets. We already have a few examples of successful programmes in South Africa.