ANC to decide whether your pensions are safe, while Solidarity prepares for lawfare

The country will know by June whether the ANC plans on implementing prescribed assets, which would see pension and investor funds being used on projects and companies managed and owned by government.

The governing party said it was exploring the idea and was currently investigating how it would be implemented.

The ANC’s head of economic transformation Enoch Godongwana set the record straight this week, telling The Citizen that nothing was set in stone as yet.

“The resolution of the ANC says that we will explore the possibility of prescribed assets and not necessarily implement it. From the perspective of the ANC, we want to investigate it. We are not at the stage yet of how prescribed assets should be done,” he told The Citizen. He said such probes into the idea would be concluded by June, but he did not want to pre-empt what would happen next.

Labour union Congress of South African Trade Unions (Cosatu) had last week proposed to government and business leaders that various financial institutions establish a special purpose finance vehicle to rescue Eskom by funding R250 billion of the power utility’s R450 billion debt. This would be done by using the Industrial Development Corporation (IDC), the Development Bank of Southern Africa and the Public Investment Corporation, which manages the Government Employees Pension Fund, the federation said.

While analysts and economists are against the proposal, stating that it would affect the taxpayer in the long run, Godongwana said it contributed to the party’s debate of prescribed assets.

“As the ANC, we have not discussed [Cosatu’s] proposal… The proposal needs to be fine-tuned so that pensioners can get their returns. I do not think that Cosatu is proposing that this [negatively] affects the pensions of government employees.”

Chief Economist at auditing firm PriceWaterhouseCoopers, Lullu Krugel opposed Cosatu’s proposal, saying it did not deal with the power utilities issues.

“We are throwing good money after bad money, again. I am not a supporter of that. If they have a separate vehicle, where they want to put this money in, how is it going to be monitored? How is the spending going to be watched and how is it different from any other bail outs from government?”

Meanwhile, civil society organisation the Helen Suzman Foundation (HSF) has weighed in on the debate with a series of articles on prescribed assets.

Charles Collocott, Policy Researcher at the HSF wrote that prescribing assets has in the past proven to be detrimental to fund performance, suggesting that it is likely to detract from portfolio returns in future.

Collocott wrote: “The trend in all asset returns has been downwards for some time now and especially so for local assets. And while extrapolating past returns is generally a poor indicator for future returns, the general consensus among market participants world-wide now is that economic growth levels globally are likely to be on the downside for the immediate future… Locally, the challenges to the economy are well known to the average South African. Adding further downward pressure by re-introducing prescribed assets will only exacerbate the difficulties fund managers currently face in generating sufficient returns to secure beneficiary.”

The HSF examined data from when prescribed assets were first introduced in 1956, under the apartheid government’s Pension Fund Act, requiring 75% of public investment commissioners and 33% investment from long-term insurers. At the time prescribed assets came in the form of government bonds and covering state-owned entity (SOE) debt.

They found that prescribed assets were most beneficial for funds during the 1960s, when inflation was around 3%, but took a turn for the worse in the 1970s when inflation averaged 11%. This was due to the fact that prescribed asset returns hovered around 7%, leading to a negative return on investment.

To emphasise just how poor the returns really were, they compared this to the stock market returns at the time averaging a nominal annual return of 24.5%. Being forced into prescribed assets instead essentially cost investors a potential return of 17,2%, and this only got worse in the 1980s, when inflation rose to an average 14.5%.

The policy was scrapped in 1989, after the Jacobs Committee found that it led to serious market distortions.

Collocott argues that “investment limitations that currently exist for pension fund managers, which will be covered in the following briefs are, the HSF suggests, in the best interest of beneficiaries in that they avoid the risk of over-concentration of any single asset class. But prescribing assets has in the past proven to be detrimental to fund performance, and going forward it is likely to detract from portfolio returns.”

The GEPF (Government Employees Pension Fund). Image: Moneyweb

Don’t be hasty in cashing out:

Economist and professor at the North West University’s school of business and governance, Professor Raymond Parsons, said the ideas surrounding prescribed assets should be thoroughly investigated and consulted before any final decisions are taken by ninvestors.

Though prescribed assets were not a new phenomenon in the country, globally the experience of prescribed assets has generally been poor and during apartheid, returns were lower than that of other investments, Parsons explained.
“And with the present need to boost investor confidence in South Africa, the ANC would be wise to approach the issue of prescribed assets with great caution and circumspection in present economic circumstances.
But until there was certainty and clarity on prescribed assets being reintroduced in the country, the impact on investment portfolios cannot yet be quantified.

“It is therefore too early for investors to take any precipitate action about their investment portfolios, and no steps should in any case be implemented without consulting a credible investment adviser.”

Prepare for lawfare:

Should the Public Investment Corporation (PIC) take any steps to implement a proposal of using government pension funds to clear Eskom’s debt, they would face legal action.

In a letter of grievances addressed to the PIC and the Government Employees Pension Fund (GEPF), labour union Solidarity reminded the finance institution of its fiduciary mandate, which was for such governing bodies to act in good faith and in the best interest of their members.

Solidarity CEO Dirk Hermann said using employees’ pension funds to bail out any state-owned enterprise was a breach of GEPF’s and PIC’s mandate as well as their contractual and statutory obligations to their members.

“We would therefore like to highlight and reiterate that a decision to provide funding out of employees’ pension funds in order to assist Eskom in its debt debacle, when banks and other financiers are becoming increasingly reluctant to fund the utility, should not be taken lightly.

“We would further like to reiterate that the responsibility and repercussions of such a decision also rest on the shoulders of the individual members of the governing bodies of this fund and/or company. Any such steps or actions to implement the ‘Cosatu proposal’ would be challenged by way of legal action, including urgent legal action.”

The PIC and GEPF were given until the end of business today to confirm that no such steps would be taken. “It would not be an investment. It would be a travesty,” Hermann said.

SA state-owned enterprises. Pictures: Neil McCartney, Nigel Sibanda, AFP & Gallo Images

16 Reasons why Prescribed assets aren’t a good idea:

The HSF’s series of articles unpack the idea of prescribed assets, and list the following potential negative consequences:
1. Undermining government’s fiscal discipline.
Quoting a study conducted by World Bank in 1994, titled Developing a Domestic Funding Strategy for South Africa’s Public Sector, on the experiences of several countries that instituted prescribed assets in the 1960s and 1970s, they point out that:
“Prescribed investment policies have generated mostly negative results, and in a significant number of instances they have been financially catastrophic. The fundamental difficulty with prescribed asset programs is that, because they permit governments to commandeer financial resources, governments tend to view them as a source of virtually free funds, an attitude which severely undermines fiscal discipline… The reports in South Africa that the contractual savings industry represents a huge source of funds that should be tapped to finance social upliftment reflect a comparable attitude. Prescribed investment programs in many countries have eventually led to negative economic growth and hyperinflation.”

2. Undermining the effects of market discipline as applied to SOE and government run projects.
“Forcing investors to fund specific state-owned-entities or projects will remove the incentive for these entities and projects to compete in the open market for funding through performance. Fiscal discipline would be undermined due to complacency created by a guaranteed supply of funding, so will South Africa’s government run enterprises and projects continue to under-deliver.”

3. Misallocation of funds
The flip-side of point 2 is that investment funds are a finite resource, and driving funds to prescribed assets may well mean that more deserving projects that could drive sustainable growth are unable to raise the required capital.

4. Erosion of investment value due to lower than market returns for investment funds.
“Making investment funds instruments of government policy will result in lower than market returns for the beneficiaries. A large-scale forced asset allocation will most likely result in an imbalance between desirable projects and investment funds, with fund managers chasing after the same assets, i.e. those prescribed assets which are considered sought after. This excess demand will artificially decrease the return on these assets while increasing the risk to funds that have no choice but to invest in the less desirable assets, with the result being an erosion of fund value.
“It will also limit a fund manager’s ability to allocate assets in reaction to market conditions. Not only will this cause lower than market returns, it may also cause negative real returns, which is what happened during apartheid’s prescribed assets policy era.”

5. Fiduciary duties of fund managers being superseded by regulations.
“The lower than market returns for the beneficiaries, resulting from making investment funds instruments of government policy, would be counter to the fiduciary duty of fund managers to act in the best interests of its members – as per Regulation 28 of the Pension Funds Act for example. It would also be against the best interests of the beneficiaries to force fund managers to invest in loss making SOEs such as Eskom.”

6. Asset / liability mismatches for pension funds, banks, and insurance companies.
“Forcing the hand of financial institutions in asset allocation could very likely result in mismatches between the institution’s assets and the liabilities it needs to service. Asset / liability matching seeks to ensure that, first, the institution’s assets are growing at a rate of return which at least matches its liabilities and, second, that liquid assets are available to service the liabilities as and when they become due.

7. Defined benefit pension funds not being able to meet their pension payment requirements.
” With defined contribution funds however, pensioners (and workers) are directly affected by the risk and return of the funds into which they have contributed their pension contributions. Therefore, maximising returns at acceptable levels of risk should be the pension fund’s only consideration.
“Furthermore, defined contribution funds often offer their beneficiaries daily pricing and liquidity, which will become more difficult with an increase in long-term illiquid investments, such as infrastructure, which is likely to occur under prescribed investments.”

8. Tax payers having to fund a shortfall at the GEPF.
The Government Employees Pension Fund (GEPF), which is a defined benefit fund; would most likely be unable to avoid any difficulties if prescribed assets are applied to it, since it is a defined benefit fund and its pension payments need to reach the predetermined absolute level guaranteed by the employer, namely government. “Government would therefore have to stand in to cover any shortfall, placing additional pressure on the already overburdened fiscus and tax-payers.”

9. Reduced incentives to save for retirement.
“A limitation on the rights of pension funds to make choices about fund allocation and associated risks and rewards could reduce the willingness of pension fund members to save for retirement, which is counter to government’s aim to encourage savings through preferential tax treatment. Reduced retirement savings will cause future social issues and increase the burden on the fiscus in trying to deal with these.”

10.  A negative impact on the stock-market and the country’s overall financial stability.
“South Africa’s various categories of fund managers currently hold over R10.8 trillion in stock. This stock has been accumulated over a long time period, and the sudden and potentially very large scale sale of shares that will be required to move funds into prescribed assets will have a negative impact of the stock-market, with the potential to affect the country’s financial stability.”

11. Decreased foreign investment in government bonds and SOE debt and government funding shortfalls.
“Foreign investors are the single largest holders of South African government debt, holding 36.9% of total outstanding debt.
“There is the risk that prescribed assets could discourage foreign holdings of local debt (government or SOE) because it will create artificial demand for bonds, resulting in lower yields. While this would be good for current holders of the debt, there will be a point where foreigners are not compensated for the risk in real terms and they decide to sell their holdings. The resulting oversupply would be too much for local savings/investment funds to absorb, resulting in a funding shortfall for government.
“The resulting oversupply from foreigners eventually selling out of their bond holdings would be too much for local savings/investment funds to absorb. An inability to sell all of its bonds will cause a funding shortfall for government.”

12. Crowding out growth inducing private sector investment.
“The consequences of prescribed assets in point 7 above will be government crowding out the private sector due to less savings/investment funds being available for private sector borrowing, as a part of domestic savings is absorbed by government debt. Prescribed assets may also suppress the demand for other important asset classes, such as listed equities and corporate debt.”

13. A slow-down in economic growth.
“Crowding out of the private sector tends to coincide with periods of lower fixed investments and suppressed growth rates, especially if there is concurrent policy uncertainty.”

14. Hyper-inflation.
“As noted in point 1 above, a study by the World Bank found that many of the countries that implemented a policy of prescribed assets in the past experienced hyper-inflation. This was due to the erosion of fiscal discipline the policy brought with it, and the countries then had to start printing money to pay back their debt obligations.”

15. Distorted portfolio valuations.
“In order to meet the minimum prescribed holdings requirements for bonds, there is a real risk that portfolio managers will inflate the value of their bond holdings when marking them to market for portfolio valuation purposes. The distortion becomes easier when bonds are illiquid, as happened during the prescribed assets policy era in apartheid South Africa.”

16. Decreased liquidity in the bond market.
“During the prescribed assets policy era in South Africa from 1956 until 1989, bonds were valued at the lower of their cost or redemption value, resulting in big discounts in their pricing and hardly traded because investors did not want to sell a bond at a loss. If they did they would have to buy more to top up on their prescribed requirements.”

rorisangk@citizen.co.za

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