The FSCA has issued a warning to collective investment scheme (CIS) managers who re-invest distributions and ascribe the resulting breach of the portfolio’s exposure limit to market movements.
In a communication published yesterday, the Authority said several CIS managers seem to have adopted the practice of:
- re-investing income distributions (dividends) from an equity security in a portfolio in the same security that distributed the dividend, which may result in the security exceeding the prescribed exposure limit for the portfolio; or
- applying income received in the portfolio from an underlying portfolio to purchase more participatory interests of that underlying portfolio, which may exceed its exposure limit; and
- deeming the re-investment of the income in the portfolios as part of the market movement exclusions provided for in paragraphs 3(1)(b)(i) and 3(3)(b) of Board Notice 90 of 2014.
Paragraph 3(1)(b)(i) states: “Where a portfolio breaches the limits set out in sub-paragraphs (a)(i) and (ii) due to appreciation or depreciation of the market value of the equity securities in that portfolio, or as a result of any non-optional corporate action by the relevant concern, the manager may not purchase any further equity shares issued by that concern for as long as the market value of an equity security in any particular concern exceeds the limit specified in subparagraphs (a)(i) and (ii).”
Paragraph 3(3)(b) provides: “The limit determined in sub-paragraph 3(a) may be exceeded only if the excess is due to appreciation or depreciation of the value of the underlying participatory interests constituting the portfolio, provided that a manager may not, for as long as the excess continues, purchase any further participatory interests for the portfolio.”
Kedibone Dikokwe, the executive: Conduct of Business Supervision, said paragraphs 3(1)(b)(i) and 3(3)(b) provide for temporary breaches of the exposure limits because of market movements (appreciation or depreciation of the value of the underlying equity securities or participatory interest). The manager may not, for as long as the excess continues, purchase any further equity securities or participatory interest for the portfolio.
Where income distributions are re-invested in the underlying equity securities or portfolio, the manager creates an additional participatory interest, and thus it cannot constitute a fluctuation in the value of the participatory interest because of market movements.
Therefore, where income distributions are re-invested and the re-investment results in a breach of the limits, the exceptions provided for in paragraphs 3(1)(b)(i) and 3(3)(b) do not apply, Dikokwe said.
Communication 8 of 2024 (CIS) said the FSCA is monitoring compliance with Board Notice 90 and is engaging with the CIS managers who are acting contrary to paragraphs 3(1)(b)(i) and 3(3)(b).
The FSCA expects CIS managers to implement adequate controls to ensure that portfolios do not exceed the prescribed limits because of the re-investment of income distributions.
A manager who is found to have acted contrary to paragraphs 3(1)(b)(i) and 3(3)(b) may be subjected to enforcement action by the FSCA, which could include a directive in terms of section 144 of the Financial Sector Regulation Act or an administrative penalty in terms of section 167 of the Act for a breach of a financial sector law, Dikokwe said.
