The FSCA has published a conduct standard setting out the conditions for retirement funds to invest in derivatives.
Conduct Standard 1 of 2023 (RF) (“Conditions for investment in derivatives instruments for pension funds”) will take effect 12 months from the date of publication, which was 11 May 2023.
The FSCA said derivatives have a role in retirement funds’ portfolios. Retirement funds can use derivatives for efficient portfolio management and risk management, as well as to hedge risk exposure to specific financial instruments.
However, there are major risks inherent in these instruments, including market transparency, counterparty risk, and liquidity risk. “Such investments are often complex, illiquid, or opaque, and therefore require close monitoring, analysis, and intrusive supervision than most traditional investment products. This is more so when potentially vulnerable investors, such as pension fund members and beneficiaries, are involved,” the FSCA said.
Regulation 28(7) of the regulations issued under the Pension Funds Act provides that retirement funds may invest in derivatives and empowers the FSCA to prescribe conditions in respect thereof. To date, no conditions have been prescribed.
The conduct standard sets out overarching principles for the uses of derivatives by funds.
It also sets conditions relating to the following:
- Permissible uses of derivative instruments;
- Net derivative positions must at all times be covered by appropriate reference assets;
- Valuation of derivative instruments;
- Determining the allowable counterparties for purposes of derivative instruments;
- Providing guidance on the calculation of exposure to derivative instruments;
- Setting out the allowable netting provisions for derivative instruments;
- Determining the conditions in respect of collateral; and
- Prescribing the conditions for reporting.
The FSCA acknowledged that the conduct standard will, in some instances, result in increased costs, particularly because it may be necessary to change systems and processes. The Authority said the additional costs are justified because of the expected positive outcomes that will be achieved.
The Statement of Need provides more information about the impact and implementation of the conduct standard.
The draft conduct standard was published for public comment in June 2020. The FSCA received 236 individual comments from 18 different commentators. The Consultation Report provides a summary of the submissions and the Authority’s response to them.
For more information about the conduct standard, contact the FSCA’s Regulatory Framework Department at andile.mjadu@fsca.co.za.
