The FSCA has published a draft Conduct Standard for collective investment scheme (CIS) managers that sets requirements pertaining to, among other things, governance, risk management, avoiding and managing conflicts of interest, portfolio design, and the information that must be included in a prospectus.
The purpose of the draft Conduct Standard is to align the South African CIS regulatory environment more closely to international standards, thereby improving confidence in the South African market. The draft Conduct Standard is also expected to ensure better protection and outcomes for customers, the Authority said in a communication on 23 November.
The draft Conduct Standard applies to all CIS managers and the collective investment schemes and portfolios they manage in terms of the Collective Investment Schemes Control Act. It does not apply to managers of a CIS in participation bonds.
The draft Conduct Standard sets out:
- high-level requirements pertaining to business principles, governance and control functions, the latter entailing the risk management, compliance, and internal audit functions;
- requirements pertaining to the identification, avoidance and management of conflicts of interest, and the adoption of a conflicts of interest management policy;
- substantial requirements pertaining to portfolio development, including the establishment of a portfolio development framework, principles related to portfolio design, development and distribution, and portfolio approval, monitoring, review and reporting;
- requirements pertaining to the adoption of a prospectus and what must be contained therein;
- requirements pertaining to the appointment of a trustee, fiduciary, or custodian, including a sub-custodian; and
- requirements relating to trade execution and related-party transactions.
The draft Conduct Standard allows a CIS manager to design and establish its governance arrangements and control functions in such a way that it is proportional to its nature, size, scale, and complexity, considering its business and operating model, scope of activities, financial customer profile, and associated level of risk exposure, according to the FSCA.
Cost implications may be significant
The FSCA acknowledges that implementing the draft Conduct Standard will have cost implications for CIS managers – some of which may be substantial, particularly for smaller managers.
The Authority identified the following aspects of the draft Conduct Standard as potentially having the most significant cost implications:
- The requirement to have an internal audit function.
- The requirements pertaining to conflicts of interest, particularly the initial costs to establish a compliance risk management framework. The latter will mostly affect CIS managers that do not already have a robust conflict of interest management framework.
- The requirements pertaining to portfolio development.
The Authority believes the benefits brought about by the draft Conduct Standard will outweigh the potential cost implications. But it asked commentators to provide detailed insights into the potential impact of the draft Conduct Standard’s requirements on their operations.
Deficiencies identified by the IMF
The FSCA explained that the draft Conduct Standard has its origins in a Financial Sector Assessment Program (FSAP) of South Africa’s financial sector conducted by the International Monetary Fund (IMF) in 2020 and 2021.
An FSAP provides an in-depth analysis of the resilience of a country’s financial sector. It includes “stress tests” of financial institutions, an evaluation of the quality of supervision and regulation of the sector, and an assessment of the crisis management framework.
In January 2022, the IMF issued its final FSAP Report and made various findings and recommendations aimed at assisting South Africa to identify key sources of systemic risk and implement policies to enhance the financial sector’s resilience to shocks and contagion.
Some of the recommendations in the FSAP Report pertained to matters related to the CIS environment that fall within the FSCA’s jurisdiction. These recommendations included:
- The current framework lacks product governance requirements, and there is a need to distinguish between the duties of CIS managers and the duties of a distributor. The specific issues identified included that CIS managers should identify and assess target markets and financial customers for each new product created and should have clear marketing and distribution strategies. These elements are particularly important because the distribution of CIS through online platforms is increasing.
- There is a need for the adoption of a standardised prospectus for a CIS that lists the scheme’s operating rules in accordance with international best practice. This approach will provide more clarity on the content and format of information presented to financial customers and will facilitate the comparability of CIS offerings. There is also a need to continue to align CIS disclosure requirements to international best practice.
- Issues were raised pertaining to the oversight of trustees, fiduciaries, or custodians, particularly where the custodial function is sub-delegated.
- A need was identified to clarify and strengthen the responsibilities and obligations of the risk management function, provide for requirements pertaining to an internal audit function, and establish requirements for the compliance function.
- Notwithstanding the existing general obligation pertaining to conflicts of interest, a need was identified to strengthen the conflicts of interest framework and address specific issues pertaining to conflicts of interest, such as best execution obligations, timely trading and transaction allocation, related-party transactions and group structures, and the prevention of churning.
- There is a need to define a list of changes in a CIS’s operating rules that are considered as material and that require prior notification to and/or the consent of financial customers, and eventually redemption at no cost.
The draft Conduct Standard is aimed at addressing some of the recommendations in the FSAP Report.
The draft Conduct Standard is an interim measure pending the implementation of the Conduct of Financial Institutions (COFI) Bill.
“The FSCA considered whether the draft Conduct Standard should be placed on hold and rather be incorporated into the COFI Bill transition project, but it was decided that addressing the FSAP recommendations is a strategic imperative and cannot be dependent on the conclusion of the COFI Bill process,” the Authority said.
Deadline to comment
Comments on the draft Conduct Standard must be submitted on the comments template to FSCA.RFDStandards@fsca.co.za by 16 February 2024.
For more information about the draft Conduct Standard, contact the FSCA’s Regulatory Frameworks Department at Marius.deJongh@fsca.co.za or Andile.Mjadu@fsca.co.za.
