Behind the opposition to Prescribed Assets
The issue of prescribed assets is one that we at Prudential are very concerned about due to its potentially negative impact on client returns. As a long-standing member of the Association for Savings and Investment South Africa (ASISA), we have been in full agreement with their approach to addressing the issue with the government, and would like our clients to know that they have been very active in their opposition so far. ASISA is a significant and credible representative for the financial services industry, with members holding savings and investments totalling R6.2 trillion, as shown in the accompanying graph.
ASISA, on behalf of the industry, has held extensive engagements with many parties on the potential negative impacts of prescribed assets, while also offering positive alternatives. These interactions have included directly with government Ministers, via Business Unity South Africa (BUSA) into the National Economic Development and Labour Council (Nedlac) and via the CEO Initiative. Here we unpack the views and research ASISA has been sharing to help clients better understand the issue.
What does “prescribed assets” mean?
The financial services industry understands prescribed assets to mean the government forcing the industry to buy government-backed assets like bonds and equities using the savings of their clients, including pension funds, life insurance companies and individual investors. These assets could be issued by state-owned entities (SOEs), by stand-alone projects like a highway, power plant or other specific public infrastructure initiative, or by the government directly for “general purposes” like funding transport or water infrastructure.
The discussion around prescribed assets arose in the ANC’s 2019 election manifesto, which proposed to “investigate the introduction of prescribed assets on financial institution funds within a regulatory framework for socially productive investments (including housing, infrastructure for social and economic development and township and village economy) and job creation whilst considering the risk profiles of the affected entities”. However, it has not yet been officially tabled as part of any draft legislation or regulation, and hence there is very little detail around what form it would take.
Underlying the proposal is the fact that the ANC government has effectively run out of funding options for its many spending priorities, and has identified the country’s pool of private savings (ASISA’s R6.2 trillion,) as a potential new source. Yet the practice of asset prescription is familiar to many South Africans since it was used under the Apartheid government between 1958 and 1989 for essentially the same purposes.
What happened under the previous regime?
Under the Apartheid government, pension funds, life insurance companies and the Public Investment Corporation (PIC, the manager of the Government Employees Pension Fund) were required to invest from 33% to 75% of their assets in government, government-guaranteed and specified approved bonds, resulting in large distortions in the local bond market. These prescriptions originally served as prudential guidelines, such as today’s Regulation 28. However, the Jacobs Committee of 1988, established to investigate these inefficiencies, found that the prescribed investments eventually came to be regarded as an “assured source of public funding”. As a consequence, we saw the development of a dual market, a lack of trading in the bonds as investors wanted to hold them to maturity, a lack of transparent pricing and underpricing of risk, and most importantly for investors, a resultant underperformance in returns from the prescribed assets: investors weren’t receiving adequate returns for the full risk they were assuming.
The Jacobs Committee found that, because investors were forced to invest in prescribed assets rather than better-performing equities – holding far more bonds than would likely have been appropriate for their risk profiles – investors received a real return of 8.6% less than they should have in the 1970’s, and 2.9% less than they should have in the 1980’s. This was a significant opportunity cost to investors. In the face of these negative impacts, the Committee recommended abolition of the practice, which was implemented in the 1989 National Budget.
A look at Namibia
We only have to look north to Namibia to see the negative impact of prescribed assets on a financial market. The Namibian government instituted a minimum investment requirement in Namibian assets for pension funds, which has recently been increased to 45%. This is explained in more detail in Anthea Agermund’s article, “Regulations skew prices, asset allocation”, in this edition of Consider This.
Given the above, it should be no surprise that ASISA’s stance on prescribed assets is that it did not work under the Apartheid government, and that it would have negative effects on the country should it be introduced now. The primary concern is that the country’s savings becomes an instrument of state policy, and so avoids the investment discipline of financial markets and the fiduciary responsibility of asset managers and trustees, in turn imposing lower-than market returns on investors. Among the main elements of this highlighted by ASISA are the following:
- Prescribed assets would force the financial services industry to invest funds into SOEs and other entities that have recently been mired in State Capture, mismanagement and a lack of delivery. As custodians of these savings, ASISA is opposed to this.
- The funds are owned largely by retirement fund members, not asset managers. Asset managers and retirement fund trustees have a fiduciary duty to make asset allocation decisions that are in the best interest of their members and clients. Prescription would jeopardize this fiduciary duty. Because there is a fixed pool of investments, it is likely that funds would have to be shifted from equities into government-directed “developmental” bonds, which would have potential systemic risks and would have wealth effects across the industry.
- Dictating how to invest interferes with the capital allocation function of the capital markets, which should always be objective and driven by performance. Forcing the market to invest in low-yielding and/or high-risk assets could have two direct consequences:
1) The incentive for investment competition would be removed as funding would no longer be incentivized by performance; and
2) Given that capital is a finite resource, deserving or more appropriate projects or assets could be deprived of funding. These projects that would otherwise have driven growth and created sustainable employment would therefore not be funded. For example, think of a company raising capital to expand by issuing shares on the stock market. While this would create more jobs and contribute to economic growth, and pricing would be determined by the market, investors could miss this opportunity and the share issue could fail if they were instead obliged to buy the bonds of infrastructure projects that possibly offered below-market yields, or a risk profile inappropriate for the investor.
- Prescription would have a negative impact on the country’s credit rating. If South Africa loses its investment grade rating, foreign investors, many of whom are pension funds, would be forced to withdraw their money. Currently, around 38% of rand-denominated government bonds are held by offshore investors.
ASISA also points to examples of infrastructure project investments in other countries. According to an OECD member country survey, pension fund investments in infrastructure via unlisted equity and debt represent only 1.1% of assets under management. Exceptions include Australia and Canada, where the average infrastructure investment by pension funds is higher.
Financial institutions are willing to invest
According to ASISA, the lack of funding for infrastructure projects in South Africa has had more to do with the absence of commercially viable projects than the willingness of financial institutions to fund them. In the past 10 years, the success of numerous public-private partnerships (PPPs) in the financing and construction of South Africa’s renewable energy programme, involving over R200 billion for 112 different projects, shows that this model can work well when the correct conditions are in place. Financial institutions have also indirectly participated in funding public sector spending through their purchases of government and SOE bonds valued at some R1.3 trillion.
More recently, ASISA has been actively working with the government to find infrastructure financing solutions for water, energy and student accommodation projects, and is looking at collaborative delivery mechanisms with the government and the Development Bank of Southern Africa for programmatic financing solutions. They are optimistic that many of the country’s challenges can be overcome through effective PPPs going forward, without the need for prescribed assets. At Prudential, we agree with this view and ASISA’s approach in engaging with the government on this important issue. Going forward we will be following developments closely to ensure that our clients’ best interests are protected under any proposed solutions to our developmental financing challenges.
For more information, speak to your financial adviser or call our Client Services Team on 0860 105 775 or email us at email@example.com.
*This article draws extensively from ASISA statements and information and research conducted by Gill Raine, Senior Policy Advisor at ASISA, in the report “The Reality of Prescribed Pension Fund Assets – and other Interventions”, 13 June 2019.