Section 65: Marketing offshore funds in South Africa

HedgeNews Africa sits down with Matthew Pykstra, who is a director and head of the management company at Sanne, a specialist global provider of outsourced corporate, fund and private client administration, reporting and fiduciary services. 

Based in Cape Town, Pykstra oversees the Sanne manco, working closely with a range of South African asset managers, offering both long-only and hedge fund products.

In recent years many South African investors have sought to increase their exposure to offshore markets, looking to diversify away from a shrinking local equities market as the country faces political and economic pressures. 

In the most recent budget, in February, prudential rules were amended to enable pension and mutual funds to invest up to 45% of their assets offshore, up from 30% previously. It’s the largest adjustment yet to the offshore limit, giving domestic investors an opportunity to fundamentally rebalance their portfolios, accompanied by many local managers now offering offshore products, investing ex-South Africa to meet demand. 

Established offshore managers are also seeing potential to attract allocations from local investors – the pension and savings industry oversees a total of R2.96 trillion (almost $200 billion) in the country, according to the Association of Savings and Investment South Africa. 

Q: Matthew, how does one go about marketing an offshore fund to local investors?

A: The first step is to ensure that the offshore fund is Section 65 approved, allowing it to be marketed to the South African public.

Section 65 is a piece of legislation in the Collective Investment Schemes Control Act (CISCA) that addresses restrictions on foreign collective investment schemes to carry on business in South Africa.

One of the requirements under Section 65 of CISCA is that Foreign CISs that want to market their portfolios to the South African general public would need to ensure that the scheme and funds are registered and approved by the Financial Sector Conduct Authority (FSCA). 

The foreign scheme, which is also termed the operator, has a fund or multiple funds that reside under the foreign scheme, and the foreign scheme is typically represented by the investment manager.

The foreign scheme with the investment manager must either establish a representative office in South Africa and seek authorisation from the FSCA or enter into a representative agreement with a third-party FSCA-approved management company such as Sanne Management Company (RF) (Pty) Ltd.

Once the application documents have been approved to the FSCA then the foreign scheme would be able to market the product to the South African public.

Sanne, through the compliance function, would then vet any marketing material including minimum disclosure documents, brochures, presentations, application forms, and advertisements and lodge with the regulator before marketing to the public.

Q: Since the rule came into effect in 2014, how many funds have been Section 65 approved by the regulator? Are they domestic managers offering offshore portfolios to local investors, or are these global players looking for a slice of the South African market?

There are over 600 foreign portfolios that have been Section 65 approved for marketing to the South African market. These are primarily long-only funds with a small minority that are hedge funds.

In terms of domestic managers versus global players, I would say a bit of both, however they are predominantly domestic managers. Amongst local players, we have the likes of Allan Gray, NinetyOne and others, whilst global players include Ishares and Blackrock.

We want to create awareness to our existing hedge fund base, which is over 60 regulated QIHFs and RHFs that have offshore portfolios in existence wishing to market to the South African public. Then there are other local hedge fund managers that have established offshore portfolios or alternatively, foreign investment managers with foreign funds looking to tap into the South African market.  

As an example, we recently had a Cayman-based fund approved. This took a fair amount of time to approve the jurisdiction before the control environment of the fund was looked at, given that this was the first Cayman-based fund to be approved.

Q: What does the approval process entail? How long does it typically take? 

The first step is to ensure that there is a foreign portfolio and scheme that has been established and approved with an approvable jurisdiction in the eyes of the regulator. Sanne can assist in this process by providing guidance in terms of the costing across jurisdictions.

Once the foreign portfolio and scheme is established and approved by the foreign jurisdiction, then a foreign scheme could appoint Sanne Manco as a representative office. Sanne together with the investment manager would collate the application documents utilising the offering memorandum or founding documents of the foreign scheme by ensuring the control environment of the portfolio is equivalent to South African regulated hedge funds, therefore salient details such as the investment policy, risk restrictions, liquidity requirements and protection of investors are paramount.

In addition, there is a list of similarities and differences form that would need to be completed by Sanne comparing the South African jurisdiction to the offshore jurisdiction.

Lastly, a representative agreement between Sanne and the foreign scheme would need to be entered into.

It is important to note that the scheme must be available for investment in its domicile of registration; and be promoted in South Africa to the same type of investors under the same, or substantially similar, requirements and conditions relating to the type of investors as in its domicile of registration. In other words, if the offshore fund is available to professional investors abroad then it can only be available to professional investors in South Africa, so we would typically then apply to the regulator for the foreign fund to be structured as a QIHF type fund.

In terms of the time taken, it really depends on the fund as well as the jurisdiction. If the regulator has a good standing with the offshore jurisdiction, then this would typically be quicker than trying to approve a new jurisdiction. 

Furthermore, the more measures the portfolio itself has, the shorter the time it would take to approve.

So one would need to look at both the jurisdiction and fund measures itself.

Typically, this can take 2-3 months, however that is more an estimate rather than an exact timeline.

Q: Which domiciles are most popular with the South African regulator, and why? What are they looking for before they approve a fund?

Typically, a UCITs funds label serves as a stamp of quality and reliability for investors and carries a high regard given that they are highly regulated in terms of risk measures – including requirements around allowable investments, liquidity, disclosure, and investor protection, as well as the technical and practical organisation of such funds.

The most common funds that have been approved operate within Ireland and Luxembourg, specifically structured as UCITs and Icavs.

When approving the fund, the FSCA will look at the jurisdiction as well as the fund’s control environment. 

The regulator’s approval process is to ensure that the offshore portfolio has a regulatory environment that is comparable to the South African regulatory environment to ensure homogeneity between the offshore and local portfolios in terms of structure and governance.

Furthermore, key requirements are that the FSCA needs to be satisfied that:

·      the scheme is sufficiently liquid to meet investor redemptions.

·      the scheme does redemptions at regular intervals.

·      the scheme does not permit investment in an instrument that compels the acceptance of physical delivery of a commodity, and the scheme particulars or prospectus prohibits it from accepting physical delivery.

·      the assets of the relevant fund are properly protected by application of the principle of segregation and identification.

Q: What are the costs of having a fund Section 65 registered – both at the outset and on an ongoing basis? What sort of AUM should a fund have to justify this expense, and what level of assets should they realistically be looking to raise to make it worthwhile?

There are costs to the regulator, namely:

Initial registration fee 

·      For the scheme (including one portfolio) R73,560 

·      For an additional portfolio R20,980

Ongoing quarterly FSCA levies 

·      R12,300 per scheme 

·      R6,671 for each portfolio 

Representative office charges

·      Charged in the country of fund denomination.

·      US$8,000 to $10,000 per year for the scheme and first fund (R130,000 to R160,000) 

·      An additional fund is $1,000 (R16,000).

It becomes a lot more scalable the more portfolios one has.

Given that these are fixed costs, if you add up the FSCA costs with the initial registration fee and levies as well as the representative office fees, then for the first year a R140 million  based portfolio would equate to 20 basis points. If you strip out the initial registration fee, then this scales down to 15bps. If you double the fund to R280 million, it would equate to 10bps including the initial registration fee and 7.5bps if you strip out the fee. 

A lot of the costs are at scheme level with the first portfolio, so naturally it becomes a lot more scalable should one apply for additional portfolios.

Q: What role does a company such as yours play in the process? Can managers go through the approval process alone or should they work with service providers?

Sanne would be involved in reviewing the foreign scheme prospectus and relevant documentation, such as the annual financial statements, manager company information, representative agreement, and the regulator letter.

When it comes to the submission process to the FSCA, we would facilitate the completion of all the required application documents, prepare the representative agreement, facilitate the preparation of the motivation letter, monitor the application process and engage regularly with the FSCA.

We also undertake ongoing compliance support and maintenance such as compliance monitoring and regulatory submission of all marketing material including minimum disclosure documents, brochures, presentations, application forms, and advertisements. 

We monitor the submission of quarterly statistical information, to be submitted by the foreign manager within 30 days after the end of each quarter. 

This includes ensuring that levies are paid by the foreign manager within required deadlines (the levy statement will be sent through to the foreign manager once such statement is obtained from the regulator).

We will also review any amendments to the scheme or fund legal documentation and submit to the FSCA for approval, as required.

An operator or foreign scheme could apply on their own accord by applying as a representative office, however this is typically done via a Manco as the Manco licence is a key consideration when applying. The application process can be quite burdensome and only becomes scalable when operating a large number of portfolios across a multitude of AUMs. 

It can be seen as similar to hedge fund investment managers with local funds typically partnering with hedge fund mancos rather than establishing their own mancos. Additionally, that layer of independence is always going to be favourable in the regulator’s eyes, all else being equal.

Q: What are the benefits of having a product Section 65 registered? How do the local distribution channels work once you are registered?

If Section 65 approved, one would be able to market to the South African public. 

Local managers would find this appealing given that they have existing relationships with the main distribution channels through:

·      Financial advisers

·      Lisps that house offshore funds (Sanne has relationships with the vast majority of local Lisps).

·      Asset consultants that have access to the South African pension fund market that could allocate a portion to the offshore fund 

·      Local CIS portfolios, especially considering that the Asisa requirement for South African classified portfolios, is 45%, not to mention offshore and worldwide mandates. 

Foreign managers would also find this appealing for the above reasons as well as the fact that South Africa is often seen as the gateway to the rest of Africa for international fund managers.

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