Jessica Blumenthal and Johan Loubser, ENS
ENS proudly provides legal, tax and forensics services to leading and up-and-coming hedge fund managers, brokers, and investors.
Our core services to the hedge fund industry include support in respect of:
- Financial services regulation, fund formation, mandate negotiation and regulatory advocacy;
- Intellectual property;
- Forensics investigations;
- Employment; and
- Corporate and M&A advice.
Surveying the landscape
Chief operating officers and general counsel in the industry must continually keep up with ever more exacting regulatory and tax requirements, as well as meeting the needs of other stakeholders such as staff, core service providers and, of course, clients.
For example, recently:
- The Financial Sector Conduct Authority (FSCA) adopted a standard for pension fund exposure to derivatives, and separately proposed a standard for the reporting of short sales by authorised users and exchanges;
- The Supreme Court of Appeal sided with the South African Revenue Services (SARS) in relation to the reach of the South African tax net to offshore activities; and
- Many fund managers for the first time navigated the choice of class action lawsuits to recover portfolio damages and, at the same time, considered the robustness of their own liability mitigation measures.
Business-as-usual regulatory and tax issues of portfolio management also continue, such as whether inclusion of a particular security in a portfolio meets all of the regulatory and mandate requirements; whether the manager is barred from trading in a particular security due to corporate action or particular inside knowledge; and whether or not a particular profit should be distributed as income.
In this piece, we highlight four additional areas that merit consideration.
Getting internal policies right
There is no doubt that the FSCA has in recent years moved away from a compliance model (where industry participants are coached into compliance) toward an enforcement model (where non-compliance leads to punishment). This can be seen, for example, from the substantial increases in the administrative fines levied by the FSCA for wrongdoing by licence holders. At the same time, the volume of regulatory requirements is increasing. The board of directors of any licence holder must ensure that it has sufficient capacity and operational policies in place to monitor and implement burgeoning regulatory requirements. We suggest particular and renewed attention be paid to policies relating to risk management, compliance with the Financial Intelligence Centre Act (FICA), IT governance and risk management, cyber resilience and security, and staff conduct. There is also more to come: we await a conduct standard in respect of enhanced regulatory control of collective investment schemes, a re-write of the advertising regulation and the Conduct of Financial Institutions Bill.
Taking action on ESG
Apart from the requirement to form a social and ethics committee under the Companies Act, environmental, social and governance issues (ESG) have not yet found direct application for hedge fund managers. Nevertheless, hedge fund managers may increasingly find institutional investors undertaking enhanced due diligence to ensure their managers have meaningfully engaged with, and integrated, ESG factors into operational and investment decision-making. We expect investors to adopt qualitative frameworks and quantitative tools assessing alignment of their portfolios with ESG criteria. This will require appropriate reporting by managers in line with specific investor requirements. For example, insurers are now required to develop a risk-management strategy, which sets out the material risks to, for example, the financial soundness of an insurer, as well as the mitigation measures adopted to address these risks. Hedge funds, in managing certain of the assets of the insurer in this context, may play a key role in meeting and reporting on any such risks and mitigation measures. If South Africa follows international trends in respect of collective investment schemes more broadly, it is likely that ESG will in future form a part of the “fit and proper” requirements applicable to managers of such schemes. It is also likely that, as part of the development of appropriate risk-management systems, hedge fund managers will increasingly need to engage with and consider ESG risks to their operations and portfolios.
Planning for BEE requirements
The Financial Sector Transformation Council (FTSC) recently sent notices to financial services providers reminding them of their duty to provide annual reports to the FTSC in respect of their contribution to broad-based black economic empowerment (BBBEE). The FTSC monitors compliance with the amended Financial Services Sectoral Charter (FSC) adopted in terms of the Broad-Based Black Economic Empowerment Act, 2003.
At present the FSCA and applicable law have not imposed minimum BBBEE contribution requirements for financial services providers. It is anticipated, given the recently published FSCA Financial Sector Transformation Strategy, that this could change in future and be given impetus when the Conduct of Financial Institutions Bill is introduced and adopted by Parliament. In future, maintenance of a licence may require a minimum BBBEE score, especially for firms that exceed the small business turnover threshold of R10 million. Whilst no detail is available at present, hedge fund managers should consider whether more should be done to support BBBEE in their businesses.
Getting personnel incentives right
Given the increased scrutiny on incentive and remuneration packages, and the calls for transparency to address pay gaps and ensure reasonableness of remuneration, both hedge fund managers and platform providers (mancos) should consider existing and proposed incentive schemes. A relook may, in any event, be driven by empowerment imperatives in light of the FSCA’s Financial Sector Transformation Strategy discussed above. Fine-tuning ambitious key performance indicators, ensuring appropriate tax treatment for both the manager and individual participants, guarding against cashflow timing issues and managing dilution are but some of the issues requiring attention. Copyright. HedgeNews Africa – November 2023.
The authors are executives at ENS. Jessica Blumenthal and Johan Loubser work in the firm’s Banking and Finance Department and have advised industry participants for many years.