FSCA Financial Statements for Retirement Funds

FSCA TRUSTEE WORKSHOP 1 Financial Statements Retirement Funds

A look at retirement funds financials A Governance and Regulatory Tool (Financial Sector Conduct Authority) 27 May 2019 Presenter: Ms Wilma Mokupo Head: Retirement Funds Prudential Supervision

Structure and objectives of twin peaks Consumer Education Market Integrity Conduct of Business Banking Insurance Financial Conglomerates Financial Stability Oversight Committee Financial Market Infrastructure Resolution Authority MARKET CONDUCT PRUDENTIAL FINANCIAL STABILITY FSCA Retirement funds PA SARB

Implications for boards  Backward-looking  Compliance-based  “One-size-fits-all”  “Silo” approach  Forward-looking  Pre-emptive and proactive  Outcomes-based  Risk-based and proportionate  Comprehensive and consistent  Intensive and intrusive…

Slide 4 Implications for boards Culture and governance Product value Unfair contract terms Misleading advertising/marketing Ineffective disclosure Conflicted advice Poor claims handling Poor complaints handling Empowered customers Testing outcomes, rather than compliance ‘tick-box’ Rebalancing of responsibilities: Increased scrutiny of the way firms develop products; Product provider oversight of chosen distribution channel Fair outcomes can be achieved in different ways, through emphasising different TCF elements

5 AGENDA: Financial statements 101 “Back2Basics”  Legal requirement for financial statements (contained in registered rules of the Fund and Section 15 of PF Act & prescribed format & audit requirements are contained in Board Notice 77 of 2014)  Key features of annual financial statements (9 Schedules A to I with Annexures)  Schedule A: Regulatory information*  Schedule B: Statement of responsibility by the Board*  Schedule C: Statement of responsibility by the Principal officer (PO) & Deputy Principal Officer (DPO)*  Schedule D: Report of independent auditor (if applicable)  Schedule E: Report of the board of Fund  Schedule F: Statement of Net Assets and Funds (Balance Sheet)  Schedule G: Statement of Changes in Net Assets and Funds (Income Statement)  Schedule HA: Notes to the financial statements  Schedule HB: Report of the board of the valuator*  Schedule I: Report of independent auditor (whichever is applicable to your fund)  Annexures to Schedule I*:  Annexure A to Schedule I or “Schedule IA”: Investment schedule to the AFS + Investment Notes  Annexure B to Schedule I or “Schedule IB”: Assets held in compliance with Regulation 28  Regulation 28: Audit report to Schedule IB  Regulatory quarterly reporting : non-compliance with Reg 28:  Fund level breaches of limits & non-compliance with Reg 28 Notices/ conduct standards  Member level breaches of limits  Regulatory reporting – a governance toolkit for all  WAY FORWARD – what to expect in the next 12 -18 months?  TCF – fairer outcomes for members

Cover Page to AFS Annual Financial Statements Important points to note for boards:

• Correct fund name and FSCA registration number
• Correct reporting period in line with the registered rules of the Fund (should not exceed 16 months)
• Certain aspects not subject to audit: e.g. regulatory information e.g. statement of responsibility by the board e.g. statement of responsibility by PO & DPO e.g. report of the board e.g. statement and Board e.g. report by the Valuator e.g. investment schedule IA “the look through” to the derivatives etc.

Schedule A: Regulatory Information* Annual Financial Statements Important points to note for boards:

• Check correctness of board, term of office, changes of board members, section 26 trustees (if applicable)
• Check correctness of service provider and the requisite status and approvals in terms of FAIS, Section 13B, auditor is recognised and approved by IRBA
• Make sure credentials of all service providers are in good standing, fit & proper in terms of various laws before appointing new ones or on renewal of mandates, contracts admin agreements etc.
• Addresses and contact details in case you need to trace them and find them when you need information or to address concerns or questions etc.

Schedule B: Statement of responsibility by the Board of Fund* Annual Financial Statements Important points to note for boards:

• DO NOT just copy and paste (make it relevant to your fund)
• The FSCA prescribed format is a guide
• Make the report applicable to your Fund
• Make sure to list all non-compliances with the PFA and the registered rules of the fund
• Make sure to list remedial action taken during the financial year.
• The fund’s first-line of defense is the Board of Fund/ Board of management/ the trustees
• The buck stops with the Board/ Trustees
• Remain accountable even if some functions are delegated (monitor service providers.
• Report non-compliances and corrective action taken

Schedule C: Statement of responsibility by the Principal Officer* Annual Financial Statements Important points to note for boards:

• Reminder to check that duties if the PO and DPO are clearly delineated in the registered rules of the Fund and in this Report
• The FSCA prescribed format is a guide
• Make the report applicable to your Fund
• Report non-compliances and remedial action taken
• Report all non-compliances and remedial action as an officer bearer of the Fund
• Assist with transfer of skills, board orientation & induction
• Liaison officer of the Fund with regulator, administrator, service providers along with Chairperson of the Fund
• Monitoring function of contributions can also be delegated to the PO or DPO
• Timely signing of AFS & correspondence

Schedule D: Report by the independent auditor Annual Financial Statements Important points to note for boards:

• Audit opinion only applicable to funds with assets above R50 million (funds with assets below R50 million must complete the relevant section 15 report under Schedule I (AUP) only)
• The FSCA agrees the content of the audit report with SAICA and IRBA in consultation with industry
• The audit reports is based on international standards on auditing (ISA) as identified with IRBA standards committee (CFAS) (recently revised audit reports)
• South Africa has adopted the ISAs
• The recognition and measurement of the assets and liabilities is set out in the Regulatory Reporting Requirements (RRR) Board Notice 14 of 2009 (currently being revised to bring it more in line with international reporting standards where applicable to retirement funds)

Schedule E: Report of the Board of Fund* Annual Financial Statements Important points to note for boards:

• Everything you the reader needs to know about Your fund “at a glance”
• Proper description of the Fund
• Rule amendments
• NB: Investment strategy of your Fund (summary of the Fund’s IPS)
• Membership movements NB: adjustments & reasons for these
• Significant matters
• Subsequent events (from financial year end to date of signing)

Schedule F: Statement of Net Assets and Funds Annual Financial Statements Important points to note for boards:

• Non-current assets (plant & equipment, investments in participating employer, housing loans facilities, etc.)
• Current assets (transfers receivable, contributions receivable, cash at bank etc.)
• Member funds & surplus accounts (accumulated funds, transfers)
• Reserves
• Current liabilities (transfers payable benefits payable, accounts payable, contributions payable, etc.)
• Avoid bank overdraft

Schedule G: Statement of Changes in Net Assets and Funds Annual Financial Statements Important points to note for boards:

• Contributions
• Reinsurance proceeds
• Net investment income
• Other income
• Reinsurance premiums
• Administration expenses
• Transfers
• Benefits
• Reserves
• NB: monitor these items via the quarterly cash-flow statements presented at board meetings by the administrator (compare)
• FSCA considering submission of cash￾flow statements (monthly or quarterly to monitor charges etc.)

Schedule HA: Notes to the financial statements Annual Financial Statements Important points to note for boards:

• Excellent monitoring tool for boards (details provided to ensure adherence to mandates, contracts etc.)
• Principle accounting policies of your fund
• Financial instruments
• Investments
• Collective Investment schemes
• Insurance policies….
• Property (direct & indirect)
• Derivatives (yes/ no) require “know-how”
• Asset impairments
• Provisions e.g. for recoveries
• Dividends
• Transfers (movements)
• Unclaimed benefits (movements)
• Net investment income (includes charges/ fees)
• Administration expenses (check if in line with fund expense policy, check proper disclosure & large amounts/ leakages, value for money for members, etc.)
• Risks (legal, credit, liquidity, currency, cash flow etc.) DO NOT CUT & PASTE THESE ITEMS
• Related party interests Note the actual Rand amounts)

Investments extract from Annual Financial Statements Notes to the AFS

Investments extract from Annual Financial Statements Notes to the AFS

Investments extract from Annual Financial Statements Notes to the AFS

Investments extract from Annual Financial Statements Notes to the AFS

Investments extract from Annual Financial Statements Notes to the AFS

Schedule HB: Report of the valuator* Annual Financial Statements Important points to note for boards:

• Statement on net assets
• Actuarial value
• Contingency reserves
• Methodology
• Actuarial basis
• Statement on financial soundness of fund
• Additional remarks

Schedule I: Report of the independent auditors* Agreed upon procedures (the AUP) Annual Financial Statements Important points to note for boards:

• Prepared by and signed off by a registered auditor
• Based on agreed upon procedures (AUP) to be performed by a registered auditor who signs a factual findings report after performing certain “tests” e.g. on contributions e.g. investments e.g. benefits e.g. transfers and other high risk areas identified by the FSCA from time to time
• This is not an audit of the financial statements (Schedule D above contains the audit opinion & is only applicable to funds with assets of R50 million or more)
• Governance tool for boards as part of monitoring function
• Board can monitor these items pro￾actively on quarterly basis and raise questions on administrator reports

Schedule IA: Investment schedule pertaining to the annual financial statements* Annual Financial Statements Important points to note for boards:

• Look-through tool on investments especially derivatives and non-compliant CIS and Insurance policies
• Derivatives not an asset but a hedging instrument (cost efficiency, effective portfolio management)
• No look-through required for hedge funds and private equity because seen as the final asset in Reg 28 NB: structures are important such as bewindt trusts, en commandite partnerships, OEIC) see Notices & Conduct standards issued by FSCA/ FSB
• Extensive investments Notes as a governance & monitoring tool Note A to P)
• Non-compliance checks against Reg 28 limits:
• Spilt between local & foreign investments
• Complaint vs non-complaint investments

23 Investments extract from Annual Financial Statements Notes to the Investment schedule

24 Investments extract from Annual Financial Statements Notes to the Investment schedule

25 Investments extract from Annual Financial Statements Notes to the Investment schedule

26 Investments extract from Annual Financial Statements Notes to the Investment schedule

27 Investments extract from Annual Financial Statements Notes to the Investment schedule

Investments extract from Annual Financial Statements Notes to the Investment schedule

29 Investments extract from Annual Financial Statements Notes to the Investment schedule

Investments extract from Annual Financial Statements Notes to the Investment schedule

31 Investments extract from Annual Financial Statements Notes to the Investment schedule

32 Investments extract from Annual Financial Statements Notes to the Investment schedule

Schedule IB: Assets held in compliance with Regulation 28 Annual Financial Statements Important points to note for boards:

• Asset spreading requirements check against the limits set in Reg 28
• Overall limit per asset class (also see SARB quarterly asset allocation reports)
• Sub-limits per issuer, entity or counterparty (check concentration risk) local & foreign classifications:
• Cash (deposits & money market < 12 months)
• Equities
• Immovable property
• Commodities (Krugerrands, ETFs, Gold)
• Investment in business participating employer (read with section 19(4) of PF Act
• Hedge funds
• Private equity
• Other (not listed above)
• NB: Investment Summary (breaches, notes on exemptions granted by FSCA , etc.)

Investments extract from Annual Financial Statements Regulation 28 INVESTMENT SUMMARY

Report of the independent auditor on compliance with Regulation 28 (Schedule IB audit report recently revised with IRBA) Annual Financial Statements Important points to note for boards:

• Based on International Auditing Standard as agreed with IRBA and industry
• Auditor performs recalculation of compliance with the limits
• Types of audit reports:
• Unqualified report (clean audit but may include an EOM emphasis of matter to bring something to the attention of the board or FSCA)
• Qualified audit opinion
• Disclaimer (no opinion expressed e.g. insufficient information etc.)
• Adverse opinion
• New Reg 28 audit report approved by IRBA/ FSCA will contain a dual opinion on:
• Basis of preparation of the Schedule IB
• Audit opinion on the Fund’s compliance with all the Reg28 limits
• EOM on soft breaches or non￾discretionary breaches (market movements) and where rectifications were done within the 12 months)

Reg 28 asset spreading limits Per Issuer/ Entity limit TOTAL LIMIT CASH 25% 100% GOVT DEBT 100% BANK DEBT 25/15/10/5 75/25 CORP DEBT 10/5 50/25 EQUITY 15/10/5/2.5 75/10 PROPERTY 15/10/5/5 25/15 COMMODITIES 10/5 10% PART. EMPLOYER 5/10 HOUSING LOANS 95% HEDGE FUNDS 5/2.5 10% PRIVATE EQUITY 5/2.5 10% AFRICA 5% FOREIGN FSCA SUB LIMITS PER ASSET CLASS SARB LIMIT 30% ( includes 5% AFRICA) OTHER 2.5% OVERALL LIMITS UNLISTED, ALT. ASSETS 35%

37 A Governance and Regulatory Tool Various scenarios presented to the “registrar” in 2011 with the advent of the revisions to regulation 28 Scenario 1: More than 80% of our fund is not compliant at member level Our Fund operates mainly in the segregated or specialist mandates space This is mainly in the RA & preservation fund space (grandfathered policies mainly) Scenario 2: Our Fund is at least 60% compliant at member level Less than 5% of our portfolios/ member offerings are non compliant Our administrators are reviewing their business models, systems, etc. Should be fully compliant by end Quarter 2 of 2012? What is the status quo almost 9 years later? Mainly occupational – based funds Scenario 3: Our Fund is 100% compliant at member level All investment offerings/ choices have been reg 28 compliant This provides our members with greater protection and diversification from the start Is there a need for another stock taking? Out of mandate trades and wrong codifications have declined. Reported breaches mainly of non-discretionary nature e.g. market movements… What is not being reported? Retirement funds investments: Regulation 28 revised July 2011

38 A Governance and Regulatory Tool List of in-force Regulation 28 Notices that may be withdrawn in future and replaced with conduct or prudential standards under the FSR Act or replaced with financial instruments under the COFI Bill once in force:  2011  Notice no.1 of 2011 – Transitional arrangements: time to adjust monitoring & reporting systems  Notice no.2 of 2011 - Transitional arrangements: exemption reg 28(3)(j) quarterly reporting instead of reporting to Registrar “without delay”  Notice no.3 of 2011 – Prescribed format for quarterly non-compliance (breach) reports  Notice no.4 of 2011 – Public entities for purposes of paragraph 2.1(d)  2012  Notice no.1 of 2012 – Conditions for investments in private equity funds, approval in terms of section 5(2)(e)  Notice no.2 of 2012 – Conditions for securities lending  Notice no.3 of 2012 – Quarterly non-compliance reporting (30 days)  Notice no.4 of 2012 – Implementation date for pension funds to be compliant with the conditions for securities lending transactions  Notice no.5 of 2012 – Conditions for investments in private equity funds  Notice no.6 of 2012 – Replacing the format of quarterly reporting & 90 days submission deadline  Notice no.8 of 2012 – Classification of Eskom guaranteed bonds par 2.1(a)  Notice no.9 of 2012 – exemption from 25% per issuer limit for funds in liquidation, transfers, benefits payable, contributions, etc.  2013 – n/a  2014  Notice no.1 of 2014 – exemption for pension funds investing in assets on the stock exchanges which is no longer a full member of the WFE (World Federation of Exchanges)  Notice no.2 of 2014 – exemption from Regulation 28(8)(b) requirements for audit confirmation of compliance with regulation 28 where the FYE of insurer, CIS and fund differs  2015 – n/a  2016 – n/a  2017  Notice no.1 of 2017 – exemption in respect of debt instruments issued by a South African bank where the bank itself is not listed but the holding company is listed Retirement funds investments: Regulation 28 revised July 2011

39 A Governance and Regulatory Tool Regulation 28 (adherence to the asset spreading requirements): • 9 Principles (i) Promote trustee education iro PF investments, governance & related matters; (ii) Monitor compliance with Reg28 by its advisors & service providers; (iii) In contracting services consider B-BBEE; (iv) Ensure fund’s assets appropriate for liabilities (ALM); (v) Perform due diligence, risk analysis before contracting e.g. credit, mkt & liquidity risks, operational risk for assets not listed on an exchange, etc.. (vi) Before making contractual commitment in 3rd party managed foreign asset or in foreign asset, perform reasonable due diligence iro currency risk & sovereign risks etc.. (vii) In risk analysis take credit rating into account (but not sole criteria & not to exclusion of fund’s own due diligence) (viii) Understand changing risk profile of assets of fund over time through comprehensive risk analysis e.g. credit risk, mkt risk, liquidity & operational risk, currency risk, geographic & sovereign risk of foreign assets; (ix) Consider any other factors that may materially affect sustainable LT performance of fund assets incl. Environmental, social & governance factors (ESG) …. Retirement funds investments: Regulation 28

40 A Governance Tool for Boards and Investments board sub committees Financial statements, statistics, reports (schedule IB audit report > NAV R50m) Regulation 28 asset spreading requirements It has crucial information on investment activities of your fund (Schedule E, Notes to the financials, schedule IA on look through where required and Schedule IB reports) Use regulatory reports & other financial info as a Governance Tool Have direct access to your auditor with regards to fund financials, when necessary Engage auditor & ask for assistance with interpretation issues around Regulation 28 Seek independent legal advice if the costs justify it (cost v benefit) Retirement funds investments: Regulation 28

41 A Governance Tool for Boards and Investments board sub committees Boards by now you should have considered following when developing IPS: •Current investments •Degree of risk tolerance •Volatility of contributions •Current & future liabilities •Structure of your fund DB or DC or hybrid •Liquidity & cash flow requirements •Maturity of your fund •Profile of your members & beneficiaries Essential elements of an IPS: •Asset mix & expected rate of return •Categories of investments e.g. list of acceptable derivative instruments to be used by the fund, if any) (see Notice conditions for the use of derivatives by retirement funds) •Diversification •Liquidity requirements •Pledging & borrowing of fund assets (exercise extreme care) •Securities lending (see Notice containing conditions) •Management fees & compensation •ESG (environmental, social & governance factors) •Voting rights (transformation) •Valuation procedures

The IPS - Investment Policy Statement

42 A Governance Tool for Boards and Investments board sub committees WHAT BOARDS NEED TO ASK THEIR INVESTMENT/ ASSET MANAGERS & CONSULTANTS? •What processes & procedures are we going to insist on ? •Do we take a more active interest in proxy voting ( e.g. via securities lending)? How has our asset manager(s) been voting on our fund’s behalf, if at all? •How do we rewrite our management agreements & mandates with our asset managers? •How regularly do we need feedback from asset managers? •How & when should breaches be reported & corrective action taken? What is the cause of the breaches? e.g. do we have any out of mandate trades/ member switches/ market movements that caused non compliance? •Do we ask for more meaningful reporting from all service providers so as to better monitor & measure their performance or lack thereof & report breaches to Registrar within the required timeframes (quarterly, annually)? Note: even if the board of trustees outsource these functions they will still be held jointly and severally liable as the fiduciaries/ decision-makers of the fund

Retirement funds investments: Regulation 28

43 A Governance Tool for Boards and Investments board sub committees WHAT BOARDS NEED TO ASK THEIR BENEFIT ADMINSITRATOR? •What systems changes have been implemented since the publication of the revisions to Reg 28 especially to check member-level compliance? •What types of breach reports can be provided to the fund and how often? By whom, when & how? i.e. level, frequency, responsible person, etc. •How many member portfolios/ offerings are non compliant with Reg28? •What does the benefit administrator’s systems capabilities look like? e.g. capacity, resources, restrictions, ability to detect breaches (fund & member level)? •What changes has been made to the systems (if any) to ensure on-going compliance monitoring? e.g. compliance monitoring at fund level, member level, sub limit levels, asset classes? •What is the extent of the administrator’s legal liability? e.g. wrong switches? Does the admin agreement & SLAs sufficiently cover these issues? Retirement funds investments: Regulation 28

44 A Regulatory Tool Legislation  Constitution of the Republic of South Africa (FSR Act)  Financial Sector Regulation Act (primary law) (PF Act)  Pension Funds Act  Regulations  Board Notices  Directives  PF Circulars &  Information Circulars  Conduct standards or prudential standards (next under FSR Act)  Financial instruments under COFI Bill (next)

Retirement funds investments: Regulation 28

45 A Regulatory Tool All funds must submit annual financial statements: section 15 requirement Large funds > R50 million full scope audit including schedule IB audit report Small funds > R6 million < R50 million agreed upon procedures Mini funds < R6 million assets are audit exempt but submits unaudited financials and section 15 report signed by trustees Analysis by FSCA: •Early warning system •Ratio analysis •Analyst checklists •Audit reports, trustee reports •Section 15 report (compliance report) •Peer review (high risk cases) •Manager/ peer reviews (all cases) •Business intelligence (trend analysis) •Onsite visits inspections esp. flagging of 12 month rectifications & rebalancing •Investigations under FSR Act •Statutory management •Curatorships •Section 26 board appointments •New penalty regime under FSR Act and admin penalties continue under sectoral laws for late & non-submissions R4k per day for 2018 FYEs Retirement funds investments: Regulation 28

46 A Regulatory Tool Retirement funds investments: Regulation 28 Proposed changes to the existing reporting to FSCA:

• Proposed changes to quarterly regulation breach reports to align to SARB QAAR and timelines
• Greater focus needed on member-level compliance
• New Bi-annual Conduct return (conduct of business return similar to FAIS)
• Dedicated team specialising in monitoring fund performance and costs (value for money)
• Dedicated team specialising in monitoring fund governance and conduct of trustees
• Fund performance team working closely with SARB’s FinSurv, FinStab and Economic research unit as well as FSCA’s Specialist Support division focusing on Data analytics, using FinTech, RegTech, SupTech and digitization as well as an Innovation Hub within FSCA (it will include looking at much needed research as well as local and international benchmarks, trends)
• The Retirement Funds Prudential supervision will track how funds perform against these trends and benchmarks and identify the outliers and other factors

47 WAY FORWARD – what to expect in the next 12 -18 months?  proposed enhancements to format of quarterly report & submission criteria (all funds to submit)  proposed reduction in quarterly reporting/ submission times (3 to 2 months or less)  alignment with SARB’s QAAR reports [all funds to submit on quarterly basis]  use of SARB’s D427 glossary/ dictionary containing definitions for all foreign assets  proposed reduction in annual reporting submissions from 6 to 3 months*  withdrawal of audit exemption*  use JSE Ltd naming convention fro all listed instruments  use Issuer’s naming convention/ codification for all unlisted instruments issued *s.t. Omnibus Bill 2020 and new Cabinet post-elections 2019 POSSIBLE REVISION areas highlighted:  Definitions i.e. Banks Act vs CISCA vs FMA vs FAIS e.g. money mkt instruments –is it defined as cash or debt depending on time to maturity?  Look-through – revised schedule IA to AFS?  Member-level compliance monitoring versus reporting requirements?  Systems: grand-fathering protection – what triggers a loss of grand-fathering?  De minimus rule –schedule IA must balance with schedule F and schedule IB & provide look-through?  Hedge funds & derivatives & private equity & sec lending notices – to be revised / issued?  Guidance to trustees e.g. due diligence, interpretations, criteria etc.?  Alternative investments esp. risks contained in structured products not well understood, complex?  Skills levels of trustees – FSCA to set minimum criteria & consult?  Future standards as needed (Conduct. Prudential/ Joint standards with SARB)?  Regulation 28(9) exemption criteria & conditions? Participation in industry workgroups e.g. ASISA, SAICA, IRBA, Batseta, IRFA, etc. and during public comment period

The regulatory framework will hold all regulated entities in this value chain accountable to deliver TCF outcomes relevant to their role 48 Sponsor / Employer Administrator (Benefit & Investments) Member advisor Fund & Trustees (rules and benefit options) Insurer/ other product providers Fund advisors & other service providers

THANK YOU “It always seems impossible until it is done” Tata Nelson Mandela Remember to SPEAK OUT!!! When something wrong is happening… Thank You Q&A Useful links: www.fsca.co.za www.trusteetoolkit.co.za wilma.mokupo@fsca.co.za