There seems to be a low take up on the ruling party's recommendation to amend Regulation 28 to enable Pension funds to invest in infrastructure. Khaya Sithole believes among other reasons for the low take up is the question of whether the government can be trusted as a partner. He continues to say the tragedy of our times is that history indicates that the biggest social partner – the government – is the one with the propensity for breaking agreements regarded as binding.
He therefore suggests that investment in infrastructure should not be be prescribed it should be incentivised.
What incentive can the state can propose to create some upside for the pension funds sector to invest in infrastructure?
Investment in infrastructure should be incentivised, not prescribed
On the afternoon of 18 April 1853, William Gladstone – the recently-minted Finance Minister of the United Kingdom – rose to deliver his first budget.
So dense were the issues of the day and so committed was Gladstone to ventilating them all, his speech started with an apology and ended – almost five hours later – with an ovation of sorts.
The seminal highlight of Gladstone’s speech was captured by the following quote:
"These are the proposals of the government. They may be approved, or they may be condemned, but I have at least this full and undoubting confidence, that it will on all hands be admitted, that we have not sought to evade the difficulties of our position – that we have not concealed those difficulties either from ourselves or from others; that we have not attempted to counteract them by narrow or flimsy expedients; that we have proposed plans which, if you will adopt them, will go some way to close up many vexed financial questions."
The little red box
Over the years, and as the volumes of paper associated with his budget speeches kept expanding, Gladstone acquired a little red box whose only purpose was to hold all the documents associated with his speeches. The budget box, as it became known, became a permanent fixture of the British political protocol as every Finance Minister dangles it for the public on their way to delivering a budget.
As more speeches are produced and beamed online, its symbolism now trumps its purpose. This year, the current Chancellor – Rishi Sunak – delivered his first budget that was noted for its omissions rather than its commitments.
As Britain meanders through a laborious exit from the EU, one of the biggest consequences will be the loss of access to the EU structural funds which provide funding aimed at assisting regions and cities invest in infrastructure, tackle inequalities and boost regional development.
The fund’s annual allocation of GBP4.4 billion – made up of an equal contribution from the EU and the UK – is an important source of economic support for the poorer areas of Britain. Its allocation model specifically acknowledges that some parts of Britain are not as investor-attractive as the main economic hubs.
The funding model therefore allocates a greater share to those areas, regions and cities that – if left to the vagaries of the open market – would quite simply never see any substantive investment.
The Conservative Party manifesto had committed to setting up a successor fund – the Shared Prosperity Fund – to replace the EU version. The problem, however, is that since then, little in the way of progress in setting up the Fund has occurred.
Sunak’s March 2020 budget came nine months before the projected exit from the EU. It was the omission of any substantive details regarding the Shared Prosperity Fund that left Britons wondering if the government actually had a plan to set up the Fund before Brexit.
A similar case of omission
One runaway pandemic and three months later, Tito Mboweni found himself facing a similar case of omission.
The June emergency budget was expected to provide some clarity on the government’s stance regarding the amendment of Regulation 28 of the Pension Funds Act.
The question is simple – should the Regulation be amended to specifically refer to infrastructure as an asset class; and should pension funds be forced to invest in public infrastructure? Surprisingly the Regulation 28 issue was curiously missing from the final speech.
Conceptually, Regulation 28 is aimed at tempering the unbridled excitement of fund managers by promoting diversity in investments.
By identifying investable asset classes and then setting limits on how much can be invested in an asset class; the regulation ensures that there is no acute concentration of risk that would arise if a fund manager invested everything in one basket.
Currently, the regulation is seen as an important tool for ensuring that prospective pensioners aren’t burdened with a risk of their lifetime savings being wiped out simply because they are invested in just one pot which may be underperforming at precisely when a pensioner wants to cash out.
Prescription vs. optimisation
In the current discourse, the question seems to be whether Regulation 28 ought to be amended, and what the effect of such an amendment would be. The debate seems to fluctuate within a spectrum of prescription versus optimisation.
The current model of setting a cap of how much can be invested in an asset class, provides latitude for fund managers to select the asset classes they prefer based on their risk appetite.
In other words, the sum of investments is across a range of asset classes but not necessarily in each of them. Naturally, as risk appetites differ, there will be an asset class that a fund manager would simply avoid.
The dilemma of the modern-day discourse, however, is best understood by analysing the purpose of the proposed amendments.
The purpose
It is now a generally accepted reality that South Africa has an infrastructure backlog and that the current pace of rollout and implementation isn’t narrowing the gap fast enough. The reasons for the relatively low take-up are a combination of preferences, investment horizons, availability of viable and feasible co-investment structures, and the question of whether the government can be trusted as a partner.
In the original deliberations, the view was that amending Regulation 28 would facilitate investment in infrastructure. Apparently, the problem is that in the current wording of the Regulation itself, infrastructure is not explicitly stated as an investable asset class.
This seems to have convinced some politicians that Regulation 28 therefore prohibits investment in infrastructure – which is obviously nonsensical to anyone who has read the regulation.
In its latest economic roadmap, the ANC suggests that the Regulation should be amended to enable pension funds to voluntarily invest directly in infrastructure. For a party with a 20-year track record of observing the limitations of recommending rather than prescribing transformative rules and regulations, the ANC’s naivete in believing the benevolence of the market participants, is delightfully worrisome.
The problem with recommendation
The problem with that recommendation is that amending the regulation to explicitly identify infrastructure as an asset class may indeed enable pension funds to invest in the manner that the ANC envisages; but in the context of other asset classes remaining available to fund managers as options, then the question of whether direct investment in infrastructure will materialise, is still a question of appetite and discretion.
And if fund managers regard all other asset classes as providing a better risk-reward balance than infrastructure, then the original dilemma – finding a way to channel more investment towards infrastructure – remains unresolved anyway.
The natural follow-up to that realisation is then the question of whether fund managers must then be compelled to invest in infrastructure regardless of their ranking of it as an investment class.
Such a policy – referred to as prescription – seems to be the bone of contention that resulted in the bureaucrats at National Treasury deleting the matter of Regulation 28 from Tito Mboweni’s winter emergency budget without informing Mboweni himself.
And judging by the nature of the exchange between the Minister, his chief bureaucrat and the media when the issue of the omission was raised, we may never know what really happened inside the red box of Mboweni’s speech.
A stay of execution
However, that can only serve as a temporary stay of execution for Mboweni.
The fundamental anxieties around prescription, are premised on the fear that by forcing pension funds to invest in an asset they would prefer to avoid on the basis of preference and quality of returns, you drag the performance of the entire pension fund to the detriment of its members.
Such a problem wouldn’t exist if asset classes were in the habit of guaranteeing particular returns; but as we now know, that’s not how capital markets work.
What must inform the deliberations is a question of whether the national interest is best served through a process of selective prescription that identifies particular infrastructure projects for investment with the downside risk secured by the state in the same way the current loan guarantee scheme has been conceptualised.
And if such a model were to be pursued, it would require the type of salesman who is able to articulate that the long-run outcomes from a coordinated infrastructure drive will eventually have positive spillover effects for the economy at large and by extension, the various asset classes that pension funds are already invested in.
An easier sell
Naturally, this would be easier to sell in relation to public infrastructure that has a business model that levies a fee on the end-user like railways, for example. Redirecting pension fund investments to those type of investments would free up the space for the state to focus on the type of social infrastructure – schools, clinics – where the business model of charging the end-user is less feasible.
If anything has been learned from this crisis, it is that solidarity is still a possibility when social partners unite for a common purpose towards a shared prosperity.
In seeking to table a possible way forward, I would suggest a conversation centred around what incentive the state can propose to create some upside for the pension funds sector.
As we all know that the risk of underperformance is ultimately borne by the pensioners, it may well be that the government proposes a flexible tax model for pension funds that participate in the scheme.
In that way, pensioners whose retirement pot may have been dragged down by the infrastructure component, can be given additional relief through a lower tax rate at the payout stage compared to members of pension funds that opt not to participate in the infrastructure drive.
That – Mr Mboweni – would be prescription by concession rather than coercion.
The tragedy of our times is that history indicates that the biggest social partner – the government – is the one with the propensity for breaking agreements regarded as binding.
Those glaring tensions notwithstanding, Mboweni would do well to take a leaf out of Gladstone’s book by tabling the proposals of government even if a risk of condemnation exists. Because if the plans are well-articulated and provide an appropriate balance between risk and reward; he may indeed discover that the country adopts the proposals in a way that goes some way to closing up many vexed financial questions.
Omitting the conversation altogether, risks missing out on a unique opportunity to explore alternatives that are not shackled by the chains of historical practices.
This article was written for Fin24 by Khaya Sithole an accountant, academic and activist who writes and Tweets on finance, economics and politics
Comments
Post a Comment