The economic policy document tabled by National Treasury in 2019 described South Africa’s current economic trajectory as unsustainable. It further lamented the stagnation of economic growth and the unprecedented levels of unemployment and inequality.

According to Statistics South Africa in July 2019, and the subsequent commentary from the pundits, the reported unemployment rate sits at 27.2% while the expanded unemployment rate sits at an alarming 38.5%. To salvage this dire situation, National Treasury proposed that: “The government should urgently implement a series of reforms that can boost South Africa’s growth in the short term, while also creating the conditions for higher long-term sustainable growth.”

The state of state-owned companies (SOCs) in South Africa has compounded the country’s economic woes. Eskom reportedly has a debt burden of approximately R450-billion and the national carrier, SAA, was placed under business rescue after incurring more than R28-billion in cumulative losses over the past 13 years.

On Monday 22 January 2020, the Congress of South African Trade Unions (Cosatu) presented a proposal to rescue Eskom and the economy to government representatives and business leaders at the National Economic Development and Labour Council. The document titled, Key Eskom and Economic Intervention Proposals, has been described as an urgent initiative to help stabilise Eskom and save its workers’ jobs. The document has revived heated discourse on the use of pension funds for investment in bonds sanctioned by the state, ie prescribed assets. Cosatu has argued that paying off 50% of Eskom’s debt with workers’ pension funds is feasible and in addition:

“A discussion must begin between government, the PIC, labour, the retirement (sic) on a sustainable, correct and progressive balance to be agreed to on prescribed assets in support of key public goods and infrastructure.”

The principle of prescribed assets is no stranger to South African public policy and was implemented by the cash-strapped National Party-led government in the 1980s to fund state-owned enterprises in response to an investment exodus on account of international sanctions that were imposed on South Africa during apartheid.

While the financial context is essential to understanding the risks posed by the proposed policy, the purpose of this article is to elucidate the legal framework which governs pension fund investments and to assess whether a legal right or duty exists for the use of pension fund assets to rescue Eskom.

The Pension Funds Act 24 of 1956

Pension funds are defined in the Pension Funds Act as organisations established with the object of providing annuities or lump sum payments for members or former members of such association upon reaching their retirement dates, or for dependants of such members or former members upon their death.

There are two types of pension funds, namely a defined benefit and a defined contribution fund. In a defined benefit fund, the retirement benefit is defined by means of a formula that is not premised upon the amount of money paid into the fund in the form of contributions by or on behalf of a member of the fund. In simple terms, the benefit is guaranteed from the onset as the formula used encompasses years of service and the salary history of the employee concerned at the time of retirement, and other more technical aspects considered during the actuarial evaluation.

Many “public sector” pension funds are defined benefit funds and the government as the employer underwrites the benefit to the contributing member. The Government Employees Pension Fund (GEPF), the largest pension fund in South Africa, is a defined benefit pension fund and owns 86.5% of the assets held by the wholly-owned state asset manager, the Public Investment Corporation (PIC).

In contrast, in a defined contribution pension fund the benefits are not underwritten by the employer and are dependent on the contributions made by the members and the investment returns. The advantage to the members in this type of fund is that where the fund performs well it will reflect in their pension benefits. This distinction is essential to understanding who bears the risk of investment decisions and to what extent the members are affected.

Importantly, pension funds are special-purpose legal entities which facilitate benefits to members, former members or dependants of members and former members through the Pension Funds Act and the rules of the fund. These rules determine how the pension fund is managed and, importantly, how decisions around the assets of the pension fund are made. The pension fund, the powers and duties of its board members and the rights and obligations of its members and the employer are governed by the rules of the fund and relevant legislation. Often, the rules of the pension fund also guide how the assets of the pension fund are maintained and invested sustainably to ensure that the fund is conserved. This is to ensure members derive the best benefit possible to carry them in retirement.

While board members exercise their discretion when investing pension fund assets, these decisions cannot be made arbitrarily but must be made in a manner which upholds the fiduciary duties owed by the board members of the pension fund to the pension fund. While the assets of pension funds must be invested in a manner that benefits the funds and the contributing members, it is important to emphasise that it is the boards of pension funds that make investment decisions in consultation with finance experts who are usually its asset managers. These decisions are not made by the contributing members as some commentators have erroneously argued.

Questions, however, are often raised as to the nature and extent of this discretion and what relevant considerations board members are required to consider when making investment decisions. Logically, a pension fund ought to invest in assets which will maximise returns for the fund, but this begs the question of whether the benefit to the fund is limited to financial returns or should the fund also be able to invest in assets which may not yield the same financial margins, but are important environmental, social or even governance assets?

Regulation 28 of the Pension Funds Act

Regulation 28 of the Pension Funds Act was published in accordance with section 36(1)(bB) of the Pension Funds Act which empowers the minister of finance to make regulations limiting the extent to which pension funds may invest in particular assets. The aim of the regulation is to ensure that the savings that South Africans contribute towards their retirement are invested in a prudent manner that not only protects the retirement fund member but are also invested in a way that achieves economic development and growth.

Regulation 28 also enables investments into unlisted and alternative assets to support economic development that may be funded through such capital-raising channels. In terms of regulation 28, in making investment decisions a fund should be guided first and foremost by what is best for the fund and its members and should invest accordingly. This is consistent with the fiduciary duties of board members towards the fund.

The regulation, however, also emphasises the significance of finding the balance between optimal investment of member savings with long-term and sustainable investments which are cognisant of significant environmental, social and governance issues. This is part of the board’s fiduciary responsibilities to the pension fund in ensuring that the pension fund is managed sustainably.

Critics who adopt a strict market perspective often argue that regulation 28 unduly constrains the board of their respective pension fund and may compromise their pension interest. I, however, argue that this is a narrow and inappropriate way to interpret regulation 28.

Pension funds receive considerable tax incentives and due to the amount of money pension funds hold, these should be treated as national assets and regulation 28 merely provides a safe framework within which these national assets should be invested to ensure they are invested sustainably so the fund is able to reap long term returns in the form of a balanced socioeconomic environment and increased economic growth as opposed to short-term financial reward which may not see the fund’s return on investment continue to grow over time.

Is there a case for prescribed assets in the current macro-economic environment?

As articulated above, South Africa does have legislative guidance on how pension funds assets should be invested. While the regulation does not prescribe that pension funds must invest a portion of their assets in government bonds, the wording of regulation 28 does provide for 75% of pension fund investments to be invested in domestic assets. The regulation also provides for investment in bonds which do not typically generate short-term monetary rewards and contribute towards economic growth. Regulation 28 does therefore envisage the type of investment Cosatu has proposed. This, however, needs to be balanced with the need to ensure that the investment is in the best interests of the fund and its members and will not haemorrhage the much-needed pension fund assets to the detriment of the pension fund.

It cannot be gainsaid that Eskom is a crucial SOC and plays a pivotal role in enabling productivity in the economy. The large primary and secondary industries such as mining and manufacturing respectively are heavily dependent on the operational ability of Eskom and the frequent power cuts are not only a serious inconvenience to citizens, but they also put key South African businesses on the backfoot. According to research from the Council for Scientific and Industrial Research, power cuts by Eskom cost the South African economy up to R120-billion in 2019 and will probably persist for the next two to three years. In a macroeconomic environment with an economy where gross domestic product growth is forecast at only 0.6% and 1% in 2020 and 2021 respectively, South Africa is in a state of crisis and drastic measures need to be taken to salvage key components of the economy.

Pension fund investments do not function in isolation to all of these factors in that 75% of their assets are invested in domestic entities, including SOCs, and an ailing economy has an adverse impact on their ability to generate returns. I therefore argue that a stable macroeconomic environment characterised by productivity and economic growth is in the best interests of all pension fund investments and the benefits to their members.

The PIC is a public asset manager which is meant to act on behalf of many low to middle-income civil servants who bear the brunt of the trying economic times. It would be irresponsible for the PIC not to consider the importance of a stable economic framework in its investment strategy. Investments in critical public institutions like Eskom should be considered carefully due to the significance of the entity to the economy. The risk to the GEPF and the contributing members may also be mitigated by the fact that the GEPF is a defined benefit pension fund and the government and ultimately the taxpayer will share the risk of any failed investments.

While this isn’t an ideal solution, under the status quo the taxpayer already bears the risk of increased taxes and higher electricity tariffs to make good on Eskom’s debt repayments and the PIC’s intervention may be the better evil if implemented with the right controls on Eskom’s operations.

In conclusion, in 2019, a recapitalisation programme for leading retail group Edcon was implemented in terms of which the debt and capital structure of the retailer was restructured. This programme included the contribution of cash and rent reductions, totalling about R2.7-billion, into the Edcon group, with the PIC investment worth R1.2-billion. According to the PIC, this was in line with the Unemployment Insurance Fund’s investment mandate and was said to be “an initiative which was part of the UIF’s socially responsible investment mandate and allows the PIC to invest in projects that create and sustain jobs”.

While this example may be distinguishable with respect to scale, and more technical aspects such as the PIC’s extremely high credit risk exposure in Eskom, the principle remains relevant and Eskom finds itself in a very similar position to Edcon.

Ultimately, the discretion of the pension fund investment lies with the GEPF, which will need to conduct the requisite due diligence and make a decision which will be prudent and hopefully, will also take due consideration of its socially responsible investment mandate. DM