COMMENT

Funding govt and SOEs (IV)

Charles Collocott says currently there is no room for additional SOE equity or debt in GEPF

Funding government and State-Owned Enterprises (IV) – Pension funds not regulated by the Pension Funds Act (1)

13 February 2020

The series deals with the following topics:

Introductory brief.

Pension funds.

Funds regulated by the Registrar of Pension Funds.

The Government Employees Pension Fund and other public sector funds not regulated by the Registrar of Pension Funds (1)

The Government Employees Pension Fund and other public sector funds not regulated by the Registrar of Pension Funds (2)

Funds other than pension funds which might be required to finance SOE’s

Country comparisons (1).

Country comparisons (2).

Conclusion.

Briefs 1 and 9 summarize the approach and findings, and they will be published first. Shortly thereafter, Briefs 2 to 5 will be published, and finally Briefs 6 to 8.

INTRODUCTION

With public sector funds not regulated by the Registrar of Pension Funds making up a significant portion of South Africa’s total pension fund assets, this brief begins with an overview of the sector. It then takes a more detailed look at the GEPF, which is by far the largest of these funds. It then considers whether the GEPF can support further investments into SOE debt and equity, as may be required by prescribed assets, followed by an analysis of the fund’sholdings of SOE debt, and finally considers the implications of a drop in the GEPF’s investment returns on individual contributors, government’s contribution and payouts to beneficiaries.

FUNDS NOT SUBJECT TO THE PENSION FUNDS ACT

There are several funds that were established in terms of statutes other than the Pension Funds Act. These funds are therefore not subject to regulation and supervision of the Pension Funds Act, and by extension the Registrar of Pension Funds. The most significant of these funds include:

The Government Employees Pension Fund (GEPF).

The Transport Pension Fund, the Transnet Retirement Fund and the Transnet Second Defined Benefit Fund.

The Telkom Pension Fund and the Telkom Retirement Fund.

The Post Office Retirement Fund.

At 31 December 2017, these funds made up 42% of total retirement fund assets in South Africa:

 

R’million

GEPF

1 705 480

Transnet Funds

84 465

Post Office Retirement Fund

14 599

Telkom Pension Fund

199

Total

1 804 743

The Government Employee Pension Fund (GEPF) makes up 95% of funds not subject to the Pension Funds Act. We will therefore focus on the GEPF because of its significant size in comparison to its peers.

HOLDINGS RESTRICTIONS FOR THE GEPF

Section 6(7) of the Government Employees Pension Law, 1996 specifies that the Board of the GEPF, acting in consultation with the Minister of Finance, shall determine the investment policy of the Fund.

The Board and the Minister have determined the following constraints on the Fund’s investment holdings:

90% of assets must be invested in South Africa.

An international allocation limit of 5% in the rest of Africa and 5% elsewhere internationally. 

The GEPF is currently considering an increase in these limits.[1]

Invest only in the bonds included in the Bond Exchange of South Africa’s All Bond Index (ALBI), within specified risk parameters including a minimum rating of BBB.

Total exposure to any single bond issuer is subject to restrictions stipulated in the investment mandate. The mandate is not available to the general public, but examples have been announced, such as; not more than 5% of the total bond portfolio can be invested in bonds issued by an A-rated issuer, and not more than 2% can be invested in bonds issued by a BBB-rated issuer.[2] 

CAN THE GEPF SUPPORT FURTHER INVESTMENT INTO SOE DEBT AND EQUITY?

In order to gauge the potential implications for the GEPF if it were forced to invest more of its funds in SOE debt and equity, we need to begin by looking at the fund’s current holdings versus the mandated holdings, as shown in its 2018 annual report:

 

Target range

Strategic allocation

Actual holdings

Local equity

45% - 55%

50%

51.16%

Local bonds

10% - 36%

31%

32.42%

Local property

3% - 7%

5%

5.23%

Local cash

0% - 8%

4%

2.37%

Africa

0% - 5%

5%

1.73%

International equity

1% - 5%

3%

4.75%

International bonds

0% - 4%

2%

1.06%

Looking at the actual holdings versus the target range, it may seem that there is room for the GEPF to take on additional SOE debt or equity. But one needs to instead focus on the strategic allocation target, because this is the allocation decision made by the GEPF to best try and achieve the goal of their liability driven investment mandate.

A liability driven investment mandate, which is common among and well suited for defined benefit funds such as the GEPF, is an investment strategy with the goal of providing the cash flows needed to fulfil the fund’s future liabilities, i.e. retirement benefits for the plan members. Therefore, the strategic allocation above is that which the GEPF believes will best achieve this.

With the GEPF’s local equity and bond holdings already above its strategic allocation, any additional SOE debt or equity will have a negative effect on the fund’s ability to match the cash flows generated by the fund with future liabilities. Any resulting cash shortfall will then have to be made-up either by liquidating investments or from a cash injection by government, the plan’s sponsor, or increased member contributions. These would be undesirable outcomes. Liquidating investments will have a negative effect on the GEPF’s ability to generate future required returns, the considerable stress facing government’s finances are well documented and member’s available monthly incomes would decrease.

Furthermore, even if the GEPF were to reconstruct its portfolio to accommodate an increased allocation in SOE debt and equity, given that such an allocation would be imposed from the outside and is not the fund manager’s first choice, it would be logical to assume that current as well as future returns to the fund will be sacrificed.

GEPF HOLDINGS OF SOE DEBT IN RELATION TO TOTAL SOE DEBT

The table below shows the total debt issued by each SOE in which the GEPF has invested, followed by the GEPF’s actual debt holdings in nominal terms and also as a percentage of the SOE’s total debt.

 

National Credit Rating

SOE Total 2018 R'm

GEPF Holdings 2018 R'm

% owned by GEPF

Eskom

 

 

 

 

Non-current debt securities and borrowings

B

348 112

87 564

25.15%

Current debt securities and borrowings

40 572

831

2.05%

Transnet

 

 

 

 

Long-term borrowings

AA+

93 593

21 732

23.22%

Short-term borrowings

 

28 957

99

0.34%

Sanral

 

 

 

 

Non-current financial liabilities

AA-

45 908

25 960

56.55%

IDC

 

 

 

 

Borrowings

AAA

33 217

509

1.53%

TCTA

 

 

 

 

Long-term borrowings

A+

17 653

12 478

70.68%

ACSA

 

 

 

 

Long-term borrowings

AA+

5 789

665

11.49%

Rand Water Board

 

 

 

 

Non-current borrowings

AA+

4 393

544

12.39%

Total

 

 

150 382

 

National Long-term Rating

Rating Symbol

Highest grade quality

AAA

Very high credit quality

AA+, AA, AA-

High credit quality

A+, A, A-

Adequate protection factors

BBB+, BBB, BBB-

Capacity for timely repayment

BB+, BB, BB-

Possessing risk that obligations will not be met when due

B+, B, B-

Defaulted

D

The GEPF’s total SOE debt holdings comes to over R150 billion and makes up 26.7% of the fund’s local debt holdings, which includes corporate debt. The question that would need to be sufficiently answered is; if the GEPF is forced to increase its SOE debt holdings through prescribed assets, what would be the implications for the fund due to the increased concentration of this investment class in the portfolio?

What is immediately clear and a cause for concern is that the GEPF’s single largest debt holding, other than South African government bonds, is the over R87 billion it currently holds in Eskom debt. This, according to the National Long-term Rating Scale, is only two ratings away from default. There can be no rational argument for prescribed assets that would force pension funds to invest in debt where there is “risk that obligations will not be met when due,” as with the B+, B and B- ratings. The same can be said for prescribing that funds invest in the equity in an entity such as Eskom.

Eskom currently has to borrow money to service its debt. It cannot service its debt from its operational revenues. And if funding from the GEPF were to go into Eskom in the form of equity, how are Eskom’s shares to be valued to figure out what percentage of the company if to be made available to the GEPF?

IMPLICATIONS OF A DROP IN THE GEPF’S INVESTMENT RETURNS ON INDIVIDUAL CONTRIBUTORS, GOVERNMENT’S CONTRIBUTION AND PAYOUTS TO BENEFICIARIES

If the GEPF’s investment returns were to decrease to a level that would have a material negative impact on the fund’s funding levels (assets versus liabilities), contributions by both government employees and government itself as the plan sponsor would need to increase. This would place strain on the monthly income available to the employees and increase the burden on government’s fiscus.

With regards to payouts to beneficiaries, these increased by 5.5% year on year for 2018, which was above the inflation rate of 4.62%. The Rules of the Fund require that benefits increase by at least 75% of inflation. If the GEPF was to come under increased financial pressure due to say a large drop in returns, and payouts to beneficiaries were then increased annually by only75% of the inflation rate, this would mean a shrinking in real terms of the benefits received by the pensioners.

CONCLUSION

With public sector pension funds making up over 42% of South Africa’s pension assets, and the GEPF by itself representing over 40%, the current state of these funds and implications which prescribed assets might have on these funds and their sponsor, the government, need to be taken seriously.

The GEPF’s local equity and debt holdings are currently slightly overweight versus its strategic target, so currently there is no room for additional SOE equity or debt. Furthermore, the fund is already by far the largest holder of debt in a number of SOEs, and an increase will further stretch the fund’s security/asset specific risk.

A policy of prescribed assets which causes the GEPF to increase its holdings in SOE equity or debt will also come at the expense of investment returns, thereby placing pressure on the GEPF’s funded status (assets versus liabilities), increasing financial pressure on both the fund’s members and government as the plan sponsor, as they will be required to shore up the assets in order to ensure that future obligations can be met.

By Charles Collocott, Policy Researcher, HSF, 13 February 2020

[1]https://www.businesslive.co.za/bd/national/2019-04-29-mandatory-high-exposure-to-jse-a-drawback-to-gepf/

[2]https://www.gepf.gov.za/gepf-invests-responsibly/