08 May 2017

Pension Law: Structural Independence and King IV

Practice Area(s): Pension & Employee Benefits |

In addition to the accepted good governance principle that board members act with an independent mind (as confirmed in an amendment to the Pension Funds Act in 2013); the King IV Report on Corporate Governance for South Africa (in respect of financial years commencing on or after 1 April 2017), has suggested further requirements regarding structural independence when considering good governance best practice, including those for retirement funds.

From a legislative perspective, the Pension Funds Act prescribes that every fund must have a board consisting of a minimum of four trustees, at least fifty percent of whom the members of the fund shall have the right to elect. This is an absolute requirement for standalone funds (where a single employer or holding company participates in a fund). Where the fund is a multi-employer fund (also referred to as an “umbrella fund”), a retirement annuity fund, a beneficiary fund or a preservation fund, the Registrar of Pension Funds may, at his / her discretion, provide an exemption from the requirement that members of the fund have the right to elect at least half of the persons on the fund’s management board.

The King IV Report moves away from the King III principle of “apply or explain” to “apply and explain”, confirming that for any organisation to substantiate a claim that it practices good governance it must be able to explain the application of each of the 17 Principles of Good Governance set out in the King IV Report. Principle 7 requires the composition of “the governing body” (in this case the board of a pension fund) to be sufficiently independent for it to discharge its governance responsibilities. Regarding Principle 7, the sector supplement directed at the retirement fund industry states that:

“It is recommended that at least half of the members of the board are independent and appointed from a pool of professional board members...smaller funds should consider appointing at least one independent professional board member.”

Regarding independent members, the King IV Report explains that independent board members should not be an employee of the employer nor be controlled nor be in common control with the employer, the administrator or the sponsor of the fund. Independent board members should further preferably not provide any other services to the fund or the employer or sponsor.

The recommendation in the King IV Report that at least half of the board be made up of independent trustees does not change the requirement in the Pension Funds Act that the members of the fund should have the right to elect at least fifty percent of the board. The result of the King IV’s ‘best practice’ would therefore dictate that funds that do not hold an exemption should be made up of fifty percent member elected trustees and fifty percent independent trustees. An issue with this ‘best practice’ approach is that other stakeholders in the fund (particularly the participating employer/s) may feel that they have been left out of the equation. From the opposite perspective, where a fund does hold an exemption from the requirement that the board be fifty percent member elected, who should be appointed or elected to make up the remainder of the board where a fund has applied the recommendations contained in Principle 7 of the King VI Report?

All employers participating in a fund are stakeholders by virtue of their participation, having an obvious general interest in ensuring the good governance of the fund on behalf of their employees (employers have a duty of good faith to their employees), as well as ensuring that the retirement funding arrangements set up for the benefit of their employees function optimally. Many employer appointed trustees provide valuable input and expertise to the board of the fund at no cost to the fund. The drafters of King IV would presumably argue that good governance is better achieved through the appointment of independent professional trustees than via employer appointments and that the value added by independent professional trustees over the long term exceeds the cost to the fund. This may not be the case for all funds, some of which may require advice around the application and explanation of Principle 7 so that the structure of the board continues to be optimal.

An argument can be made that the employer’s direct interests can be forfeited in an effort to further good governance in a defined contribution structure due to the limited nature of the employer’s liability. That being said, where benefits in the fund are of a defined benefit nature, the employer may be far less comfortable being deprived of a right to be represented on the board.

Generally, sponsors go to considerable expense to set up the infrastructure of a commercial umbrella fund. The sponsor would market the fund and provide the strength of brand and reputation to encourage employers to commence participation in the fund. Once the fund is registered, however, it is established as an autonomous legal entity separate from its stakeholders (including the sponsor). This begs the question - Should the sponsor ever be given the right to elect/appoint members of the board?

It is important to highlight that Principle 7, instead of differentiating between different types of funds, for example multi-employer funds and stand-alone funds, provides a general best practice requirement for the independence of governing bodies of funds and then refers to a different standard for smaller funds. It is unclear what the drafters of the Report view as a smaller fund – is this based on the total value of fund assets, the number of members, the number of participating employers or some other consideration? Considering the requirement that funds ‘apply and explain’ how the Principles in the Report are implemented, it may be important for the standards to be framed in more descriptive terms.

While the King IV Report is not binding (where it conflicts with a legally binding requirement the legislation will take preference), the Report does profess to prescribe best practice for good governance. The requirements contained in the Report regarding the independence of board members therefore leaves funds, and their stakeholders, with some difficult questions to answer and with some difficult decisions to make.

Currently, with regards to the constitution of the board, if a fund complies with the Pension Funds Act and the registered rules of the fund, it cannot theoretically be open to criticism. For the sake of clarity, however, perhaps some guidance is needed from the Registrar as to how funds are to ‘apply and explain’ the Principles contained in the King IV Report with specific reference to recognised types of fund. In this regard, while higher standards in corporate governance must always be applauded, the publication of a standard is futile unless it can be properly and legally implemented in the context of the organisation that it seeks to uplift.