NBC MALAWI LIMITED

REPORT ON THE PARADIGM SHIFT IN PENSION REGULATION IN MALAWI.

(Challenges and Opportunities in implementing the pension act of 2011)

PENSION ACT SEMINAR BY LEGAL KNOWLEDGE SHARING AND CONSULTANCY

(27 April and 28 April 2011)

Prepared By:

Innocent Patrick Mapwetekere

(Employee Benefits Consultant)

NBC Malawi Limited

 

 

1.0       INTRODUCTION

Pensions in Malawi originated back in 1998 when they came through the Taxation Act (third schedule of the Taxation Act 14 of 1998). Pension Funds were created as trusts and comply with the Taxation Act. The manner in which retirement benefits were calculated was not prescribed in the Act. Though the Reserve Bank of Malawi was to offer directives, but there was inadequate regulation as the following were observed:

1. Pension Funds did not have legal personality
2. No guarantee of right to fund information about rights and benefits
3. Did not promote preservation of retirement benefits
4. Did not regulate the payment of death benefits.
5. Did not regulate investment of pension funds assets.

The resolution to have the Pension Act was then to establish a national pension fund to which employers and employees will make periodic mandatory pension contributions. The Pension Act has gone through several reforms for the past few years and recently, the Malawi Parliament adopted Pension Act No. 14 of 2011.

As such, it was very necessary to orient different pension players on the act so that they have a good knowledge and a feel of the challenges and opportunities in implementing the pension act.

This report seeks to summarize all the presentations and discussions that covered the following areas:

1. Fund governance
2. Individual Rights under the Pension Act: Benefit Designs and other Rights
3. Investment Law
4. Pension Fund Regulation
5. The view from investment managers on the Pension Act

1.0              OBJECTIVES OF THE PENSION ACT

The following are the objectives of the Pension Act as stated in section 4 of the act.

1. Ensure that every employer provides pension for every person employed by that employer.
2. Ensure that every employee in Malawi receives retirement and supplementary benefits as and when due.
3. Promote the safety, soundness and prudent management of pension funds that provide retirement and death benefits to members and beneficiaries.
4. Foster agglomeration of national savings in support of economic growth and development of the country.

2.0       FUND GOVERNANCE UNDER THE PENSION ACT

There are many areas on Fund Governance that are included in the Pensions Act as discussed below:

2.1  REGISTRATION OF PENSION FUNDS

The Pension Act provides the minimum requirements for registration of restricted fund. Below are the requirements as stated in section 17.

        i.            Fund rules are to provide pensions to members on their reaching retirement age, on their ceasing to be engaged in their business, trade, profession, vocation, calling, occupation or employment, to dependants of members on the members’ deaths or to members on being permanently disabled (section 17(a)).

      ii.            The fund rules provide for contributions to the fund to be made at specified times and rates (section 17(b)).

    iii.            It appears that the fund complies with this Act and the other financial services laws e.g. Employment Act and Financial Services Act (section 17(c)).

    iv.            The trustee of the fund is licensed as required by this Act (section 17(d)).

      v.            The fund rules provide that each employer shall make membership compulsory (section 17(e)).

    vi.            The fund assets shall be held by a custodian (section 17(f)).

  vii.            The trustee is not to be paid any fee out of the fund assets for acting as a trustee (section 17(g)).

viii.            The principal officer has been approved by the Registrar in terms of the fit and proper person requirements as determined in the registrar’s directive (section 17(i)).

The Pension Act provides the same minimum requirements for registration of unrestricted fund except that with restricted fund the fund rules may permit an independent trustee to be paid a fee out of the scheme assets for acting as trustee or director.

2.2  STATUTORY COVENANTS

A covenant is a solemn promise to engage in or refrain from a specified action. Section 36 provides the covenants in favour of members for both restricted and unrestricted funds and even umbrella funds as below:

1. To act honestly, exercise with care, skill and diligence in all matters concerning the fund.
2. Perform duties and exercise powers in the best interests of the members and beneficiaries of the fund.
3. To formulate an investment strategy and give effect to it.
4. To keep the money and other assets of the fund separate from any money and assets

Section 43 provides the restrictions on the trustee of Pension Funds. As such, the trustees are restricted from:

1. Falling under the direction of any person except by the court ruling, directive by the Registrar, Nominations or decisions by the Appeals Committee.
2. Abdicating discretionary powers to another person but can delegate only with permission of the Registrar.
3. Making decisions by the consent or approval of an employer only except where the decision:

a.       Increases the benefits or rates of benefits payable

b.      Would have effect of increasing costs to the employer.

c.       Is made to comply with a directive or Appeals Committee ruling.

d.      Is a directive from the Registrar.

4. Amend the Fund rules except with a consent or compliance with directives.

2.3  COMPOSITION OF BOARD OF TRUSTEES

Sections 26, 27 and 28 of the Pensions Act outline the following points that guide the composition of board members. So the board shall:

1. Consist of equal numbers of employer and member representatives.
2. Have at least six (6) individuals as trustees.
3. Appoint an independent additional trustee as a trustee.
4. Shall make arrangements to establishment one or more advisory committees for the fund.
5. Fill any vacancies within 90 days.

2.4  DUTIES AND POWERS OF BOARD OF TRUSTEES

                    i.            Establish and maintain a separate account in its books for each member.

                  ii.            Establish and operate Advisory Committees (AC) for the fund.

                iii.            Provide fund information to fund members

                iv.            Allocate contributions to a DC Fund into the member accounts

                  v.            Make sure that rules and operations of the fund are not in violation of legislation and directives.

                vi.            Make sure that the fund is managed in accordance with its registered rules.

2.5  FIDUCIARY RESPONSIBILITIES OF THE FUND

The following fiduciary duties and responsibilities of the trustees are described in section 36 of the Pensions Act.  A fiduciary duty is a duty that results from the holding in trust of something of worth for another (Section 36(1) (b)).

                  i.            Control of property with which they are bound to deal for the benefit of others.

                ii.            Perform duties and exercise powers in the best interest of the members and beneficiaries. s

              iii.            Act with care, skill and deligence as an ordinary prudent person.

              iv.            Duty of loyalty requires trustee to act in good faith with the powers conferred on him.

                v.            Act honestly in all matters concerning the Fund

              vi.            Avoid conflict of Interest.

            vii.             Act impartially.

2.6  THE PRINCIPAL OFFICER

The Act requires a fund to appoint a PO who must be approved by the Registrar and based on the following requirements.

                    i.            Citizenship and resident of Malawi

                  ii.            No convictions under any financial services laws in Malawi or outside Malawi

                iii.            Competence of person to fulfill responsibilities of PO

                iv.            Previous conduct in business or financial matters

                  v.            Previous contraventions of provisions of any law, especially financial service law as defined in the FSA

                vi.            Minimum qualification or experience in the financial services sector.

He may not be removed or change without Registrar‘s approval.

The following are the main functions of the Principal Officer:

        i.            Receive and process communications between the fund and other authorities concerning the fund

      ii.            Ensure implementation of decisions of the board of trustees

    iii.            Ensure that all legislatively required returns are submitted on time

    iv.            Responsible for all administrative functions in terms of the rules and legislation.

3.0              DEATH BENEFITS

3.1 DEATH BENEFITS PROVISIONS

Sec 15 mandates the employer to maintain a life insurance policy in favor of ever covered employee and Sec 15 and 72 also says that proceeds of the life policy shall form part of member’s death benefit and distributed accordingly.

3.2  PAYMENT OF DEATH BENEFITS

A member of a pension fund may give the trustee a written nomination directing the trustee to pay the member’s benefits on his death to member’s widow or widower, the member’s child or the member’s close relation. It shall set out the amount or proportion of the benefits to be paid to each of the persons specified. Revocation of a nomination shall be signed by the member.

Benefits payable out of the fund on the member’s death shall be paid as directed in the nomination if:

                                i.            If a member’s nomination to the trustee of a pension fund is current at the death of the member.

                              ii.            The nomination was made voluntarily.

                            iii.            For the close relation who is 18 yrs old or above, was at the time of the member’s death, financially dependant on the member.

Otherwise, those benefits, or that part of those benefits, shall be paid, in such proportions as the trustee determines, to a person or persons determined by the trustee of the fund, being a person or persons who the trustee is satisfied, was or were financially dependent on the member at the time of his death.

3.3  POTENTIAL CHALLENGES ON THE PAYMENT OF DEATH BENEFITS

The following challenges are to be met when dealing with payment of death benefits:

                                i.            Payment after murder of member (PA Section 71(4)).

                              ii.            Payment to homosexual partner (PA Section 71(4)).

                            iii.            A minor’s benefit shall be held in a separate account than other fund assets.

3.4  STATUTORY DUTIES ON DEATH BENEFITS

What is an equitable distribution of benefits will depend on age of dependants, the relationship with the deceased, extent of dependency, wishes of deceased, i.e., nomination or last will and financial affairs of dependants. However, the following are also the duties of trustees on the payment of death benefits:

                    i.            Investigate authenticity of nomination or revocation and currency.

                  ii.            Investigate whether close relation was financially dependent on deceased member at the time of death.

                iii.            Investigate financial dependants at the time of death.

                iv.            Make equitable payments to financial dependants.

                  v.            Hold benefits to a minor beneficiary in a separate account.

3.5       RIGHT TO FUND INFORMATION

Right to Fund information must include the following aspects:

                                  i.            Fund investment strategy, investment performance and financial position, Fees and charges payable by fund members, rights and entitlements of members or beneficiaries.

                                ii.            Fund rules, obligations of member to pay contributions, obligations of employer to pay contributions

                              iii.            Member right to request information (section 60) and Fund Information must be accurate (section 58(2).

                              iv.            Members have a duty to seek advice about their fund information.

                                v.            Benefit statements must be made available annually

                              vi.            Duty to use simple language is more important when a member is faced with an impending decision.

                            vii.            Pension funds should consider holding annual general meeting where the trustee can report about the affairs of the fund.

4.0       INVESTMENT LAW

4.1       PENSION FUND DESIGNS

This refers to the scheme under which retirement benefits accrue and are distributed to the beneficiary employees. According to the Pensions Act there are two basic forms of pension fund design used to calculate pension benefits by the industry. These are the defined benefit fund and defined contribution fund though a third design is also explained separately.

4.1.1        DEFINED BENEFIT FUND

A fund where a member’s benefit is calculated wholly or in part by reference to the  the member’s remuneration at the date when benefits are payable, member's remuneration averaged over a period of time before the date of payment and an amount specified in the fund rules. The rules define the pension and other benefits payable to the member or dependants independently of the contributions and investment returns. And benefits are not directly related to the investment of the fund but are guaranteed.

4.1.2        DEFINED CONTRIBUTION FUND

This Fund is defined as a fund where under the fund rules a member’s benefits on retirement has a value equal to the value of the contributions paid by member and employer in terms of the rules, less expenses as trustee determine should be deducted from contributions (e.g. administration or investment fees), any amounts credited to the member’s account either upon conversion from DB to DC fund or amalgamation and  any amount credited or debited from member’s account as increased or decreased by fund investment.

Benefits are not guaranteed but are determined by reference to the contributions paid into the fund by or on behalf of that member and the investment growth plus interest earned on those contributions and the amount of a member’s actual pension benefit cannot be determined until he has retired.

4.1.3        HYBRID FUNDS

A form of pension benefit design that determines the pension benefit with reference to both models (DB and DC). The Pension Act is in sense a hybrid fund because it has has both DC fund and DB Fund models.

4.2       GOVERNMENT REGULATION UNDER PENSION ACT

In the view of the investment managers, the following emerged to be some of the reasons for need of regulation of pension investments in Malawi.

1. Risk to Pension Benefits e.g. Risk to capital value, inflation risk and annuity rate risk.
2. Complexity of investment i.e. types of investment assets
3. Parties to a Fund e.g. Member, Insurer, Board, Employer, Actuary, Consultant, Administrator e.t.c.

The following are some of the government regulations as stipulated by the Pension Act.

1. Sec 36(1)(e) creates a duty to formulate an investment strategy of the fund
2. Sec 36(1)(f) requires trustee to give effect to strategy, incentives for formulating investment strategy and a statutory defense in a suit against a trustee if an investment was made in line with the strategy.
3. Sec 49 prevents asset manager from being exempted from liability. Sec 52 states that a trustee may not invest in more than 5% of employer assets except if employer is listed on Malawi Stock Exchange.
4. Sec 56 regulates offshore investments and refers to Exchange Control Act
5. Sec 50 regulates agreements between trustee and asset managers to have a proviso allowing manager to provide information about investment and the returns and must enable trustee to assess capability of a manager
6. Trustee empowered to terminate existing agreements

4.3       COMMON LAW FIDUCIARY PRINCIPLES

Common law of Malawi which is of general application, lines out the following principles on the trustees of pension funds.

1. The duty of Loyalty
2. Duty to exercise investment powers to ensure that Fund is able to fulfill its objectives while complying with the law.
3. Duty of Care
4. Duty to take expert advice and delegate to expert when necessary, but retain control and supervision over those to whom functions have been delegated to.
5. Duty to exercise investors’ rights.

4.4       FIDUCIARY DUTIES ON INVESTMENTS

Getting trustee to invest responsibly is not just a matter of blunt regulation. It also requires a policy framework that can improve how trustee are selected and educated, as well as how they interact with pension members and their service providers. There is a substantial body of law governing duties and responsibilities of trustees:

         i.            A trustee is neither an insurer nor guarantor of the value of a trust’s assets.

       ii.            A trustee’s performance is not to be judged by success or failure, that is, whether he or she was right or wrong.

     iii.            Unlike negligence, an error of judgment will not result in liability

     iv.            Neither prophecy or prescience is expected of trustees

       v.            A trustee’s performance must be judged, not by hindsight, by facts which existed at the time of the occurrence.

     vi.            Body of case law rejects the notion that a decline in stock’s market price forbids retention by a trustee of that stock.

   vii.            It is not inherently negligent for a trustee to retain stock in a period of declining market values, nor is there any magic percentage of decline which, when reached, mandates sale.

5.0       ROLE OF THE REGISTRAR OF FINANCIAL INSTITUTIONS

The Registrar’s role (in this case the Reserve Bank of Malawi) is to supervise and regulate the financial services sector. Two of the most significant powers conferred on the Registrar are the Power to issue Directives (FSA and Pension Act) and the Power to impose administrative penalties (FSA). The Registrar is permitted to delegate his power but not the power to delegate.

5.1       POWER TO REGISTER AND LICENSE FUNDS

(All the sections and subsections referred on this topic refer to the Financial Services Act)

Section 21 of the FSA prohibits any person from operating a financial institution without registration or licensing. Failure to comply is an offence which when convicted attracts a fine of K10 million (Sec 21(2)).

The Registrar is empowered by the Pensions Act to impose additional registration requirements through directives. When a person is granted an application for a license, Registrar shall issue a license to the applicant (Sec 25(1)). When a person is granted an application for registration, Registrar shall issue a certificate of registration Sec 25(2).

Sec 25(4) requires a licensed or registered institution to display a copy of its license at place of business. Generally, license cannot be revoked or suspend a license without a hearing.  Sec 25(2) gives Registrar power to suspend pension fund license without a hearing if this will prevent or mitigate damage to clients or the financial system.

The provision allows Registrar to give the affected financial institution opportunity to be heard when practicable after the suspension.  Sec 28 gives Registrar power to exempt (by notice in the Gazette) certain pension funds from the provisions of the relevant legislation

5.2       AREAS THE REGISTRAR MAY ISSUE DIRECTIVES

The registrar may issue directives on governance of financial institutions to ensure that the financial institutions maintain a sound financial position in the following areas of consideration.

1. Fit and proper requirements of Principal Officers (FSA sec 34(2) (a)).
2. Capital and liquidity requirements.
3. Use of financial instruments (investments).
4. Record keeping.
5. Adequacy of resources including human resources and technical resources.

5.3       POWER TO ISSUE DIRECTIVES

(All the sections and subsections referred on this topic refer to the Financial Services Act)

1. Sec 39(2) (b) empowers Registrar to remove a director or trustee in pension fund context
2. Sec 39(2) (c) empower s Registrar to appoint an independent trustee to run affairs of the fund.
3. Sec 39(2) (k) Empower Registrar to remove any person from management of a financial institution e.g. trustees of a pension fund for various prescribed reasons
4. Sec 39(2) (l) empowers Registrar to impose personal liability on an offending member of the management e.g. trustees of a pension fund.
5. Sec 39(2) (m) empower Registrar to compel a pension fund to reconstitute its board of trustees.
6. Sec 63 empower Registrar to prohibit certain practices, fees or pricing structures if will reduce competition in the financial service sector

5.4       STATUTORY MANAGEMENT OF FINANCIAL INSTITUTIONS

The FSA section 68 empowers the Registrar to place a financial institution under statutory management (taking over control) if:

         i.            It is not complying with the legislation i.e. the Pensions Act, Financial Services Act e.t.c

       ii.             It is in an unsound position

     iii.            It may commit a financial crime

     iv.             It refused to submit to inspection by the Registrar

       v.             The practice will improve the stability and soundness of the financial institution

5.5       FINANCIAL SERVICES APPEAL COMMITTEE

Established under section 78 and its main purpose and powers are to review decisions made by Registrar and exercise and performs functions conferred by other financial services laws. The members of the Committee are appointed by Minister of Finance and may be removed for the following reasons.

1. Failure to perform duties
2. Unfit to discharge duties because of mental or physical disability
3. Unfit to discharge duties because of misconduct
4. Member is disqualified as director outside Malawi
5. Member is declared bankrupt by a competent court
6. If convicted outside Malawi of an offence similar to the one in section 7(g) of Reserve Bank Act

5.6       SUPERVISION MODEL

Following financial crisis, Malawi adopted risk based approach to supervision. The starting point for this approach is an analysis of the risk profile for each authorised firm.

The approach entails the following:

          i.            The identification of inherent risk arising in the business itself, and risks arising in the management and control of those inherent risks by the financial institution.

        ii.            Risk assessment and ranking

      iii.            Communication of final result directly to the board members.

6.0       THE PENSION ACT: THE VIEW OF INVESTMENT MANAGERS

6.1       PENSION FUNDS MANAGEMENT

The objective of fund management strategies is to generate a high level of investment returns as possible, without taking a level of risk that would jeopardize the fund’s assets and its ability to meet its future pension payment obligations. Most Malawian players in Pension Fund Management observed that:

1. It is a business of specialists (fund managers, brokers, analysts, researchers, etc) where all must be actively involved.
2. It is a business where market rules must be known to all players and that reliable information must be readily available to all. Including members.
3. Pension funds traditionally should invest in low-risk asset classes e.g. real estate, government treasuries, money markets, listed equities, and listed fixed-income securities.

One of the categories of fund management strategies is the strategy set per recommendations of actuarial analyses. This strategy consists of two essential elements in minimizing risk:

1. Avoiding individual high risk investments i.e. where there is high uncertainty over the maintenance of the principal value of assets such as venture/”Greenfield” venture capital investments.
2. Asset diversification, where a certain level of risk can be accommodated if funds are invested across a broad enough range of assets with different characteristics.
3.  Risk is further reduced by investing across a range of markets in different economies and currencies.

The new pensions regime in Malawi, through the contractual “forced saving”, will over time boost the national savings rate though it will depend on the rate of industrial growth as well as growth in employment, among other factors.

New products, new risk management strategies, new oversight principles must continually emerge to avoid stifling growth and investment.

6.2       FUNCTIONS OF THE INVESTMENT MANAGER

The investment managers in pension fund management have the following functions:

                    i.            Fund analysis i.e. Assessment of each client's individual needs and risk profile.

                  ii.            Portfolio construction e.g. Recommendations on appropriate investments, benchmarks, investment policy.

                iii.            Investment Decision-making to ensure that investments are placed according to agreed policy

                iv.            Performance monitoring to ensure compliance with the agreed exposures, market conditions, portfolio adjustments.

                  v.            Reporting to trustees, quarterly basis, monthly portfolio schedules and valuations

6.3       CHALLENGES ASSOCIATED WITH PENSION FUNDS MANAGEMENT IN MALAWI

There are several challenges that the Fund Managers are facing in Malawi and likely to be faced even by future fund managers. Some of these challenges are listed below:

1. Pension Fund Management involves several stakeholders e.g. Investment managers, administrators, trustees, custodians e.t.c.
2.  Managing investments in Malawi e.g. through investment policies or investment agreements. A good statement of investment principles should contain clear primary and funding objectives, investment objectives, risk management guidelines, expected return, performance benchmarks, corporate governance, social responsibility and compliance which is difficult to handle in Malawi.
3. Limited investment assets/avenues i.e. Bank deposits, corporate debt instruments (privately placed only), listed equities (15 counters only) and Real estate. Pension funds in a market with limited investment assets equal to excess liquidity, resulting into slow member fund growth and low returns.

6.4       OPPORTUNITIES ASSOCIATED WITH PENSION FUNDS MANAGEMENT IN MALAWI

Pension Fund Management in Malawi, has brought and is expected to bring more opportunities to investment industry. Below are some of the notable opportunities.

1. Availability of investment capital
2. Creation of investment assets
3. Development of the capital market
4. Infrastructure development
5. Skills development
6. Employment opportunities

CONCLUSION AND RECOMMENDATIONS

In summary of all the discussions, the following emerged to be the main recommendations about the Pension Act.

1. Government need to continually review their regulations on pension funds, especially those regarding permitted asset classes.
2. Pension Funds must make investment choices that impact on the business environment and the pension contributors.
3.  Pension Funds need to improve their internal governance mechanisms to create sustainable investment opportunities.
4. Government should issue longer dated instruments.
5. Issuers of long dated debt instruments should consider the capital market route as an active option to raise capital.
6. Trustees must consider having multiple investment managers as we believe that no fund manager can perform well at all time and in all market conditions. It is also not possible to predict which fund manager will be next to outperform.

The seminar has helped in the understanding and interpretation of the Pension Act. It has introduced to various aspects of the Pension Act i. e. Fund Governance, Benefits designs, Individual Rights e.t.c.

 It was also an opportunity to introduce NBC and its products and services to different employers, employees and fellow pension players. The first hand experience from the local pension fund investment managers will also help as we are joining the business.