Leon Campher, CEO of the Association for Savings and Investment South Africa. Picture: FINANCIAL MAIL

HEDGE funds are finally coming out from the shadows, with an industry task group recommending that two regulated products, "lite" and "heavy" versions, be created for the South African market space.

The move to regulate hedge funds - previously unregulated and known for high risks and fees yet often surprisingly low returns - forms part of the Treasury's overall drive to a "twin peaks" regulatory model for South Africa within the next two years.

Expanding access to financial services, improving cost transparency and reducing fees and charges are other key planks to the proposals.

"A huge task team is working with the Treasury and the Financial Services Board (FSB) on hedge fund regulation," says Leon Campher, CEO of the Association for Savings and Investment South Africa (Asisa).

The "lighter" version proposes to restrict investment powers, while the "heavier" version would enable unrestricted investment powers but with heavy disclosure and restricted access in the context of the professional investor.

This twin-peaks model will usher in a broader role for the FSB as it regulates market conduct across the entire financial services industry, including banks. The Reserve Bank will take up overall responsibility for ensuring financial stability, supported by an oversight committee co-chaired by the governor of the Bank and the minister of finance. A new market conduct regulator for banking services will be established within the FSB.

Combating financial crime will be another major issue, especially in light of continuing pyramid schemes in South Africa and recent disasters in the property syndicate space, where regulatory gaps were exploited.

Mr Campher says plugging the gaps is all well and good, but a problem is that the legal system in South Africa is not very good at prosecuting crooks. While pyramid maestro Bernard Madoff was behind bars within three months of being found out in the US, Barry Tannenbaum is still at large five years after his scheme unravelled in South Africa.

"Justice must be seen to be done and handled adequately by the legal system," says Peter Stephan, attorney and senior policy adviser at Asisa.

On remuneration and costs, Mr Campher says regulators will "probably regulate bonuses for bankers". This comes amid a groundswell of public discontent with banks, found to have affected simple interest payments for clients by manipulating interbank rates.

Mr Stephan says regulators in South Africa want to get rid of "conflicted remuneration schemes", which would include the ultimate hot potato - up-front commission schemes. They are looking for plenty of disclosure and transparent fees to enable clients to make comparisons and determine the effect of costs, while simplifying products.

This does not mean a "cut and paste" of international trends - where the Netherlands has recently banned commissions outright and India up-front commissions - as some type of product regulation at the low end of the market is likely to come in South Africa, according to Asisa.

This ties in with the government's stated aim to improve access and will probably mean more standardised products and some type of commission fee structure still remaining at this end of the market.

The South African industry group giving feedback on the government's proposals would prefer a system where payments are agreed upon, so fees could come out of the investment itself, if so agreed. It is calling for an opt-in system for continuing fee-based advice, although the client should be able to agree to "switch off" at any point.

There is also an international trend to move away from volume incentives - and the dreaded churn rate where brokers make money each time clients switch products - while local regulators could explore the "best interest" regulation recently enacted in Australia, where it is accepted not all clients need a holistic needs analysis at all times. It makes provision for scalable advice depending on clients' needs.

The South African industry is calling for up-front commission to remain on risk business, rather than on investment business.

The bottom line, though, is that the need for advice is growing as surveys on retirement paint a more parlous picture every year, while insurance gap studies show South Africans are underinsured. It is now so bad only 6% of South Africans can afford to retire, while the average underinsurance on death is R600,000, and R900,000 on disability. It means more than 200,000 families will suffer distress.

Richard Carter, director at Allan Gray Life, says more than 80% of retirement money today is going into living annuities - where clients have their own portfolios - rather than conventional annuities - with a guaranteed payout - from a 50/50 split in 2003. He is not so sure this is the right balance as expectations are being framed by recent market outperformance.

"My prediction is guaranteed annuities will only become popular again after a sustained bear market, probably right when a living annuity offers the best value," he says.

A major problem is that too much income is being drawn down from these living annuities for them to last long enough.

In South Africa, up to 50% of people are drawing more than 7% on their living annuities, meaning they would need the consumer price index rate plus 6% to have an income flow for their possible life spans - and that is not likely. At best, they are only getting 10 years out of the product, when most need close to 30 years.

So while investors still have much work to do on their retirement savings, at least legislation and regulation are catching up.

pickworthe@bdfm.co.za