South Africa has a unique hybrid legal system, founded on the principles of Roman Dutch law and influenced by English law, but subject to the values of the South African Constitution of 1996. For commercial purposes, South Africa generally follows English law in relation to matters of company law and civil procedure, and Roman-Dutch common law in relation to matters of contract law.
Two types of companies are recognised in terms of the South African Companies Act, 71 of 2008 (Companies Act): a non-profit company and a profit company which is incorporated for the purpose of financial gain for its shareholders.
The Companies Act creates a flexible framework for the incorporation, capitalisation and governance rules of profit companies. Foreign investment in all facets of the economy is encouraged and there are no statutory restrictions on the level of foreign ownership, except in the limited sectors of banking, insurance, broadcasting, security and the airline industry.
Alternative investment funds (AIFs) are generally established as private equity funds (or similar sector-specific funds), hedge funds or regulated collective investment schemes.
AIFs that are registered under the Collective Investment Schemes Control Act (CISCA) are usually formed by a trust agreement entered into between an authorised manager and a registered trustee. The collective investment scheme (CIS) creates portfolios via a supplement to the trust agreement, subject to approval from the Financial Services Conduct Authority (FSCA), in which investors purchase participatory interests. While CISCA permits other legal structures, in practice, only these forms of unit trusts are used.
Hedge funds in South Africa are licensed as CISs under CISCA. However, hedge funds differ from other unit trusts regulated by CISCA in that, as a designated scheme, they are permitted to enter into certain transactions and employ certain strategies that unit trusts may not enter into. There are two types of hedge funds that may be registered under CISCA: Qualified Investor Hedge Funds (QIHFs) and Retail Investor Hedge Funds (RIHFs). Managers may only market QIHFs to investors who have demonstrable knowledge and experience in financial and business matters that would enable them to assess the merits and risks of a hedge fund and who initially invest at least ZAR1 million. A RIHF does not have any such restrictions, but retail funds must comply with other more onerous regulatory and prudential requirements.
Private Equity Funds
The most common structure in South Africa for a private equity fund or similar fund is the en commandite partnership, which is equivalent in all material respects to a limited partnership as understood by international investors. There is no statute in South Africa governing the establishment and management of en commandite partnerships, which are created through written agreement between the partners. In its simplest form, an en commandite partnership comprises two categories of partner, a disclosed or general partner, whose liability is unlimited, and one or more commanditarian partners (limited partners), whose liability is limited.
Another type of structure sometimes used for private equity funds is a bewind trust. A bewind trust is a type of trust vehicle governed by the Trust Property Control Act, in terms of which the assets are owned by the beneficiaries of the trust, but the trustee of the trust holds and manages such assets on their behalf. Each investor is a beneficiary of the trust and the investors own the assets of the trust jointly in undivided shares in proportion to their respective contributions. The trust deed must be registered with the master of the High Court.
Private equity funds may also be structured as companies, but these are generally unattractive to institutional investors, who prefer to invest through fiscally transparent vehicles (such as the en commandite partnership or bewind trust).
The legislation governing the establishment and operation of an AIF will depend on the structure of the AIF. If the AIF is structured as a company, the Companies Act, 2008 will apply. If the AIF is structured as a trust, the trust will be governed by the Trust Property Control Act, 1988, and the trust deed will need to be registered with the master of the High Court in the jurisdiction where the trust’s assets are situated. If the AIF is structured as an en commandite partnership, there is no specific legislation governing the establishment of the partnership, meaning that the AIF will be established and operated in terms of the partnership agreement constituting the AIF.
The promotion of local and foreign CISs in South Africa is regulated by CISCA. If the AIF is a CIS, it will be regulated under CISCA and will be required to be registered with the FSCA. An AIF will only qualify as a CIS if members of the public are invited to invest in the AIF.
CICSA currently recognises five categories of CIS, being:
At present, private equity funds do not fall within any of the categories of CIS and accordingly may not be registered under CISCA. This means that private equity funds may not be offered to members of the public in South Africa and may only be offered through a private placement.
Funds can originate loans, provided they always comply with the constitutional documents and investment guidelines of the AIF. The fund manager will need to register as a credit provider in terms of Sections 40 and 41 of the National Credit Act 34, 2005 (NCA) unless the loans fall within the NCA exemption (ie, the NCA does not apply to any loans granted to a juristic person for more than ZAR250,000).
If the AIF is registered as a CIS, it will need to comply with the prudential obligations imposed by CISCA. These vary depending on the type of CIS but, except in the case of a hedge fund, will generally limit the CIS's ability to invest in non-traditional assets.
There are no statutory rules or prescriptions that regulate the asset classes in which a private equity fund may invest.
Establishing a Collective Investment Scheme
The prior approval of the FSCA is required to establish a CIS under CISCA or to form a new portfolio of the CIS in which investors participate. As part of the authorisation process, CISCA prescribes various requirements in relation to the authorisation of both the CIS manager who administers the scheme and the trustee or custodian who holds the assets and oversees compliance with CISCA, the formation of the CIS itself and the creation of each portfolio. The FSCA will generally take up to nine months to approve the application.
Applying for a Financial Services Provider Licence
There are no registration requirements for AIFs that are not offered to members of the public, but the manager or adviser of such AIF must be registered by the FSCA as a financial services provider (FSP) under the Financial Advisory and Intermediary Services Act, 2002 (FAIS Act).
An application for an FSP licence by the manager of, or adviser to, an AIF involves the completion and submission of the prescribed application forms, together with the applicant’s financial statements, business plan and organisational chart. The key individuals of the FSP who will be responsible for managing and overseeing the activities of the FSP must also be approved by the FSCA. Key individuals must meet the fit and proper requirements of honesty and integrity, demonstrate that they have appropriate management and financial product experience, have a recognised qualification and pass regulatory exams. The FSCA will generally take around five months to approve the application and grant the FSP licence.
A manager of a registered CIS is required to be authorised as a CIS manager under CISCA, rather than licensed as an FSP under FAIS (although, in practice, managers will be authorised under both CISCA and FAIS if they conduct financial services business other than the management of the CIS).
Any person who manages the assets of an unregulated AIF, or who advises such AIF on the management of its assets, will be required to obtain an FSP licence. The FAIS Act provides that no person may act or offer to act as an FSP unless such person has been issued with a licence by the FSCA under the FAIS Act. An FSP is defined as any person other than an employee or agent of an FSP who, as a regular feature of the business of such person, furnishes advice (ie, investment recommendations but not factual advice) and/or renders any intermediary service (which includes discretionary investment management) to clients in respect of financial products (defined to encompass a broad range of local and foreign securities and financial instruments).
There are no other local requirements.
There are no specific requirements for an unregulated AIF to appoint an administrator or custodian. However, an approved CIS manager must appoint a custodian or an approved trustee to hold the CIS assets and oversee compliance with CISCA. Hedge fund managers may also appoint a prime broker to settle the transactions and provide additional securities lending services to the hedge fund scheme.
All local managers/advisers that are registered as FSPs under the FAIS Act will need to appoint a compliance officer approved by the FSCA and a money-laundering reporting officer under the applicable anti-money laundering legislation.
Administrators are licensed as Category I FSPs under the FAIS Act. No person may act as a prime broker in South Africa unless they are a registered bank under the Banks Act, No 94 of 1990 or an "authorised user" in terms of the Financial Markets Act No 12 of 2012 (FMA). As authorised users, prime brokers must comply with the FMA when they register or transfer dematerialised securities.
Non-local service providers are required to register as FSPs under the FAIS Act if they render investment advice (excluding merely factual advice) and/or intermediary services in South Africa. There are no other requirements for non-local service providers in this regard.
A partnership is not a separate juristic person under South African tax law, and is therefore fiscally transparent from an income tax and capital gains tax perspective. This means that en commandite partnerships are not recognised as separate taxpayers in South Africa, but rather that the individual partners are taxed separately based on their fractional interest in the partnership. For income tax and capital gains tax purposes, amounts received by or accrued to a partnership retain their nature as dividends, interest and capital gains in the individual partner's hands.
Given that partnerships are fiscally transparent and are not recognised as separate taxpayers in South Africa, the individual partners will bear the tax consequences arising on a transaction involving a partnership. It is therefore unnecessary for partnerships to qualify for relief or benefits under double- tax treaties. Generally, the double-tax treaties entered into in South Africa define the term "person" to include "an individual, a company and any other body of persons which is treated as an entity for tax purposes". A partnership does not therefore qualify as a “person” in this regard.
It is common for AIFs to use subsidiaries to ring-fence investment portfolios where necessary, in order to partner with different sets of shareholders at the operating company level and to set up different investment vehicles in different jurisdictions.
Promoters and sponsors of local AIFs are mostly from South Africa, but occasionally, promoters and sponsors from jurisdictions across the world, including Europe, the United States, China, South America and various countries in Africa do become involved.
Investors from jurisdictions across the world invest in South African AIFs, including investors in Europe, the United Kingdom, the United States, Canada, Australia, China, South America, the Middle East and various countries in Africa.
Local AIFs generally invest in South Africa and more broadly in sub-Saharan Africa.
In relation to unregulated AIFs, there has been a renewed focus on impact investment funds, particularly in sectors such as infrastructure, renewable power, healthcare and student housing.
Figures from emerging markets private equity show that South Africa accounted for 31 out of 33 investments in Southern Africa in 2018 and for USD243 million of the region’s USD246 million of disclosed capital invested. Accordingly, regional activity is still very much concentrated on South Africa. However, the nation’s low GDP growth (less than 1%) and high unemployment, as well as the depreciation of the South African rand, all limit investment activity.
If the AIF is registered as a CIS, then it will need to comply with the disclosure and reporting obligations imposed by CISCA. These include disclosures of specific information to investors, and submission of financial statements and compliance reports to the CIS Registrar.
There is no statutorily prescribed disclosure or reporting regime for local private equity funds. Typically, the fund governing documents will require the fund, at a minimum, to provide annual financial statements in accordance with International Financial Reporting Standards.
An AIF structured as a private company will also be subject to the disclosure and reporting requirements prescribed in the Companies Act.
The introduction of the Conduct of Financial Institutions Act (COFI) and the ongoing Retail Distribution Review (RDR) may have an impact on the operation of AIFs. COFI is intended to focus on the conduct of financial institutions; it is expected to replace the conduct provisions of most existing financial sector laws in order to streamline the market conduct framework for all financial sector institutions. The RDR has proposed a number of regulatory reforms related to the distribution of financial products and the provision of financial advice, including:
The most common legal structure is the CIS, in respect of regulated AIFs, and the en commandite partnership for private equity funds. A private equity fund may also take the form of a private company or bewind trust.
Local managers and advisers of AIFs are required to be licensed as FSPs under the FAIS Act. In addition, in the case of an AIF that is a regulated CIS, the CIS manager must be licensed under CISCA.
There is no specific or preferential tax regime for fund managers of alternative funds in South Africa.
There is specific legislation in South Africa to ensure that the acts of a fund manager do not create a "permanent establishment" for the investors in a partnership.
The definition of a "permanent establishment" in the Income Tax Act, 1962 provides that any act of a partnership, trust or foreign partnership in respect of any financial instrument must not be ascribed to that qualifying investor. A "qualifying investor" includes, inter alia, a member of a partnership or foreign partnership if the liability of the member to any creditor of the partnership or foreign partnership is limited to the amount that the member or beneficiary has contributed or undertaken to contribute to the partnership.
Carried interest generally retains its legal character and is taxed accordingly in investors’ hands (including the fund manager).
An exception to this general rule applies where employees of the fund manager obtain, either directly or indirectly, carried interest in the fund by virtue of their employment or services rendered or to be rendered. In these circumstances, it is possible that distributions arising from, or realisation of, such carried interests will be fully taxed as remuneration in the employees’ hands.
Outsourcing of investment functions and business operations is subject to the constitutional documents of the relevant AIF. If a manager/adviser of an AIF outsources a regulated function (such as investment management services), it may only do so to an FSP that is licensed to provide similar services.
If an AIF is a registered CIS in South Africa, the CIS manager must be a company registered in terms of the Companies Act and the trustee of the CIS must be a South African public company, a South African bank (or South African branch of a foreign bank) or a South African-registered long-term insurer. A foreign CIS that is carried on outside South Africa but which will be promoted in South Africa, must be registered under CISCA as an approved foreign CIS. A foreign manager may not perform management activities for a South African CIS without prior authorisation from the FSCA and would require an appropriate licence in South Africa to authorise it to perform any outsourced services in South Africa. Directors of a South African company may be resident outside South Africa.
There are no local resident or local qualification requirements for the manager or adviser of an AIF that is a private equity fund.
Foreign FSPs may not render financial services in or into South Africa without an FAIS licence. Such licence is obtained in the same manner as a local FSP licence (depending on the level of activity in South Africa, the foreign applicant may have to register as an external company with the CIPC).
A foreign CIS that is carried on outside South Africa, but which will be promoted in South Africa, must be registered under CISCA as an approved foreign CIS. The requirements for such approval include that the foreign scheme must be carried on in a regulatory environment of at least the same standing as the South African regulatory environment and may not offer investments with a significantly higher-risk profile than investments that may be offered by any local CIS. The foreign scheme must either establish a representative office in South Africa or enter into a representative agreement with a local CIS manager.
Typical investors in South African private equity funds include local and international pension funds, institutional investors and funds of funds, and international development finance institutions. High net worth individuals will also invest in South African private equity funds.
Depending on the type of fund, established managers may choose to market their fund to accredited investors in the particular sector or from a variety of sectors (these are investors who are deemed to possess adequate wealth and expertise to navigate the intricacies associated with private equity funds). Fund managers may also market their funds to retail investors, provided that the provisions of CISCA read with the Financial Sector Regulation Act (FSRA) have been complied with.
An AIF may not be marketed to members of the public in South Africa without first being registered as a CIS under CISCA or, in the case of a foreign AIF, as a foreign collective scheme. In respect of a hedge fund, there are two types of schemes – the Retail Investor Hedge Fund (RIHF) and the Qualified Investor Hedge Fund (QIHF). An RIHF may be marketed to the public at large while a QIHF may be marketed to a qualified investor who commits a minimum of ZAR1 million and who has illustrated that he, she or it understands the workings and risks of hedge funds.
CISCA prescribes comprehensive requirements relating to the documentation used to market the AIF. These requirements also apply to any foreign CIS that is carried on outside South Africa and which is also registered under CISCA as an approved foreign CIS for marketing in South Africa. The manager of the local or foreign CIS must lodge copies of all price lists, advertisements and other marketing material with the FSCA (including fund fact sheets and relevant investor application forms) before publication or use of the material.
CISCA requires the CIS manager to disclose to each investor (prior to any investment) information about the investment objectives of the CIS, the calculation of the net asset value and dealing prices, charges, risk factors and distribution of income accruals. CISCA also prescribes various particulars that must be included in any price list, brochure or similar document published for the purpose of soliciting investment in a CIS. These particulars include details of charges levied by the manager and the basis on which the manager will undertake the repurchase of interests, as well as a clear and unambiguous statement to the effect that the value of participatory interests in a portfolio is subject to fluctuation from time to time.
There is no specific legislation governing the marketing of AIF interests in South Africa through private placement (which is the basis on which private equity funds must be marketed).
Local investors may invest in South African AIFs.
All marketing and advertising material used to market AIFs that have been registered or approved in accordance with CISCA must be filed with the FSCA prior to the publication or use of the material. The manager must keep a record of all advertising and marketing material that it has published, including the date of publication, the publications in which the advertisements have been included and evidence to support any statement made in an advertisement which purports to be a statement of fact or opinion (or details of how to access the evidence supporting a statement made in an advertisement). The manager must keep these records for a period of at least five years.
There are no such filing requirements in relation to unregulated AIFs (such as private equity funds).
Board Notice (BN) 92 of 2014, issued in terms of CISCA, deals with advertising, marketing and information disclosure requirements for a CIS. In terms of this notice, CIS managers need to provide all investors with certain prescribed information and disclosures, and CIS managers also need to ensure that anyone marketing or distributing their CIS portfolios has the necessary procedures in place to comply with the requirements.
Disclosures need to be provided to investors prior to the investment being made (or any top-ups and switches being implemented). The disclosures must cover fund objectives, fund risk profile, performance and costs and must be updated quarterly. CIS managers also need to report on asset changes and how the fund performance measures against the fund’s stated objectives.
There are no prescribed statutory disclosure requirements applicable to investors in private equity funds or other unregulated AIFs.
There is no special or preferential tax regime for investors who have invested in alternative funds in South Africa. Generally, investors will only be subject to tax if they are tax-resident in South Africa or if they invest in a fund or partnership through a permanent establishment in South Africa.
The rate of income tax and capital gains tax will differ depending on the legal nature of the investor.
Individuals are subject to income tax on a sliding scale between 18% and 45%, with capital gains tax being charged at the individual's income tax rate, multiplied by a 40% inclusion rate. The maximum effective capital gains tax rate for individuals is therefore 18%.
Companies are subject to income tax at 28%. Capital gains tax for companies is calculated by multiplying the income tax rate of 28% by 80%, resulting in an effective capital gains tax rate of 22.4%.
Trusts are subject to income tax at 45%. Capital gains tax for trusts is calculated by multiplying the income tax rate of 45% by 80%, resulting in an effective capital gains tax rate of 36%.
South African financial institutions are required to identify accounts held by customers who are foreign tax residents or entities connected to foreign tax residents and report those accounts to the South African Revenue Service (SARS). SARS will then report the account information to the respective foreign tax authorities and vice versa. This information is required by law in terms of the US Foreign Account Tax Compliance Act (FATCA) and the OECD Common Reporting Standard (CRS).
These South African financial institutions include banks, asset management companies and private equity funds and they are required to apply the prescribed due diligence requirements under the FATCA intergovernmental agreement (IGA) and the CRS to determine the reportable accounts and report the prescribed information to SARS. Such prescribed information includes the account number and balance of the reportable account and the name, address, date of birth (individuals) or identification number (corporate) of the reportable person or entity. The submissions for both FATCA and the CRS are due annually by 31 May and the financial institution is typically required to submit a data file to SARS with the prescribed information and the declaration (FTI-02 form) to conclude their reporting obligations.