STUART THEOBALD: It’s time for an overhaul of SA’s foreign investment regime

The Sunday Times last weekend reported an apparent mea culpa by finance minister Enoch Godongwana over the increase of the institutional offshore investment limit two years ago to 45%. His description of it as a “grave mistake” was unusual for a politician. But it misses the mark in a big way.

First, a brief background. Since the end of apartheid, the regulations governing exchange control, introduced in 1961 based on legislation passed in 1933, have been gradually relaxed. Those regulations cover everything from the amount of jewellery that travellers can leave the country with to how much South Africans are allowed to invest offshore (the manual is 293 pages long).

For some years, these regulations have been going through a “modernisation” led by the National Treasury. There are a great many reasons why this is important. Exchange controls are classic red tape — burdening businesses and consumers with needless and expensive bureaucracy. Many other countries have got rid of them, including neighbours such as Botswana.

Forms are required for every international payment, banks add charges for every international transaction, consumers pay among the highest fees in the world to send small amounts of money to loved ones elsewhere. It functions as poorly as you might expect for legislation and regulations designed in the 20th century for the purpose of trapping capital from fleeing apartheid. It comes at great cost, and the benefits are hard to see in a democratic country integrated into the global economy.

It is also possibly unlawful. While no-one has brought the right test case to the Constitutional Court, in litigation between Mark Shuttleworth and the SA Reserve Bank a decade ago, many aspects of the regulations were questioned. While in that case the Bank was ultimately vindicated on the narrow question before the court, there was a strong feeling left over that many aspects of the regulations are in desperate need of updating to match our constitutional jurisprudence.

When it comes specifically to investment rules, the modernisation effort has been framed in terms of the Organisation for Economic Co-operation and Development’s (OECD) Code of Liberalisation of Capital Movements. This is for good reason — SA stands to be benefit from reciprocal treatment if it is in line with the OECD’s standards, which have become global benchmarks for how countries treat each other on many economic matters.

Exchange controls are at present in conflict with the OECD’s code, essentially because they violate the principle of equal treatment. SA imposes no restrictions on foreigners investing in our markets. Indeed they are welcomed with open arms and account for a large part of the investment in our bond and equity markets.

Yet South Africans cannot reciprocally invest in foreigners’ markets without having to navigate the investment limits imposed by exchange control. Foreign governments have a right to ask why they should allow their citizens to invest in SA when they cannot enjoy reciprocal treatment. It is at odds with basic principles of international law and moreover leaves SA’s investors worse off by frustrating their access to diversification and return opportunities.

While we have been long promised an overhaul to bring exchange control in line with the OECD code, we have instead been drip-fed piecemeal updates within the existing regulations. The 45% limit is one example of this. In the 2022 budget, the 30% offshore limit, with 10% extra for the rest of Africa, was upgraded to a single 45% limit. The concern is that this new limit has led institutions to externalise investment, starving our markets of much needed capital.

The facts are not that clear — there is no obvious swing in the data after the change. Many portfolios are optimally diversified anyway, especially given the level of foreign exposure inherent in many JSE-listed companies. The fund manager whom the Sunday Times quoted, Ntobeko Stampu of All Weather Capital, said “our savings are now fuelling the growth and productive capacity of the recipient countries”, without apparently considering the corollary of how much of those countries’ savings are reciprocally invested in SA.

The data shows that foreigners hold R8-trillion of assets in SA, while South Africans hold R10-trillion offshore, with the balance having tipped in 2015 when there was a sharp depreciation of the rand. The data suggests the growth in relative SA holdings has been because of a weakening rand, leaving the offshore assets relatively more valuable, not because of dramatic externalisation of SA funds.

But here is a fundamental question: is the limit meant to be a conduct regulation or a macro-prudential risk management tool? In other words, is the limit supposed to protect SA savers from the risk of reckless investments and excessive currency risk or is it supposed to protect the country from the risk of capital flight?

There is considerable confusion over which of these interests matters. The minister spoke of the 45% limit in terms of regulation 28 of the Pension Funds Act, which sets asset class exposure ceilings for pension fund portfolios, limiting concentration risk. Regulation 28 is a conduct regulation, designed to protect pension fund members, but the regulation itself does not in fact contain the institutional limit. The regulation merely says to refer to the exchange control manual, where the limits apply to all institutions, not just pension funds, and it is in the manual that the change was made to 45%. The manual is decidedly not about protecting individual savers. Trapping domestic savings remains the conceptual foundation of the manual today, even though the capital flight risk is far higher in respect of foreign inward portfolio flows, which are unaffected by the exchange control regime.

So, one important step is to resolve the confusion of conduct and macro-prudential regulation. Institutional investors should manage foreign currency risk in the interests of their clients and regulation should enforce this. Macro-prudential risk should be managed using the modern tools available through the OECD codes, which allow for handbrakes to deal with crises while managing our economic integration with the global economy.

Yet, so far, none of the reforms have enabled the Financial Sector Conduct Authority to take direct control of the conduct aspect, which is where the question of appropriate exposure limits should be answered. If it is not treated this way, we risk losing the confidence of savers that the system is designed in their interests, giving them reason to avoid it.

I agree in principle with Stampu that the change is “hurting the asset management industry” locally. But the solution is to enable the local financial industry to manage offshore savings. One bizarre counterproductive feature of exchange control liberalisation is that it has been done by allowing savers to move their money out of the domestic system and straight to foreign providers.

We could instead have, for example, allowed SA asset managers to offer their clients US dollar-denominated portfolios stuffed with Amazon, Microsoft and Apple shares traded on the JSE. We do allow them to offer dedicated foreign portfolios but only to the extent that these make up less than 45% of the institution’s total assets, making it impossible to be a specialist foreign investment manager in SA (there are some complicated exceptions I leave aside for now).

For many clients, having to open offshore accounts is a pain. Had we simply enabled the domestic financial system to offer offshore investments more easily, a lot of jobs and economic activity would have been sustained here. Moreover, we could have built some capacity as international investment specialists, potentially attracting some of the world’s $30-trillion in cross-border portfolio investments to be managed from Cape Town and Sandton, creating more local jobs and tax revenue.

Last week’s Budget Review announced a process to evaluate the impact of reforms already made in line with the OECD code while proposing further reforms. However, many of the reforms previously announced have not in fact been implemented and momentum has slowed. It feels like a stocktake and clear road map for reform are needed in which piecemeal changes are replaced by a proper overhaul.