Issue: Oct 2010/Jan 2011
Editorials

Black Economic Empowerment

Let rip

An informed debate into the future of BEE must start. Two studies, unique and refreshing in their own ways, should surely spark it.

By happy coincidence, author Jenny Cargill’s Trick or Treat: Rethinking Black Economic Empowerment was followed hot on the heels by JSE president ’s release of research into black shareholdings on the local bourse. The former expounds the need to assess where BEE goes in the future, having analysed the benefits and flaws in its past. The latter dispels popular myths, vigorously expounded but woefully unsubstantiated, similarly preparing the course for better-informed policy formulation.

The one fortuitously complements the other. Best is to check them in conjunction. They offer a context that surmounts an idiot’s guide.

Both can boast objectivity: Jenny’s because her political record in the ANC is eclipsed by her intellectual integrity (to which this writer can attest, having had the pleasure of working with her in the glory days of Finance Week); the JSE’s because it was commissioned from an independent professional (Trevor Chandler & Associates) where value resides in clinical methodology derived from the good-practice codes as gazetted by the Department of Trade & Industry (the dti).

Amongst the avid readers should be trustees of retirement funds. Despite the case long argued by TT, black fund members have largely been ignored in BEE transactions although their indirect shareholdings are substantial. In a re-evaluation, it would be untenable for them to continue subsidising these transactions – by proportionate equity dilution and dividend reduction – rather than benefiting from them, or at the least being acknowledged for their existence as shareholders.

Cargill takes the point (see box). Loubser promises that the next round of JSE research will include “mandated investments”, retirement funds amongst them. The gauntlet is being thrown, for trustees either to start asserting their clout or be negligent in advancing fund members’ interests.

Inclusion of retirement funds and other collective vehicles will shoot upwards the JSE estimate that 36% of available share capital is held by black shareholders. Key word is “available”. This 36% figure assumes the removal from the calculation of foreign ownership. Heaven forbid that foreign investment be discouraged. The more it increases, paradoxically, the more the proportion of BEE ownership decreases under the dti measurement formula.

But taking foreign ownership into the calculation, consistent with the dti code, the figure comes out at 18% of the available pool. It still much higher than numbers previously touted.

The pool of share capital available for investment, in the top 100 companies accounting for 85% of the JSE’s total market capitalisation, is only 44% of total market cap. The dti code requires a company’s BEE “economic interest” to be calculated by taking its total share capital without mandated investments such as pension funds, investments held by the state, shares which the remains a serious imbalance in the transformation equation. As Cargill points out, BEE transactions have so far absorbed far more capital than has been invested in low-income housing and land redistribution; or, for that matter in enterprise development.

BEE deals still to be done might require amounts of finance similar to the amounts already spent. The more that goes to ownership, the less for other priorities. In this tight allocation of capital, she contends, interest rates will increase to the detriment of economic growth. The best way of making choices about BEE is to “bring it into the macro-economic frame”, integrating into it the debates on racial imbalances in wealth and economic participation.

Jenny Cargill

Cargill . . . facts and argument

Cargill forcefully argues for understanding the trade-offs needed between capital allocation on the one hand and efficient use of capital on the other. A central theme of her book is to show the typically unproductive nature of BEE investments. Time and again, she notes, the codes have encouraged redistributive rather than productive ownership: “Where productive investment has occurred, it has been more by chance than design. Policy itself has not provided the necessary lever.”

As a mechanism for redistribution, BEE ownership has been less than equitable. Some people have been able to access BEE deals; others haven’t. Some have secured good assets; others haven’t.

Moreover, she adds, debt financing has made it extremely difficult to maintain shareholdings: “Deals have been transacted using vast quantities of the country’s limited capital resource, knowing that finally some of that shareholding will have to be sold to pay off the loans used to acquire it in the first place. A puzzled ‘Why are we doing this?’ is in order, particularly when we consider the costs involved.”

Loubser

Loubser . . . facts, no argument

She’s especially worried about the “corrupting influence” of BEE ownership: when wealth is extracted without being productive; when policy legitimises this process, and when there’s an abdication of responsibility to do things better and differently.

As this rent-seeking conduct escalates – particularly among the political elite and often in the guise of opening up opportunity to new entrants – BEE corporations that have been built as real businesses are at risk of being sidelined as the “usual suspects” instead of being promoted as role models.

Forever the realist, Cargill anticipates that at best there’ll be no more than tampering with the codes. Amongst her suggestions for modification:

  • Wind down and stop BEE ownership as currently envisaged. Bring to a close its redistributive and rent-seeking character. Find other ways to promote black investment;
  • Expand on areas that offer flexibility so that companies ill-suited to third-party shareholders can meet their obligations in other ways;
  • Smaller and medium-sized businesses, with annual turnovers below R35m, are a growth engine of the economy. They have limited capacity for dedicating 3% of after-tax profit to developing other enterprises and should not be placed in the invidious position of attempting to avoid compliance.

RIGHT FOR RETIREMENT FUNDS

We need to be consistent about our measurements. The codes, for example, state that only those economic benefits of shareholding that can be traced back to black individuals may be counted. Such economic benefits flow to black individuals via two routes – direct shareholding, which is what BEE transactional activity is about, and indirect shareholding, which is individual savings usually invested in funds for pensions, unit trusts and life assurance. The individual savings constitute more than half the JSE’s market capitalisation, and yet they are grudgingly recognised in the codes, with a limitation placed on how much may be counted. But there is considerable black wealth captured here, and there is no justification for not fully measuring such economic benefits.

– Cargill, pg 192

Then she explores such alternatives as the option of companies offering a proportion of their shares for free, ways to promote more productive relationships, improvements in allowing good-faith transactions to unwind, more leeway for smaller firms and an easing-up for foreign investors. So well thought-through are these proposals that they deserve lively consideration.The same goes for the book taken as a whole.

The same goes for the book taken as a whole. Cargill has made an immense contribution to a debate that begs to advance, unconstrained by political and selfish opportunism.

  • Trick or Treat: Rethinking Black Economic Empowerment’ by Jenny Cargill. Published by Jacana; 258pp; R194. The JSE research can be found on its website www.jse.co.za.