A seemingly nondescript change to regulations has effectively resulted in the biggest relaxation of exchange controls in South Africa’s history.
The move, announced last month in an explanatory note put out by Treasury in the Medium-Term Budget Policy Statement has lifted the cap for South Africans to trade in foreign assets.
“All debt, derivatives and exchange-traded instruments referencing foreign assets, that are inward-listed, traded and settled in rand on South African exchanges, will be classified as domestic. The classification of all inward-listed shares denominated in rand remains domestic.”
This means if a locally-listed firm holds offshore assets, there is no longer a limit to how much they can hold, as long as they trade these assets locally and in rand.
Mike Schüssler chief economist at economists.co.za says this seemingly ordinary statement is very far-reaching.
“This is the biggest relaxation of exchange control this country has ever had,” adds Schüssler.
The change is huge because it effectively does away with foreign investment caps of 30% if the investment is listed locally and is traded in rand. This means local pension funds, which collectively have an asset pool of around R4 trillion – pending the aforementioned provisions – are no longer limited in how much they can invest abroad.
This move does not apply to offshore investments that are directly held or holdings on foreign exchanges, as no changes were made regarding those caps under Regulation 28 of the Pension Funds Act.
The Financial Sector Conduct Authority (FSCA) noted on November 13 that: “All remaining foreign classified debt and derivative instruments as well as exchange-traded funds referencing foreign assets, that are inward listed on a South African exchange and traded and settled in rand, will be reclassified as domestic, provided they meet all eligibility criteria.”
“Further guidance will be provided from the authority in this regard and no presumptions pertaining to Financial Sector Conduct laws should be formed on the reclassification.”
The changes were confirmed in the South African Reserve Bank’s Exchange Control Circular No. 15/2020.
The explanatory note says in order to support South Africa’s growth as an investment and financial hub for Africa, this move is part of “far-reaching reforms to modernise the capital flow management framework” first announced in the February 2020 Budget.
If the Treasury note is to be believed, more changes like this are on the way.
“These reforms will result in the phasing out of current exchange control regulations to be replaced with new regulations under the Currency and Exchanges Act, 1933.”
Treasury says it is engaging with industry associations to “explore measures to strengthen specific mechanisms to enhance SA as a Gateway into Africa.” This will possibly see the creation of non-rand denominated listing instruments, collateral for derivative exposures, and possible mechanisms to enable financial services providers and asset managers to manage collective investment schemes of foreign assets from SA.
A regulatory task team made up of the Prudential Authority, FSCA, Financial Intelligence Center and Sarb, will work with stakeholders to finalise proposals for a possible announcement on Budget Day.
Caught by surprise
The change, which caught everyone by surprise, also re-classified foreign exchange-traded funds’ (ETFs) domestic assets as domestic assets, says Sygnia CEO Magda Wierzycka.
“It’s a gentle relaxation of foreign exchange controls, which gives South African investors and the economy a much-needed boost, whilst retaining the overall limits on how much South Africans can physically externalise.”
Wierzycka says: “The circular goes as far as to list the categories of investors who can now treat these instruments as domestic, including institutional investors, trusts, partnerships and companies.”
This change is a particularly good move for low-cost asset managers like Sygnia, as it allows them to sell more of a broader range of offshore products which have better growth prospects than those in South Africa.
“The mechanism of allowing investors to diversify their strategies through index-tracking ETFs not only enables the potential for more attractive, lower-risk returns, but also does so in a low-cost manner. Given the pedestrian returns from domestic equities and listed property in particular, a boost in investment performance is a boost to the economy.”
The 30% cap has long been an issue for institutional investors, as it has limited their investment options in the JSE, which has seen the number of listings on it shrink from 410 ten years ago to 341 today.
Wierzycka notes that as the shares of many of the listings are illiquid, the investment options available to investors are a lot more limited than the total number of companies on the exchange.
Naspers and Prosus, on the back of their Tencent exposure, constitute 21% of the JSE – this is also a problem for investors. With the 30% cap, they have to limit how much they can invest in other offshore entities, as many are already exceeding this cap buy holding a single share.
Wierzycka says people below age 55 will likely benefit the most from the change, as they are still building up their savings.
Those over the age of 55, however, who have accumulated significant savings can also gain from it as they can “convert from a retirement annuity to a living annuity and invest 100% of their living annuity’s asset offshore.”