Advice for Finance Minister Tito Mboweni

SUBJECT: PLEASE DEAL WITH FINANCIAL REGULATORY PERVASIVE

Thanks for inviting us to submit inputs to your maiden budget speech which will be tabled on the 20th February 2019. From the onset, I should declare that I had previously sent the contents of this letter to Mr Floyd Shivambu, MP. As part of influencing public policy trajectory, one tends to lobby various politicians and stakeholders. Despite huge temptation, I have shied away from commenting about your love for Kigali and your stance on Afrikaans as a medium of instruction.

Honourable Minister, I hereby urge you to deal with three other matters as follows – (1) high banking services charges; (2) possible amendment to Regulation 28 of the Pension Funds Act; and (3) possible zero tax payment by impact investors.

Exorbitant bank charges

South Africa’s banking sector features among the most highly concentrated banking sectors globally, with the Top 5 controlling approximately 90% of the market. As in any industry high concentration tends to lead to higher prices, lower outputs and a smaller consumer surplus even in the absence of collusion. Firms in highly concentrated markets often sustain high profits for long periods of time.  The sector arrangements lead to a situation where the poor borrow small amounts of money and pay extremely high interest rates and service charges, even after adjusting for the higher default rates and cost of servicing smaller loans. 

It is easier to borrow money for consumption or consumption assets than it is to borrow money to start a business. Assets such as office blocks and shopping malls which are oversupplied are easy to finance, while assets in critical shortage like housing, hospitals and other infrastructure or assets like hotels that create permanent jobs, are virtually impossible to finance. Banks are often advisors and major lenders in the same transaction, seemingly oblivious to the blatant conflict of interest. The cherry on top is that banks say they are unable to report on the racial breakdown of their lending, despite the legacy of apartheid and the transformation imperative.

The upshot is that national policy priorities including housing, healthcare, education, infrastructure, job creation and transformation are neglected, while banks build and hold significant reserves on their balance sheets comprising a major proportion of the nation’s savings.

Amendment to Regulation 28

Regulation 28 of the Pension Funds Act may be the most critical item of regulatory intervention in capital allocation in our economy and the bluntest.  The Act is intended to control pension funds by stipulating maximum investable levels per asset class – currently only 15% is allowed in Alternative Investments, the very asset class that is necessary for infrastructure development projects, SME development, Venture Capital, Private Equity and Impact Investing.

However, what the Act does not cater for is limits with respect to diversification, return volatility, and consultant/manager concentration. It purports to provide prudential limits on investment into “alternative asset classes” to protect the pensioner from undue risk. In that regard, it is a pair of spectacles protecting a person in a high speed head-on crash.  An equity stake in an unlisted power plant or hotel could be significantly lower risk than an equity stake in a listed property portfolio. Regulation 28 is not designed to make this distinction, in effect, failing the pension fund member it is trying to protect.  The consequence is that the investment priorities of the country are completely disregarded in the interest of a false paradigm of “safety”. 

Favourable tax rebate to impact investors

A significant hoarder of the nation’s savings, and second only to the banks, is the listed property or REIT (Real Estate Investment Trust) sector.  Here again, just five companies control 50% of the asset value in the sector. Concentration of economic power and its downside aside, REITs provide the case study for regulatory perversity. All companies pay 28% income tax and then 20% dividend tax. The REITs are allowed to earn income and pay this out to their shareholders without any tax deduction, that is, their tax rate is ZERO. This advantage is the simple explanation for why there is a national oversupply of office blocks and shopping malls.  It also substantially explains why listed property has been the fastest growing sector on the JSE. 

It is also remarkable that REITs are not regulated by the Financial Sector Conduct Authority, despite the obvious fact that they are merely listed property funds with the board and management acting in a fiduciary capacity over public investment capital. This regulatory deficit provides another perverse arbitrage in that a JSE listed REIT is practically unlimited in its ability to raise money in SA and invest it into property holdings overseas. On average SA REITs, have about 30% of their investments offshore while raising more than R26bn in new equity from new listings, dividend reinvestment plans, Mergers & Acquisitions and secondary placement.  This loophole is not open to any other class of asset manager and the sector has taken significant advantage.

Sir, if we can get some of the regulatory inadequacies highlighted resolved, the South African finance sector would go a long to achieve meaning transformation.

Thanks for your indulgence.

Yours in the service of humanity,

Rabelani

Dr. Rabelani Dagada, PhD (@Rabelani_Dagada)

Founder: GrandPoint Capital

Managing Director: The Financeburg Group

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