International Business, Offshore Structuring

Offshore Exposure

Posted on by Franco Cronjé

Why it’s smart to diversify risk and explore overseas options in light of a failing local economy.

Why it is a wise move

  • You are a viable and vibrant business situated in South Africa. You have been in operation for many years and have direct exposure to the South African economy. You are a patriot and truly a South African citizen.
  • Your drive for business excellence, international exposure and wanting to be set free has lead you to question your current business model and local only economic exposure.
  • You realise that South Africa is a small country on the Southern-most tip of the African continent and that the South African economy currently represents less than 1% of the world economy.
  • On face value the South African economy seems structured, well diversified and mature especially measured against other developing nations.  
  • However, a recent article on the businessinsider.co.za (February 2020) indicates that South Africa and the Johannesburg Stock Exchange lost 250 listed companies since 2000. Indicating that there are now the same number of listings as before 1994. The South African Stock Exchange is the bourse responsible for and platform on which the listing and trading in public equities occur. There are currently about 344 listed entities on this exchange. Of these 344 companies there are the so called Top 40 index which basically comprises the 40 companies with the highest market capitalization as well as trading liquidity. Moving out of the top 40 one quickly realize that the remaining 304 companies on the JSE is not necessarily quality investments including stocks that are illiquid, the so-called small caps which represents higher risk as well as significantly reduced quality of stocks due to either management or underlying business models.
  • Another recent article in the Business Day during October 2020 headlined “desperate local investors look offshore… Poor returns, gloomy economic outlook hit investment in SA Inc.” These poor returns which is referred to is in addition to the limited number of publicly traded entities available on the JSE.
  • During October 2020 Peter Major who was previously ranked as the top asset manager in SA pictured the grim reality of the South African economy stating that South Africa is not an appealing investment destination. There’s no sign of a turn-around in mining. Major specifically referred to the mining sector pointing out: ‘God gave us 10 commandments, Gwede Mantashe (minister or mineral resources) gave us 2,000 new regulations in mining and 3,000 policy changes… and you now have to give away 30%.' This country has more minerals than America and Russia but policy makes it more attractive to delist than list. There are 200 or so countries in the world to invest in and this is the least attractive, before you factor Eskom woes into the picture, he says.
  • All this, the slowdown in the South African economy, policy uncertain and a severely undervalued rand has resulted in an economy on the brink of collapse.
  • Diversification and risk mitigation is paramount and therefore you have decided to invest in international expansion. Globalising your business and targeting growing economies.
  • Competing globally and trading internationally is consuming and requires dedication and hard work.
  • Ease of and access to unrestricted and state of the art financial systems is paramount in ensuring your response to an ever-changing business landscapes and associated risks are pro-actively managed.
  • You as a Nomad seeking to be set free understands that in South Africa due to the previous regime the South African economy has become severely isolated especially during the 1980’s. It was during this regime that the South African government had to implement measures to curb the outflow and divestment of capital from South Africa. As a result, the foreign exchange regulations were drafted and put into effect. This ensured that the free flow of capital was curtailed requiring approval from the South African Reserve Bank in order to transfer money to and from South Africa. 
  • These policies in South African Is not prohibiting the flow of capital it is however severely restrictive imposing numerous requirements which should be met should you wish to effect international trade. In other words, the free flow of money is adversely affected.
  • As a businessman your responsibility is to allocate capital seeking superior investment yields with limited risk whether locally or globally. 
  • You know that the plight of the South African economy is not good presenting with low yields and many unmanageable risks.
  • For local businesses and capital allocators government has implemented limited if no policy assisting or enabling a stable local economy. Little if nothing has been done assisting with international expansion of business allowing businesses to compete with international players on a global scale.
  • You as a local South African businessman is well aware of the policy uncertainty and poor governance resulting in South African large international corporate investors, both locally and internationally seeking alternative regional investments rather than targeting South Africa. Taking que from such businesses, this uncertainty, the ever-increasing difficulty of doing business in South Africa along with the latest spades of corruption has increased the risk profiles of this country resulting in making risk adjusted returns less favorable than other world economies.
  • As part of your philosophy to be set free you know that if que is taken from such international investors both retail and corporate investors in South Africa should actively devise and implement action plans to follow suite.
  • Governments around the world is funded mainly by three methods being firstly the issuing of debt instruments and subsequently paying interest on such instruments to the investors (government bonds), secondly by collecting of taxes from both corporates and individuals and thirdly by generating income from parastatals.
  • Issuing debt instruments as a primary source of funding government capital plans or shortfalls are futile as have been noted in recent years. This method should only be used in circumstances of shortfall or due to specific short-term requirements. One only has to look as far as Greece, Brazil, Ireland etc. to see the effect of large debt levels. In theory, parastatals on the other hand seems like a very plausible method to fund governments expenditure. In practice this could however not be further from the truth as governments seldomly have the capacity and expertise to run such institutions profitably. Again, one does not need to look much further than Eskom, SAA, Denel etc. in actual fact it is hard to find any parastatal which is profitable and well run.
  • Taxation on the other hand is a brilliant measure to fund governments, redistribute wealth and upscale an economy. It has however become more apparent in recent years that taxation and tax collection in stagnant and poor performing economies are increasingly under pressure and therefore tax collection is not fulfilling the need of governments.
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  • In the South African context the debt to GDP ratio has increase from a manageable 30% in the early 2000’s to close to 80% in 2020. This indicates a significant rise in debt which is mainly due to a shortfall in collection of taxes. In turn, poor tax collection is mainly a result of poor economic conditions as a result of poor economic growth, a large and ever-increasing informal sector not contributing to the fiscus as well as moral decay by tax paying residents due to ethical failures by government. Many measures can be used to define this poor growth of the South African economy but none more so than the rise in the unemployment rate coupled with the rise in grants paid by the South African government.
  • A clear point to support the case of the South African government focusing on tax collection rather than supporting the growth of the economy is the latest changes made to Section 10(1)(o) of the Income Tax Act which relates to South African residents working abroad. Before changes to this section South African residents working abroad and being out of the country for more than 183 days a year were able to pay no taxes on their foreign earned income. Subsequent to these changes being imposed only the first R1m will be exempt from taxation whilst the rest being taxed at your marginal tax rate. These amendments seems rather unfair to the taxpayer as this person has for a significant portion of the year not contributed to the South African economy but is now required to pay taxes in South Africa.
  • You, having a Nomadic mindset clearly sees that the South African government has ran out of ideas. The only card they have to play is tax collection as all other avenues are dismally failing on all measures. You know that tax collection without economic growth is unsustainable and futile.  
  • You have noted that more and more corporate and retail investors are realising that the South African economy is posing a huge concentration risk to their investment profile and are therefore actively seeking alternative offshore exposure.
  • With an increase in globalisation and access to foreign markets being much more accessible South African investors you are realising that offshore asset allocation is not a luxury any more but in actual fact it is a diversification imperative.
  • You realise that true diversification and accessing foreign regions from a base in South Africa is however not advisable nor practical as the South African economy and country as a whole provides too many drawbacks such as:
    • Uncompetitive labor and labor unrest.
    • Regulations limiting the free flow of capital.
    • Policy uncertainty.
    • Undervalued currency.
    • Not ideally situated on the Southern most tip of the African continent.
    • And many more.
  • In your drive to globalize and to compete internationally you require your businesses to address these issues and to ensure that capital is allocate to assets and regions which provide the best possible return. Therefore, your business is seeking alternatives as a measure to increase yields, compete internationally as well as avoid uncertainties relating to the South African economy. You, the Nomad wanting to be set free have decided that you need to go where they are treated best and you realise that this does not seem to be South Africa.
Franco Cronjé