IRR Full Submission on the draft Broad-Based Black Economic Empowerment Regulations – 17 March 2016

The IRR's Full Submission on the draft Broad-Based Black Economic Empowerment Regulations.
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IRR Full Submission on the draft Broad-Based Black Economic Empowerment Regulations – 17 March 2016

The IRR's Full Submission on the draft Broad-Based Black Economic Empowerment Regulations.

South African Institute of Race Relations NPC
Submission to the Department of Trade and Industry
regarding the draft
Broad-Based Black Economic Empowerment Regulations, 2016
Johannesburg, 17th March 2016

Table of contents

Introduction  1
Further major shifts in BEE requirements  2
New BEE reporting and ‘compliance’ requirements  2
Registration of BEE transactions  4
Complaints to the Commission  5
Investigations and findings  6
Fronting practices  7
Permission to exceed qualification criteria  8 
Applications for exemption or deviation  9
Increased pressure for 51% BEE ownership  9
          Ambit of the 51% ownership provision 10
          Possible ramifications for the mining industry 11
          Costs of raising BEE ownership to 51% 11
          Likely economic consequences 13
          A further erosion of property rights 14

Growth and increased opportunities the key requirements   14

Introduction

The Department of Trade and Industry (DTI) has invited public comment on the draft Broad-Based Black Economic Empowerment Regulations (the regulations) published in the Government Gazette on 17th February 2016. Such comment is due not later than 30 days from this publication date and thus by 17th March 2016. This period is too short, however, to meet the constitutional requirement for proper public consultation.

This submission is made by the South African Institute of Race Relations NPC (IRR), a non-profit organisation formed in 1929 to oppose racial discrimination and promote racial goodwill. Its current objects are to promote democracy, human rights, development, and reconciliation between the peoples of South Africa.

The regulations have been gazetted by the minister of trade and industry under the powers given to him by the Broad-Based Black Economic Empowerment Act of 2003 (the 2003 BEE Act), as amended by the Broad-Based Black Economic Empowerment Amendment Act of 2013 (the BEE Amendment Act).

Further major shifts in BEE requirements

In 1994, shortly before it came to power as part of a government of national unity, the African National Congress (ANC) published a document saying that black economic empowerment (BEE) was needed to help remove ‘all the obstacles to the development of black entrepreneurial capacity’ and ‘unleash the full potential of all South Africans to contribute to wealth creation’. These goals have been forgotten, however, in the constantly shifting and ever more prescriptive BEE requirements being developed by the DTI.

When the generic codes of good practice were gazetted in 2007 and introduced in 2008, business understood that BEE was to have limited lifespan and would remain in place only until 2017. Yet, a mere five years after these codes took effect – and despite the fact that average compliance levels stood at some 70% in 2013 – sweeping changes were introduced via the revised generic codes brought into operation in May 2015.

Further major changes were effected under the BEE Amendment Act of 2013, which came into operation in October 2014. The BEE Amendment Act includes a trumping provision which came into effect in October 2015. Under this provision, the BEE requirements set out in the Act – including those in the generic codes – are now seemingly to take precedence over all other BEE rules, including those in the mining charter.

These already very major changes are now being compounded by those set out in the regulations. These regulations are supposed merely to flesh out the provisions of the BEE Amendment Act, but in several respects they go very much further, allowing an extraordinary degree of intrusion by bureaucrats and making BEE rules yet more uncertain. They also put great pressure on very many businesses to increase their BEE ownership from 25% (plus one vote) to 51% or more. This is a substantive change, which needs to be debated and approved by Parliament, not imposed via regulation without adequate public consultation.

Other provisions in the regulations are likely to undermine business and investor confidence yet further and should also be abandoned – especially now that the economy stands on the brink of a recession and urgent action is needed to increase the growth rate to avoid the downgrading of South Africa’s sovereign debt by international ratings agencies.

New BEE reporting and ‘compliance’ requirements

Under Clause 12 of the regulations, every ‘sphere of government, public entity or organ of state’ (hereafter, ‘organ of state’ for ease of reference) must report every year, in its audited financial statements and annual reports, on its compliance with the generic codes of good practice (or with any sector BEE code that may be applicable).

In doing so, an organ of state must report on its ‘state of compliance’ with all five elements in the generic codes, along with ‘any sector specific element’ that may be relevant. It must also report on ‘how each element contributes to the outcome of the scorecard in terms of the codes’ (a requirement which so poorly phrased as to be difficult to understand). [Clause 12(1), Regulations]

Essentially the same reporting requirement applies to every ‘public company listed on the Johannesburg Stock Exchange’ (JSE). Every such company must submit its compliance report to the Broad-Based Black Economic Empowerment Commission (the Commission) within 30 days of the end of its financial year. [Clause 12(3), (4), Regulations]

In addition, every Sectoral Education and Training Authority (Seta) must report annually to the Commission on its skills training and skills development services and its contribution to ‘critical and priority skills’, among other things. Each Seta must also report on ‘how each element contributes to the outcome of the scorecard in terms of the codes’, a requirement which is again confusingly worded. [Clause 12(6), Regulations]

The Commission must ‘consider’ each report that it receives, [Clause 12(9), Regulations] which in itself will be a major administrative task. In ‘cases of non-compliance’, the Commission may notify the organ of state, listed company, or Seta of this. The entity in question must then ‘correct’ its report within 30 days. If it fails to do so, the Commission ‘must reject’ the report, and give reasons for doing so. It may also ‘allow’ the entity in issue to ‘appear before it in a closed or open meeting to respond to questions by the Commission’. [Clause 12(11), (12), Regulations] The Commission may also ‘conduct a site visit’ to verify a report, or it may ‘initiate an investigation...in respect of any non-compliance’ with the reporting obligation.

Organs of state, many of which are already failing to fulfil their core functions, including sound financial management and the proper maintenance of essential infrastructure, will now have to devote many hours and a significant proportion of their often limited skills to compiling compliance reports, providing any additional information the Commission may request, and attending the Commission during the site visits it may require. This will be a huge administrative burden not only for the Commission itself but also for a struggling public service and a host of state-owned enterprises.

Under the ‘management control’ element of the scorecard, organs of state will also come under increased pressure to comply with racial targets which both the skills shortage and the age profile of the black population make difficult to fulfil. Black people of a suitable age for management posts (35 to 64) make up only 40% of the economically active population (EAP) at national level, while those with post Grade 12 qualifications make up only 5% of the national EAP. Yet the BEE generic codes require 60% black representation at senior management level, 75% at middle management level, and 88% of junior management level. These unrealistic targets help explain why the efficiency of the public service has declined over the past 20 years. They also help explain why ‘an inefficient government bureaucracy’ is now identified by the World Economic Forum as the second ‘most problematic factor’ for doing business in South Africa. [World Economic Forum, The Global Competitiveness Report 2015-2016, p326]

The public service, along with Eskom and other state-owned enterprises, should be doing all they can to improve their performance. They should also be able to use whatever skills are available for this purpose. Instead, their endeavours to demonstrate compliance with unrealistic BEE demands could see their operational efficiency decline yet further.

The burden on listed companies will also increase. Having to report to the Commission on their compliance with all the elements in the generic (or sector) codes will be only the start of the additional burden placed on them, for they will often also have to put significant time and effort into responding to the Commission’s queries and/or site visits.

Moreover, if they fail to satisfy the Commission as to their compliance, they will also have to gear up to deal with any investigation the Commission may then initiate.

Moreover, both the BEE Act and these regulations are silent on what level of compliance the Commission may in practice require. The scorecard in the generic codes recognises eight ‘levels of BEE contribution’, ranging from level 1 (for contributors with BEE scores of 100 points or more) to level 8 (for contributors with BEE scores of between 30 and 40 points). Will organs of state and listed companies be considered ‘compliant’ at level 8 (or below), or will they in practice be expected to attain higher scores in order to satisfy the Commission?

There is also nothing in the BEE Act or in these regulations that obliges the Commission to take into account the practical difficulties standing in the way of full BEE compliance. These include not only the age and skills profile of the black population, as earlier described, but also the adverse economic climate. For example, can companies battling to maintain profitability in an economy on the cusp of recession realistically be expected to spend 6% of annual payroll on skills training for black staff (in addition to the statutory 1% skills levy)? Can they realistically be expected to buy 80% of the goods and services they need each year on any basis other than price and functionality?

Compliance with BEE targets must, at the very least, be assessed in the light of all the practical and financial obstacles to their attainment. However, there is no obligation on the Commission to take these salient factors into account.

The Commission’s apparent powers to demand corrections, conduct site visits and decide on the extent of ‘non-compliance’ by organs of state and listed companies are extraordinary intrusive and potentially damaging to the efficient operation of both organs of state and listed companies. They are also ultra vires the BEE Amendment Act, which merely gives the Commission the power to ‘receive and analyse’ the reports compiled by organs of state and listed companies. [Section 13(F)(1)(g), BEE Amendment Act]

Registration of BEE transactions

Under the regulations, ‘a party that enters into a major BEE transaction that is above the threshold determined by the minister by notice in the Gazette’ must within 15 days ‘submit the transaction to the Commission for registration’. [Clause 18(1), Regulations]

Such a BEE transaction is not further defined, but would include, for example, a BEE ownership deal of a value above the threshold specified by the minister. The minister has complete discretion as to where this threshold is to be set. He can also increase or lower it at any time, again at his discretion.

A major BEE transaction might also include a preferential procurement contract above a certain value, or an enterprise development transaction, or a socio-economic development transaction. [Business Day 14 March 2016]

Once the transaction has been submitted, the Commission must ‘issue a certificate of registration’ within ten days. However, it may also ‘at any time’ start to ‘assess’ the transaction to ‘determine adherence to the BEE Act’ [Clause 18(3), Regulations] and the codes of good practice. [Section 1, BEE Act of 2003] If the Commission has ‘any concerns about the transaction’, it may advise the party that applied for registration, which ‘must take steps to remedy the transaction within a reasonable period’. If it fails to do so, the Commission may ‘initiate an investigation’ into the matter. [Clause 18(4), Regulations]

Hence, if the Commission is not satisfied with any element in that BEE ownership deal – perhaps because it thinks the initial 40% ‘net value’ requirement has not been fulfilled, or that the realisation principle (which is aimed at reducing the debt of BEE investors over time) is not adequately satisfied – it can effectively unstitch key aspects of the transaction and require that they be redone.

This will make for great uncertainty. It could also add significantly to the cost of BEE transactions – especially as the Commission will be able to start its assessment ‘at any time’. This suggests that, if an ownership deal ends up under water after several years – because share prices have declined and dividends have not been paid – the Commission will be entitled to demand that the deal be renegotiated for the benefit of the BEE investors even though there is no fault on the part of the company.

These provisions are again inordinately intrusive and economically damaging. They are also clearly ultra vires the BEE Amendment Act, which merely gives the Commission the power to ‘maintain a registry of major broad-based BEE transactions’, not interfere with the terms on which such transactions are concluded.

Complaints to the Commission

According to the regulations, ‘any person may lodge a complaint with the Commission’ by sending in the prescribed form and providing the prescribed information. Such information must include ‘a description of the conduct or practice alleged to be in contravention’ of the BEE Act. The complainant must also provide information on measures taken ‘to attempt to resolve the complaint’, and on ‘the way in which the alleged contravention...might be addressed’. [Clause 15(1), (2), Regulations]

Within a year of receiving a complaint, the Commission must assess the merits of the complaint and ‘investigate the complaint if it is justifiable to do so’. [Clause 15(4)(a) and (c), Regulations] Within this period, it may also ‘hold a formal hearing’, if it so wishes, and ‘make a finding’ on the complaint. [Clause 15(4)(f) and (g), Regulations]

Under the BEE Amendment Act, the findings issued by the Commission may include a finding ‘as to whether any BEE initiative involves a fronting practice’. [Section 13J(3), BEE Amendment Act] Though such a finding potentially carries major penalties (see Fronting practices, below), the Commission is allowed (by both the Act and the regulations) to come to such a finding without holding a formal hearing into the matter and without in fact conducting any investigation at all.

Under the regulations, if the Commission does embark on an investigation, this probe must ‘conform to all the rules relating to fair administration of justice processes applicable to investigations’. [Clause 15(17), Regulations] This clause may provide some guarantee of fairness in the way investigations are carried out. However, no equivalent provisions apply to the making of findings by the Commission. Though the right to administrative justice would of course apply, the regulations should make it clear that no finding may be made without a prior investigation, without respect for the key principles of natural justice (audi alteram partem and nemo judex in sua causa), and without sufficient reliable and admissible evidence.

Investigations and findings

Under the BEE Amendment Act, the Commission ‘has the power, on its own initiative or on receipt of a complaint,...to investigate any matter arising from the application of the BEE Act, including any BEE initiative’. [Section 13J(1), BEE Amendment Act] The Commission has the right to decide on ‘the format and procedure to be followed’ and on whether or not to hold ‘a formal hearing’. [Section 13(2), BEE Amendment Act]

Under the regulations, if the Commission decides to hold ‘a formal hearing’, it ‘may’ do so before ‘a panel chaired by the chairperson’. [Clause 15(10), Regulations] A panel is defined as meaning ‘a group of not more than five persons that may be appointed by the Commission to preside in a formal hearing’. [Clause 1, Regulations] No minimum quorum for the panel is laid down.

The chairperson of the panel ‘may include’ the Commissioner, which means he may not necessarily be the Commissioner. There is no adequate guarantee that the panel will be an objective body or that it will act in an objective way. On the contrary, the chairperson may indeed by the Commissioner, who has little institutional independence from the minister of trade and industry under either the BEE Amendment Act or the regulations.

Under the BEE Amendment Act, the Commissioner is appointed by the minister for a (once renewable) five year term. His remuneration is decided by the minister. He may also be removed from office by the minister for ‘undermining the integrity or standing of the Commission’, or on ‘any other legitimate ground’. [Section 13C(1),(2), (6), BEE Amendment Act] He is also subject to ‘ministerial directives of a general nature’ in the way he carries out his functions.

These provisions significantly undermine the independence of the Commission, as indicated by the Constitutional Court judgment in the second Glenister judgment in 2011. [Glenister v President of the Republic of South Africa and Others (CCT 48/10) [2011] ZACC 6; 2011 (3) SA 347 (CC) ; 2011 (7) BCLR 651 (CC) (17 March 2011)] Hence, they are likely to trump a provision in the BEE Amendment Act stating that the Commission ‘must be impartial and perform its functions without fear, favour, or prejudice’. [Section 13B(4)(3(a), BEE Amendment Act]

Since the Commission is not adequately insulated from ministerial control, any panel it appoints will not have adequate institutional independence either.

Worse still, the Commission may issue findings without holding any investigation, let alone convening a formal hearing. If it receives a complaint, it must notify the respondent of this. [Clause 15(4)(d), Regulations] If it decides to investigate a matter on its own initiative, it must issue a ‘notice to investigate’ and inform the respondent of this. [Clause 15(8), Regulations] Thereafter, it has no obligation to involve the respondent in its deliberations. All it need do is ‘notify the respondent in writing of any adverse finding’ and give him 30 days to respond. However, it need not give the respondent a hearing or allow him to test the evidence on which it has relied. [Clause 15(13), Regulations]

Fronting practices

The BEE Amendment Act defines a ‘fronting practice’ in extraordinarily wide terms to include any ‘transaction’ or ‘conduct’ which ‘directly or indirectly’ (that is, intentionally or unintentionally) ‘undermines or frustrates the achievement of the objectives’ of the 2003 BEE Act. [Section 1, BEE Amendment Act]

The objectives of the 2003 BEE Act are to ‘facilitate broad-based black economic empowerment’ by (among other things): [Section 2, 2003 BEE Act]

(a) promoting economic transformation;
(b) achieving a substantial change in the racial composition of ownership and management structures;
(c) increasing the extent to which...collective enterprises own and manage existing enterprises;
(d) increasing the extent to which black women own and manage existing and new enterprises;
(e) promoting investment programmes that lead to...meaningful participation in the economy by black people’;
(f) empowering rural and local communities; and
(g) promoting access to finance for black economic empowerment.

Any firm that fails to increase the number of co-operatives that own existing companies may thus be found guilty by the Commission of a ‘fronting practice’. Similar findings may be made against any company which proves unable (in this low-growth environment) to ‘promote investment programmes’ for the benefit of black people, or which finds that its own resources are too limited to ‘promote access to finance’ for BEE.

This is outrageous. Still more extraordinary, as the regulations make clear, is the fact that such a finding can be made by the Commission without a formal hearing or any comprehensive and objective evaluation of the relevant evidence. Worse still are the penalties for any fronting practices, which include fines of up to 10% of annual turnover (more than the annual profit of many companies), and/or prison terms for directors of up to ten years. [Section 13(O), BEE Amendment Act]

The Commission cannot itself impose these penalties on a company that it finds guilty of a fronting practice. Instead, it must refer this criminal offence to the National Prosecuting Authority for prosecution, or to the South African Police Service for further investigation. [Section 13(J)(5), BEE Amendment Act] In a country battling to counter murder and rape rates that are among the highest in the world, this is absurd. It does, however, at least mean that these draconian penalties can be imposed only after a trial in the magistrate’s court. In the interim, however, the reputational damage to a company found guilty of a fronting practice by the Commission could be significant. The further risk, of course, is that prospective direct investors, in deciding whether or not to invest in South Africa, will find these rules so unacceptable that they will simply go elsewhere.

It is not enough for the DTI to try to minimise the impact of these extraordinary rules by promising that the Commission will make findings of fronting only where the conduct of a company amounts to the fraudulent misrepresentation of BEE status. Such assurances count little against the actual wording of the BEE legislation and the lack of any appropriate safeguards in the regulations.

Permission to exceed qualification criteria

The BEE Amendment Act allows organs of state to ‘specify qualification criteria for procurement and other economic activities’ that exceed those set by the minister in the generic codes of good practice (or in any relevant sector code), provided they obtain the minister’s consent. [Section 9, BEE Amendment Act]

This provision allows government departments, municipalities, state-owned enterprises, and a host of other organs of state to increase the normal BEE criteria with ministerial consent. Organs of state may thus stipulate, for example, that companies wanting to do business with them must have a BEE ownership level far above that specified in the relevant BEE rules. Eskom, for example, thus insists that the mining companies from which it buys coal must have 51% BEE ownership rather than the 26% set out in the mining charter.

According to the regulations, an organ of state wanting to increase the usual BEE criteria must apply to the minister, motivate for the increase, explain how great an increase it seeks, and provide any additional information the minister may require. [Clause 19(1), Regulations] The minister must then satisfy himself that ‘the proposed scorecard exceeds the qualification criteria’ in the relevant generic or sector code, this being the only factor he is obliged to take into account. He must then grant or refuse the application within three months. If he grants permission, he may do so with or without conditions and for a specified period, which may not exceed 10 years. His decision must also be published by notice in the Gazette. [Clause 19(3), (4), (7), Regulations]

There is no obligation on the minister to consult with companies likely to be affected by his decision. Nor is there any obligation on him to weigh the negative economic impact of allowing the qualification criteria set out in the generic or sector codes to be increased in this way and for such prolonged periods. In addition, the more organs of state use these provisions to introduce additional qualification criteria, the more this will generate a quagmire of conflicting BEE rules. Such uncertainty will further poison the investment climate in the country.

Applications for exemption or deviation

Under the BEE Amendment Act of 2013, the minister may ‘exempt’ an organ of state from having to apply either the generic codes or a relevant sector code. He may also allow such an entity to ‘deviate’ from these codes. However, he may do so only if ‘particular objectively verifiable facts or circumstances...necessitate an exemption or deviation’. [Section 10, BEE Amendment Act]

According to the DTI, these powers are needed to authorise state entities to purchase essential equipment from foreign companies lacking good BEE credentials. However, since the Government’s aim is also to promote empowerment and encourage local industry, ministerial discretion is to be strictly limited and organs of state will have to follow the normal BEE rules in all but the most exceptional circumstances.

The regulations flesh out the process to be followed in seeking exemptions or deviations. An organ of state must apply to the minister, motivate for the exemption or deviation, show the steps it is taking to achieve compliance with the codes, and specify the time frame within which this will be done. The minister must then decide if the exemption or deviation is indeed ‘necessitated’ by ‘verifiable facts or circumstances’.

The minister must also grant or refuse the application within 90 days. If he approves it, he must lay down any necessary conditions and ‘set time lines for the organ of state to comply with the codes of good practice’. He must also specify the period for which the exemption or deviation will be allowed, which may not exceed ten years. The exemption or deviation may, however, be terminated by the minister at any time if, in his ‘view’, the ‘reasons for granting the exemption or deviation no longer prevail’. In these circumstances, he need not notify the companies that will be affected by the withdrawal or give them any time to adjust. [Clause 21, especially (14)-(16), Regulations]

The regulations do not require the minister to obtain or take into account the views of companies likely to be affected by the granting of the exemption or deviation. Yet these rules could readily be used to favour some companies (Chinese or Russian ones, for instance) over local ones.

Increased pressure for 51% BEE ownership

The most damaging aspect of the regulations is the increased pressure they bring to bear on companies to increase their BEE ownership from 25% (plus one vote) to 51%.

The revised generic codes, with their 25% BEE ownership requirement, entered into force less than a year ago, in May 2015. Though most companies are still battling to get to grips with the revised codes, the ownership element is now effectively being changed yet again for a host of companies.

Under the regulations, every organ of state, ‘in determining the qualification criteria’ for the issuing of licences and other authorisations ‘must...give more consideration to companies that are at least 51% black owned’. [Clause 20(1)(a), Regulations] This preference for companies with 51% BEE ownership will also apply to companies seeking grants or incentives from organs of the state under relevant schemes. The preference will also apply to every company wanting to do business with any organ of the state. The regulations will thus have a very extensive reach – and will put great pressure on very many companies to raise their BEE ownership from 25% to 51%.

Ambit of the 51% ownership provision

Companies that currently need licences or permissions from the State include, among other things, those in the private hospital sector, the liquor industry, the casino and gambling industry, and the fishing industry. The mining industry could also be affected if the trumping provision in the BEE Amendment Act, which came into force in October 2015, is seen as requiring mining companies to comply with the generic codes rather than the mining charter (see Possible ramifications for the mining industry, below).

A vast array of companies, both large and small, do business with national and provincial departments, municipalities, state-owned enterprises, and other organs of state. All these companies, including many in the construction, financial, IT, transport, hospitality, and catering sectors (to name but some examples) will be affected. Many other companies, including those in the clothing, motor, and manufacturing sectors that benefit from grants and incentives from organs of state and/or development finance institutions, will be affected too. Overall, there will be relatively few companies – except perhaps those in the wholesale and retail trade – that fall outside the scope of these provisions.

The DTI could also, of course, bring back and enact into law the Licensing of Businesses Bill of 2013. If this occurs, every business in the country, from the smallest micro enterprise to the largest corporation, will need a municipal licence do business at all. Each and every enterprise would then become subject to these provisions and might battle to obtain a business licences unless its BEE ownership stands at 51% or more.

Many foreign-owned companies operating here, including the South African subsidiaries of multinational corporations, may also come under pressure to achieve 51% BEE ownership. In practice, they may see this as little different from a 51% ‘indigenisation’ requirement, of the kind being introduced in Zimbabwe. In these circumstances, some may choose to disinvest from South Africa (which, after all, contributes a mere 0.6% to global GDP) and seek opportunities elsewhere.

Pressure for 51% BEE ownership also overlooks the extent of foreign equity ownership on the JSE. In 2015, according to research by Bank of America Merrill Lynch, some 46% of the JSE All Share Index was owned by foreigners, while 63% of the resources sector was foreign-owned. Many listed companies will not be able to raise their BEE ownership levels to 51% without buying back at least some of their foreign-owned shares (and then selling them on to BEE investors). Such buy-backs could see a major further outflow of portfolio investment. This, however, is something that South Africa – with its major budget and trade deficits – simply cannot afford.

Possible ramifications for the mining industry

Now that the trumping clause in the BEE Amendment Act has taken effect, mining companies – which, of course, need licences from the State to prospect or mine – could also be affected by these provisions. Yet the value of BEE ownership deals aimed at meeting the much lower ownership requirement in the mining charter (26%) has already risen to some R205bn. So concerned is the Chamber of Mines about never-ending BEE ownership obligations that it has applied to court for clarity on the current status of the ‘once-empowered, always-empowered’ principle that was included in the original mining charter. As the Chamber points out, a unilateral shift away from this clause, made by the Department of Mineral Resources (DMR) in 2010, has major implications for all mining companies. The DMR wants mining companies which have already achieved 26% BEE ownership to maintain their BEE ownership at this level at all times, even if their BEE investors sell out. This exposes mining companies to the risk of having to enter into ever more BEE deals, most of which must be concluded at significant discounts and financed via debt. Having to enter into additional BEE deals will also entail significant costs for existing shareholders, whose holdings in the mining companies in issue will become still more diluted every time a new BEE deal has to be done.

The regulations create a risk that mining companies will not simply be obliged to maintain their BEE ownership at the 26% level, but will instead be compelled to raise it to 51% if they want to acquire or retain prospecting or mining licences. This shift – coming on top of all the other mining policy changes already made or in the pipeline – will make it still more difficult to turn the ailing mining industry around. It will also see South Africa move yet further down the Fraser Institute’s policy perceptions index, which measures the extent to which adverse policies undermine the attractiveness to investors of different mining jurisdictions.

Already, South Africa ranks poorly on this index, coming in at 78th out of 109 countries in 2015. (Neighbouring Botswana, by contrast, comes in at 14th out of 109.) Under the BEE regulations, South Africa’s ranking is sure to decline further. This will deter any fresh investment in the sector, while mining companies already in the country will have yet more reason to disinvest. The resulting damage to South Africa’s fragile economy is likely to be great.

Costs of raising BEE ownership to 51%

There will be major direct compliance costs for all businesses that find themselves under pressure to raise their BEE ownership levels from 25% to 51%. The value of known BEE deals aimed at achieving the 25% BEE ownership target is already high, standing at some R600bn in 2013. This figure no doubt greatly underestimates the overall value of such deals, if only because it excludes the BEE deals done by private companies, which are generally not disclosed.

In 2007 the National Empowerment Fund, a government vehicle set up in 1998 to fund BEE transactions, estimated that the value of the empowerment deals needed to meet the 25% BEE ownership requirement might rise as high as R2 trillion. If the ownership target is now effectively to be doubled to 51%, the value of BEE deals might have to double too. Such an additional compliance cost is huge. It will also have many negative ramifications for the economy, if only because allocating so much scarce capital to BEE deals will hardly help to improve infrastructure, increase employment, or enhance South Africa’s limited international competitiveness.

Indirect compliance costs are likely to rise sharply too, if only because a great deal of management time will have to be put into endeavours to raise BEE ownership levels from 25% to 51%. Much of the indirect cost of the shift is also likely to be borne by institutional investors, such as pension funds and unit trusts, in which small savers and pensioners, both black and white, have substantial interests. Every additional BEE deal done at a discount by a company that has institutional investors of this kind – and virtually all the top JSE companies fall within this category – will dilute the shareholding of these existing investors, leaving less available to pay them dividends or pensions. Hence, much of the cost of enriching the small political elite likely to be the main beneficiaries of the 51% ownership provision will (again) be borne by ordinary savers and pensioners, many of them black.

Moreover, if BEE ownership is to be raised to 51%, this will often imply a loss of current majority control. This is likely to be particularly damaging to business confidence and investor sentiment. As Nigerian billionaire Aliko Dangote warned in 2013, even a 25% BEE ownership requirement is enough to deter FDI. In his words, a BEE ownership requirement is like ‘a forced marriage’, in which a business must partner with ‘someone who may not have the same appetite’ and ‘who does not have the equity behind them’ to make a real contribution. Notes Dangote: ‘The whole world needs capital. If you make it difficult for me to invest in one country, then I will move my capital somewhere else where it is easier to invest... In Nigeria, we used to have these laws demanding that any [foreign] investor had to have a Nigerian partner. But that just dried up the capital flows. Now anyone can do business with anyone in Nigeria.’

Since even a 25% BEE ownership requirement is enough to deter foreign investors, pressure for 51% BEE ownership will clearly be even more inimical to FDI. What foreign investor will want to come to South Africa if this implies the loss of ownership and control to outsiders?

Also relevant is the fact that FDI into South Africa has already declined from R63.6bn in 2009 to R22.6bn in 2015. With investor interest in the country already so limited, there is a great danger that FDI will drop even more sharply if the regulations are adopted. Capital outflows – which have already gone up sharply, from R10bn in 2009 to R68bn in 2015 – are also likely to increase. The more FDI stays away and capital outflows increase, the greater the economic costs of the regulations will be.

Regulatory pressure for 51% BEE ownership is also likely to erode genuine entrepreneurship even further, and give yet more impetus to crony capitalism. As Moeletsi Mbeki has commented (in the context of the current 25% BEE ownership requirement): ‘BEE tells blacks – “you don’t have to build your own business, you don’t have to take risk, the whites will give you a job and shares in their company.’ This situation has already been enough to ‘strike a fatal blow against black entrepreneurship’. If companies find themselves obliged in practice to transfer 51% of their assets or equity to BEE investors at greatly discounted prices, the impetus to risk-taking entrepreneurship by black South Africans will be even further reduced.

Moreover, whites will have no impetus to start new businesses when state pressure for a 51% BEE ownership requirement is what lies ahead. At the same time, black South Africans – no matter how hardworking, efficient, or entrepreneurial they may be – will battle to make a success of the new enterprises they may establish for themselves in the highly adverse economic climate the regulations will help to bring about.

Likely economic consequences

As FDI diminishes, economic growth – which is already unlikely to exceed 0.5% of GDP in 2016 – is likely to decline further or turn negative. Tax revenues will diminish, while government spending will prove difficult to cut. Public debt – which has already increased very rapidly from R805bn in 2009 to close on R2 trillion in 2015 – is then likely to rise even faster. Downgrades of the country’s sovereign debt rating to sub-investment (or ‘junk’) status will become increasingly difficult to avoid. Such downgrades will raise borrowing costs, accelerate capital outflows, and push the economy into an even more damaging downward spiral.

In 2009 the rand:dollar exchange rate stood at R8.44 to the dollar. In December 2015, in the aftermath of Nhlanhla Nene’s dismissal as finance minister, it stood at R16.38. Though it has since recovered a little, in the negative economic scenario likely to arise from a 51% BEE ownership requirement, the rand’s value could easily slip to R20. It could even reach R25 to the dollar over the next few years.

As the exchange rate deteriorates, inflation is likely to soar, rising to perhaps as much as 20% a year. The impact on the poor will be devastating as food and other prices rise very sharply – and the social grants provided by a cash-strapped government fail to keep pace with these rapid increases.

Joblessness will worsen. On a broad definition (which takes account of those too discouraged to keep looking for jobs), the number of unemployed South Africans has already gone up from 6.7 million in 2009 to 8.4 million in 2015. The unemployment rate (on the same broad definition) has also gone up significantly, from 32% in 2009 to 35% now. The youth unemployment rate, among people aged 15 to 24, has long been even higher and stood (again on the broad definition) at 63% in 2015.

Though unemployment is already at crisis levels, the increase in joblessness has at least been relatively slow in recent years. However, in the circumstances outlined above, unemployment is likely to expand very fast. On the broad definition, which is widely seen as more accurate, it could rise to 40% in general in the near future, and perhaps to as high as 70% among young people.

These economic consequences will be devastating, especially for the poor, but also for the growing middle class. In these circumstances, there will be little or no prospect of expanding opportunities for the disadvantaged.

A further erosion of property rights

The more a 51% BEE ownership requirement is imposed, the more this will also amount to an ‘indirect’ or ‘regulatory’ expropriation. Such an expropriation occurs when the State itself does not acquire ownership of a company (or other property), but its regulations deprive current owners of many of the benefits and powers of ownership.

However, this indirect expropriation will not be recognised as an expropriation under the present wording of the Expropriation Bill of 2015, which has already been adopted by the National Assembly and needs only the approval of the National Council of Provinces and the president’s assent to be enacted into law. On this basis, current business owners will be expected simply to absorb the costs of losing control of their enterprises while having to sell the bulk of their equity or assets at heavily discounted prices. Many may choose rather to close or move elsewhere.

This further erosion of property rights will do great harm to the business environment. As experience from all around the world has repeatedly confirmed, property rights are the essential foundation for investment, growth, jobs, prosperity, political autonomy, and upward mobility. Moreover, where property rights are eroded, it is not only current owners who pay the price, but the entire society that is impoverished. Those who are already poor bear the worst brunt, but the middle class is also greatly damaged as employment shrinks and the jobless become increasingly dependent for their survival on the relatively few still able to earn an income.

Growth and increased opportunities the key requirements

South Africa already stands on the brink of a recession, while finance minister Pravin Gordhan is doing all he can to stave off damaging downgrades of South Africa’s sovereign debt. The key requirement, according to international ratings agencies, is not simply greater fiscal discipline and measures to hold government spending in check. The most pressing need is rather to ramp up economic growth.

However, raising the growth rate critically depends on the Government’s success in boosting business confidence and implementing key reforms. This in turns means that the regulatory shackles weighing on the private sector must be lightened, not made heavier still. Hene, instead of constantly increasing the BEE burden, it is time for the DTI to call a halt.

As earlier noted, when the ruling party urged the introduction of BEE in 1994, it said this was aimed at ‘removing all the obstacles to the development of black entrepreneurial capacity and ‘unleashing the full potential of all South Africans to contribute to wealth creation’. BEE was never supposed to put a stranglehold on the economy or eliminate existing property rights. Nor was it intended to keep ever more South Africans mired in poverty for the benefit of a relatively small (and politically connected) elite.

BEE has failed in its objectives. It needs urgently to be replaced by a new system of ‘economic empowerment for the disadvantaged’ or EED. This would shift away from the current narrow focus on redistributing a static, if not shrinking, economic pie. Instead, EED would put a necessary emphasis on rapid economic growth, excellent education, and very much more employment as the most effective and sustainable means of increasing opportunities for all.

South African Institute of Race Relations NPC  17th March 2016

IRR TV

South African Institute of Race Relations NPC
Submission to the Department of Trade and Industry
regarding the draft
Broad-Based Black Economic Empowerment Regulations, 2016
Johannesburg, 17th March 2016

Table of contents

Introduction  1
Further major shifts in BEE requirements  2
New BEE reporting and ‘compliance’ requirements  2
Registration of BEE transactions  4
Complaints to the Commission  5
Investigations and findings  6
Fronting practices  7
Permission to exceed qualification criteria  8 
Applications for exemption or deviation  9
Increased pressure for 51% BEE ownership  9
          Ambit of the 51% ownership provision 10
          Possible ramifications for the mining industry 11
          Costs of raising BEE ownership to 51% 11
          Likely economic consequences 13
          A further erosion of property rights 14

Growth and increased opportunities the key requirements   14

Introduction

The Department of Trade and Industry (DTI) has invited public comment on the draft Broad-Based Black Economic Empowerment Regulations (the regulations) published in the Government Gazette on 17th February 2016. Such comment is due not later than 30 days from this publication date and thus by 17th March 2016. This period is too short, however, to meet the constitutional requirement for proper public consultation.

This submission is made by the South African Institute of Race Relations NPC (IRR), a non-profit organisation formed in 1929 to oppose racial discrimination and promote racial goodwill. Its current objects are to promote democracy, human rights, development, and reconciliation between the peoples of South Africa.

The regulations have been gazetted by the minister of trade and industry under the powers given to him by the Broad-Based Black Economic Empowerment Act of 2003 (the 2003 BEE Act), as amended by the Broad-Based Black Economic Empowerment Amendment Act of 2013 (the BEE Amendment Act).

Further major shifts in BEE requirements

In 1994, shortly before it came to power as part of a government of national unity, the African National Congress (ANC) published a document saying that black economic empowerment (BEE) was needed to help remove ‘all the obstacles to the development of black entrepreneurial capacity’ and ‘unleash the full potential of all South Africans to contribute to wealth creation’. These goals have been forgotten, however, in the constantly shifting and ever more prescriptive BEE requirements being developed by the DTI.

When the generic codes of good practice were gazetted in 2007 and introduced in 2008, business understood that BEE was to have limited lifespan and would remain in place only until 2017. Yet, a mere five years after these codes took effect – and despite the fact that average compliance levels stood at some 70% in 2013 – sweeping changes were introduced via the revised generic codes brought into operation in May 2015.

Further major changes were effected under the BEE Amendment Act of 2013, which came into operation in October 2014. The BEE Amendment Act includes a trumping provision which came into effect in October 2015. Under this provision, the BEE requirements set out in the Act – including those in the generic codes – are now seemingly to take precedence over all other BEE rules, including those in the mining charter.

These already very major changes are now being compounded by those set out in the regulations. These regulations are supposed merely to flesh out the provisions of the BEE Amendment Act, but in several respects they go very much further, allowing an extraordinary degree of intrusion by bureaucrats and making BEE rules yet more uncertain. They also put great pressure on very many businesses to increase their BEE ownership from 25% (plus one vote) to 51% or more. This is a substantive change, which needs to be debated and approved by Parliament, not imposed via regulation without adequate public consultation.

Other provisions in the regulations are likely to undermine business and investor confidence yet further and should also be abandoned – especially now that the economy stands on the brink of a recession and urgent action is needed to increase the growth rate to avoid the downgrading of South Africa’s sovereign debt by international ratings agencies.

New BEE reporting and ‘compliance’ requirements

Under Clause 12 of the regulations, every ‘sphere of government, public entity or organ of state’ (hereafter, ‘organ of state’ for ease of reference) must report every year, in its audited financial statements and annual reports, on its compliance with the generic codes of good practice (or with any sector BEE code that may be applicable).

In doing so, an organ of state must report on its ‘state of compliance’ with all five elements in the generic codes, along with ‘any sector specific element’ that may be relevant. It must also report on ‘how each element contributes to the outcome of the scorecard in terms of the codes’ (a requirement which so poorly phrased as to be difficult to understand). [Clause 12(1), Regulations]

Essentially the same reporting requirement applies to every ‘public company listed on the Johannesburg Stock Exchange’ (JSE). Every such company must submit its compliance report to the Broad-Based Black Economic Empowerment Commission (the Commission) within 30 days of the end of its financial year. [Clause 12(3), (4), Regulations]

In addition, every Sectoral Education and Training Authority (Seta) must report annually to the Commission on its skills training and skills development services and its contribution to ‘critical and priority skills’, among other things. Each Seta must also report on ‘how each element contributes to the outcome of the scorecard in terms of the codes’, a requirement which is again confusingly worded. [Clause 12(6), Regulations]

The Commission must ‘consider’ each report that it receives, [Clause 12(9), Regulations] which in itself will be a major administrative task. In ‘cases of non-compliance’, the Commission may notify the organ of state, listed company, or Seta of this. The entity in question must then ‘correct’ its report within 30 days. If it fails to do so, the Commission ‘must reject’ the report, and give reasons for doing so. It may also ‘allow’ the entity in issue to ‘appear before it in a closed or open meeting to respond to questions by the Commission’. [Clause 12(11), (12), Regulations] The Commission may also ‘conduct a site visit’ to verify a report, or it may ‘initiate an investigation...in respect of any non-compliance’ with the reporting obligation.

Organs of state, many of which are already failing to fulfil their core functions, including sound financial management and the proper maintenance of essential infrastructure, will now have to devote many hours and a significant proportion of their often limited skills to compiling compliance reports, providing any additional information the Commission may request, and attending the Commission during the site visits it may require. This will be a huge administrative burden not only for the Commission itself but also for a struggling public service and a host of state-owned enterprises.

Under the ‘management control’ element of the scorecard, organs of state will also come under increased pressure to comply with racial targets which both the skills shortage and the age profile of the black population make difficult to fulfil. Black people of a suitable age for management posts (35 to 64) make up only 40% of the economically active population (EAP) at national level, while those with post Grade 12 qualifications make up only 5% of the national EAP. Yet the BEE generic codes require 60% black representation at senior management level, 75% at middle management level, and 88% of junior management level. These unrealistic targets help explain why the efficiency of the public service has declined over the past 20 years. They also help explain why ‘an inefficient government bureaucracy’ is now identified by the World Economic Forum as the second ‘most problematic factor’ for doing business in South Africa. [World Economic Forum, The Global Competitiveness Report 2015-2016, p326]

The public service, along with Eskom and other state-owned enterprises, should be doing all they can to improve their performance. They should also be able to use whatever skills are available for this purpose. Instead, their endeavours to demonstrate compliance with unrealistic BEE demands could see their operational efficiency decline yet further.

The burden on listed companies will also increase. Having to report to the Commission on their compliance with all the elements in the generic (or sector) codes will be only the start of the additional burden placed on them, for they will often also have to put significant time and effort into responding to the Commission’s queries and/or site visits.

Moreover, if they fail to satisfy the Commission as to their compliance, they will also have to gear up to deal with any investigation the Commission may then initiate.

Moreover, both the BEE Act and these regulations are silent on what level of compliance the Commission may in practice require. The scorecard in the generic codes recognises eight ‘levels of BEE contribution’, ranging from level 1 (for contributors with BEE scores of 100 points or more) to level 8 (for contributors with BEE scores of between 30 and 40 points). Will organs of state and listed companies be considered ‘compliant’ at level 8 (or below), or will they in practice be expected to attain higher scores in order to satisfy the Commission?

There is also nothing in the BEE Act or in these regulations that obliges the Commission to take into account the practical difficulties standing in the way of full BEE compliance. These include not only the age and skills profile of the black population, as earlier described, but also the adverse economic climate. For example, can companies battling to maintain profitability in an economy on the cusp of recession realistically be expected to spend 6% of annual payroll on skills training for black staff (in addition to the statutory 1% skills levy)? Can they realistically be expected to buy 80% of the goods and services they need each year on any basis other than price and functionality?

Compliance with BEE targets must, at the very least, be assessed in the light of all the practical and financial obstacles to their attainment. However, there is no obligation on the Commission to take these salient factors into account.

The Commission’s apparent powers to demand corrections, conduct site visits and decide on the extent of ‘non-compliance’ by organs of state and listed companies are extraordinary intrusive and potentially damaging to the efficient operation of both organs of state and listed companies. They are also ultra vires the BEE Amendment Act, which merely gives the Commission the power to ‘receive and analyse’ the reports compiled by organs of state and listed companies. [Section 13(F)(1)(g), BEE Amendment Act]

Registration of BEE transactions

Under the regulations, ‘a party that enters into a major BEE transaction that is above the threshold determined by the minister by notice in the Gazette’ must within 15 days ‘submit the transaction to the Commission for registration’. [Clause 18(1), Regulations]

Such a BEE transaction is not further defined, but would include, for example, a BEE ownership deal of a value above the threshold specified by the minister. The minister has complete discretion as to where this threshold is to be set. He can also increase or lower it at any time, again at his discretion.

A major BEE transaction might also include a preferential procurement contract above a certain value, or an enterprise development transaction, or a socio-economic development transaction. [Business Day 14 March 2016]

Once the transaction has been submitted, the Commission must ‘issue a certificate of registration’ within ten days. However, it may also ‘at any time’ start to ‘assess’ the transaction to ‘determine adherence to the BEE Act’ [Clause 18(3), Regulations] and the codes of good practice. [Section 1, BEE Act of 2003] If the Commission has ‘any concerns about the transaction’, it may advise the party that applied for registration, which ‘must take steps to remedy the transaction within a reasonable period’. If it fails to do so, the Commission may ‘initiate an investigation’ into the matter. [Clause 18(4), Regulations]

Hence, if the Commission is not satisfied with any element in that BEE ownership deal – perhaps because it thinks the initial 40% ‘net value’ requirement has not been fulfilled, or that the realisation principle (which is aimed at reducing the debt of BEE investors over time) is not adequately satisfied – it can effectively unstitch key aspects of the transaction and require that they be redone.

This will make for great uncertainty. It could also add significantly to the cost of BEE transactions – especially as the Commission will be able to start its assessment ‘at any time’. This suggests that, if an ownership deal ends up under water after several years – because share prices have declined and dividends have not been paid – the Commission will be entitled to demand that the deal be renegotiated for the benefit of the BEE investors even though there is no fault on the part of the company.

These provisions are again inordinately intrusive and economically damaging. They are also clearly ultra vires the BEE Amendment Act, which merely gives the Commission the power to ‘maintain a registry of major broad-based BEE transactions’, not interfere with the terms on which such transactions are concluded.

Complaints to the Commission

According to the regulations, ‘any person may lodge a complaint with the Commission’ by sending in the prescribed form and providing the prescribed information. Such information must include ‘a description of the conduct or practice alleged to be in contravention’ of the BEE Act. The complainant must also provide information on measures taken ‘to attempt to resolve the complaint’, and on ‘the way in which the alleged contravention...might be addressed’. [Clause 15(1), (2), Regulations]

Within a year of receiving a complaint, the Commission must assess the merits of the complaint and ‘investigate the complaint if it is justifiable to do so’. [Clause 15(4)(a) and (c), Regulations] Within this period, it may also ‘hold a formal hearing’, if it so wishes, and ‘make a finding’ on the complaint. [Clause 15(4)(f) and (g), Regulations]

Under the BEE Amendment Act, the findings issued by the Commission may include a finding ‘as to whether any BEE initiative involves a fronting practice’. [Section 13J(3), BEE Amendment Act] Though such a finding potentially carries major penalties (see Fronting practices, below), the Commission is allowed (by both the Act and the regulations) to come to such a finding without holding a formal hearing into the matter and without in fact conducting any investigation at all.

Under the regulations, if the Commission does embark on an investigation, this probe must ‘conform to all the rules relating to fair administration of justice processes applicable to investigations’. [Clause 15(17), Regulations] This clause may provide some guarantee of fairness in the way investigations are carried out. However, no equivalent provisions apply to the making of findings by the Commission. Though the right to administrative justice would of course apply, the regulations should make it clear that no finding may be made without a prior investigation, without respect for the key principles of natural justice (audi alteram partem and nemo judex in sua causa), and without sufficient reliable and admissible evidence.

Investigations and findings

Under the BEE Amendment Act, the Commission ‘has the power, on its own initiative or on receipt of a complaint,...to investigate any matter arising from the application of the BEE Act, including any BEE initiative’. [Section 13J(1), BEE Amendment Act] The Commission has the right to decide on ‘the format and procedure to be followed’ and on whether or not to hold ‘a formal hearing’. [Section 13(2), BEE Amendment Act]

Under the regulations, if the Commission decides to hold ‘a formal hearing’, it ‘may’ do so before ‘a panel chaired by the chairperson’. [Clause 15(10), Regulations] A panel is defined as meaning ‘a group of not more than five persons that may be appointed by the Commission to preside in a formal hearing’. [Clause 1, Regulations] No minimum quorum for the panel is laid down.

The chairperson of the panel ‘may include’ the Commissioner, which means he may not necessarily be the Commissioner. There is no adequate guarantee that the panel will be an objective body or that it will act in an objective way. On the contrary, the chairperson may indeed by the Commissioner, who has little institutional independence from the minister of trade and industry under either the BEE Amendment Act or the regulations.

Under the BEE Amendment Act, the Commissioner is appointed by the minister for a (once renewable) five year term. His remuneration is decided by the minister. He may also be removed from office by the minister for ‘undermining the integrity or standing of the Commission’, or on ‘any other legitimate ground’. [Section 13C(1),(2), (6), BEE Amendment Act] He is also subject to ‘ministerial directives of a general nature’ in the way he carries out his functions.

These provisions significantly undermine the independence of the Commission, as indicated by the Constitutional Court judgment in the second Glenister judgment in 2011. [Glenister v President of the Republic of South Africa and Others (CCT 48/10) [2011] ZACC 6; 2011 (3) SA 347 (CC) ; 2011 (7) BCLR 651 (CC) (17 March 2011)] Hence, they are likely to trump a provision in the BEE Amendment Act stating that the Commission ‘must be impartial and perform its functions without fear, favour, or prejudice’. [Section 13B(4)(3(a), BEE Amendment Act]

Since the Commission is not adequately insulated from ministerial control, any panel it appoints will not have adequate institutional independence either.

Worse still, the Commission may issue findings without holding any investigation, let alone convening a formal hearing. If it receives a complaint, it must notify the respondent of this. [Clause 15(4)(d), Regulations] If it decides to investigate a matter on its own initiative, it must issue a ‘notice to investigate’ and inform the respondent of this. [Clause 15(8), Regulations] Thereafter, it has no obligation to involve the respondent in its deliberations. All it need do is ‘notify the respondent in writing of any adverse finding’ and give him 30 days to respond. However, it need not give the respondent a hearing or allow him to test the evidence on which it has relied. [Clause 15(13), Regulations]

Fronting practices

The BEE Amendment Act defines a ‘fronting practice’ in extraordinarily wide terms to include any ‘transaction’ or ‘conduct’ which ‘directly or indirectly’ (that is, intentionally or unintentionally) ‘undermines or frustrates the achievement of the objectives’ of the 2003 BEE Act. [Section 1, BEE Amendment Act]

The objectives of the 2003 BEE Act are to ‘facilitate broad-based black economic empowerment’ by (among other things): [Section 2, 2003 BEE Act]

(a) promoting economic transformation;
(b) achieving a substantial change in the racial composition of ownership and management structures;
(c) increasing the extent to which...collective enterprises own and manage existing enterprises;
(d) increasing the extent to which black women own and manage existing and new enterprises;
(e) promoting investment programmes that lead to...meaningful participation in the economy by black people’;
(f) empowering rural and local communities; and
(g) promoting access to finance for black economic empowerment.

Any firm that fails to increase the number of co-operatives that own existing companies may thus be found guilty by the Commission of a ‘fronting practice’. Similar findings may be made against any company which proves unable (in this low-growth environment) to ‘promote investment programmes’ for the benefit of black people, or which finds that its own resources are too limited to ‘promote access to finance’ for BEE.

This is outrageous. Still more extraordinary, as the regulations make clear, is the fact that such a finding can be made by the Commission without a formal hearing or any comprehensive and objective evaluation of the relevant evidence. Worse still are the penalties for any fronting practices, which include fines of up to 10% of annual turnover (more than the annual profit of many companies), and/or prison terms for directors of up to ten years. [Section 13(O), BEE Amendment Act]

The Commission cannot itself impose these penalties on a company that it finds guilty of a fronting practice. Instead, it must refer this criminal offence to the National Prosecuting Authority for prosecution, or to the South African Police Service for further investigation. [Section 13(J)(5), BEE Amendment Act] In a country battling to counter murder and rape rates that are among the highest in the world, this is absurd. It does, however, at least mean that these draconian penalties can be imposed only after a trial in the magistrate’s court. In the interim, however, the reputational damage to a company found guilty of a fronting practice by the Commission could be significant. The further risk, of course, is that prospective direct investors, in deciding whether or not to invest in South Africa, will find these rules so unacceptable that they will simply go elsewhere.

It is not enough for the DTI to try to minimise the impact of these extraordinary rules by promising that the Commission will make findings of fronting only where the conduct of a company amounts to the fraudulent misrepresentation of BEE status. Such assurances count little against the actual wording of the BEE legislation and the lack of any appropriate safeguards in the regulations.

Permission to exceed qualification criteria

The BEE Amendment Act allows organs of state to ‘specify qualification criteria for procurement and other economic activities’ that exceed those set by the minister in the generic codes of good practice (or in any relevant sector code), provided they obtain the minister’s consent. [Section 9, BEE Amendment Act]

This provision allows government departments, municipalities, state-owned enterprises, and a host of other organs of state to increase the normal BEE criteria with ministerial consent. Organs of state may thus stipulate, for example, that companies wanting to do business with them must have a BEE ownership level far above that specified in the relevant BEE rules. Eskom, for example, thus insists that the mining companies from which it buys coal must have 51% BEE ownership rather than the 26% set out in the mining charter.

According to the regulations, an organ of state wanting to increase the usual BEE criteria must apply to the minister, motivate for the increase, explain how great an increase it seeks, and provide any additional information the minister may require. [Clause 19(1), Regulations] The minister must then satisfy himself that ‘the proposed scorecard exceeds the qualification criteria’ in the relevant generic or sector code, this being the only factor he is obliged to take into account. He must then grant or refuse the application within three months. If he grants permission, he may do so with or without conditions and for a specified period, which may not exceed 10 years. His decision must also be published by notice in the Gazette. [Clause 19(3), (4), (7), Regulations]

There is no obligation on the minister to consult with companies likely to be affected by his decision. Nor is there any obligation on him to weigh the negative economic impact of allowing the qualification criteria set out in the generic or sector codes to be increased in this way and for such prolonged periods. In addition, the more organs of state use these provisions to introduce additional qualification criteria, the more this will generate a quagmire of conflicting BEE rules. Such uncertainty will further poison the investment climate in the country.

Applications for exemption or deviation

Under the BEE Amendment Act of 2013, the minister may ‘exempt’ an organ of state from having to apply either the generic codes or a relevant sector code. He may also allow such an entity to ‘deviate’ from these codes. However, he may do so only if ‘particular objectively verifiable facts or circumstances...necessitate an exemption or deviation’. [Section 10, BEE Amendment Act]

According to the DTI, these powers are needed to authorise state entities to purchase essential equipment from foreign companies lacking good BEE credentials. However, since the Government’s aim is also to promote empowerment and encourage local industry, ministerial discretion is to be strictly limited and organs of state will have to follow the normal BEE rules in all but the most exceptional circumstances.

The regulations flesh out the process to be followed in seeking exemptions or deviations. An organ of state must apply to the minister, motivate for the exemption or deviation, show the steps it is taking to achieve compliance with the codes, and specify the time frame within which this will be done. The minister must then decide if the exemption or deviation is indeed ‘necessitated’ by ‘verifiable facts or circumstances’.

The minister must also grant or refuse the application within 90 days. If he approves it, he must lay down any necessary conditions and ‘set time lines for the organ of state to comply with the codes of good practice’. He must also specify the period for which the exemption or deviation will be allowed, which may not exceed ten years. The exemption or deviation may, however, be terminated by the minister at any time if, in his ‘view’, the ‘reasons for granting the exemption or deviation no longer prevail’. In these circumstances, he need not notify the companies that will be affected by the withdrawal or give them any time to adjust. [Clause 21, especially (14)-(16), Regulations]

The regulations do not require the minister to obtain or take into account the views of companies likely to be affected by the granting of the exemption or deviation. Yet these rules could readily be used to favour some companies (Chinese or Russian ones, for instance) over local ones.

Increased pressure for 51% BEE ownership

The most damaging aspect of the regulations is the increased pressure they bring to bear on companies to increase their BEE ownership from 25% (plus one vote) to 51%.

The revised generic codes, with their 25% BEE ownership requirement, entered into force less than a year ago, in May 2015. Though most companies are still battling to get to grips with the revised codes, the ownership element is now effectively being changed yet again for a host of companies.

Under the regulations, every organ of state, ‘in determining the qualification criteria’ for the issuing of licences and other authorisations ‘must...give more consideration to companies that are at least 51% black owned’. [Clause 20(1)(a), Regulations] This preference for companies with 51% BEE ownership will also apply to companies seeking grants or incentives from organs of the state under relevant schemes. The preference will also apply to every company wanting to do business with any organ of the state. The regulations will thus have a very extensive reach – and will put great pressure on very many companies to raise their BEE ownership from 25% to 51%.

Ambit of the 51% ownership provision

Companies that currently need licences or permissions from the State include, among other things, those in the private hospital sector, the liquor industry, the casino and gambling industry, and the fishing industry. The mining industry could also be affected if the trumping provision in the BEE Amendment Act, which came into force in October 2015, is seen as requiring mining companies to comply with the generic codes rather than the mining charter (see Possible ramifications for the mining industry, below).

A vast array of companies, both large and small, do business with national and provincial departments, municipalities, state-owned enterprises, and other organs of state. All these companies, including many in the construction, financial, IT, transport, hospitality, and catering sectors (to name but some examples) will be affected. Many other companies, including those in the clothing, motor, and manufacturing sectors that benefit from grants and incentives from organs of state and/or development finance institutions, will be affected too. Overall, there will be relatively few companies – except perhaps those in the wholesale and retail trade – that fall outside the scope of these provisions.

The DTI could also, of course, bring back and enact into law the Licensing of Businesses Bill of 2013. If this occurs, every business in the country, from the smallest micro enterprise to the largest corporation, will need a municipal licence do business at all. Each and every enterprise would then become subject to these provisions and might battle to obtain a business licences unless its BEE ownership stands at 51% or more.

Many foreign-owned companies operating here, including the South African subsidiaries of multinational corporations, may also come under pressure to achieve 51% BEE ownership. In practice, they may see this as little different from a 51% ‘indigenisation’ requirement, of the kind being introduced in Zimbabwe. In these circumstances, some may choose to disinvest from South Africa (which, after all, contributes a mere 0.6% to global GDP) and seek opportunities elsewhere.

Pressure for 51% BEE ownership also overlooks the extent of foreign equity ownership on the JSE. In 2015, according to research by Bank of America Merrill Lynch, some 46% of the JSE All Share Index was owned by foreigners, while 63% of the resources sector was foreign-owned. Many listed companies will not be able to raise their BEE ownership levels to 51% without buying back at least some of their foreign-owned shares (and then selling them on to BEE investors). Such buy-backs could see a major further outflow of portfolio investment. This, however, is something that South Africa – with its major budget and trade deficits – simply cannot afford.

Possible ramifications for the mining industry

Now that the trumping clause in the BEE Amendment Act has taken effect, mining companies – which, of course, need licences from the State to prospect or mine – could also be affected by these provisions. Yet the value of BEE ownership deals aimed at meeting the much lower ownership requirement in the mining charter (26%) has already risen to some R205bn. So concerned is the Chamber of Mines about never-ending BEE ownership obligations that it has applied to court for clarity on the current status of the ‘once-empowered, always-empowered’ principle that was included in the original mining charter. As the Chamber points out, a unilateral shift away from this clause, made by the Department of Mineral Resources (DMR) in 2010, has major implications for all mining companies. The DMR wants mining companies which have already achieved 26% BEE ownership to maintain their BEE ownership at this level at all times, even if their BEE investors sell out. This exposes mining companies to the risk of having to enter into ever more BEE deals, most of which must be concluded at significant discounts and financed via debt. Having to enter into additional BEE deals will also entail significant costs for existing shareholders, whose holdings in the mining companies in issue will become still more diluted every time a new BEE deal has to be done.

The regulations create a risk that mining companies will not simply be obliged to maintain their BEE ownership at the 26% level, but will instead be compelled to raise it to 51% if they want to acquire or retain prospecting or mining licences. This shift – coming on top of all the other mining policy changes already made or in the pipeline – will make it still more difficult to turn the ailing mining industry around. It will also see South Africa move yet further down the Fraser Institute’s policy perceptions index, which measures the extent to which adverse policies undermine the attractiveness to investors of different mining jurisdictions.

Already, South Africa ranks poorly on this index, coming in at 78th out of 109 countries in 2015. (Neighbouring Botswana, by contrast, comes in at 14th out of 109.) Under the BEE regulations, South Africa’s ranking is sure to decline further. This will deter any fresh investment in the sector, while mining companies already in the country will have yet more reason to disinvest. The resulting damage to South Africa’s fragile economy is likely to be great.

Costs of raising BEE ownership to 51%

There will be major direct compliance costs for all businesses that find themselves under pressure to raise their BEE ownership levels from 25% to 51%. The value of known BEE deals aimed at achieving the 25% BEE ownership target is already high, standing at some R600bn in 2013. This figure no doubt greatly underestimates the overall value of such deals, if only because it excludes the BEE deals done by private companies, which are generally not disclosed.

In 2007 the National Empowerment Fund, a government vehicle set up in 1998 to fund BEE transactions, estimated that the value of the empowerment deals needed to meet the 25% BEE ownership requirement might rise as high as R2 trillion. If the ownership target is now effectively to be doubled to 51%, the value of BEE deals might have to double too. Such an additional compliance cost is huge. It will also have many negative ramifications for the economy, if only because allocating so much scarce capital to BEE deals will hardly help to improve infrastructure, increase employment, or enhance South Africa’s limited international competitiveness.

Indirect compliance costs are likely to rise sharply too, if only because a great deal of management time will have to be put into endeavours to raise BEE ownership levels from 25% to 51%. Much of the indirect cost of the shift is also likely to be borne by institutional investors, such as pension funds and unit trusts, in which small savers and pensioners, both black and white, have substantial interests. Every additional BEE deal done at a discount by a company that has institutional investors of this kind – and virtually all the top JSE companies fall within this category – will dilute the shareholding of these existing investors, leaving less available to pay them dividends or pensions. Hence, much of the cost of enriching the small political elite likely to be the main beneficiaries of the 51% ownership provision will (again) be borne by ordinary savers and pensioners, many of them black.

Moreover, if BEE ownership is to be raised to 51%, this will often imply a loss of current majority control. This is likely to be particularly damaging to business confidence and investor sentiment. As Nigerian billionaire Aliko Dangote warned in 2013, even a 25% BEE ownership requirement is enough to deter FDI. In his words, a BEE ownership requirement is like ‘a forced marriage’, in which a business must partner with ‘someone who may not have the same appetite’ and ‘who does not have the equity behind them’ to make a real contribution. Notes Dangote: ‘The whole world needs capital. If you make it difficult for me to invest in one country, then I will move my capital somewhere else where it is easier to invest... In Nigeria, we used to have these laws demanding that any [foreign] investor had to have a Nigerian partner. But that just dried up the capital flows. Now anyone can do business with anyone in Nigeria.’

Since even a 25% BEE ownership requirement is enough to deter foreign investors, pressure for 51% BEE ownership will clearly be even more inimical to FDI. What foreign investor will want to come to South Africa if this implies the loss of ownership and control to outsiders?

Also relevant is the fact that FDI into South Africa has already declined from R63.6bn in 2009 to R22.6bn in 2015. With investor interest in the country already so limited, there is a great danger that FDI will drop even more sharply if the regulations are adopted. Capital outflows – which have already gone up sharply, from R10bn in 2009 to R68bn in 2015 – are also likely to increase. The more FDI stays away and capital outflows increase, the greater the economic costs of the regulations will be.

Regulatory pressure for 51% BEE ownership is also likely to erode genuine entrepreneurship even further, and give yet more impetus to crony capitalism. As Moeletsi Mbeki has commented (in the context of the current 25% BEE ownership requirement): ‘BEE tells blacks – “you don’t have to build your own business, you don’t have to take risk, the whites will give you a job and shares in their company.’ This situation has already been enough to ‘strike a fatal blow against black entrepreneurship’. If companies find themselves obliged in practice to transfer 51% of their assets or equity to BEE investors at greatly discounted prices, the impetus to risk-taking entrepreneurship by black South Africans will be even further reduced.

Moreover, whites will have no impetus to start new businesses when state pressure for a 51% BEE ownership requirement is what lies ahead. At the same time, black South Africans – no matter how hardworking, efficient, or entrepreneurial they may be – will battle to make a success of the new enterprises they may establish for themselves in the highly adverse economic climate the regulations will help to bring about.

Likely economic consequences

As FDI diminishes, economic growth – which is already unlikely to exceed 0.5% of GDP in 2016 – is likely to decline further or turn negative. Tax revenues will diminish, while government spending will prove difficult to cut. Public debt – which has already increased very rapidly from R805bn in 2009 to close on R2 trillion in 2015 – is then likely to rise even faster. Downgrades of the country’s sovereign debt rating to sub-investment (or ‘junk’) status will become increasingly difficult to avoid. Such downgrades will raise borrowing costs, accelerate capital outflows, and push the economy into an even more damaging downward spiral.

In 2009 the rand:dollar exchange rate stood at R8.44 to the dollar. In December 2015, in the aftermath of Nhlanhla Nene’s dismissal as finance minister, it stood at R16.38. Though it has since recovered a little, in the negative economic scenario likely to arise from a 51% BEE ownership requirement, the rand’s value could easily slip to R20. It could even reach R25 to the dollar over the next few years.

As the exchange rate deteriorates, inflation is likely to soar, rising to perhaps as much as 20% a year. The impact on the poor will be devastating as food and other prices rise very sharply – and the social grants provided by a cash-strapped government fail to keep pace with these rapid increases.

Joblessness will worsen. On a broad definition (which takes account of those too discouraged to keep looking for jobs), the number of unemployed South Africans has already gone up from 6.7 million in 2009 to 8.4 million in 2015. The unemployment rate (on the same broad definition) has also gone up significantly, from 32% in 2009 to 35% now. The youth unemployment rate, among people aged 15 to 24, has long been even higher and stood (again on the broad definition) at 63% in 2015.

Though unemployment is already at crisis levels, the increase in joblessness has at least been relatively slow in recent years. However, in the circumstances outlined above, unemployment is likely to expand very fast. On the broad definition, which is widely seen as more accurate, it could rise to 40% in general in the near future, and perhaps to as high as 70% among young people.

These economic consequences will be devastating, especially for the poor, but also for the growing middle class. In these circumstances, there will be little or no prospect of expanding opportunities for the disadvantaged.

A further erosion of property rights

The more a 51% BEE ownership requirement is imposed, the more this will also amount to an ‘indirect’ or ‘regulatory’ expropriation. Such an expropriation occurs when the State itself does not acquire ownership of a company (or other property), but its regulations deprive current owners of many of the benefits and powers of ownership.

However, this indirect expropriation will not be recognised as an expropriation under the present wording of the Expropriation Bill of 2015, which has already been adopted by the National Assembly and needs only the approval of the National Council of Provinces and the president’s assent to be enacted into law. On this basis, current business owners will be expected simply to absorb the costs of losing control of their enterprises while having to sell the bulk of their equity or assets at heavily discounted prices. Many may choose rather to close or move elsewhere.

This further erosion of property rights will do great harm to the business environment. As experience from all around the world has repeatedly confirmed, property rights are the essential foundation for investment, growth, jobs, prosperity, political autonomy, and upward mobility. Moreover, where property rights are eroded, it is not only current owners who pay the price, but the entire society that is impoverished. Those who are already poor bear the worst brunt, but the middle class is also greatly damaged as employment shrinks and the jobless become increasingly dependent for their survival on the relatively few still able to earn an income.

Growth and increased opportunities the key requirements

South Africa already stands on the brink of a recession, while finance minister Pravin Gordhan is doing all he can to stave off damaging downgrades of South Africa’s sovereign debt. The key requirement, according to international ratings agencies, is not simply greater fiscal discipline and measures to hold government spending in check. The most pressing need is rather to ramp up economic growth.

However, raising the growth rate critically depends on the Government’s success in boosting business confidence and implementing key reforms. This in turns means that the regulatory shackles weighing on the private sector must be lightened, not made heavier still. Hene, instead of constantly increasing the BEE burden, it is time for the DTI to call a halt.

As earlier noted, when the ruling party urged the introduction of BEE in 1994, it said this was aimed at ‘removing all the obstacles to the development of black entrepreneurial capacity and ‘unleashing the full potential of all South Africans to contribute to wealth creation’. BEE was never supposed to put a stranglehold on the economy or eliminate existing property rights. Nor was it intended to keep ever more South Africans mired in poverty for the benefit of a relatively small (and politically connected) elite.

BEE has failed in its objectives. It needs urgently to be replaced by a new system of ‘economic empowerment for the disadvantaged’ or EED. This would shift away from the current narrow focus on redistributing a static, if not shrinking, economic pie. Instead, EED would put a necessary emphasis on rapid economic growth, excellent education, and very much more employment as the most effective and sustainable means of increasing opportunities for all.

South African Institute of Race Relations NPC  17th March 2016

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