Further relaxing of exchange controls, announced recently by finance minister Pravin Gordhan, will open more doors to investment into and out of SA. But will this invitation be riskier for the SA investor, and how can investors protect themselves from potential financial loss?
"People have learnt a lot from the collapse of Lehman Brothers, and also Bear Stearns," says Deneys Reitz Banking & Finance director Deborah Carmichael. "And though SA is an emerging market we transact globally and the recent further relaxing of exchange controls will open doors to bigger global investment into and out of the country."
Deborah Carmichael
South African individuals are now entitled to a foreign capital allowance of up to R4m (up from R2m). SA companies and parastatals have been given increased offshore investment capability. They can now make foreign direct investments of up to R500m (increased from R50m) through an authorised dealer, without specific approval required from the SA Reserve Bank.
Southern African investment space has been increased with the removal of the prohibition regarding Southern African Development Community (SADC) loop structures. Qualifying SADC member countries, for the purposes of this exchange control relaxation, are Angola, Botswana, Malawi, Mozambique, Tanzania, Zambia and Zimbabwe.
As the doors to increased offshore investments open, the question is: Have SA investors learnt anything from the Lehman experience and the challenges that have faced the Lehman administrators in unbundling the Lehman transactions? "There are a number of recurring themes in the reports of the Lehman administrators and these issues are instructive to SA investors seeking to invest and to place their assets with offshore financial institutions," she says.
There are a number of practical steps investors can take to manage the risks associated with investments abroad, she says, particularly where investors place their assets with financial institutions of foreign jurisdictions:
- Investors must ensure they understand the insolvency laws and client asset rules in the jurisdictions in which they invest. SA investors frequently invest in the UK and service providers in jurisdictions other than the UK often place client assets with UK financial institutions. Fortunately the insolvency regime in the UK is similar to the system used in SA.
- Investors must ensure that their assets are properly segregated from the assets of the financial institution so that on insolvency their proprietary claims over those assets are not in doubt. The aim here is to ensure that investor-owned assets do not form part of the estate of the financial institution. Part of the Lehman problem, which has been uncovered by the administrators, has been the discovery that the bank did not properly segregate client assets. It tended to co-mingle clients' assets (including cash) with its own cash and assets - to the extent that client-owned assets lost their identity as client-owned assets. In addition, Lehman mixed client funds with its own such that the administrators have been unable to separate client assets (trust property) from those of the general unsecured estate of Lehman. Understand whether the financial institution is entitled to use client property to defray liabilities to it and if so on what basis.
- Ensure the financial institution keeps adequate records and that there are regular reports and statements. In the case of Lehman, records were found to be poor and the providence of funds could in many cases not be reliably traced.
WHAT IT MEANS
 Understand the insolvency laws and client asset rules where you invest
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- Know which financial institution is holding your assets and where necessary place limits on the institution's ability to subcontract or make use of affiliates, subsidiaries or subcustodians. A large proportion of client assets held with Lehman were held by way of indirect third parties; the longer the legal relationship chain the more complex the relationship. Where affiliates, subsidiaries or subcustodians are used, clients should find out where those parties are located and what the client asset rules and insolvency regimes governing those entities are. Find out about the types of assets those entities hold, the value of the assets, whether the assets are pooled together with the assets of other investors and what the rights of the asset holder in relation to the assets are.
- Where possible consider using clearing houses to hold assets on over-the-counter trades.
- Scrutinise documentation relating to client accounts to ensure that assets are properly segregated and trustee/fiduciary relationships are properly established (and not excluded) through properly executed documentation.
The secret for the prospective investor abroad is to do one's due diligence, says Carmichael.
"Take steps to mitigate for loss; act precipitously to find out the legal grounds of what the institution is entitled to do, and if it goes under administration, where you will stand in the queue," she says.
