‘Look-through’ not an issue on exchange controls – Wierzycka

How much exchange controls are relaxed may come down to the interpretation of a clause in the Pension Fund Act.

This is according to Sygnia joint CEO Magda Wierzycka, who hosted a webinar on the impact of changes announced by National Treasury to exchange controls in the Medium-Term Budget Policy Statement a few weeks ago.

The changes allow offshore assets to be treated like domestic assets if they are held by locally-listed firms, whose shares can be traded locally and in rands.

Read:
Offshore 30% cap effectively lifted
Exchange controls: All eyes on the FSCA

The move by Treasury was followed up by the South African Reserve Bank (Sarb) confirming it in a circular, and the Financial Sector Conduct Authority (FSCA) saying in a notice that it is looking at reclassifying what constitutes a domestic asset.

These moves on behalf of the country’s financial authorities have led to some debate on whether Regulation 28 of the Pension Funds Act, which limits investment in foreign assets to 30%, is still in effect.

Though many asset managers don’t think the exchange control changes will have a meaningful impact, Wierzycka sees it opening the door for a radical change to asset management in South Africa.

A closer look

She says those thinking that the ‘look-through’ principle in the Pension Funds Act will enforce the 30% cap have it wrong.

The look-through principle requires pension funds to look through an instrument and measure the local and foreign exposure of the underlying assets.

So, if a fund invests in a locally-listed entity, but if this entity has offshore holdings, then these holdings should be counted under the cap for foreign-owned assets.

Wierzycka says that as soon as Sygnia discovered the move to ease exchange controls, it asked for and received a legal opinion from law firm ENS on the implications of the change. The opinion it got back was that based on a deeper reading, the look-through requirements are not set in stone as a clause in the act allows the Sarb some flexibility when it comes to the principle.

Wierzycka points out that when determining whether there is direct or indirect exposure to a foreign asset using the look-through requirements, this assessment must be “in accordance with conditions set by the South African Reserve Bank.”

She says that as the Sarb can change the aforementioned ‘conditions’ of the look-through requirements, it in effect has the right to determine investments in offshore assets.

Wierzycka further argues that the Sarb in its circular has already allowed for derivative instruments such as offshore exchange-traded funds (ETFs) to be treated as domestic assets, subject to the listing, trading and rand-dominated requirements.

She says as the bank has already redefined what makes up domestic assets, the look-through requirements can’t be used to “undermine or conflict with conditions set out by the Sarb”.

In other words, if it is seen as a domestic asset, it must be treated as a domestic asset and applying the look-through requirements would undermine the Sarb’s position on the matter.

Asset managers don’t see much change

Wierzycka’s view differs sharply with those of many other asset management firms that are waiting for further guidance from the financial authorities.

Allan Gray head of product development Earl van Zyl, for instance, does not think the exchange control relaxation will mean changes to Regulation 28.

Van Zyl says for pension funds, it looks like things will stay as is. “Based on our understanding and engagements with the FSCA, this look-through principle continues to apply.”

Rather than opening the way for pension funds, he sees it as a way for individual investors to invest more abroad.

“The interpretation of this notice may impact individual investors’ ability to increase their offshore exposure.”

Coronation Fund Managers head of personal investments Pieter Koekemoer also plays down the significance of the move. He says that on the whole, the fund wants to see a relaxation of exchange controls but points out that this latest move has been in the works for a while.

“We do not believe that this is the biggest relaxation of exchange control in the democratic era.”

Koekemoer points out that South African investors hold R2.6 trillion in assets in offshore jurisdictions, externalised through various investment allowances that have been in place since the 1990s.

“The current changes commenced in the February 2020 National Budget, when Treasury announced their intention to phase out further components of the exchange control system and align with the OECD’s Code of Liberalisation of Capital Movements.”

Wierzycka, for her part, still sees the relaxation of exchange controls as a notable step, as it offers a way to broaden the tax base. She says with ‘financial emigration‘, where people are transferring their financial assets overseas, the relaxation provides a way for the state to earn income that would probably have been lost to it.

Wierzycka says the move is also good for investors. With the FTSE/JSE All Share Index only rising 8.7% in rand terms in the past 10 years, compared with the S&P 500 Index shooting up 20.5%, local investors will be able to access global markets that are growing much quicker than local ones.