/ 26 August 1994

Jse Opens Up To Shareholders

Jacques Magliolo reports on the ground-breaking JSE proposals to put more power in the hands of shareholders

SHAREHOLDERS are set to obtain greater control of companies listed on the Johannesburg Stock Exchange if proposed changes to disclosure and listing requirements are implemented next year.

A draft consultation document has been released and sent to companies, auditors and stockbrokers for comment prior to the proposals being carried out in January 1995.

These changes are to be imposed on all existing and new companies and aim to increase transparency and improve liquidity. The new regulations should vastly benefit shareholders.

Firstly, from 1995 all companies will have to place 25 percent of issued shares in the hands of the public and companies must ensure this percentage remains in force at all times.

Existing companies will have until the year 2 000 to comply with this. The JSE proposes that existing companies meet this requirement by issuing new shares to the public.

This rule should increase the number of shares traded and reduce present shareholder control. Companies will not be able to avoid such a step through the creation of pyramid companies, as new regulations will prohibit second-tier pyramid structures.

In addition, the role of the JSE to enforce these new requirements will increased and encompasses responsibilities of sponsoring stockbrokers in company transactions.

Secondly, an important new direction of the JSE lies in its desire to strengthen company disclosure. Companies will be obliged to announce any information shareholders need about the financial position of the company and which could affect the company’s share price. This will include information on possible takeovers, new contracts and even the discovery of new mineral resources.

Implications of such disclosure are vast as it places greater power in the hands of the shareholders. While shareholders are now only warned of major transaction when a company’s nav (total assets of a company expressed per share) is affected and when the issue of new shares reduce eps (earnings per share), new regulations will encompass five methods of assessing whether disclosure to shareholders is necessary.

In addition to nav and dilution effects of new shares, the JSE proposes to look at bottom-line profits, the price offered for a purchase and market capitalisation, which is a company’s issued shares multiplied by the share price. This should result in a more cautionary announcements being made in the media and, more importantly, should increase the number of shareholder meetings called by the company to obtain approval for a particular projects.

If the JSE can accomplish a greater shareholder spread and increase shareholder meetings, then companies are bound to face bidding wars. The multitude of cross shareholdings in South Africa means competitors will invariably be able to attend such meetings and make counter-offers.

Listings GM Richard Connellan says: “In terms of their fiduciary duties to shareholders, directors will have to do what is in the best interest of shareholders.” While this may not mean that a counter-offer has to be accepted by a company, it would have to be considered if the public controlled more than a quarter of the shares.

Changes in pre-listing statements will also be amended to include the listing of new shares — that is, rights issues — which exceed 30 percent of the share capital. Companies will have to get the permission of shareholders before any major subsidiary issues shares which will materially dilute the holding of the listed company.

Finally, the JSE intends to place more control in the hands of minority shareholders. Although equity instruments with differing voting rights will continue to be allowed, shareholders — other than the controlling shareholders — will have to approve the issue of debentures and other such instruments.

WHAT would follow if South Africans woke up one day to find that the financial rand dual-currency system had been scrapped — an economic wasteland or a wonderland of foreigners queuing to invest in the country?

The Reserve Bank’s Callie Hugo gives the official view. First, he says, media reports that the bank’s governor, Chris Stals, had said interest rates would have to rise to 30 to 40 percent (if the financial rand were to be abolished) are untrue. The bank believes that the percentage increase in interest rates will roughly match the discount between the commercial and financial rands.

Secondly, the bank estimates that foreigners have invested about R65-billion in the country using the financial rand. This money could leave the country if the financial rand were to be abolished.

“We cannot say with certainty that any capital will leave the country. Our concern is that the bank has sufficient reserves in case there are capital outflows. As a central bank we have to consider the possibility of a worst-case scenario occurring,” Hugo says.

What do the foreigners think? Jon Berg-theil, a South African who worked as a fund manager at Southern Life before joining London broker James Capel in 1987, is one of the foreign investors Hugo says could withdraw their money if the financial rand were discarded.

James Capel is the largest offshore trader in South African bonds and shares. From its offices in the City (London’s financial district), the firm trades in South African bonds and shares worth billions of rands every year.

For their efforts, Bergtheil and his team were recently voted the top stockbrokers in London when it comes to the quality of research on South African bonds and shares, according to the prestigious Extel Survey of international fund managers.

With speculation rife recently that the financial rand will be abolished, Bergtheil has been spending more time pondering the likely effects of an end to the days of the foreign investment currency.

He explains that the financial rand is essentially an incentive for foreigners to invest in South Africa, but a disincentive for them to take their money out.

“When a foreigner buys South African bonds, he does so using the financial rand, which is about 25 percent cheaper than the commercial rand. When he takes dividend payments out, he is allowed to do so using the commercial rand. The net effect is that the yield foreigners get (of about 20 percent) is roughly 25 percent better than the 15,6 percent South African investors get.”

Bergtheil says one cannot predict with certainty what would happen if the financial rand were to be abolished, but he believes the following is a likely scenario if the announcement were to be made this weekend:

* 17H00, Friday, August 26: Stals makes the long-awaited announcement after financial markets have closed.

* 09H00, Monday, August 29: Pandemonium breaks out on the bond market as foreign investors suddenly find themselves without a yield commensurate with the risks they are taking investing in an emerging market whose government’s economic policies are still not clear.

* 09H01, August 29: Frenzied trade in bonds and shares begins, but most of the action is in equities. Foreign investors offer their loan stock to domestic investors and an intriguing tussle between the two parties begins. A lot depends on how keen domestic investors are to take the loan stock being offered.

* l5H00, August 29: Long bond rates break through 16 percent, but a lot of stock is still on the market.

* Two days later: Yields appear to have settled at around 18 percent, a level which market players believe will be the benchmark for the next six months. Foreign selling has subsided because yields are at a level commensurate with the country’s risk profile. The net result: a short, sharp shock which has pushed rates from 15,6 percent to about 18 percent.

“In the worst case, it would take a week for the market to settle at such a level,” Bergtheil says.

On the share market, there would not be any major shocks. Foreign investors in equities would view the developments as positive and some sectors (big exporters) would gain. The rest of the equity market would benefit mildly from the expected higher rate of inflation.

“There is a perception that inflation is good for equities,” Bergtheil adds.

Other effects of abolishing the financial rand are: a depreciation in the commercial rand exchange rate (10 percent?); a higher inflation rate (two percent?); higher interest rates (three percent?); higher cost of servicing government debt; improved exports (the current account recovers, as do the reserves); and more expensive imports at a time when the economy is recovering and needs imported capital equipment.

The big unknown is how much selling will occur before yields for foreigners return to a level commensurate with the country’s risk profile, but it is unlikely to be significant.

“Many of these investors have been in the country for many years. Why should they dump bonds when the financial rand is abolished when there have been so many other opportunities to do so?” a bond trader asks.

Is this a worthwhile price to pay in the hope of attracting more foreign capital?

Bergtheil thinks so: “There will always be a short-term shock in such cases, but the country will benefit in the medium term. It should be done sooner (before the end of the year), rather than later. The market is expecting it anyway.

“The uncertainty and resulting guessing games based on rumours are not conducive to attracting foreign investment. Better to bite the bullet now and settle down to business. Now is probably the best time to do away with the financial rand because the economy is at a favourable stage in the inflation cycle when expectations are still relatively low. Exchange controls on residents could be lifted later,” he says.

What do local investors think?

The case against lifting exchange controls now is argued by Southern Life economist Sandra Gordon: “The goalposts for attracting foreign investment have been shifting all the time. First it was the election, then it was the budget. Now it is the financial rand that is supposed to be preventing foreigners from investing. If it were to be abolished, who knows where the next goalpost would be? Maybe foreign investors are waiting for the new government to establish some sort of track record.

“Stals has spent so much time trying to contain inflation, it would be a pity for all his efforts to go up in smoke. Many governments in the rest of the world have preferred to go through a process of adjustment — privatisation, containing growth in government spending and reducing budget deficits — before embarking on foreign exchange market liberalisation. We should rather liberalise from a position of strength.”

The case for scrapping the financial rand is argued by Ed, Hern, Rudolph economist, Nick Barnadt. He says talk of billions leaving the country is nothing but a scare story. “The inflationary effects of an exchange rate depreciation have been exaggerated while the beneficial impact on the reserves and the country’s deteriorating balance of payments position have been understated. Stals’ strategic mistake was to stake everything on protecting the external value of the rand.”

Whichever way, speculators on the foreign exchange and bond markets are bracing themselves for some interesting times in the months ahead.

Remember John Major and his futile battle against the European Exchange Rate Mechanism in 1992? International currency speculator George Soros may have started betting against Stals holding the fort for very long.