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28 APRIL 2011
Black Economic Empowerment: Should it be kept alive?
by Carol Paton
Black Economic Empowerment (BEE) has been an emotive, political issue. Should it be kept alive?

How much of the JSE do black South Africans own? Is it 8%, the figure claimed by JSE CE Russell Loubser? Is it 5%, the “optimistic” guess of the Black Management Forum, shared by ratings agency Empowerdex? Or is it 36%, the proportion of shares held by black individuals (as opposed to white South Africans) once direct foreign holdings on the exchange are excluded?

It is an emotive debate without a firm conclusion. For those who stand to benefit from BEE, what has been done so far is not enough. For those who don’t, too much has been done already.

While BEE was initiated with good intentions — the idea was to give black people a stake in every level of the economy — along with it have come deals for the politically well-connected and pay-offs for the ruling party.

Since BEE has increasingly become a system for the redistribution of wealth rather than one to draw black people into productive activity as owners of capital, it is viewed by large portions of society as unfair and a wellspring of corruption. But despite — or because of — the social costs and poor image of BEE, there is a need to return to a serious discussion about its future and where it is going.

Says Claudia Manning, MD of development consultancy ECIAfrica and a member of President Jacob Zuma’s BEE advisory council: “The strategy that originally drove BEE policy is one that is absolutely pertinent: there has to be transformation at all levels of the economy, from ownership to management to workers. It is about a holistic look at the economy.” The reality, she says, is a perception that control of the economy is unfair or skewed, and this will lead to social instability.

The advisory council and the department of trade & industry, which is responsible for BEE policy, have begun some tentative work to redeem it. Trade & industry minister Rob Davies, who appears to be the most active player in the process (the advisory council has had only a handful of meetings), has brought his own bent to the debate, focusing on the failure of BEE to create productive and sustainable new black enterprises.

For economic growth and job creation, the primary objective is to multiply the number of enterprises, especially small and medium-sized ones. But, says Davies, instead of active partnerships between parent companies and BEE partners, the result has been equity deals that don’t produce real economic players.

“The initial intention was that if you are a newcomer you go into a partnership and that there is active learning. But in practice, these are deals made on paper and black partners are not involved in operations,” he says. “The deals are also encumbered, because [parent firms ] need to ensure their empowerment. So the [BEE partners] get no real benefit. Instead of an active partnership that empowers people to become real players, BEE has been for too few people and based too much on ownership.”

Davies describes this behaviour as “sophisticated fronting”, implicitly blaming large corporates for continuing to marginalise black business.

It is this “fronting” that Zuma and the council, in its only public statement in months, made on April 1, singled out as the issue of overriding importance in reforming BEE.

Says Davies: “When people do a deal, they think they are getting a partnership. But when they look at the fine print they find out that they are not. That is what I mean by more sophisticated fronting.”

Other analysts and critics have described fronting as “opportunistic rent-seeking” and “parasitic” behaviour, blaming instead the aspiring new elite for chasing assets without any intention of productive engagement. Whichever way you look at it, the policy direction emerging from the council is to close this loophole by adjusting the BEE scorecard.

The scorecard, which came with the BEE codes in 2007, marks what empowerment analyst Jenny Cargill calls the second phase of BEE. During the first phase, from 1998 to 2003, when the codes appeared, BEE deals gravitated towards the sale of controlling stakes in companies to prominent individuals.

However, the codes, which introduced a range of additional factors by which the BEE status of a company would be assessed, changed all that. The generic scorecard against which companies can measure their BEE rating was intended to shift the emphasis away from ownership.

But companies did the easier stuff, says Manning. A one-off equity deal which involves hiring a transaction adviser and looking at the price is easier than creating enterprises or changing the way you procure goods and services.

What is under consideration now, says Davies, is whether companies that don’t achieve the “developmental” elements of the scorecard — in particular enterprise creation — should be penalised. “We give people points if they do it. The debate is: shall we take away points if they don’t do it?”

Handing over money to support new enterprises will not be enough. The codes say that to get full points for enterprise creation a company must invest 3% of before-tax profit into new enterprises.

“What we find is if anyone plays in this space what they want to do is hand over a packet of money, rather than support an incubator. But what we really need is active involvement of the private sector,” adds Davies. “In Asia you find that small and big business have a symbiotic relationship. Big business gets lot of input from small business, so they work with suppliers to make sure they are able to improve. What we want to say is, if you don’t do that, you can’t earn a higher BEE score.”

The best way for a company to get involved in enterprise creation is through its own supply chain, says Manning.

The highly concentrated structure of the economy means that big companies tend to rely on other big companies for supply. Changing that will take strategic effort from the top leadership of companies, she says. Procurement managers lower down the command chain are looking for the best deal and for efficiency.

What Davies calls “import fronting” — when a black company wins a supply contract over an established manufacturing non-BEE company and then imports the goods — is another unintended consequence of the codes that he wants ended. Reforms to preferential procurement regulations will enable government to set down requirements for local production to help prevent this.

The incentives in the codes have been of little help in encouraging procurement from black companies. A company can earn all its enterprise development points through early settlement of accounts, says Manning, and so need not procure a cent from a black firm to be fully compliant.

Achieving good compliance levels without actually contributing to substantial BEE has been a typical outcome during the codes era, says Kio Advisory Services empowerment analyst Duma Gqubule. He says corporates have “gamed the system” and that compliance is far too easy.

Of the 22 JSE top 40 companies to which the codes apply (this excludes mining and financial companies, which are covered by separate charters), 16 have achieved level 4 BEE status or above. (Level 4 status or higher based on the generic scorecard is where a company wants to be in order to be considered compliant.)

“That just shows how easy it is to comply. There are a lot of loopholes,” says Gqubule. “There are companies that can achieve 75% compliance with the target without procuring a cent from a black empowered company. Enterprise development is a complete scam — the target is 3% of net profit. About 13 of the top 40 have achieved full compliance .”

Gqubule recently presented his research to the advisory council, which appears to have reinforced its determination to tackle these two areas of the scorecard. There is broad agreement that the codes are a blunt instrument, with many unintended consequences.

Cargill says that while the codes increased the flow of BEE transactions, the consequence was that “BEE started to become a matter of compliance. When that happens, companies do whatever they have to do and then stop there. They do the minimum.

“As a policy objective [initially] the idea had been to create an engaged and active shareholder. With compliance as the emphasis, that falls away. The notion of a black controlling shareholder fell away — it had to. The result is that black South Africans numerically own much more, but they have very little control. People have got the shareholding but not the influence. There’s huge discomfort over that.”

Liberty Holdings chairman Saki Macozoma, whose investment holding company Safika was formed during the first phase of empowerment, says: “In some ways the codes have done more harm than good.” He, too, says BEE has become about compliance.

“It forces you to tick boxes. So for instance, it forces the creation of unnecessary jobs, so that you can get maximum points for your management team. So now we keep two scores: what we want to achieve; and what government wants us to achieve.”

The downside of focusing on compliance has been that new BEE players have little influence over the companies in which they purchase equity stakes. “At least we were in the room. We played an active role; we made our views known. This [broader] type of BEE doesn’t do that,” he says.

Macozoma also agrees that it has not led to the growth of sustainable black-owned firms, partly because of fronting — a prime example being the construction industry, where despite billions being spent in procurement by government, few sustainable black-owned firms have emerged. Instead front firms are established to win one-off contracts, which fold when the contract ends.

“This is where empowerment fails. The opportunity is created [for firms to be established] but no capacity is built,” he says.

But will tinkering with the “developmental” dimensions — enterprise creation and procurement — as Davies envisages be enough to head off some of BEE’s negative consequences?

A big point of contention in the BEE debate is the emphasis on share ownership. From all sides, and particularly since the advent of the codes, this has been unsatisfactory. The trend has become for corporates to fund their own BEE transactions, while locking in new BEE shareholders and preventing them from trading their shares.

The arrangement has caused bitterness among black business people who have been unable to realise returns on their deals as dividends are used to pay off debt and they are unable to cash out because of lock-in clauses.

Cargill says as long as the current approach to the codes applies, it will be difficult to encourage active shareholding and black control. The pressure on companies to retain empowerment status usually results in “handcuffs” being placed on BEE shareholders, locking them into an investment for many years. This limits the ability of BEE investors to realise the value of their investments at the best possible times and to later consolidate or focus their equity holdings.

So capital accumulation and its potential productive reinvestment may inadvertently be inhibited by the rules that are intended to help achieve this.

Equity deals may be funded through third-party loans or financing provided by the companies that require BEE shareholding. Both have implications for capital allocation and economic growth. Increasing company liabilities to finance BEE share ownership affects debt-equity ratios, which could restrain corporate expansion plans. SA also doesn’t have an unlimited pool of capital for investment.

To date, Cargill adds, BEE ownership has absorbed a big amount of capital compared with other forms of socio economic transformation — estimated between R500bn and R600bn, as against less than R150bn on affordable housing and land reform. So we need to be mindful of our priorities. If BEE ownership is concluded as envisaged in the codes, another R500bn or so may be needed to make the necessary equity transfers.

But in the current environment is this where priorities lie, when we have a R900bn infrastructure programme that needs funding plus other pressing priorities like job creation and housing? “Where do we get the best social and economic returns?” asks Cargill.

Making real progress in black ownership by using debt to fund equity is inherently difficult in any case, she says. “Invariably you will have to sell down. It’s a financial reality of funding equity through debt. It’s difficult for BEE companies to maintain their shareholding.”

With these bigger macroeconomic constraints in mind, tinkering with the developmental elements of the scorecard won’t be enough to return BEE to the course that it was intended to take.
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