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DEVELOP: ANALYSIS

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OFFSHORE INVESTMENT in the spotlight

As governments target offshore structures for tax avoidance, their other advantages come to the fore.

Offshore structures. There was a time when South Africans who didn’t have them, wanted them, and when those who did, couldn’t talk about it.

In recent years, however, more relaxed exchange controls allow greater flexibility for setting up offshore structures. But the current trend for anti-avoidance tax provisions, transfer pricing rules and thin capitalisation rules to be broadened makes offshore
structures less suitable for legitimately reducing the tax burden of South Africans. The USA and EU have also focused their attention on offshore jurisdictions, which are under tremendous pressure to enter into tax information exchange agreements, enabling tax
authorities to access relevant taxpayer information.

Challenging times indeed for creative tax planners… At first glance, the days of offshore jurisdictions appear to be numbered, but a deeper look into why the majority of our clients choose structures in traditional offshore ‘tax havens’ shows that, in most cases, tax is
not the driving factor. In virtually every case, there is a commercial rationale other than tax for setting up an offshore structure.

Although offshore structures can be tax neutral, this is of secondary importance when deciding on a particular offshore jurisdiction.
In my experience, ultra high net worth families are more concerned with wealth preservation, including hedging risk (particularly political, currency and continent risk) and proper estate planning.
Relaxed or absent exchange controls in offshore jurisdictions allow clients to use their structures there to conveniently hedge against risks and access foreign investment. Several leading fund managers in South Africa also manage offshore investment funds
typically used to assist investors to diversify their holdings and to manage risks.

Still available are the traditional benefits of offshore structures (particularly those set up with a discretionary trust holding structure), such as protecting assets settled into the trust from creditors of the settlor or the beneficiaries, or pegging the value of the estate of the settlor for estate duty purposes by ensuring capital growth is in the trust, and avoiding the administration and associated costs to transfer heirloom assets from generation to generation. Care should, however, be taken that the affairs are properly structured to prevent contravening applicable legislation.

When choosing an offshore jurisdiction, multiple aspects must be considered to ensure that the client’s needs are catered for, without the costs of the structure outweighing the benefits. The most inexpensive jurisdictions at first glance may not always be the most cost-effective option.
These jurisdictions may attract a marginal rate of tax, while other slightly more expensive offshore jurisdictions don’t charge tax at all. Regulation is also a key consideration – service providers must be subject to strict professional conduct rules. Although each client will have particular needs that require a detailed look at the various offshore offerings, a handy guide is the Global Financial Centres Index (GFCI), which evaluates and ranks all the world’s financial centres. The most recent GFCI, published
in March 2013, ranks Jersey as the best offshore jurisdiction in the world (28th in the overall index), with Guernsey in second place (31st overall) and Monaco in third (35th overall). Mauritius, which is fairly popular amongst South Africans, comes in at tenth (70th overall). Interestingly, Johannesburg is ranked at just the 62nd position, demonstrating the strength of the offshore jurisdictions rated higher than it.

Offshore jurisdictions have also become increasingly competitive with regard to structures offered and the level of pricing. As an example, Jersey has over the last four years introduced foundations, incorporated limited partnerships and separate limited partnerships to its already impressive offering of ordinary companies, incorporated cell companies, protected cell companies, limited partnerships, limited liability partnerships and trusts. It also introduced three new streamlined investment fund offerings, namely
unregulated eligible investor funds, unregulated exchange traded funds and private placement funds.

These new offerings make Jersey cost competitive against more traditional offshore fund jurisdictions, such as the Cayman Islands.
It is, therefore, imperative to stay abreast of the latest offerings and fee levels in this fast changing international environment.

In my view, offshore jurisdictions may be frowned on at present, but they are here to say. As exchange controls ease and globalisation deepens, offshore structures will become even more the norm.

Author: Hannes Botha, LLB, LLM, is a South African qualified advocate and a consultant at Hatstone Lawyers.

 

Africa as a prime investment destination?

I recently attended a banking seminar at which various European banks were presenting their recent year-end results. Needless to say, these results showed little growth. Among the grumblings there were comments that banking had gotten as innovative as possible and nothing new was left to offer. That got me thinking about the current banking space in Africa.

A key focus area for most banks – whether in mature markets or an emerging market like Africa – is to grow market share and become the preferred choice of wholesale or individual depositors. South African banks have consequently led the race into Africa,
with some international banks focusing on specific regions. For South African banks, this move was sparked by the fact that the rest of Africa is expected to grow quicker than South Africa, while the number of people without access to basic banking services is
significantly larger.

Despite the challenges afflicting the global economy, the World Bank has forecast that in the next two years the African continent –
driven by mainly by sub-Saharan Africa – will grow by an average of 6% per year. Angola and Nigeria are expected to grow at 8% and 7% respectively. Coupled with research identifying that only about 20% of African families have banking accounts, this means potentially lucrative opportunities.

Currently some of the biggest players in the African banking environment are Ecobank, Standard Bank, Barclays Africa and the United Bank for Africa. Of the South African ‘Big Four’ banks, FNB and Nedbank have started making inroads into
the African market, with a presence in six and five African countries respectively. The African banks fortuitously benefitted from the global financial crisis when international banks diverted their focus back to their home country core markets. While international
banks have become less exposed to Africa, South African banks have also been cutting their exposure to non-African markets. The biggest example is Standard Bank, which significantly pruned its non-Africa exposure to concentrate on growing its market share
on the continent.

What Africa needs from banking
In recent years Africa’s middle class has grown phenomenally, although its inadequate infrastructure has hampered economic growth. This handicap largely results from decades of political instability, corrupt governments and unending battles over natural
resources. Africa’s peoples now clearly want to benefit more from the continent’s resources and as the middle class grows, it increasingly consumes higher-end goods and services. This has seen marked growth in the need for banks, retailers and telecommunications companies. Unfortunately the infrastructure to move goods from place to place, as well as for transferring
funds, remains poor and restricted by geographical isolation and low financial literacy. The cost of providing banking services remains astronomically high in the areas where these services are needed most.

Recent advances in information technology (IT) and infrastructure being implemented in years rather than the decades in the 20th century. Mobile companies and mobile technology firms have become significant drivers and beneficiaries of African growth
by providing platforms through which funds are directly transferred without the need for physical cash and bank branches. These virtual/mobile-based accounts are growing fast and have evolved to where users can borrow and save amounts in a ‘virtual
account’ and make payments from a mobile phone for anything from paying local expenses to sending money
to relatives in rural areas.

Thus, opening the way for banks to invest in African countries and expand their retail market share without needing cumbersome and expensive branch and IT networks. Mpesa in Kenya is a significant example of how quick and convenient mobile phone-based money transfers have become.

In just five years after its launch in 2007, Mpesa has 17 million registered Mpesa users in Kenya, including members of the nomadic Masai tribe. While a certain degree of physical bank infrastructure is needed for certain functions such as lending money, banks can focus on growing their wholesale or individual lending books. The unsecured lending space traditionally offers high margins, but
is high risk in the African reality of relatively few formally employed individuals with easily verifiable incomes.

Lending is driving banks to establish their physical presences. While middle class consumers look primarily to build their homes, governments are aiming at developing infrastructure. This is attracting specialist banks that offer specific banking services to governments, especially bond issuances for infrastructure projects. These banks concentrate on investment banking and do not necessarily enter the retail market. These are now competing with the traditional Development Finance Institution (DFI)
providers of such funding. With Chinese investment in Africa growing, we can also expect an increase in Asian banking institutions looking out for positive return investments. For example, the Tanzanian government in September 2012 secured a $1.2bn loan from the Export Import Bank of China to construct a pipeline linking gas deposits in the south of that country to its port in Dar es Salaam.

What are the investment challenges?
Africa is vast, with over 55 different countries, all with their individual socio-economic structures and political issues. Problems faced by banks entering these markets range from infrastructure inadequacy, political uncertainty, skills shortages and not knowing how best to engage specific business cultures.

This may mean significant initial capital outlay in volatile business environments. This was the case when FNB acquired the Finance Bank of Zambia with the approval of the Bank of Zambia, but later reversed by a newly elected president. That said, this does not mean ’don’t invest’, it merely highlights the old adage of high risk and high return.

It also confirms the need for banks to be innovative in their products and how they go about investing in Africa. This by no means implies that banks should take short term views on investing in Africa. On the contrary, I believe that those banks investing for the long term will reap the biggest rewards.

For most banks, developing a ‘greenfields’ African strategy will not be easy at this late stage of the game, as the barriers to entry are becoming significantly higher. For example, although Nigeria is expected to be one of the fastest growing, the Central
Bank of Nigeria has consolidated its banking system and reduced the number of banks allowed.

Expansion into this market is likely to come through acquiring existing banks and expanding their operations. This strategy brings its own problems, as valuing these banks is difficult and the acquiring institutions may well overpay.

As mentioned earlier, traditional banking systems imported from developed countries may not fit in African environments. Banks must tailor their product offerings for an African market hampered by large distances and lack of infrastructure. Mobile technology is playing a vital role in bringing the banks and their customers together. A mobile phone can now serve as a virtual bank card, a point-of-sale terminal and an internet banking terminal, while the number of people with mobile phones has grown to nearly half a billion in 2012. The type of products the banks can offer will determine their level of success, with some banks now focusing on bank assurance products that add revenue and retain customer loyalty by bundling insurance products and bank accounts, among other forms of bundled products.

Regulatory aspects
Banks are highly regulated and a flurry of new regulations was triggered by the recent global banking crisis. These include the stricter Basel III requirement and heightened money-laundering regulations. These are over and above the usual money and exchange control regulations that apply in each country. Banks wanting to invest in Africa must consider if they have the ability and expertise to comply and how will likely international and local regulations affect their operations.

Corruption is rife in Africa, stemming from historic factors, greed and dysfunctional institutions. Its impact on investors is that many
fall into the trap of indulging corrupt practices as a means to gain footholds for legitimate business. Banks must ensure that they deploy the relevant checks and balances to ensure clean entries into the countries they are expanding into.

Conclusion
South African banks are looking beyond our country’s sluggish growth to expand their earnings. The African continent is a neglected market that offers real opportunities for South African banks to expand into and play a vital role in the providing financial services.

They must however be cautious and thoroughly do their homework. Even so, this is a market with huge potential and those banks offering well targeted products and taking the long term view, are on the road to great reward.

Author: Evita Nyandoro CA(SA) is Liquidity Risk Manager at Santander UK and Lead Researcher at Cartesian Solutions.