South Africa: South Africa's Developing Financial Markets Regulation Analysed

South Africa has the largest and most developed economy in sub-Saharan Africa, and boasts well-regulated, sophisticated and relatively liquid financial markets supported by a progressive and robust common law-based legal system. The capital markets in South Africa are well established and the regulation of its securities exchanges was rated as among the best in the world in the 2011/2012 World Economic Forum's Global Competitiveness Report.

Tax developments

South African tax law has undergone several significant changes of late. In addition to amendments to the Income Tax Act No. 58 of 1962 concerning interest withholding taxes and the tax consequences of third-party backed shares, the Tax Administration Act 2011 (effective from 1 October 2012) has overhauled the entire tax administration system by consolidating the administrative elements relating to tax into a single piece of legislation. The Tax Administration Act streamlines the tax collection process, and affords the South African Revenue Service ("SARS") greater powers to protect the interests of the fiscus. In terms of the Tax Administration Act, a taxpayer is now permitted to use a single account for administering tax, which will reflect its entire tax liability, and also permits SARS to implement a single registration process for all tax types.

With effect from 1 April 2012 the Dividends Tax, which is imposed on shareholders at a rate of 15%, applies. Dividends Tax is a withholding tax to the extent that the dividends paid are cash dividends. In such instances the Dividends Tax is withheld by the company or intermediary making payment of the dividend. In respect of dividends which constitute the distribution of assets in specie, the liability for the Dividends Tax falls on the company declaring and paying the dividend.

Although non-residents are generally exempt from tax in South Africa on South African sourced interest, with effect from 1 July 2013 a withholding tax of 15% will be levied on South African sourced interest that is paid to or for the benefit of a non-resident. Tax withheld will generally constitute a tax credit for such a non-resident in its respective jurisdiction. Furthermore, interest on certain types of investments, including interest paid to a non-resident in respect of a listed debt, are exempt from this withholding tax.

The Taxation Laws Amendment Act No 22 of 2012 ("Amendment Act") contains several changes that are likely to have a profound effect on preference share funding structures. The Amendment Act treats dividends on third-party backed shares (shares in respect of which an enforcement right or obligation is exercisable as a result of an amount of a specified dividend, or a foreign dividend, not being received or accrued to the holder of that share) as ordinary revenue in the hands of the shareholder, while not allowing a corresponding deduction for the company issuing the dividend.

The fiscus has also indicated in the 2012 Budget Speech that it is considering the inclusion of financial derivatives in the base of Securities Transfer Tax, which is a single tax in respect of any transfer of listed or unlisted securities. The basis upon which such tax will be calculated for derivatives is at present unclear.

Basel III

In January 2008, the South African Reserve Bank (SARB) made clear its intention to implement the new global Basel III regulatory standard in accordance with the prescribed timeframes. The Minister of Finance has commenced the phasing in of the liquid-asset and capital adequacy requirements set out in Basel III by way of a new set of regulations to the Banks Act, No. 94 of 1990.  The regulations, which took effect on January 1, 2013, which were finalised after several rounds of public comment and follow on the heels of regulations adopted on December 15, 2011 in terms of which the Basel 2.5 framework was implemented by providing for basic principles relating to effective risk management by banks.

In the wake of concern on the part of South African banks that the liquid- asset criteria set out in Basel III may be have been difficult to achieve due to the conventional local practice of using long-term financing as collateral, the SARB has undertaken, in the form of Guidance Note 5/2012 published on May 10 2012, to make a committed liquidity facility available to assist banks in meeting the liquidity coverage ratio prescribed in Basel III. The SARB will provide such a facility for an amount up to 40% of a bank's net cash outflows under stressed scenarios, meaning that the facility may serve as a substitute for Level 2 assets. The SARB will provide the facility against the furnishing of acceptable collateral, which may comprise marketable debt securities with a minimum credit rating of A- on a domestic rating scale (equivalent to BBB- on an international scale) by an eligible external credit rating institution, equities listed on the Johannesburg Stock Exchange (JSE)'s main exchange and included in the Top 40 Index, or notes of self-securitised pools of high-quality loans, which are ring-fenced in an appropriate structure and carry a minimum rating of A- on a domestic rating scale.

There is a lack of clarity as regards how the third form of acceptable collateral will function in practice: the SARB has indicated in the Guidance Note that the self-securitised assets should be managed and controlled in a "similar manner to a normal securitisation", and that the securitisation notes would serve as collateral in the event of a draw-down. It is expected that further guidance on these proposals will follow and that a number of banks will securitise assets in order to access the liquidity facility.

Derivatives and structured products

The on-exchange trading of derivatives instruments in South Africa is currently governed by the Securities Services Act No. 36 of 2004 (SSA) (which is set to be replaced by the Financial Markets Act No. 19 of 2012 (FMA)) and the rules of the South African Futures Exchange, a division of the JSE. On the other hand, OTC trades of derivatives are largely unregulated. Notwithstanding the absence of an official OTC trading market in South Africa, it is standard practice for parties to conclude OTC transactions by entering into Isda Master Agreements published by the International Swaps and Derivatives Association. Where Isdas are concluded, an amended form of the English law bilateral transfer Credit Support Annex is often used to facilitate furnishing collateral under South African law. This, together with the use of a number of industry-standard documents, affords a measure of standardisation to a rapidly-growing segment of the economy.

In line with the call by the G20 for measures to be implemented to regulate the OTC derivatives market, including centralising the clearing of so-called vanilla derivatives and the regulation of credit default swaps, the legislature adopted the FMA, which will take effect on a future date to be determined by the President.  When it takes effect, the FMA will replace the SSA, which has regulated securities exchanges, CSDs, clearing houses and their respective members since 2005, in its entirety. Although similar in many respects to the SSA, the FMA seeks to clarify several lingering uncertainties in the SSA, with varying degrees of success. Section 38 of the FMA, for example, was intended to clarify the South African law approach to offering securities as collateral, currently regulated by section 43 of the SSA but, in truth, it offers little in the way of certainty. South African law regards the rights of the holder of securities against the issuer of those securities to be personal rights. There is a debate in South African law centred on how personal rights can be offered as collateral. In a recent case, the Supreme Court of Appeal held it to be settled law that the default approach to offering securities as collateral is through a pledge of personal rights in favour of the secured party. It did not, however, exclude the possibility of parties offering securities as collateral by way of title transfers where such a structure is expressly intended. Market participants have argued in favour of title transfers as a means of creating security because South African pledge law, which requires the secured party to retain possession of the pledged asset, prevents the secured party from using the pledged collateral (for on-lending transactions, and so on). "Possession" is taken under the SSA through the flagging of the securities account in which the securities are held by the central securities depository participant. Notwithstanding the peremptory language in the SSA, there is an argument to be made that flagging is not a requirement for the creation of a valid security interest, at least not between the pledgor and pledgee. Although the FMA entrenches the fact that flagging will perfect a pledge and render the security effect against third parties, it does not clarify whether it is possible to create security over dematerialised securities where flagging is not effected, or by means other than statutory flagging (by way of title transfer, for example).

In addition to Isdas, Global Master Repurchase Agreements and Global Master Securities Lending Agreements (GMSLAs) are commonly used in the South African financial markets for the conclusion of repurchase and securities lending transactions respectively. In an attempt to standardise the schedules contracting parties attach to their GMSLAs to cater, among other things, for South African methods of providing collateral (which do not automatically fit within section 5 of the GMLSA) as well as for "acts of insolvency" and Events of Default that accord with South African insolvency concepts, the South African Securities Lending Association has developed two South African schedules, one to accompany the 2000 GMLSA and the other to accompany the 2009 or 2010 GMSLA.

Developments in the debt capital market

The South African debt capital market is well-regulated and covers all manner of debt instruments, from conventional listed and unlisted corporate bonds to complex asset-backed securities and securitisations. With an eye on formalising and streamlining regulation of the debt capital market, the JSE replaced the previous Bond Exchange listing requirements with the comprehensive JSE Debt Listings Requirements on March 1 2010. All issuers wishing to list debt securities must now comply with them. After the July 2009 merger with the erstwhile Bond Exchange of South Africa, corporate bonds, securitised paper, exchange traded notes, exchange traded funds, warrants, structured notes and similar instruments are all listed on the Interest Rate Market of the JSE. To list a programme, issuers must, at the very least, be generally acceptable to the JSE and meet certain minimum requirements, although the JSE retains a discretionary power to approve listings by non-compliant applicant issuers, and even to reject listings by compliant applicant issuers if it is of the opinion that the listing will not be in the interests of the investing public. The Listings Requirements require issuers to make specific disclosures in their placing documents, report to the JSE on an ongoing basis and update placing documents within six months after financial year-end if any information therein has become materially outdated.

In addition to the Listings Requirements, the debt capital market is regulated by the Banks Act No. 94 of 1990. The Banks Act prohibits entities other than registered banks from accepting deposits from the general public. As a result of the broad definition of "deposit" in the Banks Act, which extends to cover the issuance of notes and debentures to the general public, the Commercial Paper Regulations to the Banks Act, dated December 14 1994 and the Securitisation Regulations to the Banks Act, dated January 1 2008 have been enacted to allow non-bank entities to issue commercial paper and implement securitisation structures.

The Commercial Paper Regulations prescribe the disclosures that must be made in an issuer's placing document, and set further conditions for the issue of commercial paper. The most important of these are that commercial paper may only be issued in minimum denominations of R1 million ($119,000) unless (among others) it is listed on a recognised exchange, endorsed by a bank or issued for a period in excess of five years; and that commercial paper may only be issued for the acquisition of operating capital by the ultimate borrower (the issuer, its subsidiary or holding company or a juristic person in a similar relationship to the issuer, or a juristic person controlled by the issuer), and not for the granting of money loans or credit to the general public.

The Securitisation Regulations strictly regulate (i) the corporate status, ownership and control of the issuer of commercial paper (which must be an insolvency-remote special-purpose vehicle independent of an institution acting in a "primary role" as originator, remote originator, sponsor or repackager); (ii) the transfer of assets from the originator to the issuer by requiring a total divestiture of rights, obligations and risks in and control over the assets (a true sale); (iii) the provision of credit enhancement and liquidity facilities; and (iv) the disclosures that must be made in the issuer's placing document. The Securities Regulations explicitly allow for synthetic securitisations as a method of securitising a pool of assets.

The Companies Act No. 71 of 2008, which completely replaced the Companies Act No. 61 of 1973 save for the provisions dealing with the winding-up and liquidation of companies, took effect on May 1 2011 and introduced some sweeping changes to the South African company- law landscape. Three changes are of particular importance from a capital market's perspective.

The first is that, for a company to qualify as a private company under the Companies Act, it needs to restrict the transferability of its securities, failing which it will be a public company by default. This, read together with the requirement in the Listings Requirements that listed debt securities must be "freely transferable unless otherwise required by law", means that unlike under the Old Companies Act in terms of which most SPVs established for the purpose of issuing listed debt securities under securitisation programmes were incorporated as private companies, an issuer company wishing to list debt securities on the JSE will now either have to be incorporated as a public company or convert from a private to a public company in terms of the Companies Act.

Secondly, the granting of financial assistance to a related or interrelated company (including granting a loan or guarantee or securing any obligation), now requires the shareholders of the company to pass a special resolution authorising such financial assistance, and the board of directors to satisfy themselves that the company will satisfy the solvency and liquidity test prescribed in the Companies Act immediately after providing the financial assistance, and that the terms of the financial assistance are fair and reasonable to the company.

Thirdly, the outmoded system of judicial management has been replaced with a business rescue regime designed to facilitate the rehabilitation of companies in financial distress for the benefit of such a company's creditors, shareholders and employees. The business rescue process involves the appointment of a business rescue practitioner to oversee the operations of the company, a moratorium on actions by creditors, and the preparation of a business rescue plan aimed at maximising the company's chances of re-attaining solvency.

It is particularly important to take note of these changes as the two-year period contemplated in Schedule 5 to the Companies Act during which companies were given a grace period to comply with the new Act comes to an end on May 1 2013, from which date any inconsistencies between a company's memorandum of incorporation, its rules and/or a shareholders agreement and the Companies Act, will be declared void.

The legislature also adopted the Credit Rating Services Act No. 24 of 2012 (CRSA) in early 2013, which seeks to give effect to the G20 recommendations on the regulation and registration of credit rating agencies. The CRSA requires any person or entity who performs data and information analysis, approval, issuance and review of credit ratings in South Africa, publishes a credit rating in South Africa, or issues credit ratings that are published in South Africa, to register as a credit rating agency.

The high-yield bond market is not separately regulated in South Africa, and both listed and non- listed high-yield bonds must therefore be issued in accordance with the regulations that apply to the issue of commercial paper generally. Although the unlisted bond market has always been active, an increasing number of listed high-yield bonds have been brought into the market in recent times.

The rules of the JSE allow foreign entities to list commercial paper through so-called inward listings if they, among others, comply with the Listings Requirements, dematerialise all scrip in the CSD, and appoint a settlement agent and local transfer secretary. The relative yields in South Africa are high by international standards and there has been increased interest from offshore market participants seeking to invest in the local markets or to list products on the local market. The documentation used and the process followed to access the capital markets in South Africa is broadly similar to that of the Euromarkets and this makes it relatively easy for offshore parties to enter the South African market.

Despite growing international interest in bank-issued covered bonds, the SARB has thus far rejected calls from banks to allow such bonds on the basis that depositors' claims would be subordinated to those of bondholders. The SARB may reconsider this decision in the future.


As a result of sound regulatory and oversight practices, the South African capital markets were not as hard hit by the global financial crisis as those of many international counterparts. Recent developments indicate that South Africa's legal framework and regulatory practices are continually being refined in line with international best practice and global developments. Investors and issuers will find that South Africa remains an attractive destination with a sophisticated market, similar in many respects to the markets in other G20 jurisdictions.  sophisticated market, similar in many respects to the markets in other G20 jurisdictions.

Awareness of the developments in the market and an understanding of the relevant legislation should assist in facilitating a broader range of transactions in an environment that enjoys clear regulation underpinned by legal certainty.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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