[DEBATE] : FM on BEE

[Russell Grinker]

What were those empowerment 'principles' again...?

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FM, 16 November 2007


BLACK ECONOMIC EMPOWERMENT

Spiritually bankrupt



By Sibonelo Radebe

It will soon be a year since the final black economic empowerment codes were
published. Next year, they will be enforced. SA business has already changed
dramatically . . . but it has become compliance-obsessed while the
principles of empowerment are forgotten 



In the world of accounting there are two philosophies. One, championed in
the US, emphasises a rule-based culture: companies must stick to a complex
set of rules and regulations. Another, seen broadly as European, emphasises
principles rather than specific rules. Accounting is about disclosure - let
that be your guide to interpreting the rule book. 
SA's empowerment effort is evolving into a similar schism. And, unlike its
accounting framework, SA's empowerment effort is becoming one squarely in
the rules-based compliance camp. 
"I am concerned with the overall approach to measurement contained in the
codes," says black economic empowerment (BEE) consultant Andy Brown. "We are
beginning to see an interpretation of the codes as an audit-driven and
compliance-orientated programme." 
The consequences are real. Black executives tell the FM that they fear
losing out in the codes-driven empowerment environment to larger firms with
the financial muscle to fit the codes. They can perform corporate
contortions to fit the codes' Byzantine scorecard while smaller black-owned
and managed firms battle. "We must be scared of what's coming with these
codes," says an executive at one black-owned medium-sized financial services
company. He reckons his firm will lose out on tenders against large players.
"These corporations have all the resources to paint themselves with the most
beautiful BEE coatings," he says. "They can easily fit into this new jargon
of level 1 contributor' and triple A BEE rating'." 
The jargon is due to become de rigueur from next year in any tender or
procurement process. The precious words will be bestowed by SA's burgeoning
industry of empowerment rating agencies, already thought to be making
R2bn/year in providing certification services. Increasingly, the same
agencies consult to companies, advising on how to improve their scores,
although moves are afoot to prevent this. 
WHAT IT MEANS
Culture of compliance rather than substantive transformation is emerging
Empowerment codes to be fully applied from next year
Much like tax has created an industry for the brightest minds to figure out
loopholes in the complexities, empowerment gurus are figuring out ways to
score on the scorecards. 
Click here for the full generic scorecard 
- and click again in lower right-hand corner to enlarge.
The elaborate structures being created are at least as clever. "The level of
detail in the codes is territory for smart people to find gaps and exploit
them," says Kevin Lester of BEE consulting firm Mohlaleng. 
Consider a vehicle created by Rand Merchant Bank (RMB). It can claim
substantial empowerment points in terms of the financial services charter
for helping create the BEE mezzanine financing vehicle, Makalani. Listed on
the JSE in 2005, Makalani is meant to contribute to boosting the
availability of BEE financing capital. It operates like an investment fund -
it raised R2,5bn by issuing shares to institutions when it listed. This
capital was then used to fund BEE equity deals. 
Now consider who scores points out of the structure. 
First, those institutions that bought shares in the vehicle can count that
investment as BEE funding and score points in terms of the charter. The
vehicle is managed by an independent management company that is 75%-owned by
RMB. The balance is spread between BEE groups Tamela, WDB Investment
Holdings and Thesele Group. Its management team is led by bright young black
executives Vusi Mahlangu (CEO) and Sydney Mhlarhi (chief investment
officer). Makalani's board features Sello Moloko of Thesele and Sonja
Sebotsa of WDB. RMB can count it as enterprise development on its scorecard.

But to all intents and purposes Makalani is an RMB subsidiary. A check of
Makalani board members - present and past - points to RMB. The operating
infrastructure is provided by RMB. The registered address is 2 Merchant
Place - the heart of the RMB empire. 
A significant portion of the deals in Makalani's book were simply moved over
from RMB's loan book. And while the stated objective was to create a funding
vehicle for black empowerment, a number of players who have knocked on the
door have come back with horror stories. They say the price of Makalani's
money is ludicrous. Looking at Makalani's deals so far, the names are among
the who's who of empowerment, like Cyril Ramaphosa's Shanduka and Tokyo
Sexwale's Mvelaphanda. Makalani counts as an empowerment investor, so those
companies in which Makalani invests can count it as black ownership on their
scorecards. Everyone wins from the structure: RMB gets points, investors get
points, target ed investments get points. But how much real empowerment has
happened here? 
RMB is one company our black executive quoted above has to compete against.
His financial services company will be tendering for the billions in assets
that the Public Investment Corp will be putting out for empowered asset
managers to manage. "I can compete with these guys on the job spec but they
are likely to beat me on the BEE front because they can afford to," he says.

Who would have thought that financial services group Investec has an "A BEE
rating". That is what the group claims in its 2006 financial services
charter- based scorecard which was verified by accounting firm KPMG. The
scorecard is pasted on Investec's website. 
Another financial services group, Alexander Forbes, also flags an "A BEE
rating" verified by BEE rating agency Empowerdex. 
The companies all manage to check sufficient boxes on the scorecards to get
the coveted "A" rating. Smaller black-owned and managed firms can't. 
This compliance problem was predicted. A stern warning was carried in a
conference paper delivered last year by former Wits academic Simon Roberts,
who now works for the competition commission. With fellow academics Stefano
Ponte and Lance van Sitter, Roberts wrote: "The current phase of BEE is
characterised by the creation and refinement of measurement and codification
systems..." 
The trio argued that in the current culture of auditing and certification,
it is perfectly possible to match procedures, indicators and management
goals and at the same time openly fail to match the spirit upon which a
certification system was built. "The managerialisation of BEE is likely to
lead to a predominant focus on process and system management," they
concluded. 
The codes and the broad-based BEE scorecard were born out of concerns that
empowerment was narrowly focused on equity transfer deals. In the early
years of BEE, white corporations needed only to produce a piece of paper
reflecting 10% black ownership to claim empowerment status. Other key
aspects of economic transformation, mainly at shop-floor level, were
neglected. 
To make things worse, many of the earlier equity transfer deals were not
worth the paper they were written on. "The situation allowed people to come
up with ridiculous empowerment claims and get away with murder," says Vuyo
Jack, executive director of Empowerdex. 
Tebogo Naledi, CEO of black-owned and managed asset management firm
Renaissance Specialist Fund Managers, has a slightly different take. "The
codes do pose a challenge in that they are complicated and require some
investment and systems," he says. But they also offer some solace for small
and medium-sized companies, he says. 
Renaissance falls into the Qualifying Small Enterprise (QSE) category which
allows for a more lenient scorecard. Under the QSE scorecard, companies can
use a maximum four scorecard factors out of seven. "With that background, a
business like ours that is black-owned and managed should score maximum
points," he says. "Anyway, I do not think it is unreasonable to expect a
company of our size to make a contribution in the development of society." 
Naledi's view adds to the sophistication of the debate. The "broad-based"
empowerment agenda rewards indirect company activities like developing
smaller business and socially responsible investing. Simply being
black-owned and managed doesn't cut it. That goes to the heart of the matter
- differences in what "real empowerment" actually means. Simply being a
black company needn't make one as good a contributor to black empowerment as
a traditionally white company that has activities across all possible
factors. 
But some of those activities now taking place in the market are merely
clever structures that have no discernable impact on real empowerment. The
same trend is discernable in other industries. Shad Mapetla, CE of black
pharmaceutical group Biotech, is also feeling the pinch from the compliance
culture. "In our sector, procurement will definitely be a challenge because
we import a significant portion of our inputs. This may be less of a problem
for big guys who are able to splash out on softer aspects of the scorecard
and earn good BEE ratings," he says. 
"The big guys are scrambling for charity initiatives which enables them to
earn points without transforming the engine room," he says. "They do not see
transformation as a business imperative but as a mere legal requirement." 
"If you are looking for someone to blame for the compliance culture, look no
further than the verification regime," says Lester. "Verification regimes
and corporations show off by sending intimidating letters to their
suppliers. They have driven the mentality by focusing on numbers and not the
qualitative initiatives," he says. But, it is not a phase that will last
forever. "These schemes cost money and people will realise with time that
they are not worth it," he says. "If you are going to have a front company
or a stooge as an executive, it will be reflected in your margins." 
It is a catch-22 situation, says Jack. "I have no doubt in my mind that the
codes as they stand were necessary. There are many companies that engage the
BEE process wholeheartedly. But then there are those who come to the party
because they are beginning to feel the procurement pressure and are forced
into the compliance mode. I think the situation has improved but there are a
number of BEE schemes which give me sleepless nights," says Jack. 
Jack says his BEE nightmares stem from the increasing use of derivative
products in BEE transactions. There is nothing wrong with derivatives, if
used correctly. "But the reality is that they can be so complicated that
people using them could use them incorrectly without realising the
implications," he says. Scorecard points are racked up by companies
oblivious to the risks they are taking on. 
As the SA economy readies itself for the full-blown application of the codes
from next year, the rules-based empowerment culture must be recognised for
what it is. American accounting tick-box culture partly gets the blame for
the US's series of corporate disasters. Consultants and accountants spend
their time figuring their way around the rules. 
SA has created similar incentives when it comes to empowerment. At the very
least, that culture will blunt the ability of the codes to achieve
meaningful transformation of the economy. At worst, it could create new
risks and complex inefficient structures across the SA economy.