It goes without saying that Foreign Direct Investment, provides for valuable foreign currency capital inflows and is generally seen as an important feature of economic growth, especially in ‘Emerging Market’ economies, through providing opportunities for job creation, in the likes of the manufacturing and services sector, as well as paving the way for a reduction in unemployment. The transfer of skills to local entities and employees is an equally relevant feature of inward FDI.
A little point worth mentioning is that during 2021, South Africa was the recipient of the largest number of FDI projects in the Software and IT services sector of any African country.
Foreign Direct Investment can take two forms.
Outward Foreign Direct Investment (FDI)
Inward Foreign Direct Investment (FDI)
This Blog will focus on Inward FDI, into local Private Companies and ‘key’ Financial Surveillance (Exchange Control) considerations.
It is nonetheless worth a short mention that there are no restrictions on local dealings by Non-Residents in quoted securities, being shares and the likes quoted on the Stock Exchange, other than bearer securities, that are owned by residents. Quoted securities or shares, are now issued in dematerialised (electronic) form and as such physical paper-based certificates are no longer available. Purchase and sale prices are validated via the issue of Broker’s Notes or similar trade advices, which should ensure fair and market related values, so monitoring and control of such transactions is well structured. In the circumstances dealings by Non-Residents on the JSE, will not be addressed further, in this note.
So, what determines an Inward Foreign Direct Investment and what administrative and Regulatory ‘hoops’ need to be jumped through, to achieve your objectives?
Apart from Financial Surveillance Regulatory issues, which will be discussed at greater length later, Inward FDI is governed in South Africa via ‘The Protection of Investment Act (2015)’, with a wide definition, as follows:
The establishment, acquisition, or expansion of a lawful enterprise, by a foreign investor, providing economic resources of value in anticipation of a profit.
The holding or acquisition of shares, debentures, or other ownership instruments of a local entity.
The holding, acquisition, or merger of a local entity with another outside of South Africa. In this regard the requirements of ‘The Competition Act’ also need to be considered, as the terms of this Act allow for ‘rights to be reserved’ in blocking certain types of mergers, if its implementation poses a National Security concern for the country.
Financial Surveillance Matters
Moving on to Financial Surveillance considerations. The Exchange Control environment in South Africa is governed by The Exchange Control regulations 1961 published under the Currency and Exchanges Act 9 of 1933 and should be read in conjunction with the Currency and Exchanges Manual for Authorised Dealers. These Rules and regulations provide for Regulatory direction, but ‘The Manual’, also delegates authority to local Banks to approve certain transactions involving the cross-border flow of funds both outwards and inwards. Where transactions cannot be approved by the Bank, then it will be necessary for detailed applications to be submitted to SA Reserve Bank to obtain formal approval.
The Currency and Exchanges Manual, issued by the SA Reserve Bank stipulates that ‘Non-Residents’ may freely invest in South Africa, provided that suitable documentary evidence is viewed in order to ensure that such transactions are concluded at arm’s length, at fair market related prices and are financed in an approved manner’, which means:
The introduction of foreign currency
Rand from a Non-Resident Rand account
Rand from a Vostro account held in the books of a local Bank
By borrowing funds in the local market subject to the so called 1:1 rule, which would enable a Non-resident to borrow locally for such a ‘financial transaction’. eg for every R100000 proven to have been introduced into the country a like sum of R10000 could be borrowed locally.
The documentary evidence referred to above should be obtained from a local Auditor or Accountant, who are well versed in the relevant requirements.
Should a foreign company wish to acquire shares in a local company by making available shares in their own company offshore to local shareholders, as payment, generally known as a ‘share swap’, such transactions can only be concluded with formal SA Reserve Bank approval. In the event that approvals are not in place, the arrangements would be deemed to be a contravention of Exchange Control.
Another key issue which must receive attention when putting an Inward FDI in place, is the ‘Non-Resident’ endorsement of share certificates issued by the local company to an offshore investor. Without this endorsement, which is appended by a local Bank, the sale proceeds of these shares cannot automatically be transferred offshore and ongoing dividends declared from the investment equally cannot automatically flow to the investor, until the matter of the endorsement is regularised.
To obtain the required endorsement the following information and documentation, needs to be presented to the Bank:
Name and address and country of domicile of foreign investor
Purchase/sale agreement (Shareholder’s Agreement) and other inter-related agreements or documentation such as Share Subscription Agreement, Loan Agreement, Security or Cession arrangements
Resolution from the Board of the resident company referencing the equity investment
Auditor’s note verifying that the purchase price paid is fair and market related and has been finalised at arm’s length
Confirmation that there is no direct or indirect South African interest in the foreign buyer
Proof of inward flow of currency or Rand from a Non-Resident Rand account. Alternatively, that local financing has been provided in an approved manner, as explained above.
Original share certificates with original signatures to be presented to a Bank for endorsement purposes, once issued. It is important to note that a local Bank will not endorse copy certificates.
Please note that should the proposed inward investment also include the introduction of loan funding, acceptance of this funding by the local company needs to be formalised in their name, at which time any agreement incorporating value of loan, interest rates and other terms and conditions must be provided to a local Bank who may be able to approve the loan funding themselves or depending on circumstances and facts presented may need to refer the matter to SA Reserve Bank, for approval. Upon finalisation of the approval process, a Loan Reference Number is then issued, which thereafter will enable the local company to transfer interest and capital payments to the lender. Should the loan not be properly authorised and no Loan Reference Number issued then interest and capital payments cannot be made by the local Bank (Authorised Dealer), to the lender until regularised.
Please note that should the proposed inward investment also include the introduction of loan funding, acceptance of this funding by the local company needs to be formalised in their name, at which time any agreement incorporating value of loan, interest rates and other terms and conditions must be provided to a local Bank who may be able to approve the loan funding themselves or depending on circumstances and facts presented may need to refer the matter to SA Reserve Bank, for approval.
A couple of further issues for consideration, should the investment into the local company also incorporate loan funding:
Interest in the case of foreign denominated shareholders' loans should be the base lending rate as determined by commercial banks in the country of denomination. Any interest payable, in excess of this rate will require formal approval from SA Reserve Bank
The applicable interest rate in respect of Rand denominated shareholder’s loans should be the local prime rate. Once again should additional interest require to be paid then an application needs to be made to SA Reserve Bank
Each loan availed of may not be repaid before a period of one month has passed
An application must be submitted to SA Reserve Bank where instances occur, subsequent to the original loan approval, which reflect changes to the original loan, interest rate, capital repayments to non-resident parties other than the original lender on record with the Financial Surveillance Department and instances where funds are draw-down or are to be received from parties other than the original lender
Any arrangements reflecting an unauthorised increase/decrease of the principal amount of the foreign loan, capitalisation of interest, compounding of interest, or conversion of the loan to share capital, will also be subject to obtaining specific approval from SA Reserve Bank
It is also very important to note that any loan proposal incorporating the upfront payment of commitment fees, raising fees and/or any other administration fees by the borrower, will not be authorised by the local Bank without a formal approach to SA Reserve Bank, when supporting documents, full details and the logic for such upfront payments, must be divulged. It follows that such fees should only be paid from South Africa once the loan funds have been received and converted into Rand locally. These fees should not exceed 5 per cent of the value of the principal sum.
This Blog would not be complete without a short reference to the Regulatory and documentary requirements pertaining to the transfer of dividends to a Non-Resident investor.
Dividend payments are made to shareholders as a method of distributing a portion of company profits. For each share owned, a declared amount of money is allocated or distributed as a dividend, eg 15cents per share. A Board Resolution is always issued to formalise and legitimise the payment of the dividend.
From a Financial Surveillance point of view, the following information and documents are required to enable a Bank to transfer dividend payments to an offshore shareholder.
Verification that the dividend payment is paid to the correct party and that it is in proportion to the Non-Resident’s percentage shareholding or ownership
A resolution from the board of Directors evidencing the declaration and payment of the dividend
A copy of the share certificates issued to Non-Resident shareholders reflecting a ‘Non-Resident’ endorsement
An Auditor’s letter verifying details of the dividend payment
A copy of the company’s latest Financial Statements would also be a useful document.
It follows that Non-Residents are free to disinvest from their investments in South Africa provided relevant Financial Surveillance administrative and documentary requirements are complied with. However, in a ‘nutshell’, you need to make sure that:
Shares issued by the local company are correctly paid for by the investor as described above. Ie a local third party cannot pay for the shares on behalf of the Non-Resident, no matter how small the value is
The issues of shares and the take up of loans must be properly supported with relevant legal documents
Share Certificates issued to Non-Residents must be endorsed as described above, otherwise the Non-Resident investor may not automatically receive dividends from their investment, or for that matter they may not receive the capital realisation of any sale of shares, before the matter is formally regularised and resolved by SA Reserve Bank
Any loans in favour of Non-Residents must reflect a Loan reference Number, issued either by a local Bank or the SA Reserve Bank, otherwise interest and any capital payments may not be transferred to the investor until the matter has been suitably resolved.
Should you require further information in this connection or need assistance in facilitating the inward or outward flow of currency, please contact the team at BeztForex. We can provide all the help you need.