In August 2016, Futuregrowth announced that we would temporarily suspend lending to certain SOEs until we could conduct in-depth governance checks.
While this was seen as controversial at the time, subsequent events have highlighted just how critical the issue of good governance at SOEs is.
We have been affirmed in our view that good governance is much more than a mere tick-box exercise and, crucially, the “who” and the “how” of governance deserves appropriate scrutiny and disclosure beyond the mere documented governance processes. Good governance is inextricably linked to Responsible Investing and, in our view, is key to ensuring that public entities, mostly funded with public money, are sustainably managed for the long term and are able to deliver on their developmental mandates.
We are about to publish an in-depth document detailing our learnings and findings from our work with certain SOEs during the past year. This article focuses on one chapter from that document: The need for much higher standards of disclosure and transparency for issuers on the JSE’s debt capital market.
- The rules governing debt capital market issuers are weaker than those governing equity market issuers.
- Repeated attempts by investors to improve listings standards and public disclosure requirements have been met with resistance.
- In order to access public capital markets, debt issuers should subject themselves to a higher degree of scrutiny and commit to a greater level of transparency and disclosure than is currently happening – they are borrowing from people’s pension funds!
- The JSE has been slow to support debt investors’ calls for better protections.
- The JSE has not been proactive at monitoring issuers to ensure compliance with requirements.
The SOEs and corporates that raise debt capital on the public capital market (the JSE) are bound by the JSE Debt Listings Requirements (DLR). While in many instances the shares of corporate issuers are listed on the JSE’s equities exchange, investors in the debt issued by these companies also benefit from the regular practice of the Stock Exchange News Service (SENS) and other equity disclosures required by the equity listings rules. However, as the SOE debt issuers do not have listed equity, investors are solely reliant on the disclosure and reporting requirements as documented in the DLR. We believe that the disclosure and reporting requirements detailed in the DLR are woefully inadequate as they do not require adequate reporting and disclosures to allow investors to make long-term investment decisions. This is exacerbated by the lack of liquidity in the South African bond markets and the resultant stale pricing which means that the decision to invest in SOE and corporate bonds has to be made with a long-term view as exiting these investments, especially in significant size, is not easy.
We believe that improvements to the JSE’s DLR are long overdue. What is needed is to align these more closely with the Equity Listings Requirements (ELR), which have much higher disclosure obligations and established practices of disseminating information via SENS. This is aimed at an overall improvement in the standards governing South African debt capital markets and will strengthen the reporting and disclosure requirements, which will give all investors the appropriate information that is currently not available to debt capital market investors.
“A public capital market -- such as the JSE equity or bond market – is a safe, fair and regulated place where buyers and sellers can meet. It is, in fact, a ‘public amenity’ like a road or a park, where any participant (whether professional or amateur) can enter on an equal access basis, and participate on a level and safe field of activity. The JSE’s bond market is anything but that: It has been designed and run to enable opaque pricing, lack of transparency on a range of terms and information, and a lack of fairness. In effect, the JSE is an enabler of both malfeasance and poor governance.” Andrew Canter
The South African Debt Capital Markets operate in terms of the Financial Markets Act No 19 of 2012 (FMA), through which the JSE’s DLR objectives are “to provide the JSE’s users with an orderly market place for trading in such securities and to regulate the market accordingly”, “to contain the rules and procedures governing new applications and continuing obligations applicable to issuers of debt securities” and are “aimed at ensuring the business of the JSE is carried on with due regard to the public interest.” 
This last objective – that of the business of the JSE being “carried on with due regard to the public interest” - is worthy of more detailed examination. Our core argument is that the JSE is not adequately fulfilling this important objective.
- As is well known, Eskom’s 2017 annual financial statements (AFS) were the subject of a qualified audit opinion, specifically for irregular expenditure. The newly amended DLR, effective from 31 October 2017, contains a rare example of a useful amendment to protect investors: All issuers with qualified audit reports must annotate their debt instrument codes with a “Q”. This clause also exists as part of the ELR for equity instruments. However, as of 13 November 2017, none of Eskom’s debt instruments contain this annotation. When queried, the JSE’s response was that the changes effective from 31 October 2017 are not retrospective and so, because the qualified audit report was issued in July, no annotation was required for Eskom’s bonds. We believe this goes against the JSE’s own stated mission to “ensure the business of the JSE is carried on with due regard to the public interest”. A qualified audit opinion for the most recent AFS is very definitely information that an investor should know. It is our belief that this would not be tolerated in the equity markets.
- Equity Listings Requirements require a much higher level of disclosure from directors, management and advisers of listed companies and further require that any changes to directors’ declarations (as documented in Schedule 13 of the Equity Listings Requirements which require extensive disclosure from each director about their experience and integrity) are made publically and within a specific time frame of 14 days, mostly via SENS announcements. These provisions do not exist in the DLR and this has resulted in little to no disclosure about the process followed to appoint directors of SOE Boards, specifically the criteria used (e.g. skills mix, experience, qualifications) and the extent and results of any probity and conflicts checks. Institutional investors are being asked to provide capital on a long-term view to these entities without having any insight into these matters.
- Debt investors have no mechanism by which they can group together when bond terms need to be negotiated and voted on. Further there is no mechanism to appoint a legal advisor for bond investors as a collective to negotiate with the issuer in cases of default or breach. Let me use an example to illustrate why this is an important investor protection. In July 2017, the Minister of Water Affairs and Sanitation did not extend the term of the entire board of Umgeni Water, who have some R1.5bn in publically listed bonds. This action left the organisation without a Board of Directors. As no mechanism exists for investors to discuss issues of common concern or to solicit legal advice on a collective basis, it was left up to each individual investor to take up the issue with the relevant authority, something that we as Futuregrowth did. This is time-consuming and not cost-effective as each investor incurs substantial legal costs and allows the issuer and the arranging bank to fragment investors’ concerns – the old “divide and conquer” strategy. The JSE in the instance of Umgeni was also not helpful. A JSE listed equity company operating without a board of directors would, we suspect, be grounds for immediate suspension of trading in that share. To our knowledge, there was no public action taken by the JSE as regards Umgeni’s bonds in this instance. The Minister has, subsequent to a series of meetings between Umgeni, the Department of Water and Sanitation staff and Futuregrowth, appointed an interim Board and investors will be closely watching the process followed in making the final appointments.
- There is no effective mechanism in the JSE’s DLR for fair engagement in the legal agreements under which borrowers issue bonds (e.g. Domestic Medium Term Note Program, “DMTN”, bond documentation). While individual lenders may give feedback and comment, there is no mechanism for constructive or efficient legal advice for lenders, and bank arrangers can – again – divide & conquer investors as a group. The idea that a borrower is substantively able to write their own loan agreement is offensive to any sense of correctness in borrowing & lending public money. (Does your bank allow you to write your own home-loan documentation?)
Complicating all of this is the conflicted role that banks play as large issuers in the bond market, arrangers for other issuers in the bond market, market makers in bonds all while simultaneously investing alongside non-bank investors at times.
We at Futuregrowth have, over the past 10 years, detailed the shortcomings in the debt market, provided input on how to improve market conditions and standards, made recommendations as to what would improve both investor rights and protections, and illustrated how this would benefit both the issuer and the market as a whole. Our view has been that improving market standards would be beneficial to all, not only in terms of giving investors a platform for voicing their concerns and requirements, but also to allow for a more open and transparent transmission mechanism for investor/issuer dialogue.
Our view remains that the listing requirements are the appropriate platform for embedding adequate investor protections and disclosures. This will ensure that all issuers (of debt or equity) are subject to the same rules and standards of reporting and that all investors will have equal and timely access to relevant information in order to make investment decisions.
Multiple layers of improvements are needed. The proposals we have as regards the amendments to the Debt Listings Requirements are a start, but what is also needed is significant improvement to the governance practices at capital market issuers – not only to the disclosures made by these entities, but also the implementation of much higher and more consistent standards of accountability, transparency, compliance with the law (especially the Public Finance Management Act) and better oversight. In the case of the SOEs, the current inconsistencies in standards between various Executive Authorities (as represented by different Ministries) need to be urgently resolved and a common understanding of acceptable practices, transparency, behaviour and consequence-management needs to be adopted. Looking back over the past year, we have realised that our concerns around SOE governance, as expressed in August 2016, were but a scratch on the surface of what has subsequently emerged. We had no way of knowing at the time the extent of the allegations revealed by the information that has surfaced since then and continues to be released.
Urgently improving the standards required to list, and maintain a listing, on the JSE’s debt capital market is an important step in delivering on our fiduciary responsibilities to our pension fund clients and ensuring that their money is adequately protected.
Disclosure we believe should be a requirement for public capital market issuers (and thus part of the regular disclosures required by the DLR):
- Annual public disclosure of the board and all sub-committee charters, including terms of reference, mandates, decision making levels and quorum requirements.
- Annual public disclosure of all current and previous directors’ and executives' dealings with the company.
- Disclosure of all board and sub-committee (including all procurement and lending committee) member changes via SENS at the time of the change, including reasons for the changes, details of CVs, experience, results of conflicts and fit-and-proper tests for incoming members.
- Annual disclosure of board and sub-committee nomination and appointment processes and decision makers.
- Annual public disclosure of the entity’s Conflicts of Interest Policy, Contentious Issue Policy and Politically Exposed Person Policy, including details of how this policy has been applied, deviations from the policy, and remedial action taken to address deviations.
- All public disclosures to be made via SENS.
 Debt Listings Requirements, Objectives