The purpose of this paper is to explain National Treasury's current exchange control policy in relation to granting of local financial assistance to affected persons and non-residents. The clarification is important in light of the recent pronouncement by the Finance Minister of the relaxations to the local financial assistance rulings in his November mini-budget speech.

The Finance Minister announced that "to improve access to domestic credit in the financing of local foreign direct investment, restrictions on the granting of local financial assistance to affected persons have been further liberalised with the abolition of the 3:1 ratio".

Financial assistance is an often debated topic and one which often crops up in financing transactions. So, a clear understanding of the policy of the South African Reserve Bank is important for lenders insofar as financial assistance if concerned.

The present exchange control measures were introduced by the Exchange Control Regulations of 1961. These Regulations were issued in terms of the Currency and Exchanges Act, 1933.

Exchange control is enforced through a number of officially authorised foreign exchange dealers. Authorised dealers include all of the major South African retail banks. The Reserve Bank gives authorised dealers written directives as to the type of payments and transactions in respect of which they may exchange Rand for foreign currency or transactions that they may otherwise authorise. Transactions that do not fall within the categories of "pre-approved" transactions must be specifically approved by the Reserve Bank. Applications to the Reserve Bank for exchange control approval must generally be made through authorised dealers, which are in turn expected to submit the applications to the Reserve Bank on behalf of the person making the application or requesting the approval.
The regulations are the legal framework within which exchange control must be interpreted and applied, and the rulings are the economic framework within which exchange control must be interpreted and applied. It is within this framework that the local financial assistance rulings need to be interpreted.

What is financial assistance for the purposes of exchange control?

Financial assistance is defined in the Regulations to include:

• the lending of currency;
• the granting of credit (with certain specified exceptions);
• the taking up of securities;
• the financing of sales or stocks;
• discounting;
• factoring;
• the guaranteeing or acceptance of any obligation;
• a suretyship;
• buy-back and leaseback transactions.

Regulation 3(1)(e) and (f) states that no person shall, without relevant permission:

"(e) grant any financial assistance to any person in the Republic, where as security for such financial assistance, the person granting the financial assistance in turn relies on any security, guarantee, undertaking or financial assistance, directly or indirectly furnished by -

(i) any person resident outside the Republic; or
(ii) an affected person;

(f) grant any financial assistance to any person in the Republic where such person -

(i) is not a resident in the Republic; or
(ii) is an affected person."

The concepts of residency and affected person are important to understand and are discussed below.

Residency is an important concept to understand because the financial assistance restrictions apply to persons who are not resident in South Africa. Interestingly, residency is not defined in the regulations. This is unusual considering that it underpins so many of the fundamental principles that underlie exchange control and so many of regulations and rulings refer to it. The concept is given some life in the Rulings which are the written directives given to authorised dealers of the Reserve Bank and reflect the Reserve Bank's policy of the day.

A resident is understood to be a person (natural or juristic and including trusts and partnerships) who has taken up permanent residence, is domiciled or a person whose existence has been registered in South Africa.

Whilst these are often legally defined terms in other areas of the law, for example, for the purposes of home affairs and tax legislation, the South African Reserve Bank uses its own mechanisms for determining the residency in South Africa of a natural person.

The concepts of "place of permanent residence" and "domicile" overlap somewhat and in legal terms are generally understood to be much the same thing. Establishing permanent residency or domicile in relation to juristic entities is easier than establishing the resident status of an individual because of the legal requirements associated with establishing a presence and conducting business in South Africa. Partnerships create a number of complexities and when a lender is faced with a partnership it should exercise some caution when establishing residency; often the test as to whether it is an affected person is more helpful.

Under the "registration" criteria, an external company would qualify as resident of South Africa for exchange control purposes upon registration of its constitution with the companies office and similarly a trust which is established in a foreign jurisdiction but registered in South Africa under the Trust Property Control Act would also qualify as a resident for exchange control purposes.

To establish who or what the National Treasury considers an affected person we can look to a definition in the regulations. An affected person is:

"... a body corporate, foundation, trust or partnership operating in the Republic, or an estate, in respect of which -

(i) 75% or more of the capital, assets or earnings thereof may be utilised for payment to, or to the benefit in any manner of any person who is not resident in the Republic; or

(ii) 75% or more of the voting securities, voting power or power of control, capital, assets or earnings thereof, are directly or indirectly vested in, or controlled by or on behalf of, any person who is not resident in the Republic."

Affected persons are treated in much the same way as residents for the purposes of this regulation, subject to relaxations in particular circumstances, because ultimate control of such a person vests in an offshore entity which is not subject to South African exchange control requirements.

Interestingly, the definition of affected person does not entail that an affected person needs be resident in South Africa, rather only that the affected person "operates in the Republic". Many affected persons are also residents of South Africa. It is, however, a useful definition for a lender who needs to determine whether the prohibitions in regard to financial assistance may apply to partnerships. It is quite conceivable that a partnership could operate in South Africa by establishing some sort of presence here and not be an exchange control resident.

The economic policy underpinning exchange control has always relaxed the complete restrictions for financial assistance contained in the regulations.

Immediately prior to the relaxation having been announced by the Minister, authorised dealers were only entitled to grant lenders exemptions from the regulations in respect of local financial assistance of up to ZAR20 000 to non-residents or to affected persons where no borrowing base existed for an affected person and provided that the total facilities borrowed did not exceed that amount.

In respect of anything over an over and above that limit:

• In relation to non-residents authorised dealers were entitled to authorise local financial assistance facilities provided that the local borrowings would not cause the non-resident to exceed 100% of the Rand value of funds introduced from abroad. In other words non-residents could only borrow locally an amount that would not cause such non-resident to exceed its local foreign direct investment. The essence of the old ruling was that non-residents were limited to a ratio of 1:1 in respect of all local borrowings.

• In relation to affected persons, authorised dealers were entitled to relax the regulatory restrictions by allowing affected persons to borrow locally up to 300% of the total shareholder investment (the 3:1 ratio) in South Africa. Permission generally expired six months after the date of the financial year-end of the affected person.

The drafting in the rulings is not always particularly clear; in the old rulings under the heading affected persons was the following statement:

"the [3:1] ratio does not apply to emigrants, the acquisition of residential properties by non-residents or affected persons and any other financial transactions, such as portfolio investments by non-residents, securities lending, hedging, repurchase agreements, etc. In these cases the 100% [1:1 ratio] still applies".

Because the wording was so unclear it seemed to some that the 1:1 ratio only applied to non-residents and not to affected persons. In fact when the South African Reserve Bank issued its circular notifying the public of the Finance Minister's changes to the financial assistance rulings the circular stated that:

"To improve access to domestic credit in the financing of local foreign direct investment, restrictions on the granting of local financial assistance to affected persons have been further liberalised with the abolition of the 3:1 ratio. This relaxation doesn't apply to emigrants, the acquisition of residential properties by non-residents or any financial transactions - such as portfolio investments, securities lending, hedging or repurchase agreements - by non-residents. In these cases the 1:1 ratio still applies. The Reserve Bank will provide further details concerning all of the above reforms".

New rulings were then circulated. True to the Ministers word, the new rulings abolished the old 3:1 ratio which previously applied to local borrowings by affected persons. The new rulings also appeared to change the generally understood position in relation to the acquisition of residential property and financial transactions as applying only to non-residents; instead the new rulings now make it clear that affected persons as well as non-residents are constrained by the 1:1 ratio in respect of residential property acquisitions and financial transactions.

The Reserve Bank has recently clarified (after some uncertainty) that financial transactions, "include, inter alia, the purchase and sale of any securities (listed or unlisted), repurchase agreements and any derivative transactions on securities". In the exchange control world securities include a vast array of financial instruments. Ironically, the definition in the regulation is far narrower in scope than the definition in the rulings; usually the converse is true. In the rulings the definition of securities includes, shares, warrants, debentures and any letter or other document conferring rights in respect of any security and government and municipal utility stocks. Importantly, it appears that by using the words include and inter alia, the list of financial transactions in the rulings is not exhaustive. In the absence of any further clarification parties should treat that list as complete.

The position in relation to local financial assistance now is:

• authorised dealers may grant or authorise local financial assistance facilities to non-residents in respect of bona fide foreign direct investment into South Africa without restriction; except where the funds required are for the acquisition of residential property or financial transactions;
• authorised dealers may grant or authorise local financial assistance facilities to affected persons without restriction; except where the funds required are for the acquisition of residential property or financial transactions.

Local lenders can also lend to affected persons and non-residents where the facilities given by it are secured against a guarantee from an affected person or non-resident. This exemption only applies where the financial assistance given does not result in an affected person borrower exceeding the value of its borrowing base or in the case of non-residents exceeding the Rand value of funds introduced from abroad (this will only be relevant to finance advanced for financial transactions and residential property acquisitions) because borrowings are otherwise permitted without restriction and the basis already discussed. This permission has not changed in principle from the exemption that existed previously.

The relaxation seems to be limited to the working capital requirements of affected persons and non-residents. It will be interesting to see how the Reserve Bank will treat a request for working capital by a securities dealer or derivatives trader, for example, whose working capital is intrinsically linked to financial transactions. It will be interesting to see whether the Reserve Bank responds to this sort of request by applying the policies that underpin the relaxations (i.e. enhancing access to domestic finance for working capital purposes) notwithstanding the nature of the business conducted by an applicant or by applying the letter of the Rulings. For now (partly because these restrictions have actually always existed and partly because of the state of the global economy) it seems the letter of the rulings will be applied.

Written by: Deborah Carmichael, Associate, Deneys Reitz Inc.