Tax Newsflash Budget 2010 Crystal clear Deloitte BA 900 summary of SA banks - December 2009 Ratings Afrika...264

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1 Contents Tax Newsflash Budget 2010 Crystal clear Deloitte BA 900 summary of SA banks - December 2009 Ratings Afrika Hedging strat e gies in South Africa Novare Investments Coming Back from the Brink Obsidian Capital The South African short term insurance industry Global Credit Ratings JSE launches an XBRL financial reporting portal JSE Limited An overview of the JSE s Currency De riv a tives Contracts JSE Limited The evolution of an asset class JSE Limited Behind the screens with the JSE s Equity De riv a tives Division JSE Limited In tro duc ing the JSE s Interest Rate Di vi sion s De riv a tives Products JSE Limited Key Per for mance In di ca tors for the 12 months ended Feb 2010 Jason Mattes Consumer Price Index (CPI) Interest Rate Change Dates (Prime and Repo) For the online version of Profile's Financial Markets Directory visit 247

2 Tax Newsflash Budget 2010 Crystal clear In This Issue The Minister of Finance, Mr Pravin Gordhan delivered his first budget speech to Parliament on 17 February In this Tax Newsflash we highlight certain economic data tabled as part of the Budget Review and the tax proposals included in the Budget Review. Income Tax Individuals Personal Tax Rates and Rebates Individuals are to receive personal income tax relief amounting to R6.5 billion which presents the majority of the net tax relief offered. The tax savings for individuals are however not as favourable as that obtained in previous years. Although tax rates have once again remained unchanged, increases to the tax brackets provide a reduction in the individual tax burden at all income levels. Most of the tax relief is however provided to taxpayers in the lower-income brackets. Bear in mind however, that the relief is aimed at partial compensation for the effects of inflation. An illustration of this relief across a spectrum of incomes is shown in table 2. The monthly saving (before adjustment for fiscal drag) for individuals in the top tax bracket is approximately R250 (compared to R419 in 2009/2010). The primary rebate for all natural persons increases from R9 756 to R10 260, and the additional rebate for persons 65 years and older increases from R5 400 to R Tax Thresholds The annual income level at which an individual starts paying tax, after taking into account the individual rebates, has increased as follows: 2009/ /2011 Under 65 years R R years and older R R Table 1: Income Tax Rates for the Year of Assessment commencing on 1 March 2010 Taxable income as exceeds R But does not exceed R Tax payable R % R % R % R % R % R % 248 For the online version of Profile's Financial Markets Directory visit

3 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Taxable Income R Table 2: Comparison of Annual Tax Payable (not inflation adjusted) (Natural Persons under 65) 2009/10 Tax Payable R 2010/2011 Tax Payable R Reduction in Tax Payable R Percentage Reduction % , , , , , , , , , , , , , , , , , ,1 Retrenchment Package Merger The so-called R exemption from income tax which applies to retrenchment packages has not been reviewed for many years. In view of the high number of retrenchments, it was announced last year that a similar exemption to that relating to retirement lump sums is to be introduced for retrenchment packages. As a result, in future all retirement and retrenchment lump sum payments will be treated the same for tax purposes. Comment The fact that fiscal drag has been adjusted for individual taxpayers is noteworthy in the light of the large fiscal deficit. It is unclear whether the R aggregation will apply to both retrenchment and retirement lump sums. Interest and Foreign Dividend Exemption The 2010/11 increase in the interest and foreign dividend exemption is 6,2% (2009/10 10,5%) for persons under the age of 65 (from R to R22 300), and a 6,7% (2009/10 9,1%) increase for persons aged 65 years and older (from R to R32 000). Of these total exemption amounts, the maximum exemption for foreign interest and foreign dividends increases from R3 500 to R3 700 per year. The exemptions will also now be limited to widely available interest- bearing instruments such as bank deposits, government retail bonds and collective investment money market funds. For the online version of Profile's Financial Markets Directory visit 249

4 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Comment As one of Government s stated objectives is to support the creation of a culture of saving, the small increases in the exemptions seems coun ter pro duc tive in the creation of such a culture. Post-Retirement Conversion of Annuities into Lump Sums Retirement savings lump sums benefit from a special rates table that provides a R tax exemption. This table predominantly applies when a lump sum payout occurs upon a person s retirement or death. However, lump sum payouts may occur after retirement if a post-retirement annuity is subsequently converted into a lump sum. It is proposed that this post-retirement conversion receive the same treatment under the special rates table and that it accordingly also qualifies for the R tax exemption. In addition, these conversions will also be subject to the rule that all exemptions should be aggregated so that a taxpayer will only be able to enjoy the R exemption over his lifetime. Retirement Savings Payouts to Third Parties In some circumstances, the Pension Funds Act allows fund ad min is tra tors to use a member s retirement benefits to make payments to third parties such as compensation to lenders for unpaid housing loans guaranteed by the fund. These payments will now be treated like other lump sum benefits for the benefit of the member, thereby triggering the special rates table. Comment It would seem that all the amendments relating to retirement issues are aimed at simplifying the tax rules. This move is welcomed. Corporate Tax Share-for-Share Reorganisations of Listed Companies Share-for-share re or gani sa tions qualify for tax relief if certain conditions are met. These re or gani sa tions would generally involve shares in the acquiring company being issued to the holder of shares in the target company whose shares are being acquired. In order for the tax relief to apply, it is necessary for the acquiring company to know certain tax information about the target company's shareholders, such as whether the target company s shareholder holds the target shares as a capital asset or as trading stock. This level of knowledge is impractical where the target company is listed, given the number of shareholders involved and the relatively small size of a typical holding. It is consequently proposed that conditions of this nature will be waived in the case of listed share for share relief, to the extent that this waiver does not create opportunities for tax avoidance. Comment This proposal is to be welcomed in that it will make share-for-share re or gani sa tions practical in a listed context. Default Elections Involving Intra-Group Rollovers Transfers of assets between group companies, (i.e. transfers within a 70% owned group of companies), can be affected free of tax by way of rollover relief granted. This rollover relief applies automatically, if certain objective conditions are satisfied unless the parties involved in the transaction elect for it not to apply. 250 For the online version of Profile's Financial Markets Directory visit

5 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Where group companies regularly dispose of trading stock to one another the automatic application of the rollover relief can give gives rise to problems. Consequently, in order to simplify compliance, it is proposed that a different methodology be provided for this class of intra-group transfers. Comment It is unclear at this stage what form the different methodology will take. Either such transactions could be excluded completely from the rollover provisions or, alternatively, such transactions could be excluded from the rollover relief unless the parties elect for it to apply. Reorganisations and Bad Debts The intra-group re or gani sa tion rules are designed for the acquiring group company to generally step into the shoes of the group company transferring qualifying assets. This concept does not apply in the case of bad debts due to a technicality. This means that a creditor can often not claim a bad debt deduction for debts acquired in a re-organisation where the debtor subsequently defaults. It is proposed to amend the re or gani sa tion rules to ensure that bad debt deductions can be claimed in these circumstances as long as it does not give rise to a double deduction. Financial Instruments held as Trading Stock The income tax rules for trading stock generally allow stock to be valued at the lower of cost or market value. An exception to this rule is where the trading stock consists of shares held by a company, in which case the stock must be valued at cost. It is proposed that in future all financial instruments, held as trading stock, be required to be held at cost for tax purposes because modern financial reporting distinguishes financial instruments from other inventory. Comment The proposal will not allow a taxpayer, holding financial instruments as trading stock, to value these below cost, even if the market value of the instrument has fallen. It is unclear whether this proposal will affect all taxpayers holding financial instruments as trading stock, or merely be applicable to companies, which are currently the only taxpayers precluded from writing down shares held as trading stock. The logic of treating financial instruments held as trading stock differently from other forms of trading stock is unclear. For example, why should one trader, holding fixed property as trading stock, be entitled to value such stock at the lower of cost or market value while another trader, holding shares in a property owning company as trading stock, be required to hold these at cost? The stated reason given, being that financial reporting distinguishes between financial instruments and other inventory, appears to lack substance. Revised Taxation of Short-Term Insurers A special concession is made for short-term insurers in terms of which a deduction for a certain level of reserves is allowed. In terms of an amendment passed in 2007, the level of reserves allowed as a deduction is determined in accordance with the minimum reserve requirements of the FSB, excluding contingency reserves. Prior to this, the deduction allowed in respect of short-term insurance reserves was determined solely at the discretion of the Commissioner and in practice was determined with reference to premiums earned in a particular year. For the online version of Profile's Financial Markets Directory visit 251

6 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Given the recent economic downturn and the proposals to reserve on a more conservative basis to protect policyholders in future, a tax deduction may now be granted for potentially inflated reserves despite these being determined within the parameters set by the FSB. Furthermore, the level of reserves of short-term insurers are typically not related to premiums earned in any particular year as they relate more closely to the history of claims experience. It has now been proposed that the taxation of short-term insurers be reviewed to address these issues to ensure that an element of matching is achieved between the level of reserves allowed as a deduction and premiums earned. Residential Property Entities In 2009 government announced a three-year window to allow certain companies and trusts, which own residential properties, to transfer these to their shareholders or beneficiaries free of transfer duty and other negative tax consequences. The relief was only granted in a limited number of circumstances and certainly did not apply to all entities owning residential property. It has now been determined that this window is insufficient and consequently a new, more flexible window period is proposed. Comment It is unclear what exactly is envisaged by this proposal. On first reading, it would appear that it merely envisages an extension of the period within which the residential property can be extracted from the relevant entity. It is however difficult to see why a three-year window period should be insufficient, particularly this early on in the period. What is hopefully envisaged is that the relief given by the proposal is extended to more entities owning residential properties and that the previously enacted requirements to benefit from the relief are relaxed. This could result in the relief being extended to, for example, residential properties held for rental purposes or as holiday homes, which are currently excluded from the relief. Sundry Various other amendments are proposed to deal with, amongst other things, plantations involved in company formations, refinements to the proposed dividends tax, changes necessitated by company law reform and refinements to the presumptive turnover tax. International Tax Promoting South Africa as a Gateway into Africa With its excellent business in fra struc ture, South Africa is ideally located to act as an investment gateway into Africa. Government has therefore signalled its intention to investigate ways to enhance South Africa's at trac tive ness as a location from which mul ti - na tion als can invest into Africa. According to the Budget Review, relief from exchange control and taxation for various types of headquarter companies will therefore be considered. Under current rules, foreign funds cannot be channelled through South Africa to other foreign locations without exchange control approval. Furthermore, from a tax point of view, an international headquarter company tax resident in South Africa is subject to South Africa's tax laws like any other resident as a consequence of which its ability to compete with some of the more tax-friendly African holding jurisdictions is 252 For the online version of Profile's Financial Markets Directory visit

7 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR restricted. For example, no relief from the secondary tax on companies (STC) is provided in respect of foreign dividends received by a resident which are on-declared to non-resident shareholders. Comment We welcome the proposal which, if correctly implemented, could significantly enhance South Africa's com pet i tive ness as a tax-friendly holding jurisdiction. National Treasury will no doubt be careful to ensure that any proposed regime is in accord with South Africa's double tax treaty rules and does not constitute harmful tax practice. Application of Thin Capitalisation Rules to South African Branches The thin capitalisation rules in the Income Tax Act restrict the amount of interest-bearing borrowings by South African residents from foreign connected persons, typically by a South African subsidiary from its foreign parent. Any excessive financial assistance will result in interest expenditure on the borrowings being disallowed and treated as a deemed dividend distribution subject to STC. These rules only apply to residents, though, and therefore not to the South African branch of a non-resident (the branch is not a separate person from its head office). The fear is therefore expressed that this permits excessive gearing of such a South African branch with no restriction on stripping interest out of South Africa in a tax-deductible manner. Consequently, it is proposed to extend the ambit of the thin capitalisation rules to also apply to non-residents. Comment It is to be noted that the fear of tax stripping is probably overstated as it relates to the application of South Africa's tax laws to foreigners who are resident in a country with which South Africa has concluded a double tax agreement. Under a double tax agreement, the profits of the branch must be determined with reference to the arm s length principle. The proper application of this principle should restrict interest that can be charged to the branch. However, this is obviously more difficult for SARS to administer than a clearly defined rule. Broadening of Tax Base Closure of Sophisticated Tax Loopholes The comment is made in the Budget Review that international competition puts pressure on South Africa to lower marginal tax rates, especially the headline corporate income tax rate. Government has over the past decade achieved lower rates by broadening the tax base, but its efforts in this regard are being undermined through the use of sophisticated anti-avoidance tax schemes. Accordingly, much effort goes into the iden ti fi ca tion of such schemes and considering appropriate measures to close these schemes. Schemes that have been identified for closure in the Budget Review deal with cross-border mismatches, protected cell companies, cross-border insurance payments, participation preference and guaranteed shares, restricting the cross-border interest exemption, interest cost allocation for finance operations and transfer pricing. Of particular interest are protected cell companies, the proposal to restrict the cross-border interest exemption and transfer pricing. For the online version of Profile's Financial Markets Directory visit 253

8 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Statutory Cell Companies According to the Budget Review, a statutory cell company effectively operates as a multiple limited liability entity, with each cell protected against the other. The investor has full control over the cell, but not over the company. If the company is established as a foreign company, it may be possible to avoid it being a controlled foreign company (CFC) on the basis that South African residents do not hold more than 50% of the participation rights or voting rights in it. As a result, the income of the protected cell does not have to be imputed to the South African resident although the resident in effect holds more than 50% of the participation rights or voting rights of that cell. To close this loophole, it is proposed that each cell be treated as a separate company, and, hence, as a CFC. Cross Border Interest Exemption As regards the proposal to restrict the cross-border interest exemption, the Income Tax Act exempts foreign legal persons from South African tax on local interest, unless the interest is paid to a local branch of that foreign person. The purpose of the exemption is to attract foreign investment, but it is considered that it is overly broad and needs to be narrowed. However, it is not anticipated that any changes will affect foreign investment in South African bonds, unit trusts, bank deposits or the like. Interest Cost to Produce Exempt Income Interest costs on debt that finances income generating assets are generally deductible for tax purposes while interest costs on debt that finances non-income generating assets, such as shares, are not. Income in this context refers to income which is taxable as opposed to exempt income. The Budget Review states that financial institutions are deducting interest expenditure beyond what they should be allowed according to tax principles. It accordingly states that it is proposed to introduce measures to ensure that interest expenses are allocated pro por tion ately among various financial assets based on a taxable income/gross receipts and accruals formula. Comment The statement that financial institutions are deducting interest beyond what they should be allowed according to tax principles is strange. If the deductions claimed are in excess of what they are entitled to then one would expect SARS to apply tax principles to restrict them to what is allowed. What is more likely therefore is that there is a perception that applying normal tax principles, as determined by the courts over many years, gives financial institutions too large a deduction for interest paid where they earn substantial dividend income. Presumably the intention is to allow interest income to be deducted in proportion to the gross taxable income generated by the institution relative to its gross total income. The review talks about gross receipts and accruals. This would include capital receipts, but it is unlikely that it is intended that capital receipts will come into the formula. Transfer Pricing On transfer pricing, it is proposed to provide a uniform set of transfer pricing rules to deal with artificial pricing or the misallocation of prices within the various components of a single transaction. It is stated that the rules will align the treatment of both onshore and offshore transactions. The transfer pricing rules apply in a cross-border context to transactions between related parties. In essence, SARS is empowered to adjust any 254 For the online version of Profile's Financial Markets Directory visit

9 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR consideration in respect of such a transaction to reflect and arm's length price. This is to protect the tax base from erosion due to the manipulation of prices between related parties. Comment The proposed changes to stamp out sophisticated tax avoidance schemes are congruent with Government s attempts to broaden and protect the South African tax base. Employees Tax and Fringe Benefits Discontinuation of SITE System The standard income tax on employees (SITE) system was introduced in the late 1980s to limit the number of personal income tax returns filed annually. Ad min is tra tive modernisation, and the fact that the personal income tax threshold for taxpayers younger than 65 years is approaching the SITE ceiling of R60 000, have eliminated the need for this system. SITE will be repealed with effect from 1 March Comment This change has long been anticipated given the larger drive to simplify the tax ad min is - tra tion system. All allowances paid to an employee (except subsistence allowances and travel allowances) will now be subject to employees tax in full or according to a formula (e.g. residential accommodation). The effect is that all taxpayers above the tax threshold will now need to register as taxpayers. Modification of Company Car Benefits Based on the continued drive to limiting salary structuring opportunities of employees, it has been announced that company car fringe benefit rules will be tightened. It is stated that the intention is to increase the deemed monthly value, but it is unclear whether this would refer to the percentage (currently 2,5% ) or to the actual determined value of the motor vehicle. Medical Scheme Contributions and Medical Expenses Effective from 1 March 2010, the caps for deductible medical contributions will increase to: R670 from R625 for the first two beneficiaries; and R410 from R380 for each additional beneficiary. The proposed conversion of the deduction into a tax credit of 30% of allowable medical aid contributions and expenses, announced in last year s budget will be postponed to 1 March Employer Payment of Professional Fees on Behalf of Employees No taxable fringe benefit arises in the hands of an employee where the employer pays the subscription fees of a professional body on behalf of the employee if membership of that body is a condition of employment. Other fees paid on behalf of an employee that mainly benefit the employer will now enjoy the same tax treatment and the fringe benefit relief will be extended to cover these related-employer payments. Comment It is unclear at this stage what type of fees would qualify for this relief. For the online version of Profile's Financial Markets Directory visit 255

10 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Administrative Issues Voluntary Disclosure Programme A voluntary disclosure programme was proposed. This programme will enable defaulting taxpayers to disclose unreported revenues and pay the associated tax with a reduced interest charge and without incurring penalties. This concession will be available subject to the following conditions: The disclosure is complete SARS was not already aware of the default A penalty or additional tax would have been imposed had SARS discovered the default in the normal course of events. The Minister also announced that alignment of exchange control violation penalties with this disclosure programme is being considered. In consequence of this programme, it is proposed that SARS s will no longer have a discretion to waive interest on unpaid provisional tax. The voluntary disclosure programme will apply from 1 November 2010 to 31 October Comment The tax associated with undisclosed revenue will still be payable as will an interest charge for late payment. The interest charge will however be reduced. Clarity on the extent of this reduction is outstanding. The interest charge benefit under the programme would appear to be linked to SARS prior knowledge of the default and to an inherent exposure of the taxpayer to a penalty as a result of the default. PAYE Assessments As a result of a recent court judgment legislative amendments are proposed to ensure that assessments for employees tax can be raised against employers who have made an incorrect determination of the PAYE that is payable on a fringe benefit. Additional amendments are also being considered to deal with situations where payment of this assessed PAYE could lead to a further fringe benefit. Exemption from Provisional Tax Registration Amendments are proposed to clarify that persons who are exempt from the payment of provisional tax will not be required to register as provisional taxpayers. It was also announced that this proposal may be extended to cover taxpayers with little or no provisional tax to pay. Process Improvements The following process improvement initiatives were announced: Improved processes for call centres, office operations and payments. Further modernisation of personal income tax, PAYE, corporate tax, VAT and customs systems. Increased system infrastructure for processing of administrative penalties. Enhancement of systems to facilitate self-service and voluntary disclosure. 256 For the online version of Profile's Financial Markets Directory visit

11 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Other Administration Proposals The following ad min is tra tion proposals were also announced: A greater focus on large taxpayers and high net worth individuals. Restricting advance tax rulings to only those taxpayers who have no outstanding returns and taxes. Greater information sharing among regulatory and enforcement agencies operating under the umbrella of the Ministry of Finance. Information sharing is currently restricted by secrecy provisions of the various agencies. It is proposed that these secrecy provisions be revised to facilitate this information sharing. Electronic filing of transfer duty returns and electronic payment of transfer duty. Tax Incentives Enterprise development Government has allocated R 3,8 billion towards incentive schemes in terms of the Enterprise Development programme, the largest programme in the Department of Trade & Industry (DTI); There is a major policy change in that production incentives will be increasingly grant based, reducing reliance on tax incentives. An additional R3.6 billion is allocated to the DTI for industrial policy interventions consistent with government s new Industrial Policy Action Plan. In particular, these funds go to support investment and production: in the automotive components; Clothing; and textile industries. (These key strategic sectors have been earmarked for the development of new support packages by the DTI. The aim of these new support packages is to boost manufacturing capacity and support job creation.) The automotive production and development programme was approved by Cabinet in October 2008 and replaced the motor industry development programme. The scheme will focus on increasing plant volumes and achieving better economies of scale, and provides for a taxable cash grant based on the amount of the investment. Provisions have been made for transfers and subsidies to the Industrial Development Corporation (IDC) for services rendered for the clothing and textiles programme to provide a production allowance for firms under certain conditions. This programme is still under development and guidelines will be published when findings is provided in 2010/2011. The IDC was tasked to develop an upgrading programme for the foundry and tooling industries. For the online version of Profile's Financial Markets Directory visit 257

12 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Specific incentive allocation: Medium Term Expenditure Estimates 2010/ / /2013 Enterprise Investment Programme R346,7 mil R524,5 mil R603,9 mil Critical Infrastructure Programme R115,7 mil R118,5 mil R181,7 mil Business Process Outsourcing & Offshoring R223,1 mil R233,1 mil R224,0 mil Film Incentive R245,9 mil R270,3 mil R286,6 mil Automotive Investment Scheme R747 mil R916,8 mil R1 025,4 mil Existing incentives will be effective immediately, while the im ple men ta tion date for proposed automotive incentives is not certain. The details of the proposed clothing and textile schemes will be announced in the course of Comment We welcome the continued spending on enterprise development and note specifically the increased spending on Business Process Outsourcing & Offshoring, Film industry & industrial policy projects. It is, however, disappointing to note that there is almost virtually no increased spend on critical in fra struc ture development. There was also no indication of the support for projects involved in co-generation /self-generation of electricity. It is also strange to note a policy shift, away from tax incentives to a grant based approach. Climate Change Climate change and concerns over global energy supply present both challenges and opportunities for South Africa. Industries must be helped to manage scarce resources more efficiently and to reduce greenhouse gas emissions through appropriate pricing of energy. This is necessary to enable investment in sustainable technologies. Green economy initiatives will create new opportunities for enterprise development, job creation and the renewal of commercial and residential environments. This must play a part in our new growth path. Comment The Minister referred in his budget speech to further measures of environmental taxes to be implemented. Our view is that this refers to the Climate Change Adaptation and Mitigation Policy & Incentives Green Paper, which the Government has indicated will be distributed for consultation by mid-year This paper is expected to propose measures to implement carbon pricing in the form of either a carbon tax on emissions or a cap and trade system of carbon emission reductions. These measures will be designed to reduce South Africa s national carbon emissions in line with President Zuma s announcement of a 34% cut in carbon emissions by 2020 and a 42% cut in emissions by Other environmental taxes and levies that will also be investigated include: A wastewater discharge levy in terms of the Water Act Air pollution levies in terms of the new Air Quality Act Levies on waste streams A landfill tax Traffic congestion charges 258 For the online version of Profile's Financial Markets Directory visit

13 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Employment Incentive Under consideration is a cash reimbursement to employers for a two-year period, operating through the SARS payroll tax platform, and subject to minimum labour standards. It will be available to tax-compliant businesses, non-governmental organisations and mu nic i pal i ties. Our preliminary estimate is that about people will qualify. The aim is to raise employment of young school-leavers by a further by The expected effective date is early Comment We welcome any initiative that supports job creation and measures that assist business, NGO s and mu nic i pal i ties in the creation in such opportunities should similarity be supported. Value -Added Tax Enterprise Development Not only has the VAT rate been left unchanged despite the fact that the VAT collections are R22bn behind the estimates, the bulk of the VAT proposals tabled by the Minister favour the taxpayer. Residential Properties It is now proposed that the full claw-back of VAT input tax on residential properties which are temporary leased before being sold by developers, be revisited with a view to reducing the value of the adjustment. In general terms a residential property developer would be obliged to charge VAT on the sale of the units and would be entitled to claim the VAT incurred on the development costs. In some instances however, the developer may be unable to sell the units and instead of leaving the units vacant whilst trying to find a buyer, temporarily leases the properties to tenants. In VATNEWS 14 (issued during March 2000) SARS ruled that in such case there had been a change of use and that because the property was being used to make exempt supplies (the letting of residential property) the developer was obliged to declare output tax on the market value of the property. Comment Not only was this ruling draconian, it is questionable whether it was correct in that the change in use adjustment in question applies where the property is used wholly for a purpose otherwise than making taxable supplies. It is our view that the temporary letting of a property prior to sale does not constitute the property being wholly used for the purposes of making exempt supplies. Although the proposal only refers to adjusting the value of the adjustment it would be preferable for SARS to review the basis of its ruling and withdraw it in its entirety. The proposal only refers to residential property developers but financial institutions which rent out repossessed properties pending the sale of such properties would also be affected. It is proposed to relax the rules relating to intra-group supplies on loan account. For the online version of Profile's Financial Markets Directory visit 259

14 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Period for Outstanding Debts In terms of current legislation where a vendor acquires goods or services and has not paid the full price for such goods or services within a 12 month period, the vendor is obliged to account for VAT on the unpaid portion of the price. This represents a claw back of the VAT which the vendor claimed when he acquired the goods or services in the first place. This provision was primarily aimed at outstanding debts which had been written off by the seller who could then claim an input tax adjustment leaving SARS out of the pocket to the extent that the defaulting purchaser had also claimed input tax on acquiring the goods or services from the seller. Anomalies are however created where these provisions are applied to supplies between companies in the same group and such loans (as is often the case) are not cleared within 12 months. In such case the group is prejudiced as the company supplying the goods or services would not have written off the debt as being irrecoverable and would not accordingly, have claimed an adjustment. It is thus proposed that the 12 month rule in respect of intra group transactions will be relaxed. Comment It is hoped that such transactions will be excluded from the ambit of the provision altogether, but it is more likely that the 12 month period will simply be extended. Other Other proposals seeking to assist vendors include: The extension of pooling arrangements from farming and rental arrangements to other industries such as betting, trucking and shipping industries Providing vendors with the option to return VAT on imported services in their normal VAT201 returns instead of the prescribed VAT215 form which requires separate payment within 30 days of the date of importation. This means that vendors in a refund position can avoid having to make a separate payment to SARS. Compliance The remaining proposals relate to compliance issues: It is intended to include provisions requiring proof of payment in order to substantiate the notional input tax on second hand goods. Although a vendor does not require a tax invoice to claim input tax where the transaction does not exceed R50 it is proposed that some form of proof (such as a till slip) will be required. It is intended to review the definition of commercial accommodation within the context that certain entities that supply exempt residential accommodation have (as a result of definitional technicalities) crossed over into supplying commercial accommodation. One of the key exclusions from the definition of commercial accommodation is any dwelling which is supplied in terms of a lease agreement. It would appear that entities supplying students with furnished lodgings where there is no such lease agreement have in fact been supplying commercial accommodation on which VAT is leviable and that such result was unintended and will be reviewed. 260 For the online version of Profile's Financial Markets Directory visit

15 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Customs and Excise Introduction The following changes to the current customs and excise legislation were proposed. Specific Excise Duties ( Sin Taxes ) The annual changes to the sin taxes were expected with an increase in the rates of excise duties payable on tobacco products and alcoholic beverages in line with annual trends and benchmark target ranges of 23, 33, 43 and 52 per cent of the average retail price for wine, beer, spirits and tobacco, respectively. As these benchmarks were set a while ago in 2002, these will be reviewed during The excise duty on malt beer increases by 8.2% from R46.41 to R50.20 per litre of absolute alcohol which equates to an average increase of 6.5c per 340ml can to a total of 85.34c per 340ml can. For the fifth year, we see no changes to the excise duty on traditional beer and traditional beer powder, which remain at 7.82c per litre and 34.7c per kg respectively. Wine incurred increases in excise duty of 8.1% unfortified, 8.3% fortified and sparkling wine 8.3%. This has resulted in the rates per litre on these products equaling R2.14 per litre unfortified, R4.03 per litre fortified and R6.67 per litre sparkling. Ciders and alcoholic fruit beverages received an increase in excise duty of 8.2% on unfortified and fortified. Spirits and liquors also saw an increase of 8.9% from R to R27.27 per 750ml bottle. Smokers will also face increased prices as a result of increases in the excise duties on cigarettes 16.1%, cigarette tobacco 6.3%, pipe tobacco 8.0% and cigars 6.2%. These duty amendments to the specific excise duties above are effective from 17 February Fuel Taxes Fuel levy has increased by 10c per litre for both petrol and diesel. An additional 7.5c per litre increase on petrol and diesel is proposed to support the new multi-product petroleum pipeline between Durban and Gauteng. The diesel fuel tax refund and biodiesel fuel tax rebate concessions will adjust automatically to maintain relative benefits to qualifying beneficiaries. We also see an increase in the Road Accident Fund ( RAF ) levy on both petrol and diesel by 8c per litre from R64.0c to R72.0c per litre. This increase is intended to strengthen the RAF s financial position and effectiveness. The above proposals will become effective from 7 April Advalorem Excise Duties No abolishment of ad valorem duties on luxury items has been provided for. For the online version of Profile's Financial Markets Directory visit 261

16 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR General Customs and Excise Matters Carbon Emissions Tax: The carbon dioxide vehicle emissions tax, a specific tax on new passenger vehicles, will be implemented from 1 September New passenger cars will be taxed based on their certified carbon dioxide emissions at R75 per g/km for each g/km above 120g/km. This emissions tax will be in addition to the current ad valorem luxury tax on new vehicles; Environmental Levy Taxes: Additional environmental levy taxes will be explored to raise revenue and meet South Africa s environmental objectives; Third Party Information Reporting for Customs: To bring the Customs and Excise Act in line with the Income Tax Act, amendments will be considered to provide for reporting of information by third parties for purposes of verifying information submitted to SARS; Electronic Communication for Customs: Amendments to the Customs and Excise Act will be considered to provide for more flexible alternative measures to secure user identification and access; Tax Administration Improvements in the next three years: Customs modernisation (work continuing to modernise Customs); Call centres, office operations and payment processes; Increased system infrastructure to process administrative penalties; Selected Economic Data Table 1: Budget Revenue Collections 2009/ / / /2013 Taxes on income and profits of which Personal income tax Corporate income tax Taxes on payroll and workforce Taxes on property Domestic taxes on goods and services of which Value-added tax Taxes on international trade and transactions State miscellaneous revenue and fees Tax revenue Non-tax revenue of which Mineral and petroleum royalties Less: SACU payments National budget revenue Provinces, social security funds and selected public entities Budget revenue Also includes secondary tax on companies, interest on overdue income tax and small business tax amnesty levy. 2 Includes stamp duties and revenue received that could not be allocated to a specific tax in stru ment. 3 Includes mineral and petroleum royalties, mining leases and de part men tal revenue. 262 For the online version of Profile's Financial Markets Directory visit

17 TAX NEWSFLASH BUDGET 2010 CRYSTAL CLEAR Table 2: Economic classification of consolidated government expenditure 2009/ / / /13 Revised estimate Medium-term estimates R million R million R million R million Current payments Compensation of employees Percentage of GDP 11.10% 10.90% 10.60% 10.10% Goods and services Interest Percentage of GDP 2.50% 2.90% 3.20% 3.40% Transfers and subsidies Percentage of GDP 11.00% 10.50% 10.60% 10.20% Payment for capital assets Percentage of GDP 2.20% 2.50% 2.30% 2.20% Payment for financial assets Contingency reserve Total payments Percentage of GDP 34.10% 33.60% 32.90% 32.10% Gross domestic product Table 3: Revised Medium Term Macroeconomic Fiscal Framework 2009/ / / /2013 GDP 2, , , , GDP real growth rate Headline CPI inflation Consolidated Budget Expenditure Consolidated Budget Revenue Consolidated Budget Balance % of GDP -7.30% -6.20% -5.00% -4.10% For further information, please contact: Business Unit Leader Tax & Legal Dave Kennedy +27 (0) Before readers take any action, we recommend that specific questions on subjects covered in this publication be directed to your financial, tax and legal advisers. The Deloitte advisers listed above would be pleased to provide you with further information. Deloitte accepts no responsibility for any errors this publication may contain, whether caused by negligence or otherwise, or for any losses, however caused, sustained by any person that relies on it. Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 140 countries, Deloitte brings world-class capabilities and deep local expertise to help clients succeed wherever they operate. Deloitte s more than 168,000 professionals are committed to becoming the standard of excellence. Deloitte s professionals are unified by a collaborative culture that fosters integrity, outstanding value to markets and clients, commitment to each other, and strength from cultural diversity. They enjoy an environment of continuous learning, challenging experiences, and enriching career opportunities. Deloitte s professionals are dedicated to strengthening corporate responsibility, building public trust, and making a positive impact in their communities Deloitte & Touche. All rights reserved. Member of Deloitte Touche Tohmatsu For the online version of Profile's Financial Markets Directory visit 263

18 BA 900 summary of SA banks - December 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 CAPITAL, DEPOSITS AND OTHER LIABILITIES TO THE PUBLIC (R MILLION) Item Cheque no Bank deposits Savings deposits Other demand deposits Short-term deposits Medium-term deposits Long-term deposits Total deposits Inter DI funding 1 ABSA AFRICAN BANK ALBARAKA BANK OF BARODA BANK OF CHINA BANK OF TAIWAN BIDVEST BANK CALYON CAPITEC CHINA CONSTRUCTION BANK CITIBANK DEUTSCHE FIRSTRAND GBS MUTUAL GRINDROD HABIB OVERSEAS HBZ IMPERIAL INVESTEC JPMORGAN CHASE MERCANTILE NEDBANK SASFIN SOCIETE GENERALE STANDARD CHARTERED STATE BANK OF INDIA TEBA THE HSBC THE ROYAL BANK OF SCOTLAND THE SA BANK OF ATHENS THE STANDARD BANK VBS MUTUAL TOTAL For the online version of Profile's Financial Markets Directory visit

19 BA 900 SUMMARY OF SA BANKS - DECEMBER 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 CAPITAL, DEPOSITS AND OTHER LIABILITIES TO THE PUBLIC (R MILLION) Item no Repurchagreements Collateralised borrowings Foreign funding Other loans Other public liabs Total public liabs Acceptances Other liabs Share capital Other reserves Total equity & liabs For the online version of Profile's Financial Markets Directory visit 265

20 BA 900 SUMMARY OF SA BANKS - DECEMBER 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 no Bank & gold Central Item bank, money LOANS, ADVANCES AND OTHER ASSETS (R MILLION) SA Banks Foreign loans Resale agreements Instalm. finance Mortgage advances Credit cards Foreign currency loans 1 ABSA AFRICAN BANK ALBARAKA BANK OF BARODA BANK OF CHINA BANK OF TAIWAN BIDVEST BANK CALYON CAPITEC CHINA CONSTRUCTION CITIBANK DEUTSCHE FIRSTRAND GBS MUTUAL GRINDROD HABIB OVERSEAS HBZ IMPERIAL INVESTEC JPMORGAN CHASE MERCANTILE NEDBANK SASFIN SOCIETE GENERALE STANDARD CHARTERED STATE BANK OF INDIA TEBA THE HSBC THE ROYAL BANK OF SCOTLAND THE SA BANK OF ATHENS THE STANDARD BANK VBS MUTUAL TOTAL For the online version of Profile's Financial Markets Directory visit

21 BA 900 SUMMARY OF SA BANKS - DECEMBER 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 Item no Redeem'l pref shares Public sector o/d, loans LOANS, ADVANCES AND OTHER ASSETS (R MILLION) O/draft Private sector Impairments Investments Accept CP, Bills PN Fixed assets (Non- Fin) Other assets Total assets For the online version of Profile's Financial Markets Directory visit 267

22 BA 900 SUMMARY OF SA BANKS - DECEMBER 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 Item SA no Bank Banks DEPOSITS BY SOURCE (R MILLION) Central & Prov Govt Deps Other monetary institutions Local Govt Deps Financial Public Corp 1 ABSA PIC 2 AFRICAN BANK ALBARAKA 3 4 BANK OF BARODA 56 5 BANK OF CHINA 6 BANK OF TAIWAN 1 7 BIDVEST BANK CALYON CAPITEC CHINA CONSTRUCTION CITIBANK DEUTSCHE FIRSTRAND GBS MUTUAL GRINDROD HABIB OVERSEAS 17 HBZ 8 18 IMPERIAL INVESTEC JPMORGAN CHASE MERCANTILE NEDBANK SASFIN SOCIETE GENERALE STANDARD CHARTERED STATE BANK OF INDIA TEBA 28 THE HSBC THE ROYAL BANK OF SCOTLAND 1 30 THE SA BANK OF ATHENS 31 THE STANDARD BANK VBS MUTUAL 2 10 TOTAL For the online version of Profile's Financial Markets Directory visit

23 BA 900 SUMMARY OF SA BANKS - DECEMBER 2009 Supplied by Ratings Afrika BA 900 summary of SA banks - December 2009 Item no Public Enterprise Insurers & Pension Funds DEPOSITS BY SOURCE (R MILLION) Private financial corp. sector Private non-fin corp sector Individuals Foreign sector Foreign currency deps Total deposits Ratings Afrika PO Box 1018 Cresta 2118 Phone No: Fax No: Website: Enquiries@RatingsAfrika.com Contact person: Charl Kocks For the online version of Profile's Financial Markets Directory visit 269

24 Hedging strategies in South Africa By Carla de Waal, Portfolio Manager, Novare Investments While the first hedge funds in South Africa were launched in the mid 1990 s, the number of hedge funds only started to pick up in the early 2000 s. The period from 2005 to 2007 witnessed exponential growth in industry assets under management a period which coincided with the latter part of a strong bull market in local equities. The performance by local funds held up well amidst the global financial crisis in 2008, with most hedge funds preserving capital and suffering far smaller drawdowns than traditional equities. However, assets under management reached a plateau during this period and we currently estimate the total size of the industry at around R30bn. Graph 1: Assets under management in SA hedge funds R R R Assets under management R Million R R R R5 000 R June June 2004 June 2005 June 2006 June 2007 June 2008 June 2009 Historically, the majority of local hedge funds invested in equity-based strategies, like equity long/short or equity market neutral. In recent years other strategies, most notably fixed income arbitrage, gained in popularity, bringing more diverse return drivers to the opportunity set for investors to choose from. Despite this, the number of hedge strategies on offer locally is still more limited (and more vanilla) than what you ll find offshore. In terms of financial instruments our local market does not yet offer investors as wide a variety as is available offshore, although there is continuous innovation, for example, commodity ETFs. Opportunities in certain hedge strategies that are based on these less conventional financial instruments, for example, convertible arbitrage, might thus be too limited to populate a whole fund given the limited number of convertible bonds in the local market. These ad hoc investment opportunities are most often pursued in a multi-strategy set-up and, as a separate hedge fund strategy, multi-strategy has also gained in popularity over recent years. 270 For the online version of Profile's Financial Markets Directory visit

25 Graph 2: Evolution in SA hedge strategies HEDGING STRATEGIES IN SOUTH AFRICA 100% % of industry assets 90% 80% 70% 60% 50% 40% 30% 20% 10% All other strategies Structure finance Multi-strategy Fixed interest arbitrage Equity market neutral Equity long/short 0% June 2004 June 2005 June 2006 June 2007 June 2008 June 2009 A benefit of having more strategies to choose from is that product suppliers such as funds of funds now have more scope to offer strategy-specific funds of funds. This can significantly support the strategic and tactical asset allocation process of the end investor, given the wider variety of strategies and risk-profiled solutions to optimise the portfolio blend. For example, exposure to equity long/short funds may be used to reduce the end investor portfolio s overall market risk, with the size of the allocation dependent on the existing exposure to equities. Funds of hedge funds form the largest allocator of assets to local hedge funds and this is also the preferred route for end investors to gain access to the local hedge fund industry. Graph 3: Investor profile % of industry assets 70% 60% 50% 40% 30% 20% 10% June 2006 June 2007 June 2008 June % Fund of Funds Pension Funds Life Funds High net worth Individuals Retail Other For the online version of Profile's Financial Markets Directory visit 271

26 HEDGING STRATEGIES IN SOUTH AFRICA Besides the additional di ver si fi ca tion gained for a similar investment amount, potential lower initial minimum investment amounts and access to hedge funds with limited capacity, funds of funds also offer additional value-adding services, including another level of monitoring and oversight. Hedge funds have always been accused of being opaque, but locally funds of funds have been instrumental in changing this for the better. As a result the South African hedge fund industry has over the past few years been characterised by a high level of self-regulation in an environment lacking formal legislation at product level. The monitoring process starts even before a fund of funds invests in an underlying fund, with a thorough due diligence process aimed at scrutinising all aspects of the hedge fund manager s business conduct, investment process and operational support, including the choice of service providers. It should not stop here. Continuous risk monitoring is crucial in managing and mitigating market as well as non-market related risks in the alternatives space. Indeed, when one looks more closely at the global headline-making hedge fund blow-ups, most often these problems resulted from operational, that is non-market related issues, such as fraud by fund principals. Monitoring these risks and implementing practices to prevent their occurrence are valuable services rendered by funds of funds. Local is lekker highlighting some unique features The South African hedge fund industry is uniquely positioned in certain aspects. Local hedge fund managers may apply for a specialised category license as financial services providers under FAIS legislation, which adds an additional layer of regulatory supervision. This differs from other financial services provider categories by requiring a higher level of experience, qual i fi ca tions, and financial soundness, to name a few of the specifications. It is common practice locally to use independent service providers. The ad min is tra tion of 89% of industry assets is outsourced. Prime brokers service more than 77% of industry assets and hedge funds are audited on an annual basis. Another unique feature of the local industry is the level of reporting and transparency offered to investors. Besides regular performance reporting, local investors can receive detailed portfolio holdings reporting on a regular basis. As at 30 June 2009 funds representing half of industry assets reported actual holdings to investors on a daily basis, with funds representing a further quarter of assets reporting holdings on a monthly basis. This helps investors to monitor mandate compliance and risk exposures. The investor that actually receives these reports is more often than not an intermediary like the fund of funds manager or an independent risk monitor who has the necessary in fra struc ture and expertise to deal with the information and interpret it. The local industry is thus well poised for potential changes in financial markets regulation that might call for increased transparency. Following the 2008 credit crisis regulators globally called for increased regulation and disclosure, with the ultimate goal to monitor systemic risk posed by financial institutions with a view to preventing a similar meltdown. Besides benefits to the investor, including higher risk-adjusted performance, hedge funds play an important role in financial markets. Through short selling, liquidity in markets is often improved as hedge fund activity increases the number of buyers and 272 For the online version of Profile's Financial Markets Directory visit

27 HEDGING STRATEGIES IN SOUTH AFRICA sellers in the market. This is valuable especially in markets of tightly-held shares or less researched areas of the market often overlooked by other participants. Short selling also helps increase market efficiency and price discovery. Given that its size as a percentage of total JSE capitalisation is less than 1% South Africa s industry is still small but the opportunity to grow is evident. Potential investors can take significant comfort from the way that the industry has evolved in terms of operational set-up, disclosure and reporting to investors. There s also been increased alignment of manager and investor interests, and a high level of oversight by the Regulator in terms of current hedge fund manager legislation. Local hedge funds remained strong during the financial crisis and are still offering an attractive risk-return profile to investors. They remain longer term investments requiring expertise when choosing the right fit for an investor s portfolio and a thorough understanding of the risks involved (as with any investment decision). Hedge funds have the ability to provide a cushion against market downturns, resulting in an overall smoother ride for the investor over the long term, and a better chance of meeting investment objectives. Graph 4: 5-year rolling 6-month returns of SA assets Compound return 40% 30% 20% 10% 0% -10% -20% -30% -40% SA hedge fund (weighted average) SA equities SA bonds Jun 04 Aug 04 Oct 04 Dec 04 Feb 05 Apr 05 Jun 05 Aug 05 Oct 05 Dec 05 Feb 06 Apr 06 Jun 06 Aug 06 Oct 06 Dec 06 Feb 07 Apr 07 Jun 07 Aug 07 Oct 07 Dec 07 Feb 08 Apr 08 Jun 08 Aug 08 Oct 08 Dec 08 Feb 09 Apr 09 Jun 09 Novare In vest ments (Pty) Ltd Third Floor, The Cliffs Office BLOCK 1, Niagara Way, Tyger Falls, Carl Cronje Drive, Bellville, 7530 Tel: +27 (0) Fax: +27 (0) carla@novare.co.za Web: For the online version of Profile's Financial Markets Directory visit 273

28 2009 Coming Back from the Brink By late 2006, early 2007, Central Banks around the world had moved interest rates high enough to tip monetary policy from an accommodative to a restrictive stance. The yield curves of most large economies of the world had inverted for the first time since 2000 and in affect the seeds of a sharp economic downturn of 2008/2009 were sown. Twelve months later the effects of higher interest rates around the world were going to erode away the buoyant economic conditions that the world had enjoyed since The headwinds from higher interest rates were in themselves not a particular surprise to most savvy economic commentators going into late 2007 and early By late 2007, Central Banks, led by the US, began to cut interest rates in an attempt to engineer a soft-landing in the world economy was always going to be a much slower period of growth for the world economy courtesy of the events outlined above, but the factors that tipped the world economy from being a normal monetary policy induced slow-down to The Great Recession of 2008/2009 were far less easy to predict! Factors within the US housing market were paramount in turning a bad situation in 2008, to a catastrophic near-global financial meltdown! The US housing market had enjoyed a multi-decade period of annual real appreciation of house prices. What started as a normal re-rating of an undervalued asset class in the early 90 s began to evolve into a speculative market by Banks eager to increase profit from the overheated housing market invented new ways to generate higher returns by offering leveraged products geared to the housing market to the financial institutions around the world. This speculative banking activity allowed many additional millions of first time home-owners into the over-heated market at precisely the wrong time. In affect, first time buyers that could ill-afford buying their first home, were incentivised into buying a house that was way above what it was intrinsically worth. Eventually the bubble burst in the property market and the collapsing prices caused a financial tsunami which spread around the world. Highly leveraged banks like Lehman s, that had massive exposure to the sub-prime market, began to fail and this led to tipping an already fragile global economy into a spectacular tailspin. Banks did not have the confidence to lend to each other and interbank rates spiralled, making the cost of doing business increasingly prohibitive. Credit notes, required for trade were not honoured. Global trade around the world collapsed and economic activity ground to a near halt. Major economies in the world suffered their worst recession in decades and in the case of Japan, the world s second largest economy, industrial output shrank to unprecedented levels as exports to the rest of the world dried up. The world s financial market s post the Lehman Brothers collapse, suffered a massive heart attack! Financial assets reacted rationally as the global meltdown played out. Bond yields collapsed as investors took flight and moved to the relative safety of bonds which benefit from the deflationary effects of the collapsing global economy. Equities, which are fuelled by continued growth in corporate earnings, were sold off as quickly as collapsing growth was eroding company profitability. 274 For the online version of Profile's Financial Markets Directory visit

29 2009 COMING BACK FROM THE BRINK Commodity currencies such as the Rand, Australian Dollar and the Canadian Dollar collapsed in sympathy with the falling commodity markets. By late 2008, the world was on the brink of a Global Depression matching, or even surpassing, the Great Depression of the 1930 s. Authorities had to act and act fast to prevent the meltdown from gathering momentum. As 2009 began, all the major world economies embarked on an aggressive Monetary and Fiscal response. Never before had the world witnessed such a synchronised response to an economic crisis. Across the globe, interest rates were slashed, massive banking bail-out packages were administered in an attempt to thaw out the frozen financial markets. Government lending soared as fiscal packages were rolled out in order to substitute the collapsing private sector economic activity. Tax cuts were widespread in order to try and pump-prime the embattled consumer. By early 2009, the major economies of the world had thrown virtually everything they had at the crisis and in hind-sight, many of them perhaps threw more at it than they had to. Government debt surged and a year later it continues to surge, exposing many countries overextended finances along the way. For the online version of Profile's Financial Markets Directory visit 275

30 2009 COMING BACK FROM THE BRINK Looking back at late 2008, early 2009, the battle was all about restoring confidence; confidence in the financial market, confidence in the sustainability of the banking system, confidence that banks could lend to each other without the risk of default. Once this confidence was restored, it was believed the global economy would begin to heal itself and economic activity would return. A very reliable measure of confidence can be seen in credit spreads, and by mid-2009, spreads had narrowed significantly, indicating that the credit-crisis that had paralysed the global economy had ended. By mid-2009, credit markets had thawed and global trade had begun to recover. The recovery, in no small part, was significantly boosted by an astounding rebound in the Chinese economy. Chinese authorities in early 2009, as part of their fiscal response to the global crisis, opened the taps on private sector borrowing and credit extension surged. Chinese imports surged and commodity prices and freight rates rebounded spectacularly. As 2009 progressed, fears of an extended deflationary cycle began to abate, economic activity began to stabilise in most major economies and by the last quarter of 2009 growth began to resume in earnest. Industrial production started to accelerate, confidence indicators began to increase and remarkably even consumer related activity began to recover. The ultra-low global interest rate environment that was rapidly put in place during the heat of the crisis in 2008 had begun to work. Debt-servicing costs were slashed on the back of the lower rates and unemployment rates stopped deteriorating. By the end of 2009 the global economic recovery was well on track! Looking back at 2009, financial assets once again appeared to have acted rationally. The strong bond market performance during the heat of the crisis of late 2008, gave way and bond markets entered a significant bear market, underperforming cash and equities through 2009 as bond yields normalised at higher levels. The Equity rally of 2009 may be regarded as The most disbelieved rally of all time but as the year progressed, once again the reasons for the rally became increasingly obvious. Global economies are exhibiting a V-shaped recovery and company profitability is being steadily restored. Equally as compelling were the very appealing valuations that equities were on during the eye of the storm in late For the online version of Profile's Financial Markets Directory visit

31 2009 COMING BACK FROM THE BRINK For the first time in recent memory investors could pick up offshore equities that were yielding higher dividend yields than bond yields. Price to Book ratios were the lowest in decades and the P/E ratios were considerably more attractive than in recent years. With the crystal clarity of hind-sight, if investors could overcome the fear of the unknown going into 2009, equities presented them with the best buying opportunity in decades! Equity index earnings have collapsed through 2009 as a product of the economic recession of Going into 2010, earnings will recover quite strongly, particularly in banking and commodities and cyclically related industrial stocks. Unfortunately valuations are not anywhere near as attractive as they were in early The average historical P/E ratio of the equity market is now quite expensive, so strong earnings recovery is likely to be the only source remaining for continued equity outperformance relative to the competing asset classes of bonds and cash. The significant equity outperformance witnessed in 2009 is therefore unlikely to be repeated going forward. Saying that, the global and local economic recovery continues to gather momentum into 2010, fuelled by excess global liquidity courtesy of continued aggressive monetary policy and further aggressive fiscal stimulus packages. China and the rest of the emerging market economies that have exhibited an ability to decouple from the developed economies, are likely to show continued strong growth. These factors combined are likely to ensure that the global economy continues to recover through To this end, those companies that are geared to the recovery should continue to see outperformance, albeit at a slower pace than in The overriding risk that overhangs sustained economic recovery is the massive accumulation of debt across many parts of the world. Debt to GDP ratios in many major countries has ballooned since 2008 and in the case of the US, exceed levels of debt reached prior to the 1930 s. The sustainability of this situation is uncertain. It is unlikely that in the short-term, with benign inflationary pressures and excess global liquidity, that this should present an immediate problem. In the long-term, both governments and consumers are going to have to retire debt. This will provide longer term headwinds to the sustainability of above trend growth. For the online version of Profile's Financial Markets Directory visit 277

32 2009 COMING BACK FROM THE BRINK On a more positive note, the continued in dus trial is ation and urbanisation of China, India and other emerging economies can provide an alternative growth engine to take up the slack from the indebted developed economies. South Africa lagged the global economy on the way down in 2008 but entered its first recession during Aggressive monetary policy will ensure that the South African economy gathers momentum as 2010 continues. Already buoyed by improving commodity prices through 2009, mining related activity will improve through the year. The consumer is likely to respond favourably to the lower interest rates and we would envisage private sector consumption returning in the second half of The Rand is currently overvalued on the back of significant offshore portfolio flows that returned on the back of renewed interest in emerging markets. We would not anticipate further strength from the Rand going forward, despite a favourable view of the global economy. OBSIDIAN CAPITAL Richard Simpson Tel: Cell: Fax: rsimpson@obsidiancapital.co.za 278 For the online version of Profile's Financial Markets Directory visit

33 The South African short term insurance industry Compiled by Melanie Brown and Patricia Zvarayi The year 2009 provided little relief for the industry, as the underlying economy remained inhibited and liquidity conditions tightened further. While interest rates have declined by a cumulative 600 basis points from June 2008 to date, and the economy is technically out of the recession, real GDP contracted by 1.8% in As such, the moderate premium growth registered by the short term insurance industry in 2008 is forecast to have persisted in Despite the declining rates of return on money market securities, the recovery of the stock market underpinned the growth of balance sheets on the back of unrealised gains. Depressed economic performance, low levels of disposable income among individuals and earnings pressure on businesses have made it difficult to achieve appropriate rate increases and led to a degree of volume attrition. Accordingly, gross premium income growth is estimated to have decreased to 6% in 2009 (2008: 7%), translating into industry GPI of around R60bn. Consumer price inflation ( CPI ) of 6.3% in December 2009 and the abovementioned economic contraction suggest that market penetration remains low, at around 3%. Although still holding dominant shares, Santam and Mutual & Federal (M&F) continue to lose market share, largely to the direct market. This notwithstanding, they still jointly account for about 35% (excluding subsidiaries) of domestic gross premiums written (from 50% in 2001). Over the same period, the four largest insurers (Santam, M&F, Zurich and Hollard) collective market share has progressively declined from 60% to 52%. Notwithstanding the growth achieved by bank-aligned and direct insurers (through affinity marketing, product innovation and improved distribution lines), the top eight insurers (each with premiums in excess of R2bn) accounted for a combined 74% stake, six percentage points lower than the market share reported in More recently, declining disposable incomes, compounded by high interest rates prevalent in 1H 2008 and tighter lending on vehicle and property sales have constrained motor and fire premiums (which typically account for in excess of 75% of GPI). Success achieved in specialist lines in recent years is expected to underpin industry growth in the medium to long term, as players diversify risk by penetrating higher margin niche markets, while continued lending restrictions in the face of moderate economic growth should check the progress of traditional lines of business despite the enabling interest rate environment. The years 2008 and 2009 saw a further narrowing of the industry underwriting margin from the 12% high reported in 2004, largely owing to a higher incidence of motor and property claims. In particular, 1H 2009 witnessed a substantially higher incidence of industrial accidents and fires, which exerted pressure on property books, with insurers unable to price adequately for risk. The frequency of motor accidents continues to increase, with accident damages accounting for over 70% of claims. This is exacerbated by above inflation increases in repair parts, driven by technological advancements and a volatile Rand. The rising number of vehicles on the road, inadequate road in fra struc ture, along with inexperienced and unlicensed drivers, point to a persistent, systemic problem. Currently, a low 30% of all vehicles are estimated to be insured, as there are no standing regulations governing vehicle or accident cover. For the online version of Profile's Financial Markets Directory visit 279

34 THE SOUTH AFRICAN SHORT TERM INSURANCE INDUSTRY * 2009 figures are GCR estimates. As predicted, NPI growth slowed to 9% in 2008 (2007: 12%), and is estimated to have declined further to around 7% in While about 85% of net premiums written were derived from motor and property lines, growth was underpinned by niche markets, with the engineering class registering strong improvements in revenue. It was further noted that the reallocation of the miscellaneous class over the last 18 months has given rise to further improvements in other classes, distorting growth statistics. Not with stand ing the prevailing low interest rate environment, it is likely that growth will remain moderate in the medium term in the face of constrained disposable incomes and profitability. The ratio of reinsurance premiums to GPI declined to 24% in 2008 (2007: 26%) and is expected to have decreased moderately in While larger insurers maintained the largest retention on their motor, property and accident books in order to broaden margins, smaller insurers increased their reinsurance in the face of higher risk. Reinsurance rates should harden in the medium term in keeping with global trends and the increased perception of risk in the domestic market, which should see international reinsurers become more selective about the type of risk they are willing to absorb. The higher cost implications of reinsurance, coupled with volatility evidenced in retained earnings is expected to keep retention ratios relatively flat going forward. * 2009 figures are GCR estimates. 280 For the online version of Profile's Financial Markets Directory visit

35 THE SOUTH AFRICAN SHORT TERM INSURANCE INDUSTRY As predicted by GCR, the industry claims experience continued to worsen in F08, with the earned loss ratio rising from a low of 60% in 2004 to 66%. Not with stand ing the continued refining of provisions to cater for changes in risk profiling, the loss ratio is expected to have risen further to around 68% in 2009, driven by the high volume of claims experienced by multiline insurers. The above-mentioned factors (which include general cost inflation) should continue to drive loss ratios going forward. * 2009 figures are GCR estimates. The net commission ratio increased to 12% in 2008, from 11% previously. GCR estimates that commission costs to earned premiums increased to around 13% in The upward trend evidenced was primarily owing to higher retention levels and a reduction in reinsurance commissions. Positively, the industry successfully contained management costs through various rightsizing measures. This saw the management expense ratio decline to 17% in 2008, from 18% in Not with stand ing increased marketing pressures, GCR envisages that the management expense ratio improved to 16% in Overall, the delivery cost ratio, which reached 29% in 2007, is expected to have remained largely unchanged in An overall underwriting result of R2.2bn was achieved in 2008, down 18% from Driven by the deteriorating claims experience, this translated to an underwriting margin of 5.4% in 2008 (2007: 7.2%). The underwriting margin is expected to have declined further to around 4% in 2009, driven by the tough economic and poor underwriting conditions, particularly in the first six months. Following the significant fire losses registered in 1H 2009, corrective action taken by some of the larger players in the second half of the year stemmed further losses, which together with continued profitability in the direct market supported a positive underwriting result. The industry is expected to maintain underwriting profitability for the tenth consecutive year in 2010, albeit that the underwriting margin has declined significantly from the 12% high reported in For the online version of Profile's Financial Markets Directory visit 281

36 THE SOUTH AFRICAN SHORT TERM INSURANCE INDUSTRY * 2009 figures are GCR estimates. The marked volatility in capital markets saw insurers suffering substantial losses on stock portfolios in While the industry evidenced some movement in investment weightings in favour of less volatile money market investments in 2009, an appreciable recovery in the stock market drove an improvement in investment income (including unrealised losses/gains). As such, although the industry reported a decline in ROaA and ROaE to 14% and 33% respectively in 2008 (2007: 18%; 43%), these rates are envisaged to have improved marginally in Going forward, it is expected that a shift in investment portfolio weightings will take place as insurers try to balance out investments to take advantage of the recovery in capital markets. * 2009 figures are GCR estimates. In light of the global credit crisis and the increased volatility experienced on stock exchanges, it is not surprising that increased emphasis has been placed on capital management. As mentioned, one of the first steps entailed the rebalancing of investment portfolios to reduce the capital required to back market volatility exposure. In addition, an ever increasing number of insurers are making use of derivatives to hedge the performance of their equity portfolios. Effectively this will result in insurers not receiving the full benefit from a strong recovery in equity prices. There is also a lot of speculation on the timing of re-entering the equity markets, as over many years, South African insurers reported good returns from investing shareholder capital on the equity markets. 282 For the online version of Profile's Financial Markets Directory visit

37 THE SOUTH AFRICAN SHORT TERM INSURANCE INDUSTRY Insurers focus on capital efficiency saw the industry international solvency margin decline consistently from In 2008, equity market volatility saw solvency decline further to 48%, from 50% in 2007, whilst the statutory ratio declined to 38% (2007: 40%). It is envisaged that the latter improved to 40% in 2009 and that the industry international solvency measure has risen to around 50%. The financial base ratio (including technical reserves) eased to 96% in 2008 (2007: 97%) and is expected to have improved marginally in 2009, to reflect modest changes in reserving and retained earnings. * 2009 figures are GCR estimates. Going forward, economic recovery is expected to be moderate; with GDP growth for 2010 forecast at just 2.3%. This is premised on the possibility of a second global recession, volatile international commodity prices and constrained domestic output. This not with stand ing, increased demand for medical, motor and property insurance should support growth in the short term, helped by positive sentiment from the 2010 World Cup. However, the economic recovery is likely to be gradual and the pressure on disposable income among individuals and earnings pressure on businesses will continue to make it difficult to achieve the appropriate rates for risks insured. The increased frequency of large industrial accidents and fire claims are also a loss driver. In terms of net premium, statistics show that the short term insurance industry is expected to grow at a CAGR of about 10% between , with growing demand for liability and engineering insurance supportive of future growth. Overall profitability in the short to medium term is not, however, expected to reach the highs reported pre The move to a risk based capital model should see significant changes in solvency and reserving in the medium to long term. However, the impact is likely to vary substantially from one company to the next, depending on current capitalisation levels and business mix, amongst other factors. While initial challenges are envisaged, the new regulatory solvency framework should result in improved risk management and more effective use of capital, conditions necessary to ensure sustainable profitability in the long term. For further in for ma tion, please contact the insurance division at GCR on For the online version of Profile's Financial Markets Directory visit 283

38 JSE launches an XBRL financial reporting portal Encouraged by leading stock exchanges and welcomed by analysts and investors alike, XBRL financial reporting is likely to become part of every financial director and investor s daily lives. Like many other stock exchanges, the JSE is set to introduce a financial online reporting portal which will allow listed companies to file their financial reports using XBRL. The introduction of this portal will allow for faster, simpler access to company information for both investors and analysts. What is XBRL? XBRL stands for extensible Business Reporting Language, and is an electronic language used for the communication of business and financial data. The original concept that continues to form the backbone of XBRL is the creation of a global standard that permits each piece of data contained within corporate financial reports, such as the primary financial statements or the notes and schedules to the financials, to be tagged with what is perhaps best described as a bar code. This tagging allows consumers of information to immediately pull out the exact information they want, and instantly compare it to the results of other companies. This includes performance in past years, industry averages in whichever way the consumer wishes to slice and dice the data. In essence, XBRL allows the user to aggregate, compare and present information in many different formats which vastly enhances the usability of the information inside and outside the organisation. This offers great advantages to listed companies, analysts, investors as well as for regulators and financial journalists. The JSE s XBRL Financial Portal In ter na tion ally, equity exchanges and regulatory authorities including the US Securities Exchange Commission, Deutsche Boerse and Tokyo Stock Exchange have embraced XBRL. While South Africa was one of the first countries to embrace International Financial Reporting Standards (IFRS), but it has been slow to recognise the benefits of XBRL. The local entity of XBRL is being driven by XBRL South Africa (which is under the auspices of SAICA), a non- profit organisation, of which the JSE is a member. Its primary objectives are to promote and create awareness of the use of XBRL in South Africa and to create taxonomies for South African specific reporting requirements, such as the additional reporting requirements of the SA Companies Act over and above IFRS standards. Like other financial portals hosted by exchanges, this online digital reporting filing platform would be voluntary and complementary to existing financial reporting. Promoting XBRL is in line with the JSE s efforts to continually innovate, encourage greater market transparency and improve efficiencies in the preparation and communication of financial information, comments Freda Evans, CFO at the JSE. Providing an online reporting portal should make it easier for listed companies to report using XBRL. The portal will have a secure login for financial staff to load their financial data and separate login for investors and analysts to download this data. The portal is designed to be as user-friendly as possible using numerous prompts and a how-to guide for users. Our intention is to provide a valuable service to our listed companies, rather than adding to their reporting requirements, adds Evans. 284 For the online version of Profile's Financial Markets Directory visit

39 JSE LAUNCHES AN XBRL FINANCIAL REPORTING PORTAL Benefits for listed companies There are numerous reasons why companies should consider reporting using XBRL: Attract foreign investment Perhaps the most compelling reason to use XBRL financial reporting is the ability to communicate better in international capital markets. As XBRL is becoming a global standard, regardless of language or location, the information embedded in XBRL data tags will allow international investors to read and analyse any financial statement. Companies whose financials are tagged will likely get the largest share of analysts attention as innovators and market leaders while non-xbrl friendly competitors will be marginalised. Less time and lower costs If implemented correctly, XBRL has the potential to cut hours of waste, cost and inefficiency not just for users of financial data but also for the companies that prepare it well. While the im ple men ta tion of XBRL has technological and training requirements, in the long term it will save the company money. Reduced errors Because computers can read information presented in an XBRL format, it means that the information can be transferred without being manually recaptured. As data is tagged when transferred, errors associated with manual data entry are eliminated, thus freeing up valuable company resources. Multiple uses for data Once data is gathered in XBRL, different types of reports using varying subsets of the data can be produced with minimum effort. A company finance division, for example, could quickly and reliably generate internal management reports, financial statements for publication, tax and other regulatory filings, as well as credit reports for lenders. Companies can benchmark Listed companies can now benchmark themselves against their industries/sectors and peers far more easily. Internal reporting Just as investors and analysts can reap the benefits of XBRL, a company could also utilise this in its internal financial reporting processes for example in con sol i da tions. Benefits for investors and analysts Whether they are locally based or international, investors and analysts will ultimately benefit from XBRL reporting. Lower cost to acquire information Large investment firms will be able to reduce costs through the use of computer extraction without the need for translation or manual checking. By going direct to the source of the data, rather than through an intermediary, they will stand to save both time and money. Human effort can switch to higher, more value-added aspects of analysis, review, reporting and decision-making. In this way, investment analysts can save effort, greatly simplify the selection and comparison of data, and deepen their company analysis. For the online version of Profile's Financial Markets Directory visit 285

40 JSE LAUNCHES AN XBRL FINANCIAL REPORTING PORTAL Allows for quick and easy comparisons Investors and analysts may use the tagged data in online databases to screen companies according to certain financial criteria, or they may use it to make valuation projections and assess whether a company s stock is over- or under-valued. Individual investors will benefit when online data providers provide information in XBRL format that can be easily rendered and used in Excel format with the click of a button. Enhanced ability to compare data XBRL means that they will be able to value a company quicker and to quickly and accurately analyse multiple companies within an industry, which improves efficiency dramatically. Analysts will also have the ability to accurately and easily compare multiple companies over an historical timeframe. For investors, XBRL will mean improved accuracy, integrity and immediacy of data. This includes an increased ability to compare companies across time periods, sectors or countries. XBRL also has the functionality to allow for automated analysis and flexible modelling. Improved screening of data Software can also immediately validate the data, highlighting errors and gaps which can immediately be addressed. It can also help in analysing, selecting, and processing the data for re-use. For more in for ma tion about the XBRL financial portal please XBRL@jse.co.za 286 For the online version of Profile's Financial Markets Directory visit

41 An overview of the JSE s Currency Derivatives Contracts In response to the market s need for an on-exchange tool to hedge against currency risk, the JSE s launched currency futures in Trading in currency derivatives allows companies and individuals to successfully hedge against foreign exchange exposure as well as take a view on the movement of the underlying exchange rate. Currency futures were launched as a retail investment product and were only available for individual investors. Then, in his 2008 budget speech, Trevor Manual the previous Minister of Finance made a special dispensation that allowed all South African corporate entities to trade currency futures. Corporate entities, including limited or unlimited companies, private and public companies, close corporations, partnerships, trusts, hedge funds and banks are authorised to trade currency futures with no restrictions on the value traded. Corporate entities do not need to apply to Reserve Bank for approval to trade the currency futures nor do they have to report their trades. Pension funds are subject to their foreign portfolio allowances. The JSE s currency derivatives products have experienced significant growth in over the past three years. Currency options were launched in 2008 and are complementary to the existing currency futures market. The introduction of currency options increased both trading volumes and liquidity in the local currency derivatives market. The JSE currently offers the following currency futures and options contracts: Dollar/Rand Euro/Rand Sterling/Rand Australian Dollar/Rand Japanese Yen/Rand Canadian Dollar/Rand Currency Futures A currency futures contract is a contract that allows market participants to trade the underlying exchange rate for a period of time in the future. Currency futures are agreements between two counterparties where one counterparty buys (longs) the underlying exchange rate and the other sells (shorts) the underlying exchange rate on a specified future date. The underlying instrument of a currency future contract is the rate of exchange between one unit of foreign currency and the South African Rand. Currency futures are contracts that allow participants to take a view on the movement of the exchange rate as well as hedge against currency risk. Currency futures will be used as a trading, speculating and hedging tool by all interested participants. Here is a simple exchange of how an import business can use currency futures to hedge against foreign exchange risk. Say ABC Importers is a South African company that imports goods from the United States. The company is due to import goods from the states to the value of $ in three months time. In order to hedge against the risk of a depreciating rand, ABC Importers can purchase a currency future contract now, in doing For the online version of Profile's Financial Markets Directory visit 287

42 AN OVERVIEW OF THE JSE S CURRENCY DERIVATIVES CONTRACTS so, lock in the current exchange rate of R One contract is worth $1000, so the company buys 70 contracts at $ or R at the stated exchange rate. Fortunately, the contract does not require ABC Importers to deposit the full amount but rather a small percentage of the amount called an initial margin amount in this case R (R310 x 70 contracts) as well as a brokerage fee negotiated with the company s broker. Three months later, when the company is due to pay the amount to the manufacturers in the states, the rate has moved to R7.9635, which will cost the company an extra R (R R X $70 000). Fortunately, the company has made a counteractive profit of R on the currency future contracts. The company can now sell the contracts and use the profit to offset the increased cost of the goods. Currency Options Like currency futures, currency options allows investors and speculators to benefit from the movement of the Rand against other currencies, but differ in that they come with a built-in insurance policy where the investor is able to resign a contract at any point in the contract term. In other words, currency options are contracts that grant the investor the right but not the obligation to buy or sell currency at a set rate at a set time. This means is that Currency Options allow the investor the choice not to exercise the contract if the exchange rate is not in his or her favour. Risk of trading Currency Derivatives No investment or trading product can offer returns without the investor having to assume some risk. The main risk associated with currency futures trading is attributable to the effect that gearing or leverage has on a position. A geared transaction is simply the deposit of a smaller amount of cash, but being exposed to the full value of the transaction. Investors deposit the initial margin amount but are exposed to the full nominal value of the contracts traded. Gearing can cause significant profits or losses on a currency future position in a short period of time because of the effect of any movement in the underlying currency. The profits and losses on the underlying currency can be up to ten times more than on the future. To find out more about the trading op por tu ni ties this market offers to both private and pro fes sional traders contact the JSE Currency De riv a tives Team on or currencies@jse.co.za 288 For the online version of Profile's Financial Markets Directory visit

43 The evolution of an asset class Commodities trading in South Africa began with the disbanding of the state-controlled agricultural boards in 1995 and the establishment of the Agricultural markets Division (AMD) of the South African Futures Exchange (SAFEX). For the first time, the AMD of SAFEX provided South African farmers with a tool for price risk management and price discovery for agricultural products. Then in 2001, SAFEX was acquired by the JSE Limited and became the Agricultural Products Division. This was line with what has happened in agricultural markets across the world in a globalising world economy, where costly agricultural subsidies have failed, as also have state-controlled marketing boards. This trading of agricultural derivatives facilitates marketing and price determination whilst ensuring price transparency in the local agricultural market. However the main objective of a derivatives market is the provision of an efficient price risk management facility. Producers and users of agricultural commodities are able to limit their exposure to adverse price movements resulting from changing weather patterns, currency fluctuations and regional and international product shortages, by hedging their price risk and locking in favourable prices on a guaranteed basis. This results in increased productivity in the sector as farmers and users are able to concentrate their efforts on managing production risks such as those caused by seasonal conditions, the weather and farm/production management. Farmers who have hedged a portion of their price risk can access funds from financial institutions at cheaper rates than would otherwise have been offered as these institutions are assured of reduced price risk profiles when dealing with such clients. In fact, the agricultural derivatives market has developed to such an extent that the cash market now largely relies on its price transparency and discovery process to function properly. Prices generated on the derivatives market are now considered to be the industry standard and reference point throughout Southern Africa. In fact this has given rise to an interesting and somewhat anomalous phenomenon. Whereas futures contracts are labelled derivatives because their prices are derived from their spot or physical markets, in South Africa the spot prices are largely derived from their futures prices. In October 2009, the division underwent another step in its evolution and was renamed the Commodities Division to signify a broadening of exchange traded commodities offered at the JSE. This does not mean that division will disinherit its roots. Agricultural products will always remain a core focus for us because agricultural commodities, especially grain, are central to the South African economy. We will continue to serve the agricultural market, but have also broadened our commodities range to offer the South African investor increased investment opportunities, says Rod Gravelet-Blondin, Senior General Manager of Commodities at the JSE. For the first time from October 2009, local investors were able to trade in gold, platinum and sweet crude oil commodities listed on the JSE s commodity derivatives market. The introduction of these commodities is due to an extension of the existing licensing agreement that the JSE holds with the CME Group, the world s largest derivatives market. For the online version of Profile's Financial Markets Directory visit 289

44 THE EVOLUTION OF AN ASSET CLASS With the extension, investors are now able to trade in futures contracts referencing benchmark gold prices from the CME Group s COMEX exchange and platinum and crude old prices from its NYMEX exchange. Expanding the existing relationship with CME Group to incorporate these additional products is an achievement for the South African derivatives market, says Rod Gravelet-Blondin, head of the Commodity Derivatives Market at the JSE. South Africa is the world s largest platinum producer and third largest gold producer and so it made sense that we needed to offer South African investors related futures products which they could use either to gain exposure or hedge their exposure to a listed equity stock involved in the two commodities. The gold and platinum settlement prices from NYMEX and COMEX, two highly liquid exchanges, will ensure that the locally listed contracts reference an international benchmark for final settlement. This will bring much comfort to investors who will be able to access the international market via these rand-denominated contracts. While the metals contracts are more likely to appeal to sophisticated investors and gold and platinum producers using them to hedge their production, any South African can trade these through a JSE registered commodities broker. The smaller contract sizes, for instance a crude oil contract could be obtained for only 100 barrels while in New York the contract minimum is 1000 barrels, which makes these attractive to the local investor. We are particularly excited about the opportunities that a crude oil contract offers. Oil has a knock-on effect on all sectors of the economy. Notably, as diesel is a major cost in farming, this will give our agricultural market a tool to hedge a major input cost. We also expect interest from many other industries, from transport to manufacturing, adds Gravelet-Blondin. Benefits Contracts are rand-denominated and settled in Rands Smaller contract sizes adapted for the South African market No foreign exchange permission required for corporates and individuals Trading on the exchange offers guaranteed settlement, transparency and daily revaluation of positions Uses of trading these commodities derivatives contracts: These new contracts offer local investors hedging and speculative avenues including the following: Hedging The two metal commodities are bound to be of interest to local investors as South Africa is the world s largest platinum producer and the third largest gold producer. These two commodities reference the international market for prices which could be used to hedge the share prices of gold and platinum mining stocks listed on the JSE, South African investors are now able to hedge their mining investment risk in these companies. Platinum and gold mining companies will now have another alternative hedging tool for their local production. Oil has a knock-on effect on all sectors of the economy. Diesel is a major input cost in farming, manufacturing and transport. These industry sectors will be able to hedge their oil component against fuel price fluctuation through the sweet crude oil contract. 290 For the online version of Profile's Financial Markets Directory visit

45 THE EVOLUTION OF AN ASSET CLASS Speculation A weak dollar and recent inflation fears in the US have fuelled demand for mining stocks, particularly gold. South Africans keen to speculate will be able to take a position on the movement of the international gold and platinum price in Rand terms. These contracts give local investors an opportunity to access off-shore exposure. The risk factor No investment trading product can offer returns without the investor having to assume some risk. The JSE cautions that as with any other investment product, investors need to be aware of the risks associated with trading these commodities futures contracts. About the CME Group Building on the heritage of CME, CBOT and NYMEX, CME Group serves the risk man age ment needs of customers around the globe as the world s largest and most diverse de riv a tives mar ket place. The exchanges within the Group offer products across all major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, ag ri cul tural com mod i ties, metals, weather and real estate. Full contract specs on the three contracts are available on or com mod i ties@jse.co.za. To find out more about investing in these in ter na tional commodity de riv a tives please contact your broker. To find out more about the trading op por tu ni ties this market offers to both private and pro fes sional traders contact the JSE Com mod i ties De riv a tives Team on or commodities@jse.co.za For the online version of Profile's Financial Markets Directory visit 291

46 BEHIND THE SCREENS WITH THE JSE S EQUITY DERIVATIVES DIVISION Behind the screens with the JSE s Equity Derivatives Division Derivatives markets play an important role in the transfer of risk from those wishing to avoid it to those prepared to take risk in the hope of a substantial reward. Trading risk has taken place for centuries, only recently through stock exchanges. However on-exchange trading provides clients with transparency and price discovery. It can also eliminate counterparty risk. The development of exchange-traded derivative instruments in South Africa started in the late 1980 s when local investment bank Rand Merchant Bank started trading contracts on various equity indices and long bonds. This was followed, in September 1988, by twenty one financial institutions meeting to establish the South African Futures Exchange (Safex) and the Safex Clearing Company (Safcom). Due to new legislation in 1990, namely the Financial Markets Control Act of 1990, Safex was officially licensed as a derivatives exchange. Safex was acquired by the JSE in July The JSE acquired Safex in July 1991 and agreed to retain the Safex branding and to create two divisions Safex Financial Derivatives and Safex Agricultural Derivatives. Safex Agricultural Derivatives is now known as JSE Commodity Derivatives Division while Safex Financial Derivatives is now called JSE Equity Derivative Division. Today, the JSE s Equity Derivatives market provides a platform for trading futures, options and other more sophisticated derivatives instruments. While the equity derivatives market is primarily used by professional investment managers, they often have a great appeal to the private investor. Such parties must however, ensure that they enter the markets with their eyes open, as the rewards may be high, but the downside can be equally enormous. Before becoming involved in derivatives, potential participants must examine their motives for using the products offered. Generally speaking there are four broad categories of market participant: hedgers who use those who use futures and options to protect an existing portfolio against possible adverse market movement; arbitrageurs who profit from price differentials of similar products in different markets investors who use futures and options to enhance the long-term performance of a portfolio of assets; and speculators who use futures for short-term profits. Futures and options are very useful tools for those in categories 1 to 3. They can also be excellent tools for speculators, but the pitfalls are great and the inexperienced must beware. On the face of it, the chances of making a profit or loss when speculating in futures appear to be equal. Furthermore, speculating in futures can be more dangerous than speculating in shares, because of the gearing effect. With shares the most you can lose is what you pay initially, whereas with futures you can lose multiples of your original outlay. 292 For the online version of Profile's Financial Markets Directory visit

47 BEHIND THE SCREENS WITH THE JSE S EQUITY DERIVATIVES DIVISION The regular ad min is tra tion of margins prevents participants from accumulating large unpaid losses, which could impact on the financial position of other market users (systemic risk). Such margining systems do not exist in over-the-counter (OTC) markets. It is important to protect and safeguard clients interests.. For this reason, regulation plays a crucial role. The Equity Derivatives market is overseen by the Financial Services Board and controlled in terms of the Financial Markets Control Act (1989). Certain regulatory activities include the registration of all members and clients, strict financial requirements for members and regular inspection of members records and procedures. Derivatives products available Single Stock Futures Single Stock Futures are derivative instruments that give investors exposure to price movements of an underlying financial instrument (shares). A futures contract is a legally binding agreement that gives the investor the right to buy or sell an underlying listed share at a fixed price on a future date. Equity Options An option is a derivative instrument that gives the investor the right (not the obligation) to buy (call option) or sell (put option) shares at a fixed price on a future date. Options provide a cost-effective way of obtaining a large amount of exposure with very little risk. Equity Index Futures Equity Index Futures give investors exposure to price movements of an underlying Index. Participants can invest in a basket of equities without trading the individual constituent equities. A futures contract gives the investor the right to buy/sell an underlying listed financial instrument at a fixed price on a future date. Variance Futures Variance Futures are contracts that obligate the holder to buy or sell variance at predetermined variance strike price at a specified future time. Dividend Futures Dividend Futures (DIVF) are derivative contracts used to hedge against dividend risk that accompany trade in Single Stock Futures (SSF s). These contracts are booked in conjunction with a relevant SSF and offer a simple transaction to enable investors to protect themselves against any perceived dividend risk. International Derivatives (IDX) International Derivatives (IDX) give investors exposure to price movements of in ter - na tion ally listed shares. Investors are able to trade Single Stock Futures on in ter na tion ally listed companies without the restrictions associated with exchange control regulations or the expense of setting up foreign trading accounts. The IDX range of products listed on the JSE includes SSFs on companies such as Nokia, LVMH Moet Hennessy Louis Vuitton, Bank of America, Apple and Berkshire Hathaway. For the online version of Profile's Financial Markets Directory visit 293

48 BEHIND THE SCREENS WITH THE JSE S EQUITY DERIVATIVES DIVISION Can-Do Futures and Options Can-Do Futures and Options are derivative products that give investors the advantages of listed derivatives with the flexibility of over the counter contracts. Investors can negotiate the terms of an Options contract, choosing the underlying asset as well as the expiry date. The market will always require innovative derivatives, but due to the global financial crisis it also requires additional regulation, oversight and security which these on-exchange instruments provide. In response to this market need, trade in Can Do derivatives, which offer the flexibility of OTC instruments but the regulation of on-exchange derivatives, jumped by 25%. To find out more about the trading op por tu ni ties this market offers to both private and pro fes sional traders contact the JSE Equity De riv a tives Team on or derivativestrading@jse.co.za 294 For the online version of Profile's Financial Markets Directory visit

49 Introducing the JSE s Interest Rate Division s Derivatives Products The JSE s Interest Rate Division provides investors with the opportunity to trade interest-rate products in both the cash and the derivative markets. Interest-rate derivatives allow market participants to hedge against adverse movements in the level of rates. As a part of the growth strategy for the division, the JSE plans to introduce more derivatives products in the near future. The following two interest rate futures have been created in response to the market s need to manage interest rates effectively within the regulated trading environment that the JSE offers. Bond futures Bond futures are conventional, fully margined, physically settled, futures contracts defined on R 100,000 nominal of each of the exchange s spot bonds. The near, middle, far and special contracts are listed at any time. Longer dated contracts may be listed from time to time if there is demand. The contracts trade on yield to maturity for settlement on their delivery dates. They are physically settled on the t+3 date of their expiry date. The settlement price is found from their closing yield to maturity, using the standard bond pricing formula. There is a daily explicit mark-to-market to the value determined from the bond pricing formula at the day s mark-to-market yield to maturity. Hedgers use bond futures to protect an existing portfolio against adverse interest rate movements. Hedgers therefore seek to reduce risk. Hedgers have a real interest in the underlying spot bonds and use futures as a way of preserving their value. Arbitrageurs profit from price differentials of similar products in different markets, for examples price differentials between the spot bonds and the futures. Investors use bond futures to enhance the long-term performance of a portfolio of assets. Speculators use bond futures in the hopes of making profit on short-term movements in prices. Speculators therefore seek to enhance risk with the aim of making a profit. Speculators have no interest in the underlying spot bond market other than taking a view on the future direction of the bond s price. JIBAR Futures In the South African financial markets, JIBAR (Johannesburg Interbank Agreed Rate) is used as the barometer of short-term interest rate movements. JIBAR is an average rate (determined from borrowing and lending rates) that is independently derived from quotes obtained from a number of different banks for one, three, six and twelve month terms. In particular, the 3 month JIBAR rate is used as a benchmark and is quoted as a yield and disseminated to the market on a daily basis. Aimed at the institutional investor and professional trader, the 3 Month JIBAR Futures contract is future created by the JSE s Interest Rate Division. The future is based on the JIBAR rate and represents an efficient way to obtain exposure to the South African interest rate markets. The 3 Month JIBAR futures can be used to speculate on the future direction of interest rates, manage money market portfolios, hedge OTC derivatives such For the online version of Profile's Financial Markets Directory visit 295

50 INTRODUCING THE JSE S INTEREST RATE DIVISION S DERIVATIVES PRODUCTS as FRAs and interest rate swaps, hedge borrowings and investments, arbitrage and manage interest rate risk inherent in a futures portfolio. If a trader expects interest rates expected to fall, he would go long and buy a JIBAR Future. On the contrary, if a trader expects interest rates to rise, he would go short and sell a JIBAR Future. A futures position can be closed out by entering into an opposite trade. Thus a long position can be closed by selling an equivalent contract or letting it expire. The difference between the purchase and sale price represents the profit or loss of the position. To find out more about the trading op por tu ni ties this market offers to both private and pro fes sional traders contact the JSE Interest Rate Division on or interestrates@jse.co.za 296 For the online version of Profile's Financial Markets Directory visit

51 Key Performance Indicators for the twelve months ended February 2010 Snapshot of Global and Local Stock Market Performance Major Global Indices Market Index Feb 2009 close United States Feb 2010 close 12 month move (%) Dow Jones Industrial Average % Nasdaq Composite % S&P % Currency United Kingdom FTSE % GBP Japan Nikkei % JPY Germany Dax % EUR France Cac % EUR Australia S&P/ASX % AUD China Shenzhen A % Shenzhen B % Hong Kong Hang Seng % HKD Canada S&P/TSX Composite % CAD Switzerland Swiss SMI % CHF Europe Dow Jones EURO STOXX % USD Brazil Bovespa % BRL Emerging markets MCSI Emerging Markets % USD Developed markets MCSI The World % USD CNY Indices for selected SADC countries (excluding South Africa) Market Index Feb 2009 close Feb 2010 close 12 month move (%) Currency Mauritius SEMDEX % MUR Namibia FTSE/Namibian Overall % NAD Botswana Botswana Gaborone Index % BWP Selected African Markets Market Index Feb 2009 close Feb 2010 close 12 month move (%) Currency Nigeria Nigeria Stck Exc All Shr % NGN Egypt EGX % EGP Kenya All Share % KES For the online version of Profile's Financial Markets Directory visit 297

52 KEY PERFORMANCE INDICATORS FOR THE TWELVE MONTHS ENDED FEBRUARY 2010 South African Indices Index Feb 2009 close Feb 2010 close 12 Month move (%) All Share % Industrials % Financials % Resources % Gold Mining % AltX % All Bond % Selected South African fixed income securities Issuer Bond Feb 2009 yield South African Government Commodities Feb 2010 yield 12 Month change (bp) R R Commodity Feb 2009 close Feb 2010 close 12 Month move (%) Gold (NY) USD USD % Platinum (London) USD USD % Oil (Brent) USD44.57 USD % Copper (Comex) USD USD % Currencies Exchange Rate Feb 2009 close Feb 2010 close 12 Month move (%) USD/ZAR R10.06 R % GBP/ZAR R14.17 R % EUR/ZAR R12.61 R % USD/GBP GBP0.70 GBP % USD/EUR EUR0.79 EUR % ZAR/AUD R6.54 R % USD/CHF CHF1.16 CHF % USD/JPY JPY98.53 JPY % Note: A positive per cent age change means an ap pre ci a tion eg. the rand strength ened against the US dollar by 24% Major South African Indicators GDP Growth Indicator Inflation CPI 5.70% (Feb 2010) Inflation PPI 3.50% (Feb 2010) Repo Rate 6.50% Prime Rate 10.00% Latest 3.20% (4th qtr 2009); 1.33% (2009 FY) Compiled and written by Jason Mattes. Edited by Lindi Smith. 298 For the online version of Profile's Financial Markets Directory visit

53 Consumer Price Index (CPI) Transition to the 2009 CPI 1. Introduction In February 2009, Statistics South Africa (Stats SA) will introduce a revamped Consumer Price Index (CPI) with the publication of the CPI for January Various changes, meth od olog i cal and other, will be implemented in the construction of this CPI, and these changes are of three main types. First, the CPI will undergo reweighting with the introduction of new expenditure weights, based largely on the Income and Expenditure Survey of 2005/6. Associated with this change is the update of the CPI basket. Second, the release of the CPI for January 2009 will mark the introduction of the Clas si fi ca tion of Individual Consumption by Purpose (COICOP), replacing the International Trade Clas si fi ca tion (ITC) currently in use. Third, the CPI will be rebased so that 2008= Reweighting In order to reflect changes in the cost of living of households, the composition of the CPI should reflect the average spending patterns of the population. Over time, however, spending patterns naturally change as incomes and preferences evolve and as new products become available and others are phased out. This means that over time spending patterns diverge from the CPI basket, which therefore needs to be reweighted from time to time. The international norm is that the reweighting of the CPI basket occurs at least once every five years based on data from household expenditure surveys. In South Africa, the Income and Expenditure Surveys (IES) have, as their main objective, the collection of information on spending patterns for use in the calculation of CPI weights. On the basis of the recently released IES 2005/6 and other supplementary data sources, Stats SA has constructed a new CPI basket. As part of the reweighting process, new items have been included and some items currently included in the CPI excluded from the new basket, with importance within total spending and widespread purchasing the main criteria for inclusion in the basket. For those items that continue to form part of the CPI basket, their relative importance as indicated by their respective weights may have increased or decreased. There have been some substantial shifts in the spending patterns of households between 2000 and 2005/6, meaning that it is likely that the introduction of the new 2006 weights will impact on the level of calculated inflation. There are two effects that will impact on calculated inflation. Firstly, incomes have risen between 2000 and 2005/6 and, as a result, spending patterns have changed. This income effect saw a shift in expenditure away from food, for example, and towards transport and services. The second effect, a substitution effect, results in households shifting their expenditure away from higher inflation items towards lower inflation items. Overall, given these behavioural changes, it is anticipated that the reweighting of the CPI will result in a decrease in the level of measured inflation. The greater importance of services, which typically have lower rates of inflation relative to goods, in the CPI basket serves to reinforce this expectation. Thus, of the three main changes, the new CPI weights and basket are responsible for the greatest disruption to the CPI time-series. For the online version of Profile's Financial Markets Directory visit 299

54 CONSUMER PRICE INDEX (CPI) 3. A new classification system: COICOP The move to COICOP, bringing South Africa in line with standard international practice, entails a recategorisation of the elementary aggregates, with some items being allocated to different CPI aggregates. As its name suggests, COICOP classifies expenditures according to their purpose and, so, expenditures for similar purposes are classified together. Thus, for example, vehicle insurance is moved from Transport under the ITC system, and medical aid contributions are moved from Medical Care and Health, to Insurance (part of Miscellaneous Goods and Services) under COICOP. Many items, though, are unaffected with some aggregates remaining virtually unchanged (e.g. Clothing and Footwear). What are the implications of this change in clas si fi ca tion for the CPI and measured inflation? On its own, a change in the method of clas si fi ca tion has no impact on the level of measured inflation. In other words, if this were the only change being implemented, there would be no difference in the overall CPI or measured inflation between the ITC or COICOP clas si fi ca tions. However, the clas si fi ca tion change impacts on the composition of certain CPI aggregates and, depending on the extent of the change, results in a break in the series of those aggregates. 4. Introduction of the 2009 CPI Of the three main changes to the CPI, it is the move to the new CPI basket that will impact on the level of measured inflation. The current reweighting process is qualitatively different from that which occurred in 2002 involving a more substantial change in the composition of the total basket and a streamlining of the number of items included in the basket. The latter has allowed Stats SA to increase the number of prices per product it collects, thereby improving the robustness of the calculated price changes. In preparation for the release of the new CPI, therefore, Stats SA began collecting price data for the expenditure items contained in the new index in January 2008, while continuing to collect price data for the current CPI. This parallel collection of price data ensures that it is possible to compare like with like in calculating inflation rates in the January 2009 release. The following table (Table 1) provides an illustration of the way in which the CPI will be moved from the current methodology to the new methodology. In this example, as will happen in South Africa, the existing CPI is replaced by the revamped CPI in January 2009, with parallel price collection occurring during The first three columns of the table detail the path of the old CPI, which has some year in the past equal to 100. From this index, year-on-year (YoY) and month-on-month (MoM) inflation rates are calculated, which are published as per usual. In January 2008, the parallel collection of prices begins, with the new CPI for January 2009 equalling 100 (column D). Over the course of 2008, the new CPI is calculated parallel to the old CPI, but the former is not published as it is not the official CPI. By December 2008, twelve months of data exist for the new CPI. Month-on-month inflation rates based on the new CPI exist (column F), but there is still insufficient data to calculate year-on-year inflation rates. The possible differing behaviour of the new and old CPIs are visible in the different rates of month-on-month inflation in columns C and F. 300 For the online version of Profile's Financial Markets Directory visit

55 CONSUMER PRICE INDEX (CPI) Table 1. Illustration of the Old and New CPI Series (Hypothetical Example) Old Consumer Price Index New Consumer Price Index Index Inflation Rate Index Inflation Rate YoY MoM YoY MoM Old CPI 2008=100 New CPI 2008=100 A B C D E F G H Jul ,1 6,4 0,5 94,8 Aug ,8 6,4 0,5 95,2 Sep ,4 6,3 0,5 95,7 Oct ,1 6,3 0,5 96,1 Nov ,8 6,2 0,5 96,6 Dec ,4 6,2 0,5 97,0 Jan ,1 6,1 0,5 100,0 97,5 97,6 Feb ,7 6,1 0,5 100,4 0,4 98,0 98,0 Mar ,4 6,0 0,5 100,9 0,5 98,4 98,5 Apr ,1 6,0 0,5 101,4 0,5 98,9 98,9 May ,7 5,9 0,5 101,8 0,5 99,3 99,4 Jun ,4 5,8 0,4 102,3 0,4 99,8 99,8 Jul ,0 5,8 0,4 102,7 0,4 100,2 100,2 Aug ,6 5,7 0,4 103,1 0,4 100,6 100,6 Sep ,3 5,7 0,4 103,5 0,4 101,1 101,1 Oct ,9 5,7 0,5 104,0 0,4 101,6 101,5 Nov ,7 5,7 0,5 104,5 0,5 102,1 102,0 Dec ,4 5,7 0,5 105,0 0,5 102,6 102,4 Jan ,4 5,4 0,4 102,9 Feb ,9 5,5 0,4 103,4 Mar ,4 5,4 0,5 103,8 For the January 2009 release, the published CPI will be the new CPI. Both the old and the new CPI series will be rebased so that the average index for 2008 equals 100 (columns G and H). However, the 2008 indices using the old weights and old prices differ from the 2008 indices calculated using the new weights and the new prices. From the launch of the January 2009 CPI, year-on-year inflation rates will be calculated based on the new weights and prices, i.e. the index presented in column D forms the basis for year-on-year comparisons starting in January In other words, the year-on-year inflation rate for January 2009 is calculated as CPI CPI 2006 Weights Jan Weights Jan Weights CPI = Jan and not Weights = CPI Jan 2008 where the superscript denotes the weights and the subscript the price data. The month-on-month inflation rates will be based on the old weights and prices (column A) until December 2008, whereafter they will be based on the new weights and For the online version of Profile's Financial Markets Directory visit 301

56 CONSUMER PRICE INDEX (CPI) prices (column D). In other words, in the January 2009 release the month-on-month inflation rate will be published as 0.5 percent, while the year-on-year inflation rate will be 5.4 percent. The transition to the new CPI will mean that for 2008, the year in which the parallel price collection took place, there will technically be two price index series, one using the old weights and the old price series (the CPI as it currently exists) and one using the new weights and the new price index series. However, there is only one official Consumer Price Index series. The publication of the new CPI indices does not and will not constitute a revision of the officially published CPI, nor will it entail a withdrawal of the price indices published during the course of Consumer price indices published for 2008 are and will remain the official consumer price indices for Price indices and their resultant inflation rates for 2008 are based on the 2000 weights and the current set of price data, classified according to the ITC system. Price indices and the resulting inflation rates for 2009 onwards will be based on the 2006 weights and the new set of price data, classified according to COICOP. 5. Time series data Various users may require historical CPI data compatible and comparable with the new CPI data. Stats SA recognises this need and will publish COICOP-consistent historical price series where the data allows. This decision is in line with International Labour Organisation recommendations that when changing classifications results in significant changes in the composition of the CPI aggregates, the CPI under the new clas si fi ca tion should be calculated backwards for at least one year to allow the calculation of consistent annual rates of change (ILO, Consumer Price Index Manual, paragraph 9.143). Essentially, these series would represent an alternative calculation of the published historical series based on COICOP as opposed to ITC clas si fi ca tions. In some instances sufficient historical price data is available to extend the COICOP-based series backwards over a considerable period of time, as may be the case for food and non-alcoholic beverages for example. In other instances, historical price data is not available and it will therefore not be possible to calculate these historical series further back than These historical COICOP-based price indices will, however, remain consistent with previously published indices. At a minimum, therefore, historical price series according to the COICOP clas si fi ca tion covering no less than the twelve months of 2008 will be made available by Stats SA in the month leading up to the CPI release in February The publication of historical price series for CPI aggregates under the ITC system will then be suspended. Phone No: Fax No: info@statssa.gov.za Website: For the online version of Profile's Financial Markets Directory visit