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BarnOwl

Counting the cost of poor governance and reputational risk

26 April 2017

I suppose that by now we are all tired and worn out by all the bad news of the ratings downgrade and the strange decisions that have and continue to be made by the government that seem to defy all logic. Whether the real reasons for the cabinet reshuffle are related to power, money, corruption, cronyism, radical transformation (transformation to what one may ask?) or fear of Russia’s Rosatom State Energy Corporation or all of the above, we don’t really know however there is no doubt that huge damage has been done to the reputation of ‘South Africa Inc.’ resulting in our credit ratings downgrade which comes at a huge cost.

Counting the cost of South Africa’s ratings downgrade:

Eyewitness news: More credit rating downgrades could see South Africa’s debt costs rise over the next couple of years. That’s the sentiment of some experts commenting on S&P Global’s decision to place the country’s foreign denominated debt on sub-investment grade. S&P Global’s downgrade will push South Africa’s borrowing costs up in light of a perceived riskier investment.

Economist Mike Schussler says it could increase by as much as 50 basis points each year, hiking the country’s debt by billions in years to come. “If these interest rates stay for a whole year or more, then government’s debt which is about R2 trillion and the state owned enterprises which are another half a trillion rand is going to end up costing us R100 billion a year more”. He’s among experts saying this will limit funding for social projects like new schools and hospitals, as well as improving the education system. Servicing the country’s debt is already the biggest expenditure item in South Africa’s budget, totaling nearly R200 billion this year.

Reuters: LONDON – The sacking of South Africa’s respected finance minister leaves the country risking a two-notch downgrade on its local currency credit rating, which would see it ejected from a key bond index and cause up to $10 billion in outflows, US Bancorp (UBS) said on Friday. Investment outflows at that level would effectively double South Africa’s current account gap, UBS said. http://ewn.co.za/2017/03/31/sa-local-debt-rating-downgrade-could-spark-usd10-bln-outflow-ubs

Businessday live: Fitch has become the second major rating agency to downgrade SA’s rating to junk status, cutting both the foreign currency and local currency ratings by one notch. Fitch says that the Cabinet reshuffle is “likely to undermine, if not reverse, progress in state owned enterprise governance, raising the risk that SOE debt could migrate on to the government’s balance sheet”. And it expressed concerns that the nuclear programme was likely to move relatively quickly under a new Cabinet, which included a new energy minister, and this would mean a substantial increase in government guarantees to Eskom.

HeraldLive: The ratings downgrade will lead to lower access to credit and‚ potentially‚ an interest rate increase‚ which would affect many South Africans because they would be paying more to borrow money. Higher interest rates increase the cost of families paying for loans from banks‚ financing things like home loans and vehicle finance payments. Additionally‚ the rand could decrease further in value‚ causing a rise in the price of imported goods.

Economist Dr Azar Jammine said a downgrade would mean international investors wanting to buy bonds would be less inclined to buy South African government bonds. Jammine said if the rand fell in comparison to other currencies‚ inflation would not come down as much as anticipated. “That is bad news for the whole economy‚ including small business.” Jammine said if the rand stayed where it is‚ the impact was not negative. “If the rand goes into free fall and reaches R16 or R17 to the dollar‚ inflation will rise‚ so will food prices and the petrol price will rise. Households will suffer.” Jammine said there was nothing new Finance Minister Malusi Gigaba could do to appease investors. “He is seen as a Gupta acolyte.”

KPMG said before the downgrade to junk status was announced that South Africa was perilously close to a sovereign ratings downgrade. “This will result in an outflow of investment funds from bonds and equities as many local and international investment funds are mandated to place their money in investment-grade jurisdictions only. “This‚ in turn‚ will adversely affect the value of the rand‚ increase the cost of imports‚ and keep inflation elevated for longer‚” said Christie Viljoen‚ senior economist at KPMG South Africa. Viljoen said uncertainty over the short-term trajectory of local politics would weigh on local and foreign investor sentiment – and hamper the investment needed to address South Africa’s challenges of unemployment‚ poverty and inequality. http://www.heraldlive.co.za/news/top-news/2017/04/03/downgrade-junk-status-mean/

Businesstech “An additional risk is that businesses may now choose to withhold investment decisions that would otherwise have supported economic growth.”

The cost of South Africa’s rating downgrade may pale into insignificance when compared with the bigger picture!

If what we hear about the nuclear deal is true, it is far more ominous and damaging to ‘South Africa Inc.’ than the credit ratings downgrade. At an estimated cost of R1.6 trillion Rand for the nuclear project and with a current excess of 6,000 Megawatts of power on the grid and a revised forecast of +- 0.5% economic growth rate, it seems that our government has sold South Africa Inc. to the Russians from under our feet.

Justin McCarthy comments on businesslive that ‘Fear is a far more persuasive emotion than power, greed or fame’. ‘Rosatom reports directly to the Kremlin. Connect the dots. Follow the money.’ https://www.businesslive.co.za/rdm/politics/2017-04-04-justin-mccarthy-is-this-the-source-of-zumas-fear/

According to an article published on fin24.com: ‘While Gordhan was doing the presentations in London a gentleman called Mr Chenkov, wanted to know if the South African government was looking at developing Nuclear energy. Gordhan confirmed that the South African government will never develop this energy. Mr Chenkov had no further questions. After the presentation Mr Chenkov made a brief call, spoke in Russian. It is believed that a call was then made to Zuma to immediately trigger the process of changing the finance minister and sign the Nuclear deal or face the consequences.’ http://www.fin24.com/Opinion/opinion-gordhans-firing-calculated-power-play-and-russian-influence-20170405

And if you still think that doing the right thing (i.e. good corporate governance) and protecting your reputation is overrated:

United Airlines Stock Drops $1.4 Billion After Passenger-Removal Controversy. Even as the internet kicked up a maelstrom of outrage, investors still thought United Airlines’ decision to forcibly eject a customer from an overbooked flight would have little effect on the company’s profits. But that changed Tuesday, when shares of United fell as much as 6.3% in pre-market trading, dropping $1.4 billion from the now $21 billion company by market cap. By early trading Tuesday, shares were down 4%. It didn’t help that apologies from United and its CEO Oscar Munoz were deemed tone deaf and insensitive by many on social media. Or that more video footage surfaced throughout the day Monday showing the passenger bleeding from the head and clinging to a curtain on the aircraft. The incident even prompted an investigation by Department of Transportation. See http://fortune.com/2017/04/11/united-airlines-stock-drop/ for more information.

And so it becomes even more apparent why good corporate governance is a critical business and country imperative.

The definition of corporate governance for the purposes of King IV (King IV is copyrighted to The Institute of Directors Southern Africa), is defined as the exercise of ethical and effective leadership by the governing body towards the achievement of the following governance outcomes: Ethical culture, Good performance, Effective control and Legitimacy.

At a recent presentation (before our ratings downgrade and before the United Airlines debacle) given by Michael Judin, partner in the Johannesburg based law firm, JUDIN COMBRINCK INC on ‘Why King IV is not another layer of regulation but creates add-on value’, Michael spoke about business (country) leaders’ misconceptions that the power lies within the board room. The power really lies with the new millennials and the power of social media and the smart phone. Harvard university commented that the King code appeals to a way of life rather than just a way of doing business. This is far reaching considering that our customers (citizens) are millennials who don’t believe a thing you say and need to see the outcomes to believe.

Michael mentioned that out of the 6 capitals (Financial, Manufactured, Intellectual, Human, Social and Relationship, and Natural), the easiest one to come by is the ‘financial’ capital. Investors will always find money for companies they trust and believe are well governed and sustainable. Conversely, we see the consequences of what poor governance and lack of transparency has wreaked on South Africa Inc. and United Airlines.

Perhaps it’s time that government and business leaders re-acquaint themselves with the King code and its principles!

The King code is now part of South African common law. King does not need to be part of statute law. Millennials will ensure that it works: ‘We distrust you, we want to see the results and outcomes of the principles applied. No more ticking boxes! It’s simple; if you don’t comply with good corporate governance, we just won’t buy your product’. King is not another layer of regulation.

Related to the King code, the business judgment rule asks three important questions: 1. If you are conflicted you don’t decide whether you are conflicted, the other party decides. 2. We live in a knowledge world; you cannot act if you are not properly informed; you need to stress test and check your info. You need to know enough and question with an understanding mind. How did you come to your decision? If you don’t know, say so. Be true to yourself, I don’t know, be honest, go and learn. 3. Are you operating in the best interests of the organisation? (a lawful organisation that is).

You can find more info at http://www.barnowl.co.za/event/information-sharing/

Warning: ‘Ignore King IV’s principles at your own peril as demonstrated by the events above’.

Witten by Jonathan Crisp

Director: BanOwl GRC and Audit software

www.barnowl.co.za

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