What are the black economic empowerment (BEE) issues that keep one awake at night? My worst fear is around two things: the use of simple and complicated derivatives in BEE transactions; and the new synthetic instruments that are being used to approximate BEE ownership.
If used correctly, there is nothing wrong with derivatives. However, the reality is that these inventions can be so complicated that people could use them incorrectly without realising the implications.
It is like having a sharp knife in the kitchen for chopping vegetables. In the hands of a cook it is quite safe, but if an inquisitive child gets hold of it, it could be deadly.
Let us explore the different derivatives used in BEE deals.
Options give the holder the right to buy or sell underlying instruments such as ordinary shares at a certain price, within a certain time period. There are different types of call and put options with different intermediate combinations of both.
A call option allows the holder of the option to buy shares within a certain time period. If this option is held by a black person, it means that person does not own the ordinary shares of the company in question and, therefore, he or she may exercise the option to buy the underlying shares if the conditions are favourable.
The conditions are favourable for BEE if the actual price of the shares is higher than the exercise price specified in the option.
This is because the holder will buy the shares from the owners at a lower price and the difference will be recognised as a positive net equity value on the BEE scorecard.
If the actual price is lower than the exercise price of the option then there is no point in buying the shares when one could get them cheaper from other sources.
The crux of the matter is that a call option in the hands of a BEE party means the underlying shares do not actually count towards the scorecard until the BEE party decides to exercise the option.
A call option held by a non-BEE shareholder that sold shares to the BEE party or in the hands of the financier, or the measured company, means that the BEE party has the underlying shares in its possession. The option gives its holder the right to buy the shares at some point.
This is usually done as security for the financing that is provided to the BEE party in case of a default on the loans given to buy the shares. However, there are dangers in these options when the intention of the holder is not to facilitate sustainable ownership by black people.
The dangers lie in two factors, the exercise price of the option and the terms of exercising the option.
Alarm bells start ringing the moment one sees that the exercise price is the same as the original price that the BEE party paid for the shares.
If the holder exercises the right, it would mean that no value would accrue to the BEE party over the period before the option is taken up.
It could be argued that dividends are paid to the black party, which are used to repay the loan. However, by having the exercise price of the option equal to the purchase value of the shares, the benefit of loan repayments by the BEE party goes to the holder of the options, who will also get the capital gains from any increase in the share's market value.
If the price is set at the market value of the shares at the time the option is exercised the adrenaline levels may go down, but not completely, because it would still mean that on exercise of those options BEE parties will no longer hold those shares.
Furthermore, if the terms for the exercise of the option are nebulous, then risks of fronting abound. The problem is that some terms will include ridiculous rates to be met by the BEE parties that might be beyond their control, laying the ground for the option holders to exercise their right to purchase.
On the surface these call options in the hands of non-BEE parties are a regular protective mechanism for deal facilitators but there is huge potential for them to be used to take away black ownership from companies on frivolous grounds. There are other means to protect a deal.
Pledges, cessions and such instruments could be directly linked to the funding of the BEE party.
Options are not always necessarily linked to the funding of the BEE stake, increasing the risk that even if a BEE party has paid off its loans it could still lose the shares to the holders of these call options.
This is a discomforting thought.