Can Shuttleworth really help startups by taking on SA exchange controls?

When news broke that tech billionaire Mark Shuttleworth was looking to take on the South African Reserve Bank over its system of exchange controls, reactions were mixed. Some lauded his actions, others were not so sure. They wondered why a man who had emigrated from the country, and been labelled an economic refugee by the central bank’s legal representation, was suddenly so interested in how money enters and exits South Africa.

If a statement released by Shuttleworth is to be taken at face value however then we have an answer. He says he’s not a spoiled businessman looking to settle a vendetta and that he’s actually looking out for South African entrepreneurs.

Shuttleworth, who has lived in the UK since 2001, but still holds South African citizenship, says the exchange controls are a “remnant of Apartheid-era concerns about capital flight that pre-date globalization” and “put South African entrepreneurs at a significant disadvantage to their counterparts in all Western economies”.

The Canonical CEO blames the system of controls for forcing him to leave the country, claiming that the system made it impossible for him to conduct his entrepreneurial and philanthropic ventures.

At the time of his emigration, Shuttleworth had R4.27-billion in South Africa (a large portion of which came from the 1999 sale of his company Thawte to US company VeriSign), but transferred the assets out of the country in 2008 and 2009, paying a 10% levy each time. Shuttleworth’s wealth is now split between the UK mainland and tax haven The Isle of Man.

He believes that they continue to cause similar problems for other entrepreneurs in the country. But are exchange controls really bad for the economy and would lifting them really help startups wanting to play in the global arena?

The Reserve Bank doesn’t think so and its legal representative Jeremy Gauntlett labeled Shuttleworth a “financial refugee” for trying to bring the whole system down.

Bringing down the “pillars of the temple”

The Reserve Bank’s position, as outlined by Gauntlett, is that if Shuttleworth’s application is successful, it could be incredibly dangerous for the country’s economy.

“He quite deliberately decided to attack the heart of the scheme and seeks to bring down the pillars of the temple,” said Gauntlett.

He also appeared to suggest that Shuttleworth had no place commenting on South Africa’s monetary exchange system. “He couldn’t get his money out of the country”, said Gauntlett, “Now he wants to pull the whole system down. Why should this financial refugee, living on the Isle of Man, speak on behalf of the entirety of South African society?”

At the time, Memeburn pointed out this last position was slightly odd. Shuttleworth still has South African citizenship and therefore has the same rights in the eyes of the law as any other South African. While this does not mean that he is necessarily right to criticise the country’s system of exchange controls, it does mean that he has every right to launch an application with a South African court.

Shuttleworth also seems to address any concern that his cause is self-serving, promising that “any proceeds from the case will go towards future constitutional defence actions, providing a fund to support cases where government actions appear to step outside their constitutional mandate”.

Do we really still need exchange controls?

That does not mean however that it is not worth interrogating Shuttleworth’s argument. Are exchange controls really old-fashioned? And would abandoning them really help startups and the general economy by driving down the cost of doing business?

As it turns out, the tech billionaire is right on at least one front. Exchange controls are a bit of an economic dinosaur. You see, they used to be common in most countries, particularly poorer ones, until the 1990s when free trade and globalization started a trend towards economic liberalization. Today, countries with exchange controls are the exception rather than the rule.

Shuttleworth’s assertion that “successful economies today recognise the value of cross-border integration” and that “modern small businesses need to be global from the start — drawing on talent and resources wherever they are best available”, therefore holds weight.

Indeed, it seems to align with the general economic tone set by post-apartheid South African governments. Since the early days of ANC power, it has been committed to “gradual liberalisation”, and has scrapped or eased the most onerous apartheid-era exchange controls.

But there are cases where history appears to be against Shuttleworth when it comes to how exchange controls effect economies as a whole. The view that capital controls are a bad thing was challenged following the 1997 Asian Financial Crisis. Asian countries like India and China that retained exchange controls could credit them for allowing them to escape the crisis relatively unscathed.

Again though, those are the two most populous nations on Earth, meaning that businesses within them can fall back on massive domestic markets when times are tough. That’s why so many Chinese tech startups have been able to exploit the country’s economic and internet protectionism by building clones of Western products.

Nonetheless, the case is there to be made that their exchange controls protected them during a time of volatility. The Reserve Bank might well therefore argue that, given South Africa’s recent past, lifting exchange controls completely could see a massive flood of capital out of the country in a time of crisis.

Steven Ambrose, the founder of analysis and research company Strategyworx however thinks that the Reserve Bank is being overly cautious on this front. “The bald face is that exchange controls don’t stop or even alleviate capital flight,” he told Memeburn.

The fact that Shuttleworth managed to move a fairly substantial portion of his fortune overseas shows that this kind of thinking is, at least in part, valid. “He took his money and all it cost him was some money. South Africa then got a short term gain but lost out completely on any further growth and activity,” Ambrose said of the entrepreneur.

“It has been proven time and again that you can’t contain the super wealthy and big business with exchange controls,” he added. “They will find ways to move their capital and keep it invested in territories that offer certainty and the ability for these entities and people to deal with their money as they see fit.”

He also doesn’t buy the Reserve Bank’s line that it will do the economy massive damage. “If Shuttleworth is successful, there will be no grand exodus of funds, and the financial markets may take some short term strain with the Rand acting as the buffer, for the most part, but in the medium to long term, the fundamentals of investor confidence and the opportunity for returns will either create inward or outward flows,” he said.

As with any economic policy however, it’s difficult to tell precisely what will happen. What works in one country may well not work in another. Nonetheless, his point that the wealthy will always find a way is an extremely pertinent one.

Giving startups a helping hand

So lifting exchange controls may not collapse the economy, but does the system really harm startups?

Ambrose certainly thinks so. “Exchange controls are an arbitrary and unnecessary market distortion and in effect stop South African businesses from competing globally with their peers, unless they leave and become based in other more friendly territories,” he told us.

Other South African entrepreneurs have also rallied around Shuttleworth’s cause, with entrepreneurial community initiative the Silicon Cape asking its members to submit cases where exchange controls have “screwed you over”.

In a piece on Business Day Live meanwhile, head of research boutique Intellidex Stuart Theobald relates how a number of his friends ran into serious difficulties when they wanted to start operating their businesses internationally. Like Shuttleworth, he says, they were forced to emigrate.

He also claims that the business he runs in London would be “next to impossible to run in South Africa.”

“In the UK, it is easy,” he adds. “The banks are geared to help companies transact across borders — I can do payments to anywhere in the world through online banking without filling in a single form or submitting any documents.”

“In contrast, the South African business once had to pay R3 000 to a supplier in Taiwan who translated a document for us. We paid him three months late after we had jumped all the hurdles thrown up by our bank and the Reserve Bank. I no longer do international business from South Africa.”

But former Mxit CEO and entrepreneur Alan Knott Craig Jr takes a different view. “As far I can see, exchange controls are not the major factor inhibiting global growth of South African startups, unless the investor is looking to keep the economic interest offshore,” he told Memeburn. “In which I guess exchange controls are performing the function for which they were designed: Keeping South African capital in South Africa”.

He also said that he’d “never encountered an international investor who raised exchange controls as an issue”. The real issue, he told us, is “negative perception of the local political and economic stability”.

While Knott-Craig might argue that the fact that he was able to build the World of Avatar family of startups and raise enough capital to buy Mxit is seemingly proof that South African startups can make it big within the current system, it does appear that exchange controls are a genuine concern for some startups.

Big South African companies who operate in a number of countries, Naspers for instance, can potentially get around the system by setting up offshore subsidiaries in countries like Mauritius. It’s not that difficult for them but when you’re a startup operating out parent’s garage (as Thawte, the venture that made Shuttleworth a billionaire, once was) it’s a different story.

It’s unclear why Shuttleworth didn’t take the subsidiary route before pulling in his money out of South Africa. It seems fairly obvious however that if he is to retain and grow any feelings of public sympathy to his cause, he will have to show that he really has the interests of entrepreneurs scraping by in garages and coffee shops at heart, rather than the ones flying around the world in Gulfstream jets.

Read Shuttleworth’s full statement below:

Exchange controls prejudice small businesses and individuals, preventing South African citizens and residents from managing their finances in a global economy, without providing the State with meaningful control over the value of the Rand. They are a remnant of Apartheid-era concerns about capital flight that pre-date globalization, created at a time when government did not reflect the broader interests of society.

Successful economies today recognise the value of cross-border integration; they encourage trade, while building domestic strength in particular sectors. Modern small businesses need to be global from the start – drawing on talent and resources wherever they are best available, in order to serve a global customer base. Exchange controls put South African entrepreneurs at a significant disadvantage to their counterparts in all Western economies.

This is particularly acute in the technology sector, but the inefficiencies of exchange controls present real costs to all residents, including the weakest and most vulnerable parts of society.

A World Bank study found the cost of remitting small amounts of money between South Africa and its neighbours was exploitatively high — a direct result of a regulatory regime built on exchange controls that adds bureaucracy and restricts competition between banks. For migrant workers, a cornerstone of the Sub-Saharan economy, exchange controls are a heavy and unnecessary burden.

The process mandated by SARB and implemented largely by banks is ‘nameless and faceless’, raises the cost of doing cross-border business for everyone, and makes for a capricious business environment where ‘who you know’ provides more certainty than what you propose to do. Inefficiencies in the domestic Rand market create bank profits, aligning the interests of industry and government against those of businesses and individuals.

After this regime was questioned by Mark Shuttleworth, the Reserve Bank took the step of removing exchange controls for emigrants, and asked Mark to drop the case. However, the goal of this application to the Court is to establish the rights of South African entrepreneurs NOT to have to emigrate in order to work on a global basis. The case seeks to ensure that South Africans can stay resident in South Africa and retain freedom of investment globally, subject to appropriate regulatory supervision in line with commonpractice elsewhere.

It is a great loss for South Africa to encourage people to emigrate rather than allowing them to build global operations from small beginnings at home, as other countries now do.

We have therefore continued to press the case, which comes to the High Court this month.

Exchange controls used to be common until the 1980’s, when Western economies dismantled them in favour of regulated globalization. The rest of the world followed.

Today, most economies have created regulatory environments that address concerns about money laundering, the financing of illegal operations, and tax, without fundamental restrictions on investors or business operations. South Africa has successfully modernised many aspects of its financial policy and regulations – and moved to a global tax view – that would support the elimination of exchange controls.

Unjust authority is rarely relinquished unless challenged, and the case seeks to do just that, challenging the validity of exchange control mechanisms and seeking a rewrite of the regulatory framework to meet legitimate state needs for surveillance, tax and security compliance in a modern form.

Authorities have said that exchange controls provide a buffer against capricious global market forces. That is false. The South African Rand is heavily traded internationally as a proxy for emerging market currencies that are less liquid. As a result, the ZAR is already as volatile as it would be without exchange controls. People outside South Africa can trade
the ZAR easily – the only actual impact of exchange controls is to prevent South African residents from participating in that market.

Similarly, South Africa’s relative resilience during the global banking crisis has more to do with effective regulation of bank lending, mortgage regulation, and capital adequacy than exchange controls.

Globalization certainly created new risks and challenges for regulators and policymakers.

But the answer is not to retreat behind ineffective tools from the 1960s. We cannot turn back the clock on globalization, even as we seek to shape it into a more manageable form.

State authorities can meet their duty of care and stewardship of the financial sector without exchange controls.

Mark Shuttleworth emigrated in frustration with Reserve Bank opacity and inefficiency, in order to pursue entrepreneurship and philanthropy in the technology arena, globally. While the scale of Mark’s interests are unusual, the core story of building new businesses from small beginnings around ideas is at the centre of modern tech entrepreneurship.

Today, such businesses are increasingly dependent on their ability to bring together small teams that span the globe.

While current regulations do not impact on Mark, as an emigrant, the case seeks to establish the same rights for those who cannot or won’t emigrate. Any proceeds from the case will go towards future constitutional defence actions, providing a fund to support cases where government actions appear to step outside their constitutional mandate, providing in one sense balance to the asymmetric resource relationship between the state and its citizens in disputes of a constitutional nature.