Cosatu’s Eskom bailout plan unworkable

Contagion from SA’s stateowned enterprises crisis is heading for its development finance institutions.

It started with a plan tabled by Cosatu two weeks ago that has gained some level of support from business to government. worth It proposes of Eskom to ’shift s R450bn R250bn of debt into a special-purpose vehicle funded by the Development Bank of Southern Africa (DBSA), the Industrial Development Corporation (IDC) and the Government Employees Pension Fund (GEPF).

No-one seems to have considered that this is mathematically impossible.

Think for a moment about what the DBSA, IDC and GEPF balance sheets can accommodate.

Mandated to fund development infrastructure, the DBSA has R89.5bn in assets and has risk management policies that include the concentration risk it can take to any one entity.

Its most recent annual report indicates it has a limit of R500m of exposure to a single government entity.

Its board allowed an exception to lend R3.5bn to SAA with a sovereign guarantee — a move that has already weakened the bank’s overall risk position.

The concentration risk guidelines set by Basel 3 would be a line the DBSA can’t cross without risking a run on its own funding.

Basel 3 limits the maximum exposure a bank can take to 25% of its capital — R9.2bn for the DBSA.

Given it already holds Eskom debt, some of this exposure is already deployed.

The IDC has a mandate of funding industrial development and has total assets of R144.6bn.

Its own risk framework specifies, in line with Basel 3, that it can take no exposure to a single industry of more than 25% of its capital. That works out to R24bn.

But, given that the IDC has been a major funder of power projects, it is already exposed to energy generation, so less than half this limit is likely to be available for further exposure to Eskom.

The GEPF seems to have serious firepower with over R2trillion in assets, but it also has to apply prudent risk management.

According to its last annual report it already holds R84.5bn worth of Eskom bonds — half of the public sector debt it holds — and 15% of the entire debt asset allocation of its portfolio.

The GEPF cannot absorb more exposure without stepping far from acceptable investment risk management practice. The GEPF is a defined benefit pension fund, so its members are not exposed to the financial performance of its investments.

The government guarantees the fund, so any shortfall must be covered by the national budget and, therefore, taxpayers.

While Cosatu has suggested using the GEPF represents workers coming to the party, it merely transfers additional risk onto the government balance sheet. One suggestion has been to convert the R84.5bn of debt the GEPF holds into equity.

But the resulting equity would have to be valued at zero, representing a claim on a company that has been losing billions.

The government would face an immediate contingent liability of an equivalent amount to make good GEPF’s funded status.

Even if the GEPF doubled its Eskom debt exposure, taking it into unacceptable risk territory, the three institutions between them would not be able to absorb even R100bn of Eskom debt. That is not even half what Cosatu imagines.

Cosatu has also suggested that prescribed assets could be used to compel the private sector to take on exposure.

Prescription is required when the normal risk and return features of an asset do not justify investment by institutional investors.

While the GEPF is a defined benefit scheme, many of those that would face prescription are not, so workers would face a loss in the value of their pensions. Prescription is a stealth tax on savers. The question is whether it is optimal to use such a stealth tax, or alternative taxes including VAT and income tax instead.

Given the damage prescription will have to normal financial market incentives, and to the savings of pension members, alternatives should be considered.

Cosatu should be concerned about the existential threat to the state’s solvency. The one sure way pension members will lose is if the government tips into bankruptcy.

A good suggestion would be to accept a wage freeze in the public sector for three years. This would contribute to avoiding collapse into the arms of the IMF.

The one option the government seems to be ignoring is to reschedule Eskom’s debt, ie forcing its debt holders into more favourable terms. It could switch Eskom bonds into sovereign bonds with different terms, removing debt from the Eskom balance sheet onto the national balance sheet.

Simultaneously, it could embrace green financing facilities from around the world that would provide it with discounted funding while following through on the Eskom restructuring it has promised.