The long-standing saga that has held foreign nationals of Ethiopian origin who are shareholders in financial institutions in limbo for about two years was resolved after the National Bank of Ethiopia issued a guideline effective from 28 October 2016.
The guideline instructs financial institutions to pay dividends up until 30 June 2016, buy their own shares at par value, keep them in temporary asset account, sell them back in auction and transfer any proceeds above par values to the treasury.
As much as the guideline resolved a number of issues and gave relief to foreign national shareholders, it has blatantly defied the provisions in the Commercial Code of Ethiopia (1960) in regard to share repurchase, some of NBE’s directives and financial accounting treatment of such transactions. Moreover, it burdens banks with additional tasks and financially penalizes relinquishing shareholders.
Share repurchase could be undertaken for a number of reasons. Mostly, companies purchase their own shares on voluntary basis so they should observe the legal, accounting, financial and tax aspects thoroughly. The instruction of the NBE seems a compulsory repurchase. Even though such repurchase is rare, I believe that several factors must be taken into account as voluntary one.
The fundamental pitfall of the guideline is that it has completely bypassed the Commercial Code of Ethiopia (1960). The commercial code has clear provisions in regard to share repurchase. According to article 332, the procedures are that the acquisition has been authorized by meeting of shareholders; the purchase price is made from the net profit of the company and the shares are fully paid. Under such circumstance, the share buyback doesn’t reduce capital of a company as the transaction will be set off against profit.
When the share repurchase reduces paid up capital, extraordinary general meeting should be called. In which circumstances Ethiopian financial institutions fall and the procedures they should follow depend on the size of their share repurchase and amount of their accumulated profits.
One of ideas of the above provisions is to close down any loopholes for shoddy practices whereby companies would buy their own shares and show them as assets in their balance sheets.
The NBE guideline demands shares repurchase to be kept as temporary assets. It should, rather, be treated as a deduction of capital and reserves as companies can’t be owners their own shares. International Accounting Standards (IAS), which Ethiopia adopted recently with a transition period of five years require companies to treat share repurchase (Treasury shares) as deduction from equity (IAS 32).
Financial institutions are ordered to buy their shares back at par value. When the shares are sold in auction, any premiums upon sale will be transferred to treasury account held with the NBE whereas the financial institutions bear the costs of buying and selling the shares. Shackling financial institutions with tasks that have no benefits to them is pretty unfair.
Financial institutions have accumulated huge legal reserves and these reserves belong to existing shareholders. If we take into account these reserves in determining share prices, the prices that relinquished shares command would be much higher than par value. For example, based on book value, shares of banks command an average premium of 41% (Industry average at 30/06/15). The share of big banks such as Dashen commands a premium of 92%. When shares are sold in open market, the premium could be higher.
If we go by clause 2.3 of the guideline, relinquishing shareholders are entitled for dividends declared up until 30 June 2016. They are not entitled for dividends for the year ended 30 June 2016 as dividend declaration dates are way after the balance sheet date. The private banking industry average dividend is about 24.5% (2015). The biggest bank forks out dividend of 44% whereas the smallest one pays 3.7%.
The average premium and dividend relinquishing shareholders of banks lose to the treasury is about 65.5% of the share prices. Shareholders of the biggest bank lose as high as 136% whereas shareholders of small banks will lose 11.2%. The values that shareholders of insurance will lose are as high as the banks.
Over the past decade, inflation has consumed the value of financial investments. The real value of shares is worth a fraction of their original investment amounts. Demanding shareholders to surrender their shares at par values and waive one year dividend is a double whammy. It is pretty clear that the law regarding investment in financial institutions is infringed. However, the price relinquishing shareholders demanded to pay is huge.
The NBE previously issued directives that require set level of paid capital for banks and insurance companies. There are possibilities of share repurchases amounting reduction of paid up capital if there is no enough accumulated profits to absorb them. The implication of the guideline on previously set level of capital should have been observed.
This is not the first time the NBE demanded shareholders of financial institutions to relinquish their shareholdings. Directive SBB/47/2010 was issued demanding shareholders (a person and anyone related to her/him) of banks to relinquish their shareholdings above five per cent. What is different is from the current guideline is that the directive didn’t demand banks to buy their own shares. It was the duty of the individual shareholders to comply with the directive.
It seems that the NBE preferred a very unusual route to bring in money for the treasury. It is glaringly obvious that the shares of banks are worth much more than their nominal values. If shareholders are instructed to sell their shares, they will be the ones who will pocket the full proceeds. That is why the NBE has dragged financial institutions in a share repurchase scheme, which has no benefits to them. It will rather shoulder them with extra works. The trouble is that this unusual course has put the NBE’s guideline in direct collision with the commercial code, its own directive and accounting practices.
I am of the opinion that neither financial institutions should be involved in buying back of their own shares nor the NBE should have included provisions in the guideline that undermine commercial law and accounting practices. The matter can be resolved without compromising the Commercial Code of Ethiopia and accounting practices and in a way more convenient to financial institutions. Foreign nationals of Ethiopian origin who are shareholders in financial institutions either should sell their shares themselves or with the help of financial institution where they invest their monies. As shares of banks and insurance companies are sought after, they can liquidate their holdings in a short space of time.
It should be noted that many of the conducts of financial institutions are subject to commercial code as any company and the regulatory role of the NBE shouldn’t undermine this code. The NBE should make sure that its actions are consistent with other laws, its directives and accounting practices of the country.
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