🔒 OLD FIRM: SA banking’s new challenger; McKinsey’s day of reckoning, Mick Davis and more

In this edition of The Old Firm, David Shapiro and I ponder McKinsey’s approach of trying to brazen out its involvement in the corruption scandal rocking South Africa; wonder why some sectors of SA business are backing KPMG despite it being deeply inflicted with the Gupta Curse; chat about my interview with Saffer Mick Davis who is now CEO of the UK’s Conservative Party and assess the chances of the first SA bank to be licensed since 1999 – a new offshoot of Australia’s mighty Commonwealth Bank.  – Alec Hogg

Well, the ‘old firm’ is back again, David Shapiro talking to us from Johannesburg. The markets looking good Dave.
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Very good. I’m thrilled with the way that the US is responding. We’re going into the earning season now and we expect earnings to be good. It’s always difficult to forecast what kind of results are going to come out but I think, Alec, what I like about the market is that there doesn’t seem to be a reason to sell and we’re seeing the S&P at an all-time high, and the European market is strong and when you go behind those kinds of numbers you’ll see that we’ve got, for the first time, synchronised growth – Europe seems to be doing well. Even the UK funny enough, is starting to point in the right direction. I think China decides what its growth is going to be but I can live with that as well. Japan is looking better so, for the first time in a long time I feel more comfortable about where the markets are. Even though I’ve been exposed to the market for the last number of years and remain in equities.

Locally, in SA, I think we’re Rand (ZAR) driven. The ZAR is at $13.60 now, which is giving some of those ZAR hedge shares a little bit of a boost. Also, we’re seeing quite a good movement in resources, which we haven’t seen. All the Anglo’s, and Billiton’s and Glencore’s are beginning to reflect a better outlook for commodities, even though you might not be able to pick it up from some of the underlying metal prices but there’s a better feeling about everything. So, I’m feeling okay.

Dave, why’s the Rand taken such a smack in the last couple of weeks because it really is, I watch it against the Pound, as you can imagine, like a hawk? It’s gone from £16.60 to over £18.00 in less than 2 weeks.

Yes, I think there’s, as we talk about synchronised growth in the advanced economies. I think there’s a concern about emerging markets and I don’t mean emerging markets in Asia. I mean other emerging markets so, we’ve got worries here. SA has got troubles. It’s economy is underperforming, the rest of the world. It’s underperforming even in advanced economies, there are a lot of troubles here. I think there was a bit of a disappointment that there wasn’t an interest rate cut here, that’s a worry. I also think a lot has to do with the strengthening Dollar. The Dollar picking up, number one on economic growth in the US and, also on more Hawkish talk that is coming out of the Fed. I think you’ve also got the tightening in Europe as well so, I think overall, there’s pressure on emerging markets.

Alec, I think you must also understand, we’re a proxy for emerging markets because of our very developed banking infrastructure. It’s easy to trade in the ZAR so, when things go well in emerging markets we improve. When things don’t go well in emerging markets we tend to be at the other end of things.

There was an interesting piece on Bloomberg this morning quoting an international bank saying, ‘it’s time to be very cautious about emerging markets – the carry trade is unwinding.’ Just explain that in layman’s terms.

The ‘carry trade’ is where you borrow so, you borrow Dollars or you borrow Yen, or you borrow Euros, on which your rate is very low, and you use those to buy emerging markets where your rates are very high. Of course, there’s a currency risk involved in that so, you can virtually borrow Yen at zero, at nothing. So, you borrow Yen and you use that to buy ZAR, on which you’re getting a 7% or 8% yield in Government stock. That’s the carry trade so, fundamentally you’re going short of one currency and long of another, and the interest rate differential gives you a very good return.

You can sometimes cover the currency risk but even so there’s a very good return so, as things begin to tighten in the US and in Europe, as there’s a perception that rates are going to start picking up – it affects your borrowing costs and you start to unwind the trade. Also, the worry that you’re going to lose on the currency as you might have done if you were to have bought the ZAR at $12.80 and it’s now $13.60. Whatever benefits you would have got on interest rate differential, you’ve lost so, it’s tricky.

So, the ‘carry trade’ then is something that artificially props up emerging market currencies because they offer better interest rates in those countries but as that unwinds and as people start selling that it would probably exaggerate the decline because I guess, everybody is heading for the exit at the same time?

Exactly, it exaggerates the increase and it exaggerates the decline, dead right. That’s what you call ‘hot money.’ When they talk about ‘hot flows’ this is not permanent capital that flows into the country and is used to build factories or to invest in the long term. This is money that flows in and out very fast and it’s fickle and that’s why when it flows out it flows out very fast and of course, as it starts to unwind, when one person starts rushing for the door everybody else rushes for the door as well so, I think we’re caught in that trap at the moment.

Former mining magnate and CEO of the UK’s Conservative Party, Sir Mick Davis

Well, David, I had a fascinating interview with Mick Davis, who’s a gent that you know from his exploits in the mining industry. He is now the CEO of the Conservative Party, in Mrs May’s Conservative Party, who are having their big meeting this week. We had an interview last Friday and I asked him would he suggest to people that he meets to invest in SA? He said, ‘I’ll tell you what I told the Mining Minister last year. I would not be able to justify an investment into SA. There are 4 major reasons why. The way that you’re always changing the goal posts on BEE, the poor productivity in the country, the corruption and the fourth one was infrastructure. If you’re getting that kind of a message coming out from a person who knows the country very well, because he invested hugely there through Xstrata. He used to work for Gencor, and for Eskom of course. Then what’s keeping the ZAR strong or what did keep the ZAR strong presumably, as the tide goes out, as Warren Buffett would say, ‘we’re going to see quite a lot of people standing there without swimming trunks.’

Yes, I think structurally SA finds itself in a very difficult position and I think what Mick, or as he is now known as ‘Sir Mick’ says, I think it’s shared by a lot of other mining people as well. I think you’ll find a very similar comment from Neal Froneman. Mick Davis carries a lot of weight, if you understand his history. He started at Eskom, he built up the whole BHP Billiton story. He was part of Glencore, and the fact that he is CEO of the Conservative Party just shows you where he’s got to. I think for a man born in SA to actually be the CEO of the Conservatives says a lot for his talent. I think he was always known as a very clever man, and highly respected. The problem is we don’t listen to those. We don’t listen to the Sir Mick’s, and we don’t listen to the Neal Froneman’s, and I think that’s a problem with the SA Government. It’s that they don’t want advice. They do it their own way and I think that’s very worrying. Structurally, we need to make big changes here. I think if you read the World Economic Forum’s Competitive Report as well, you’ll see very similar conclusions.

I think one thing that I picked up on that report was ethics. In other words, the work ethic here is very low and Alec, if we do want to save this country and it hurts so much to hear these things and it hurts so much to try and turn it around. As we try and turn it around when you hear these things and you just want to get somebody in charge who can actually help you turn it around. Now, that’s the kind of advice that we must listen to and start working on, instead of the politics. At the moment, it’s all about politics, it’s all about December, it’s all about who is going to lead the ANC Government and it’s how you vote or how you buy those votes. I’m very nervous about where we are at the moment, and it’s coming through in a lot of results that we see, which we can discuss.

Well, we had Capitec’s results and that’s a company that has always been shooting the lights out but even at Capitec it’s seeing that the road is not indefinite, the growth rate from around 20% a year ago, to 17% now. They also say that it’s a tough economic climate but if Capitec is struggling what about the other banks?

The other banks must be struggling. What they’ve done is, and what a bank does is that it lends money and then it battles to get it back and I think they’re becoming a lot tighter on their lending. Also, they make money through transactions, they have credit cards, they allow people to buy motor cars, they give them the credit to buy motor cars and so on, and if you look at the results or go into the result you’ll see very little happening at the top line. In other words, on the transactional line, where they’re making money is that they continue to cut back on their costs and they try and become a little more efficient. But you can’t do it in an economy, especially a bank, where an economy is growing in decimal points, like 0.3% or 0.4%, or whatever it is. We’re not even growing at 1% so, Capitec is well placed. I’ve always had huge respect for where they are. They offer very limited services and they do it well and they’re slowly expanding their range but as they expand their range and extend it of course the margins come down, and I think that’s why we’re seeing margins coming down and profits only growing 15% – 20%. Still well placed, very well placed but I think as you say, the market is getting a little wise to it and Alec, if you’ve followed the share price you would have seen – we were all Tweeting and we were trumpeting that Capitec was now the fourth largest bank. It had exceeded and knocked Nedbank out of its place. Unfortunately, that’s reversed and Capitec is now back at number 5. In fact, being challenged by Investec coming up, and I think for the very reasons that you bring up, they might be running out of a bit of runway but a good bank and a good operation.

The interesting point that and given the generally, negative picture that one is hearing about SA is that Commonwealth Bank of Australia has just come into the SA market. Now, just to put this in perspective because I did the market cap figures. If you take Commonwealth’s value on the one side, and on the other side of the seesaw you put First National, Standard Bank, Absa or Barclays Capital, Nedbank, Capitec and Investec combined, plus another R300bn then the seesaw balances. That’s how big these guys are and they’ve come into the SA market. Surely to goodness it’s not just Capitec that should be concerned about this but the whole banking sector, given the scale of this operation and that it’s coming in as a digital bank?

Yes, that’s so interesting. I’ve been following the story and I don’t think it’s one that we can ignore but markets are going, what they call Fintech, which means financial technology. They’re going the technology route and they’re also going down at the bottom end of the market into a much more technologically driven market. They’ve got no legacy issues. In other words, they don’t have fancy offices that they have to pay rent on, they haven’t got staff issues, they haven’t got legacy staff issues, which they have to pay pensions and so on. So, these banks tend to come in a lot more flexible than their competitors so, it allows them to sell products. When you’ve got, and as you mention, this is not a small bank. This has got a lot of muscle. I suppose it also depends on how they capitalise it here on how well it can do.

Alec, I think the point to remember is that young people now, who are going to be earning money or even older people, are not discerning anymore. We haven’t got that old bank manager that you knew, and that I knew. I started banking at Standard Bank when I started doing articles in 1969. I’ve never changed. Today your younger people are much more flexible. They go where they can get what they want quickly and at the best, and especially if it’s technologically driven. So, I’m with you on this one. I would watch this very carefully. I wouldn’t brush it aside and I think that there’s a fairly good chance of success and the banks must sharpen up. I think all the other banks must sharpen up and be aware of what’s coming in – interesting.

There is a SA connection there. Gail Kelly, who used to be the head of Nedbank Credit Card left for Australia many years ago and went to work for St George’s Bank, where she became the CEO. Commonwealth Bank bought them and ‘hey presto’ Gail Kelly ended up being the CEO of Commonwealth Bank so, if you have a look at our banking executives…

She knows, yes.

Yes, she’s not there anymore, she’s retired, but I’m sure they tapped on her door to say, ‘Gail, do you think it’s a good idea?’

Yes, and look, Africa is open. I’m not a great, what’s the word, I’m still concerned about Africa and African growth but that’s where you start – on banking, communication. If you want to build a country I think those are the infrastructures that you build it on and if you can… I always remember Kokkie Kooyman saying this to me, it is something that’s stuck with me. He said that, ‘you can’t grow a country without credit.’ In other words, if you haven’t got credit, if you don’t give people the money to start businesses and I think he was referring to India at that stage, but if you give people credit – you can grow. If you haven’t got credit – you won’t grow. I think if they can start granting credit to entrepreneurs, I don’t know what the force of their bank is going to be or their vision, but they’ll do okay. They’ll do fine but don’t ignore technology as well, as we’ve seen with Capitec, and the advances that technology have made in banking.

An interesting development and certainly a bank to keep a very close eye on, and not least because Patrice Motsepe has got 10% of it so, he’s got a good drive and he tends to make good investments, does Patrice. David, one of the issues or one of the four points that Mick Davis mentioned was corruption. We’re seeing this Gupta corruption scandal unfurling in SA and a really big development in that respect in the past week, when Bianca Goodson who was CE of Trillian, who were one of the channels through which McKinsey got business from Eskom, and 100’s of millions of Rands involved there. It’s kind of an open and shut case. She’s now gone public and she’s a whistle blower and still nothing from McKinsey. They still seem to be keeping their heads down and hoping this whole thing is going to blow away.

Well, I went through that report in fair detail and the one point she makes is that representatives from McKinsey were at every meeting she attended. There was a huge presence there, which they had originally denied so, it’s very difficult for them to distance themselves from some of the allegations that were made in that report. It all comes down to fees being paid for no service. In other words, it just seems that some of the invoices that were issued by Trillian and, I don’t know whether by McKinsey in this case, but certainly by Trillian which McKinsey approved for absolutely no work done. It comes down to literally one sound bite or one little area and for the names. She’s provided a huge amount of detail of the meeting requests and people attending meetings, and so on and yet as you rightly say, they’re silent. Nothing has come out of them and, also nothing has come out of government here as well. Nothing has come out of the Hawks or the Prosecuting Authority, etc, against people like this. In America you would have had a Senate Hearing straight away and people would have been brought to account and it’s worrying because it’s troubling us that institutions that we respected, or really run the country, can do these kinds of things. They’re not talking about a little. We’re talking about 100’s of millions. We’re talking of huge amounts of money.

But it’s extraordinary that the business community has, well in one sense and good for Business Leadership SA, they’ve kicked Eskom out, they’ve kicked Transnet out, they’ve suspended KPMG’s membership so, they’re really are taking a strong-line against corruption. But KPMG, I’ve now heard it from a couple of senior SA businessmen saying, ‘did they really do so much wrong? Surely, we should hear their side of the story.’ Adrian Gore made, apparently and I’m still trying to get a double confirmation from him, but apparently this is the message that he gave to the Gibs discussion on Thursday night last week. Certainly, one of the people who was there gave us that feedback and my letter to Adrian was, ‘Adrian, look, (a) have you been misquoted or (b) have you just not had the time to find out what the heck is going on here?’ Because nobody who knows or whose taken the trouble to investigate what’s happened could possibly take a view that, ‘well, maybe we should give them the benefit of the doubt.’ That went out the window 18 months ago.

You know what, in cases like this where McKinsey – these are people, (how can I say?) – they’re either accountants or consultants. These are people that you respect and you would expect to have the highest levels of integrity. These are international businesses, huge international businesses. You would not expect that kind of conduct. Buffett always makes a very good point…  

But that’s what they get paid for, Dave. They get paid their license to operate as auditors. They are the policemen but if they are crooked policemen, how can you give them the benefit of any doubt?

The KPMG company sign sits at their offices in the financial district of Canary Wharf in London, U.K.

Yes, I agree with you and the one think that I always say in this case and Buffett used to say it, ‘it’s not whether you’re proven guilty or not guilty. It’s why you were there in the first place.’ Are you with me? In other words, why are people challenging you in the first place? They shouldn’t be challenged. McKinsey shouldn’t be challenged. They shouldn’t have to prove whether they’re guilty or not guilty. KPMG also, they shouldn’t need to prove whether they’re guilty or not guilty. They shouldn’t be there in the first place. They shouldn’t have been implicated and that’s the point. Not the McKinsey’s and not KPMG.

But why are they trying to brazen it out? Come on Dave, you know these guys, you’ve sat in meetings with them.

I don’t know. I cannot understand and I also cannot understand the international because there should have been a lot greater response or reaction from the people in charge – I’m talking head office. I think they should make everything transparent. I’m shaken by the non-reaction or non-response, hoping that it doesn’t go away. Alec, it doesn’t – it just becomes worse and I would have thought there’d be far more of a reaction.

What was that other Buffett saying, about cockroaches in the kitchen?

Yes, you soon meet the family. If you find one, within time you’ll meet the rest of the family.

Emmanuel Macron

Macron, who’s now elevating his status in Europe, had a 90 minute speech that he gave to La Sorbonne, which is one of the oldest educational institutions in the world, it’s been going for more than 800 years. In it he gave 6 key points. Point 3 dealt with Africa, of course that’s not really of interest to most people in Europe so, you had to read the speech itself. In the speech itself he explains that he believes the financial transaction tax that France – it generates about a billion Euros a year, he says that should be throughout Europe and that all of that money should be put into a pot, almost like a Marshall aid plan marked 2 and put into Africa for African development. Why? He says, ‘because that’s the only way we’re going to stop this immigration problem or illegal migration from poor people in Africa, is by developing Africa.’ It’s a pragmatic approach, the first time you’ve seen someone say or move away from the Trump approach of building a wall to try and keep them out. To a more pragmatic approach which says, ‘you’re not going to keep them out – develop them.’ What do you think of that approach? It’s youthful and fresh.

It is because the French have had huge exposure to Africa. As colonialists they were very heavily embodied here and so many people speak French but it is their attitude. I think what they’ve got to do though is also improve the politics, and you can only do that with development. I think Africa needs a lot of love. I think a lot of these nations need a lot of love and attention. He’s the first leader to come out and say something like that. We don’t get that from any other person. You haven’t heard Theresa May, you haven’t heard Merkel, and certainly not Trump coming out and turning their attentions to Africa. It’s very good to hear and hopefully he can start a movement. I like him very much. He’s young, he’s energetic, not everything is going his way – he’s still learning at 39, but reading The Economist this week it seems they are positioning himself as one of the leading lights of Europe, as maybe Merkel fades a little. It’s good to hear and I think we need a united Europe as well. It’s a massive area. It’s a massive economic force and if you can get that kind of attitude well, good luck to us – I think we could do with a bit of it here.

If you see Africa rising then it certainly is going to help SA so, perhaps the leapfrog is on, it’s just we’re aren’t seeing it quite clearly just yet.

I hope so, I really hope so and I say, ‘I hope so,’ in a way because I’m sitting here. I’m here – I’m not really in the mood to immigrate. I don’t want to go and live in New York or Australia. Oh, anyway, I wish I had the force to change things here. I really wish I had the power.

Well, we’ve got December coming up but up until December, more of the same. The mood around boardroom tables, around those business lunches?

Not good, and I say it openly. I’m not one to bury my head in the sand. I think there’s a lot of work that has to be done here. Sadly, a lot of people are taking their kids out, immigrating, and very nervous about what lies ahead. I don’t want to see that gather momentum. I’ve been through so many of them. I went through the 70’s crisis, where people left. I went through the 80’s crisis, where people left, and the 90’s, and here we’re seeing it again and each time we lose, we lose talent and we need that talent so, I’m here and I’ll do anything to keep people here.

David Shapiro and ever confident as we always are, ever optimistic. I heard from someone this last week he said, ‘sure, be optimistic but be a rational optimist.’ I still see the messages on the wind are positive but we need the right result in December at the ANC Elective Conference. Without that David, then I’m afraid it’s even optimists, like yourself and I, are going to be scratching our heads and thinking, ‘what happens next?’

Dead right, and it’s the children we’re worried about. Look, I’m getting on in years but I worry. I’ve got grandchildren here and that’s where the concern is as to what lies ahead for them?

David Shapiro in Johannesburg. Alec Hogg here in London, and as always, our weekly update from the ‘old firm.’  

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