GTR and Memery Crystal gathered a group of Africa experts to evaluate whether now is the time to be doing trade finance business on the continent and the legal issues currently hampering funders.
- Nisrin Hala, head of Africa desk, SMBCE
- Rob Hough, director, financial & political risks, CGNMB
- Mark Ifashe, chief business officer, Diamond Bank UK
- Yaw Adu Kuffour, head of trade finance, African Development Bank
- Shannon Manders, editor, GTR (co-chair)
- Rumit Nanji, senior associate, Memery Crystal
- John O’Mulloy, managing director, trade finance & forfaiting, Standard Bank
- Andrew Titmas, partner, Memery Crystal (co-chair)
- Charles Weller, managing director, Africa trade, Barclays
GTR: Following what we have heard at the GTR Africa Trade & Infrastructure conference this week, is now a good time to be doing business in Africa?
Hala: Given the challenges that we are seeing in the market today, I think it would probably be difficult for new players to do lending business in Africa. That is especially true for those who do not have the relevant experience and track record. SMBCE has been active in Africa for a very long time, which means we have seen the cycles: we have been through certain challenges in the past. We are aware of what is going on on the ground, we understand the market and we continue to do business. There remains a negative perception out there that it may prove difficult now for new players to start. However, from what we heard in the conference yesterday and today, there are many opportunities on the continent, and business can still be done. There are some countries on the continent that will be among the fastest-growing economies in the world. There are challenges, but I see them as short-term. Perhaps in the first or second half of 2016 things will be different.
Weller: The continent is clearly very diverse, but, in summary, I would not say for someone who does not have experience of Africa that now is the time to jump into Nigeria, for example, with both feet first. However, I think it is wise business sense to put an Africa strategy together and look at country risk in lower-risk geographies like Namibia or Botswana, or maybe Kenya or Mauritius, because there are interesting secondary market deals that can you can participate in there. The risks vary and I think it depends upon your risk appetite.
Kuffour: The metrics are steadily getting better. Conditions are probably brighter now than before. If you look at the continent over the last two decades or so, a number of factors are improving. One of these is governance. Most countries now have what you would consider some form of pluralist system of government. We have a rising middle class and a more vocal civil society ready to hold authorities accountable. Governments are also making the effort to fix the infrastructure deficit. Slowly and steadily, the structures are being put in place. I think Africa recognises that to be able to achieve the robust and sustained growth required to create a dent in poverty, there is the need to create an enabling environment, and governments across the continent understand that. It is probably now or never, and I think this is the time to go in.
Nanji: What is important when going into Africa is not just focusing on jurisdiction, but also specifically identifying the corporates that you are looking to support in that region. Every corporate is going to have a different challenge, a different dynamic and a different business plan. If a funder can get comfortable and knowledgeable with the challenges and inevitable headwinds, then it will be much better equipped to support the local businesses.
I therefore do not think the answer is to stay away from Africa because of all of the upsides to doing business on the continent, but instead to be more thorough at diligence stage in determining which business to support.
Hough: From the insurance angle, it appears that those insurers who have been underwriting deals in Africa still have the appetite to do so and in some cases the appetite appears to be growing as insurers look to expand their books of business. It could be fair to say that those insurers who previously had no interest in covering deals in Africa are not showing signs of changing their ways.
Ifashe: Whenever we experience a downturn in commodity prices the question of whether Africa is a place for business takes centre stage. In the absence of such recession, however, the continent is seen as a frontier of growth and opportunity for everybody to invest in. It is a well-known fact that doing business in Africa carries a high risk, but it also comes with opportunities of a considerable measure. What I want us to take on board is the potential business cycle inherent in commodity-dependent nations, of which Africa has many. It is a global phenomenon and Africa is not the only affected region. However, I think that over the years we ought to have built a learning curve that seeks to guide us on how commodity prices trend, how slump phases out over a time horizon and the need to avoid hasty judgement on the economic viability of the continent. What is immediately desirable rather is a cautious measure to manage risk over the course of downturn: total disengagement is a bad option.
In my view, for anybody who is interested in Africa, now is the right time to take advantage of the opportunity for the future – particularly the opportunity in low asset prices with great potential for appreciation when the economy rebounds.
O’Mulloy: During the conference, the audience voted that 20% of them are looking at new markets in Africa. That suggests that the people in the room, be they banks, corporates or whatever, are being flexible about Africa’s 55 countries. If you go to any industry meeting, you would normally get 95% of people doing what they already do. 20% currently targeting new markets is a big number. For Ethiopia now to be the top target market for an audience like that is totally new. That suggests that people who know what they are doing in Africa are saying: ‘We will have to go easy on Nigeria for a year, but we know what we are doing. Ethiopia is building power stations like Nigeria.’ It gave an impression of people moving around.
People are not thinking: ‘We are terrified about what is happening in Nigeria at US$45 a barrel. We are out.’ It was more them thinking: ‘Talk to us about Rwanda. We are going to Ethiopia. What about Francophone countries?’
Kuffour: There are two types of investors. You have hot money and fund managers who are in for short-term gains. They want to make a quick buck and then will probably leave. They are the ones who would be concerned about the effect of volatility in commodity prices on current account balances, foreign exchange reserves and all of that. Those coming in for some direct investment obviously have the medium to long-term horizon in mind. That is where trends and statistics we have learned about over the last two days become very relevant. You can see why Africa is becoming increasingly attractive. For one, it has the numbers. It has close to 1.1 billion people. 60% of the world’s arable land currently resides in Africa, as well as huge hydrocarbon potential. The middle class is expanding. Overlay that with the fact that governments are becoming more responsible, with a vocal, strong civil society now holding them accountable and elections happening generally, across the continent, and the picture becomes clearer. There is also the demographic advantage, with about 60% of the population under the age of 30. What’s important is more and more of the youth are getting education. Africa has a lot going for it. Until something terrible happens to reverse these gains, the future looks promising. And countries like Nigeria, given their size, economic significance and business potential, are going to shape the future narrative. Serious challenges remain. Parts of the continent are still grappling with low-intensity conflicts.
Ifashe: I remember some years back when the telecom industry in Nigeria was liberalised, the situation in Nigeria was worse than it is today. Several European telecom companies refused to come and invest for fear of future uncertainties in Nigeria.
If those companies look back in retrospect, I am sure they will have something to regret. But those other companies that undertook the risky adventure of coming into Nigeria are smiling today as they have now grown in size, revenue and global footprint?. When they came in it was a big risk because that was immediate post-military rule Nigeria, and nobody could tell what the political future of Nigeria would be like, whether a few years down the line the military would strike again and the country would descend to a fresh state of anarchy. The fact remains that they took the risk and it paid off handsomely. I am sure there are many other similar opportunity infrastructure sectors in Nigeria, for example, that have not been tapped, most likely in power, agriculture and mining of solid minerals.
Hough: For at least four or five years, people have been talking of the huge potential on the African continent and how banks and traders would soon all be turning their attention towards Africa with respect to new growth areas. Over the last two years, we have seen many more infrastructure projects requiring political risk cover and all risks cover which we have worked on in conjunction with our energy division colleagues. Some of these now appear to be going ahead, which is progress in our eyes.
GTR: What hinders funders’ ability to easily conduct business in Africa, specifically with regard to local legal frameworks and documentation?
Titmas: We have worked on a number of transactions where a lender has assumed they will be able to get a full security package, without looking at the specifics of the security they require until well into the transaction. They then discover that local law prevents a contract assignment for example or that the security is in practice unenforceable.
There is not enough attention being paid to the detail of the security at the start of the transaction. Obviously the fundamentals of the loan are going to be the first thing a lender looks at, but I think it is important to focus on the detail of the security and make sure that you can take security over assets in a way that gives a lender the protection they are looking for, and in a way that works for the borrower’s business as well.
I have seen one case where we had to spend ages trying to reconcile these issues.
Nanji: The key thing I would like to add is pre-planning. I have seen this recently on various loans I have worked on. For example, pre-structuring could allow the benefit of certain international treaties being obtained, which can provide protection on issues such as expropriation. Consideration should also be given to the initial contracts with the government on matters such as grandfathering of local taxes, because if the project is successful you do not want extra taxes to be imposed. If issues arise on such matters then it is much more difficult to put in protections ‘after the event’.
Weller: A lot of what we are doing in West Africa is very straightforward. It is letters of credit under UCP and when it goes smoothly from A to Z everything is fine. However, we are routinely looking at underlying trade contracts on individual transactions. In most instances we go based on either UK or South African law. In addition where necessary we will talk to regional local law firms for their legal opinions and to get them to comment on the documentation and contracts. More and more there is a dialogue nowadays between the business side of banking and the legal teams.
Hough: On the political risk aspect, before a policy would be bound insurers would need to see all of legal opinions to make sure that everything signed was enforceable in each jurisdiction. For the large deals that need to be placed into the insurance market, everything would have been checked and verified in advance of anything happening with the deal.
Hala: The majority of our business in Africa is lending to financial institutions, and specifically to banks. As Charles said, when you do letters of credit you have the UCP behind you, so there are international standards. If we do a new transaction in a slightly different way, we seek legal opinion from local law firms. We have done that in many jurisdictions across the continent in Africa. For example, for the discount of documentary collections, the rules vary from country to country, and that is why we have to seek legal opinion on the enforceability of law. If a bank, for example, does not pay you, how can you force the repayment and what measures can you take as an international lender to make sure you can recover your money? The legal aspect is extremely important in what we do. We always ask about the rule of law. We always ask about the enforceability of any legal frameworks there are with the borrowers on the continent. We are an international lender; we do not have a physical presence on the ground which means the legal aspect becomes more pronounced.
O’Mulloy: Something that I have noticed is that the big UK trade finance lawyers have all paid great attention to Africa as 55 countries, and we have local legal contacts, which I would say is different to 10 years ago. Now, when you do a transaction in Sierra Leone and you pick one of the top lawyers that you would need in a difficult jurisdiction like that, if they do not immediately have an established local legal advisor in that particular country then you would consult another lawyer. I think the legal support for the different African jurisdictions in the London trade finance market has improved a lot in the last 10 years.
Kuffour: If you threw your lens on the continent, you would probably find four broad legal jurisdictions. There is the jurisdiction based on English common law. Then you have the French system. Then you have the Maghreb region in North Africa, which is largely the French system with some Islamic law influence. Then you have South Africa which has a combination of Dutch and English law, while Lusophone countries tend to follow Portuguese legal tradition. It differs from jurisdiction to jurisdiction. I work for a supranational, and we are a self-regulating entity. When we get into any commercial financing arrangements the default is English law. That is because there is a long legal tradition with lots of precedents to fall back on. There are instances when it is convenient and practical to use French law, and we do not mind doing that.
What I am seeing is that more and more, the arbitration provisions in any legal arrangement are becoming very important for investors. I am not sure how that dovetails with legal opinion.
Nanji: Often when you have a lend you have assets based in the local jurisdiction, and so whilst the loan document would be governed by English law, and you may have an arbitration dispute resolution in there, as the asset is based locally, to take security over that asset it needs to be under a local law security document. That is where you get local legal opinions to make sure such security is enforceable. Also, you want to make sure that the local entity that entered into the funding documents did so properly, so you get the opinion to cover that. You can also get the local law opinion to cover certain local law aspects in connection with operations and licensing rights there.
The other question for banks is this: because certain jurisdictions in Africa have not adopted Basel III but European banks have by and large done so, what have you seen in terms of market trends developing from the fact that the local banks are having less stringent regulation than the European banks? Are you seeing the European banks pull out of lends, which is causing local banks issues because they cannot syndicate it with the European bank, and so reducing the level of lend possible? Have you seen other players in the market? I am interested to see the banks’ perspective on such trends.
Weller: I think talk about that has occurred, but actual factual data that the Europeans are pulling out of certain transactions because they are on Basel III and African entities are on II has not yet to come through. That is partly as a result, maybe, of the current pricing levels in certain African regions, which have increased. Notwithstanding, I think that Nigeria, as an example, is on Basel II but is moving toward Basel III. The trend there, as in a lot of countries, is to pre-adopt and work towards Basel III. They are not on it yet, but they are working towards it. I have seen with a number of banks that when they are pricing things they will look to III, and say: ‘To get participants in we may need to price it at III level’. At the end of the day if the borrower is in a position to dominate the terms they will push it for lower pricing, otherwise things are moving towards the Basel III levels.
Hala: Trade finance will become more expensive for some of the international lenders simply because the classification of trade finance as an instrument is becoming too punitive from a leverage ratio perspective, etc. If we look at the balance sheets of the local banks, they are very conservative. At least that is the case for the ones we work with in various jurisdictions. They take that into account. The pricing that we are applying as international banks can compensate as well for the differences that we are seeing in terms of costs and returns, etc. Again, we do not have any data and we do not have any facts on that.
I do not think Basel III or its implementation will have a huge impact on finance and trade in Africa. There are challenges. But there are new players and new ways of getting things done. We have insurance companies, we have funds, we have DFIs and we have partnerships that are actually facilitating trade finance on the continent.
O’Mulloy: I think that compliance issues have had a much more significant impact than Basel II to III on banks pulling out of the market and transactions not getting done. There is just no doubt that is a bigger issue than Basel II and Basel III. There have been banks pulling out, there have been deals not getting done, but not because of Basel II and Basel III from what I have seen.
Kuffour: I will differ slightly on this. Certainly, Basel II and III have not been helpful in terms of the supply of credit support to trade finance transactions in Africa. As a DFI, we have been inundated with requests from international confirming banks to provide risk mitigation support to transactions in Africa. One of the reasons usually cited is the increased capital and funding costs associated with Basel II and III issues. It is having an impact. Obviously, there are other factors. AML and KYC issues are also not helping. Also, the perception of the continent itself is a factor, in terms of the poor country ratings, weak financial systems and small capital bases of banks, which seems to be acting in concert to make it difficult for these international banks to justify supplying credit to the continent. So, there are other factors, but Basel II and III remain important constraining factors, if you will.
Most of Africa is behind the curve when it comes to even Basel II. Few countries like South Africa, Morocco, Egypt and Nigeria are Basel II-compliant or close to it. The majority are still in transition to Basel II. Basel III is a long way away. Therefore, the impact will be quite minimal for the time being. Obviously, there are aspirations to get there as quickly as possible.
I also wanted to point out that the supply of credit to support trade finance has always been influenced by the historical configuration of trade between Africa and the rest of the world, with most of the suppliers of intermediate and capital goods, as well as global banks that provide trade finance, on one side. LCs from Africa need to be confirmed by international banks often from the industrialised world and emerging markets where most of Africa’s suppliers reside. The impact of regulation is felt more, when it is felt, in the industrialised world where the confirmations have to come from, where Nisrin and co are sitting. If they feel the impact, then indirectly that would be channelled to Africa through contraction in the credit support to the region