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Foreign exchange is changing apace in Sub-Saharan Africa. Not long ago, FX was a simple affair in most of the region’s markets, and a fairly uncomplicated offering even in most of the more advanced economies. All that is changing. Foreign firms and investors entering Africa, as well as local firms looking to grow regionally and globally, are seeking increasingly sophisticated and consistent levels of FX service. Succeeding in Sub-Saharan Africa, which contains a majority of the world’s fastest-growing markets, is no longer an afterthought for multinationals. In the decades to come, profit, for carmakers and banks, technology firms and fast moving consumer goods makers, will be found in one, more or all of the region’s 46 sovereign countries.
Even within Sub-Saharan Africa, the quality of foreign exchange service ranges from first-class in South Africa, Nigeria and Kenya - developed and liquid markets with increasingly excellent financial talent and advice - down to third-tier on the poorer sovereign end of the spectrum. It’s hard to see sparklingly good FX service being offered by local lenders operating in frontier markets such as Gambia or Malawi for years if not decades to come. Even the best regional banks struggle to offer the same, consistent level of FX service across all markets.
| Some regional banks|
use swap mechanisms
to facilitate their customers’ transactions
Jean Claude Karayenzi,
Access Bank Rwanda
So it remains vital to remind investors, keen to put money to work in the world’s most exciting economic area, why they need to understand the quirks of Africa’s FX markets. And why securing the best possible advice is the key to success. “Local presence and market knowledge is essential,” notes Alan Cameron, Africa economist at London based boutique investment bank Exotix. “There’s so much about the local investment landscape in these frontier markets that just doesn’t meet the eye, or the mainstream media, so without being on the ground, it’s very difficult to understand, let alone anticipate, economic and market developments.”
Jean Claude Karayenzi, managing director at Access Bank Rwanda, points to the inherent advantage of retaining a strong presence across the region. He notes that in the East African Community, a monetary and economic union spanning five nations in the eastern half of the continent, including Kenya, Tanzania and Uganda, “some regional banks use swap mechanisms to facilitate their customers’ transactions and close the gap on foreign currencies shortages or risk”.
Finding the best
In very simple terms, it remains vital to procure the best FX advice from a financial service provider that knows the region from cover to cover, and which has offices outside the region, as well as relations with other lenders across Sub-Saharan Africa. The region is packed with potential, particularly for foreign corporates looking to put their capital to work on the ground. This makes it vital for companies to secure professional help in determining how best to get capital in, and then put it to work.
“It’s extremely crucial to get great FX advice,” says Roosevelt Ogbonna, executive director, commercial banking, at Access Bank. “We are a region that is highly dependent on foreign direct investment - there is huge growth potential, but not enough capital to take advantage of the opportunities that exist. Also, we are a big producer of primary raw materials, but we don’t have a developed manufacturing sector. So the upshot is that sophisticated FX services are essential, in order for governments to manage their balance of payments, and for importers to manage their cash and hedge against currency risk and fluctuations.”
Yet with currency risk rising across the region, there is no hedge yet invented, he adds, that can entirely eliminate risk. “A lot of investors into Sub-Saharan Africa aren’t willing to take currency risk here, so they are dealt with as local operating units that aren’t dependent on parent groups in the UK, the US, or Hong Kong for leverage, but which leverage directly from local markets. That eliminates some but far from all the currency risk.”
Adedapo Olagunju, group treasurer at Access Bank, which also has a thriving London office, notes that the lender offers foreign investors and corporates a set of products that “successfully caters to their cash and risk management needs across the entire investment chain. We offer the entire product suite, ranging from access to the US dollar-Nigerian naira spot market, to both plain-vanilla and structured FX derivatives including options and swaps.” He adds that having a serious presence across the region “offers significant advantage in terms of offering FX services to multinationals with operations across Africa, due to the ease with which transactions can be executed between subsidiaries”.
Looking for liquidity
Liquidity will always, in even the smallest African market, be of paramount importance, whether investors are short, long or very long on the region. And what investors and corporates need changes as the region develops, and as investors seek to find ways to get their capital into the region, put it work and then, when necessary, extricate or redeploy it. “For institutional portfolio investors, the key motivating factor in liquidity terms is the ability to make the next redemption; for private equity investors, it’s about planning an orderly exit; and for corporations, it’s about managing working capital, ensuring access to imported inputs, and being able to repatriate profits,” notes Exotix’ Cameron.
Understanding risk is also key to developing a successful regional investment plan. Sometimes that risk is inherent in price: how the cost of FX services shifts, often seemingly arbitrarily, from one market to the next. Investing in any market requires foreign currency to be imported. “It is imperative that multinationals are able to manage attendant market risk, from the conversion of FX for local currency disbursement to the final repatriation of investment proceeds,” notes Access Bank’s Olagunju.
Risks abound. Yet good advice help investors or corporates dodge the worst of them, and realize the considerable profits to be made. The shallow nature of most financial markets means banks historically have been severely constrained in their daily operations by central banks and local regulators. Lenders may aim to offer a wide variety of FX products, but are often forced to extend a far more simplified set of FX services. Good regional lenders, notes Olagunju, will seek to exhaust all product possibilities within the defined scope of spots, forwards and swaps. “What we have tried to do is to create cross-border FX products to ensure our clients are able to transact and execute FX-related transactions seamlessly across our subsidiaries,” he says. “This is where we feel the opportunity lies, and it’s an area we intend to continue to exploit.”
|There are no restrictions on foreign investors in terms of being able to put money to work locally, and then extricate it|
Gaimin Nonyane, Ecobank
Other risks exist, notably in terms of exchange rate and currency volatility, as well as processing costs. Volatility is inevitable, given the current account deficits and political instability that characterize most African economies, currently exacerbated by extraneous factors such as the US dollar’s strength and economic torpor in China. “This often encourages investors to hedge their currency needs with the use of derivatives, ranging from plain vanilla forwards, options and swaps to more complex derivative structures engineered to meet specific needs,” notes Olagunju. He points to the example set by the Currency Exchange Fund (TCX), a fund offering over-the-counter derivatives that helps corporates and investors to hedge against currency and interest rate mismatches fomented in cross-border investments between global investors and local borrowers, usually in less liquid frontier and emerging markets.
Exchange rate volatility will remain high for some time to come. There is a “far greater sentimental attachment to exchange rates, at least compared to other emerging and frontier economies”, notes a London-based, Africa-focused analyst. “This is notably because a large volume of basic imported goods are relatively demand-inelastic, and the pass-through of exchange rate depreciation into local price increases is almost instantaneous. Also, given the limited local access to credit, exchange rates rather than interest rates are more widely seen as a barometer of economic health by the population. This has significant import for both political and economic policy formulation.”
Transaction costs also vary widely from country to country across the region, with the cost of FX transfers often proving considerably lower in developed markets such as South Africa than in the likes of, say, Sierra Leone. This is in large part due to the floating exchange rate system favoured by the South African authorities. “There are no restrictions on foreign investors in terms of being able to put money to work locally, and then extricate it,” says Gaimin Nonyane, senior macroeconomist at pan-African lender Ecobank. “Whereas in economies with managed pegs in place, it is hard to offer smooth, reliable FX service. That kind of exchange-rate system does not facilitate trade, as it places so many restrictions both on invested capital and on investors.”
There will of course always be risk when it comes to operating in these frontier and emerging markets. In the Euromoney Country Risk second-quarter 2015 survey of the world’s most stable markets, only one economy broke into the top-60, and that was South Africa in 56th place. It is still, says a prominent Nigeria-based investment banker, an “inherently risky” environment. “Political stability is changeable, so you have to invest with caution,” he adds. “But if you know the local operating environment, have a good financial partner, and get to know the pitfalls, it often encourages people to reinvest.”
And the best financial service providers will increasingly pull away from the pack in the years to come. As well as giving its customers regular updates offering regional and market-specific economic updates, Access Bank organises regular workshops, seminars and forums for its clients, where the lender pitches its latest and best FX products. This is where clients come to learn where the risk and the opportunity lie, and where the profits and potential will be found in the years and decades to come.