Broad Corporate Strategy Required to Manage Emerging Market Risk
Treasury, liquidity and volatility in Africa
by Chris Paizis, Head of Corporate and Rest of Africa Distribution, Barclays Africa
Many of the risks that company treasurers encounter in Africa require an understanding of what can and can’t be managed or hedged – and then how best to deal with things that can’t be hedged. This necessitates a broader corporate risk strategy which treasury can inform though not necessarily own in its totality.
Treasury, in its simplest expression, is about managing liquidity, regulatory and volatility risk. Liquidity and volatility are especially applicable to treasurers operating in emerging markets like South Africa and Africa in general. Beyond managing these risks by working with a counterpart who can deliver depth and access into markets, as well as the systems and platform to hedge exposures, there is little ‘new’ that treasurers can do to manage risk specific to emerging markets.
Treasurers on the continent can’t by themselves change the fact that Africa experiences little debt capital market activity as local corporates raise money bilaterally, or, in the case of large multinationals, secure funds abroad and inject foreign currency upfront. Instead, treasurers should focus on eliminating risks that they can control (like foreign currency risk). This will free the company to manage broader corporate risks.
Africa, by virtue of its diversity and emerging market status, presents more risk than many other jurisdictions. It also holds out the potential to produce higher returns since many African markets are nascent, offering first-mover advantage or less competition. Taking a broader corporate approach to managing these risks means remaining sensitive to local market and regulatory needs.
Often, for example, companies focus too much on getting profits out. In Barclays’ experience companies that have been successful in Africa have taken a local market approach, developing a more measured policy towards dividend repatriation. Waiting for pockets of liquidity to develop organically over time and then working with banks and local regulators to structure the right windows to expatriate liquidity - with the full knowledge and support of local regulators - is a more sustainable approach and reduces risk.
Importance of hedging
Since local investments deliver local currency profits, companies which keep these profits in market over time can incur local currency volatility risk. This is where the ability to hedge local currency and interest rates on local currency lending (as well as revenues) becomes important. While this is somewhat mitigated if expenses and revenue are also in local currency, hedging hard currency lending exposure can become extremely expensive in a depreciating currency environment.
Understanding and mitigating broader country risk at a corporate level will help businesses and their treasurers understand what can and can’t be managed as treasury develops an appropriate local view in each operating market on the continent.
As with many bankers some corporates attempt ‘suitcase investing’ in Africa. Essentially, this means trying to enter or manage markets from a distance and not adapting an integrated enough approach in the local market place. This doesn’t work over the long term. Businesses operating on the continent need to be prepared to have a local currency balance sheet if they want to eliminate local risks. For example, considering how much a business can borrow locally in-market, or how much it can generate organically in-market to mitigate this risk, is as important in managing risk in Africa as it is about sending the right messages to local regulators.
Not understanding local market realities, like local market depth and liquidity, often happens when companies take a purely global view as opposed to taking the time to understand specific on-the-ground limitations. Often, for example, global corporates make the mistake of considering exposures in African markets from a developed markets perspective. Assuming that an exposure of ‘only five million USD’ can be hedged locally becomes a risk in markets that can’t handle this in a day.