From political instability to FX illiquidity, investing in Africa is not without its challenges. However, with untapped markets, high growth rates and a young population with an increasing spending capacity, investment opportunities on this vibrant continent are also in abundance. So, how do European firms navigate this unfamiliar territory? Ultimately, it’s those who sow the seeds of local partnership that will better understand the risks and reap the rewards.
Africa is open for business. With the continent emerging as a hub for international investment and economic opportunity, its corridors leading towards more developed markets are going from strength to strength. But Africa’s dynamism is not without its vulnerabilities.
First, to many businesses used to operating in European markets, it can be a wholly unfamiliar territory. Across the continent’s banking, trading and foreign exchange landscape, the lie of the land is quite alien to that with which many organisations are familiar from their experience in more mature, Western markets. And when it comes to business and treasury responsibilities, such as currency hedging, it can be difficult to ensure adequate protection against the distinct challenges of the African marketplace while making the most of the opportunities available.
Second, political stability is key to enabling a country to develop deeper laws and regulations to protect its developing financial markets, commercial interests and capital controls. The challenge Africa presents is that changes in regime can often result in alterations to currency regulation. Even where regimes are more stable, rules can sometimes suddenly change in arbitrary or non-market-driven ways that will be unfamiliar to those used to navigating European markets. With political and regulatory nuances varying from country to country, steering through individual markets becomes incredibly tricky without a guide. As well as providing greater visibility for these risks, being partnered with local banks automatically gives better access to regulators and on-the-ground expertise, which makes it much easier to do business locally and surmount any rules-based challenges.
A diverse landscape
Issues of liquidity and volatility also present a very different set of challenges to those which they pose in a European context. For instance, someone who usually trades in euro/USD or sterling/USD is used to an environment where pricing is very tight and movement typically small. But the volatility for a currency such as the South African rand represents a different ball game entirely – the rate can easily move by 20 or even 30 cents in a single day.
There is tremendous variance in terms of the range of hedging instruments available and the liquidity landscape for these across different countries and markets. In South Africa, a relatively liquid market, one can transact in almost any product and find offers quickly. But this is a market that, onshore and offshore, sees around $10bn move through it every day, with between $4bn-$5bn onshore. Go elsewhere and the picture changes dramatically. In Nigeria, for instance, the onshore market is around only $150m-$200m a day. This represents a tremendous difference in liquidity that means even business as usual (BAU) currency conversions and flows become quite difficult. Partnering with a bank with local expertise is beneficial in terms of enabling institutions to create a more efficient working model that suits particular business needs.
The importance and centrality of these local connections to a successful pan-African currency hedging function means that, more than usual, carefully selecting the right relationships and partnerships is key: What are their processes? What’s their standing? What range of products can they offer, and is it a good fit?
Regional and local banks typically have lower credit ratings than their Western counterparts, and transparency levels aren’t always ideal. When choosing the right partner, it’s also key to consider the variety of sophistication on offer in terms of security and protection. Attributes such as the robustness of payment systems and embedded checks against risks, such as money laundering, are essential. Although there is currently plenty of excitement about disruptive fintech newcomers, established regional banks have far more experience and substance in these areas, in a market where the risks are greater than elsewhere.
While Africa’s political, regulatory and FX landscape is complex, there’s one clear thread that can weave its way through that complexity: the distinct importance of forming deep partnerships with a network of local and regional banks and other financial and regulatory institutions. This, more than anything else, is the key to successfully navigating opportunities on the African continent.
