Published: October 06, 2014
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.
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.[[[PAGE]]]
Broader corporate risk strategy aside, ongoing global uncertainty has driven emerging market volatility over the past year. This is currently reflected in the downgrades being experienced across emerging markets, including South Africa, now one notch away from losing its investment grade rating. This has been instantly reflected in the country’s currency. Beyond getting the broader corporate risk strategy right, this is the kind of volatility – with immediate risk implications – that treasury needs to be able to manage in emerging market contexts.
It is not the role of corporate treasurers to try to second-guess markets or volatility but rather to smooth any earnings volatility on the back of financial exposures. Key in such environments is having a transparent and established hedging policy across all exposures. Getting this right means partnering with banks that provide the broadest possible solutions (and depth) within the chosen markets that companies operate in.
Certainly a growing number of South African and other large African companies have pan-African risk exposure. Given the lack of underlying liquidity that characterises most continental markets it is not always possible to hedge this exposure in-country. Instead, being able to deal through a central point of contact (ideally in South Africa or in whichever continental centre a company is headquartered in) enabling treasurers to hedge currencies and other financial exposures across the continent requires a bank with an on-the-ground presence able to source, in the case of currency risk, whatever currency is required. To do this, some banks are able to provide transacting systems allowing straight through processing across the full range of currency pairs or markets required (such as Barclays’ much praised ‘BARX’ system).
Today this is no longer an exceptional request. Almost all businesses operating on the continent are running centralised treasuries covering a wide range of geographies.
While liquidity and volatility remain the major concerns of most companies managing exposures across the continent, regulations, especially rapid and unpredictable regulatory change, continues to keeps treasurers awake at night on the continent.
From a developed market perspective, Dodd-Frank, Basel and other global regulatory regimes have had significant implications for treasurers globally. In Africa, especially, parts of this legislation often don’t seem to make sense in economies where the level of development is far behind the United States, Europe and Asia.
For example, outside South Africa, ‘CVA’ charge on corporate hedging transactions is practically meaningless in Africa as many economies are not yet on Basel III and have no practical way to quantify such cost. Similarly, the global regulatory drive to have everything done through a clearing exchange makes less sense on a continent where most countries only conduct a handful of transactions every year. While these regulations could in theory be complied with, forcing global best practice onto markets that are not ready for them adds an unnecessary complication.
From a continental perspective, the post-financial crisis environment is seeing treasury having to deal with an increase in the number of banking counterparts and the willingness of those counterparts to trade with corporate clients across the credit chain. For example, in South Africa it has become more expensive for corporate treasurers to hedge because of regulatory costs, in other African countries these costs are yet being priced in.
As such, a local understanding of regulations is important. Recent regulatory changes in Ghana and Zambia have spooked investors and created uncertainty in these markets. Beyond the repatriation of funds, many of the questions that Barclays gets from corporate treasurers centre around the management of exchange rate volatility given continued change in local regulations. Managing currency volatility is a lot easier in the rand market with its US$5bn daily turn-over. In Nigeria, the next most liquid market on the continent, with a turn-over of between US$200 and US$400m a day, limited liquidity makes managing volatility a bigger challenge, requiring informed local support, networks, global access and guidance. The task gets even harder in many other markets where liquidity is a fraction of the numbers mentioned here.
In Africa a locally informed knowledge of the detail of local regulations, right down to the intricacies of the paper work, is important. Small bureaucratic oversights can cost businesses the ability to repatriate funds or close doors on conversations with the right regulators in the central bank when businesses want to invest more money in or take money out.
As African countries become more experienced in regulatory policy formulation and its implementation, growth deepens and financial markets become more liquid, volatility and regulatory risk are expected to reduce on the continent. This is unlikely, however, to happen overnight or in all countries equally making the need for local intermediary partners with continental and global reach critical in mitigating these risks.
Barclays, in positioning itself as Africa’s ‘Go-To’ bank is working with local businesses, regulators and its global networks and counterparts to deepen financial markets on the continent in the interests of creating more open markets by driving connectivity, increasing the sophistication of and access to financial services, driving growth and prosperity for all.[[[PAGE]]]
Barclays’ long history and deep emersion in the business and regulatory environments of its African presence markets has taught that managing risk and achieving success in Africa requires commitment over the long term. While banks with a pan-African presence like Barclays can provide treasurers with the systems, networks and contacts to transact across multiple currencies and jurisdictions, corporates operating in Africa should understand that they can’t expect the same kind of transparency of liquidity that they would achieve in developed markets. In such environments, the level of trust in the relationship between company, regulators and local and global banks is a whole lot more important than in the developed world. In such environments mitigating risk over the long term is as much about the attitude and commitment or broader corporate strategy as it is about effective and correctly supported treasury.
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