Dealing with Challenging Markets in Sub-Saharan Africa

 
by Chris Paizis, Managing Principal, Barclays Africa 

The African continent, much like any emerging market, faces a unique set of challenges particularly in the financial sector, which will concern investors, corporations and market participants. But these challenges aren’t new and can often have positive outcomes. For example, the electricity supply has been a huge issue in many Sub-Saharan Africa (SSA) countries and electrification levels have been very low, but I would see this as a long-term positive because investment in electricity can then lead to very fast growth. 

These issues are part and parcel of dealing with frontier and emerging markets and it should be remembered that in Africa one has to look through financial cycles. We might have low growth now, but in two years’ time, that could be a very different story. While there are political and other risks, external factors like the drop in commodity prices are more likely to have an impact on markets as this reduces the credit quality of our commodity producing countries and associated clients. 

In SSA, we have to live with volatility, and our clients, who have been on the ground for a long time, understand this and they are able to conduct business through the cycles to still make healthy profits and to service their own clients. 

Nascent financial markets

The African continent, with the exception of South Africa, has very nascent financial markets, and one of the reasons for this is because regulatory frameworks around them haven’t been updated over time to take into account the needs of the developing financial markets sector such as the ability to trade under ISDA [International Swaps and Derivatives Association] documentation, which is globally accepted, and, for instance, what happens to financial market obligations in the event of a liquidation. Are liquidation laws appropriate? All of these issues have not really kept pace with developments and this is why SSA financial markets have not developed as fast as we would have liked. However, there has been a growth trend despite the lack of a strong enough regulatory framework. 

Since the 2008 crisis, regulators in Africa have taken a more active role in their financial markets. For a very long time, South Africa has been a benchmark on the continent; however, not always for the right reasons. A good example is our exchange control framework, which we’ve had for many decades and which works well, partly because it’s been around for so long. Banks understand its implementation and clients understand what’s required. What we’ve seen in SSA in recent years is a knee-jerk reaction to adopting exchange control regulations, but some countries are doing this too quickly, too ad hoc and without the requisite administration around it, and that means it has been negative for some markets. 

International investors want to get more involved in SSA because of the potential for high returns and the growth prospects, but they are finding it difficult because of, amongst other things, a lack of currency liquidity, and often they don’t know which banks to trade with on the continent. Outside of a handful of international and South African based banks, local banks are mostly little-known entities to international investors, so access to the markets has been quite difficult. 

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How bank treasuries and corporate treasuries handle risk

Bank treasuries and corporate treasuries are interlinked, and a good example of this is that one of the main points for anyone operating in African financial markets is the lack of hard currency liquidity and sometimes even the lack of local currency liquidity. As a bank, our role is to manage risk and to try to help our clients as much as possible in getting access to those flows. In Mozambique, for instance, since their own financial crisis, the ability to buy foreign currency has become very difficult and that has been reflected in the weakening of their exchange rate. What we would do, as a bank, is to ensure that we remain very close to our clients, that we are aware of their currency needs, and that we do everything we can to help them. It’s difficult sometimes for corporate treasurers if they don’t see flows from other entities to be able to satisfy their on going currency hedging needs. 

For banks, it has always been that the markets and treasury area are core to how the bank operates, given that the bank’s role is to manage risk on interest rates, foreign exchange and any other risks that might affect our clients. The role of bank treasuries hasn’t changed much over the years, but for a corporate treasury, the significance of the treasury function has grown a lot given all the financial crises we’ve endured. In a place like SSA, it’s impossible to operate without a fine-tuned, well-staffed, highly confident treasury because almost of all the impediments to doing business lie in the financial markets, so access to liquidity, the cost of funding and dealing with regulators are key to what a corporate treasury should be looking at.

Frontier markets in SSA differ from European markets and even South African markets where liquidity is taken for granted. Treasurers all face similar challenges, but may have different focuses. 

The lack of market-enabling regulation 

African financial markets have experienced growth as a result of the underlying economic activity of people simply wanting to do things. Markets will continue to develop, but they could develop much more in the presence of the right regulations. Financial markets – foreign exchange, liquidity, the number of banks in a market and the systems available to trade – have all grown in line with the underlying economic activity, but they haven’t grown enough. In the majority of our markets, most transactions in foreign exchange are basically spot transactions or very short dated transactions. There tends to be a lack of long-term hedging instruments to either hedge foreign exchange or to compensate for interest rate exposure. There can also also be a lack of local currency liquidity, so funding in these markets tends to happen in hard currency and mostly in dollars. 

The perception that local interest rates are very expensive because they can be 20% or 30%, has led to people borrowing in foreign currencies and that, in itself, also prevents the development of local markets because markets become ‘dollarised’. This is also linked to a lack of investment or a lack of focus in developing local capital markets, encouraging local clients to borrow in local currencies and encouraging banks to lend in local currencies. There’s a role, a very friendly role, to be played by regulators, central banks and ministries of finance in assisting with such development. 

Technology trends in the treasury

From a markets perspective, international banks have always been at the forefront of introducing top-tier technology. We, at Barclays Africa, have an integrated risk management system across all our countries so that we can see what all our financial markets’ exposures are across all the countries we’re present in. We’ve also rolled out our online client trading system , and this new system is as good as it gets in terms of global technology. 

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Technology and innovative solutions are obviously very important, and from a corporate treasurer’s perspective, the ability to go online and do your cash management, currency hedging and money market transfers on one system is very valuable. As a bank, we have invested a lot in technology because we understand that if you’re a regional treasurer, or a global treasurer, you want the ability to centralise your risk management and treasury functions across your markets. A good treasury management system, or dashboard, will allow treasurers to improve cash visibility and positioning, optimise cashflow forecasting, automate payment streams and ultimately reduce risk.

It’s a core function of banks to manage financial market risks, and I think South African banks have proved throughout the financial crises that we are some of the best-equipped banks, globally, to deal with risks. 

Africa has also shown that it has a tendency to bypass current technology and move to the next level. For example, mobile banking is very big in countries such as Kenya where the lack of a fixed-line infrastructure has encouraged the success of such innovation. 

Future treasury trends

In the future, in SSA, we might see a consolidation of the banking sector, and with fewer banks, the choice of a banking counterpart becomes very important. In Africa, you can’t take for granted that if you’re dealing with an international bank, it’s always going to be on the ground and you can’t take for granted that if you’re dealing with a bank in a particular country, that that bank will always be there. For international investors and corporates, it’s important to understand the quality of your counterparts and their ability to partner with you through the financial cycles on the continent. 

We’re doing a lot of work with local regulators to improve regulations and documentation to make it easier and cheaper for our clients to transact and that’s an important trend to be aware of. There will be ongoing changes in regulation and, hopefully, they will be more positive than obstructive because we have several governments and central banks in place now that want to be market-friendly, and that’s good news. 

There will continue to be interest in Africa despite the high risks, mainly because this is a growth market. From an international investor perspective, even though there might be fear of the unknown in frontier markets, current growth trends should continue in the next ten years and beyond because there are few places globally where investors can get this kind of growth.

A big focus for banks right now is financial inclusion, especially in Africa where we have a very large unbanked population. This is something we spend a great deal of time on because we feel that inclusivity and giving everyone access to banking will enable faster and more equally spread growth. Financial inclusivity right across the chain, from people to small businesses to core sectors such as agriculture, as a whole, is a very important trend for an organisation such as ours. 

Credit ratings downgrade

For banks, credit risk is just another one of the risks that we manage, and we have prudent parameters in place to deal with such risk. For example, if we’re dealing with a low credit counterpart, we have to make up for that risk by limiting the amount of exposure to that counterpart and by pricing appropriately, so the lower the credit rating, the higher the interest costs. Obviously, there is a fear that if South Africa is downgraded a notch, the cost of interest servicing will go up, but we should remember that outside of South Africa, many credit ratings are significantly below investment grade. Across the continent, corporations and people are used to borrowing at very high interest rates. These costs are built into the local economies of these countries. 

The downgrade concern in South Africa has been somewhat sensationalistic. The reality is that we have been below investment grade before and we have dealt with it perfectly well. I think the concern is more reputational for South Africa, but if you’re in a country for the long haul, credit ratings are something you’re going to have to deal with as well as the consequences that go with it. Importantly, downgrades haven’t prevented African countries from borrowing money or growing at fast rates. 

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Skills trends for treasurers

Treasurers should understand that technology is a tool, which is always changing, but the underlying skills set of understanding the numbers, looking at the risks and understanding the economy won’t change. Treasurers have to be adaptable and understand that a lot of the channels that we do business on are being taken over by technology. For example, more of our clients’ trades are now happening online without the need to pick up the phone and speak to someone. Technology is an enabler and it makes the world smaller, and it definitely makes the job of a treasurer easier, but the underlying skills don’t change.

The one thing that shouldn’t be taken for granted is understanding how regulations, be they global or country-specific, can affect your day-to-day job, so it’s important to be on top of regulatory changes and to understand that you might be sitting in South Africa, but that a regulator in New York or the United Kingdom might well have an impact on how you conduct your business. I think this is far more important now than it was before the financial crisis. People took for granted before what they can’t take for granted now. 

Barclays Africa is committed to staying at the forefront of market trends and regulation to ensure that its clients’ needs are always taken care of. We are committed to shared growth and understand that if our clients prosper, so will we. 

 

Chris Paizis Managing Principal, Barclays Africa  Chris Paizis was appointed to the Corporate and Investment Banking division of Absa, member of Barclays, in May 2007. In his current role he heads up Africa Markets Sales (ex SA) across all product and client groups. In this capacity is responsible for building out the Barclays Markets client franchise across all our presence countries by delivering the firm to African clients and ensuring that we deliver Africa effectively to our global corporate franchise. Chris was also tasked with heading up the Barclays CIB Client committee (ex SA), which reports into the CIB (ex SA) Exco. In previous roles at Absa, Chris was responsible for building out the Risk Solutions Group before also being charged with FX & Commodities Sales in SA, prior to taking on his current position across greater Africa. Prior to joining Absa, Chris held various roles at different investment banks. Beginning in 1995 he was a Dealer on the Foreign Exchange desk at the French Bank of Southern Africa. In 1997 he became Head of Foreign Exchange Sales for Gauteng at NBS-Boland Merchant Bank, after which he joined the Treasury Marketing side of Citibank South Africa, where he soon took over the marketing of derivatives to Citibank’s clients. In 2004 he joined Calyon Corporate and Investment Bank. He was later appointed Head of Corporate Sales and Structuring. In his last role at Calyon, Chris assumed responsibility for the Debt Capital Markets and Structured Credit Sales portfolio.  Chris graduated with a Bachelor of Commerce (Honours) degree in Economics from the University of the Witwatersrand in 1995. He has attended a number of professional courses, mainly in Advanced Derivatives and Risk Management.