King & Spalding LLP is an international law firm representing a broad array of clients, including half of the Fortune Global 100. With more than 1,100 lawyers in 21 offices across EMEA, Asia and the United States, the firm has handled matters in over 160 countries on six continents. King & Spalding is one of the most active international law firms in Africa and has established itself among the top projects and energy practices Africa-wide.
Private credit/debt in Africa: what are some of the opportunities and risks?[1]
In recent years, private credit has become recognised as a strategic, mainstream asset class in international portfolios. Diversification via private credit strategies can help optimise the efficiency of investors’ portfolios. Its appeal centres around attractive risk-adjusted returns with a built-in liquidity premium and a cash yield. It is important to remember that unlike private equity, private credit returns are contractual, so the investor has more visibility over the timing and quantum of return repayments over the life of the investment. Again, unlike in private equity, there is less reliance on an “exit” to lock in returns.
If things go wrong, debt has priority over equity in order of claims, and with adequate monitoring and covenant protection, your downside risk can be limited. These contractual returns, combined with downside capital protection, can act as a capital buffer in adverse market environments. You also have less duration sensitivity than competing credit sub-asset classes, as loans are typically based on floating rates.
The private debt opportunity in Africa is exciting. At the core of this is a fundamental demand/supply credit imbalance: a shortage of adequate finance to mid-market corporate and financial institutions. The small and medium-sized enterprises (SME) credit gap in Sub-Saharan Africa is estimated by the International Finance Corporation to be US$140 billion. The World Economic Forum has estimated that SMEs comprise 80% of the continent’s employment. Empirical studies have shown that the relative size of the SME sector and a country’s economic growth are positively correlated.
“If things go wrong, debt has priority over equity in order of claims, and with adequate monitoring and covenant protection, your downside risk can be limited.”
The best opportunities lie in the middle market. There are many companies with ambitions to be the next MTN or Dangote Group, but they are profoundly constrained in their ability to access capital that generates private-sector growth and jobs. These companies, including many local financial institutions, find US dollar funding a challenge due to high costs of local borrowing and a range of barriers to accessing international capital. They also often lack the flexibility to provide the right tenors and structures for the mid-market.
This opportunity is augmented by Africa’s structurally superior investment and growth prospects. Sub-Saharan Africa has consistently been the second-fastest-growing global region after developing Asia since 2000. A structural demographic dividend and a growing labour force underpin higher and sustained long-term demand for goods and services. By 2034, Africa will have a larger workforce than either China or India. Burgeoning consumer markets are driven by urbanisation, with the UN forecasting SSA’s urbanisation rate to reach 46% by 2030, up from 36% in 2010.
Eco: how effective is the introduction of a new regional currency?
After forty decades of planning, the 15 members of the Economic Community of West African States (ECOWAS), agreed to adopt a new single regional currency named “Eco”, to replace the French Colonial CFA franc, in 2020, which comprises 150 million in population and $235 billion of gross domestic product. Eco will remain pegged to the Euro, with financial backing from the French treasury, at a fixed exchange rate (655 CFA franc = €1). To join Eco, these African countries must meet ten macroeconomic convergence criteria set out by the West African Monetary Institute (WAMI).
“In the long-term, Eco may improve Africa’s negotiation position regarding their economic partnership agreements with China, Europe, and the United States.”
The 15 ECOWAS countries comprises 385 million consumer population, presenting a gold mine for African entrepreneurs and investors to leverage. Despite this, statistics reveal over 80% of Africa’s export is shipped overseas, while trade amongst African countries accounts for only 10-20%. By contrast, in 2018, the 28 EU Member States exported 64% of their goods to another member state of the EU. The use of a common currency in West Africa could cure this issue. Eco will help remove trade and monetary barriers by reducing transaction costs for African enterprises. Less tax on exports can boost regional trade, enhancing economic efficiency. However, there is no guarantee that Eco will ameliorate regional trade. The issue of infrastructure, such as roads, energy, and physical networks — has proven costly to move products within the African market. The African leaders of ECOWAS must address transit and tariff issues, to make it easier to do business in West Africa.
The launch of Eco and the implementation of the African Continental Free Trade Area (AFCTA), will facilitate the free movement of goods, services, and currency. In the long-term, Eco may improve Africa’s negotiation position regarding their economic partnership agreements with China, Europe, and the United States. France is supportive of the Eco currency. Last year, the French President pledged to invest 2.5 billion euros in Africa to finance start-ups and small to medium-sized enterprises by 2022.
To that end, Africa’s economic growth is foreseeable. Eco could potentially attract international trade. Less speculation will be necessary because investors could scrutinize the macroeconomic stability of Africa lucidly and project future markets better. To be cognizant of the intricacies within this region, legal advice is indispensable. The caveat in doing business in Africa is that it requires extensive due diligence, to understand local nuances, evaluate deals and execute risk management.
Author: Nikhil Markanday, Partner
King & Spalding LLP is an international law firm representing a broad array of clients, including half of the Fortune Global 100. With more than 1,100 lawyers in 21 offices across EMEA, Asia and the United States, the firm has handled matters in over 160 countries on six continents. King & Spalding is one of the most active international law firms in Africa and has established itself among the top projects and energy practices Africa-wide.
[1] Interview with Macky O’Sullivan (King & Spalding) and Ebele Okeke (Altica Partners) – Dubai as the Gateway to Africa and the Outlook for Private Credit in Africa (January 2019).
