By Emmanuel Ajayi - Managing Director, Head of FX Trading, Africa
With more than 50 countries using more than 40 different currencies, Africa is a highly complex FX market. Indeed, currency management is generally considered one of the key challenges to doing business in that part of the world.
The importance of efficient currency management is heightened for corporates seeking to capitalise on commercial opportunities created following the establishment of the African Continental Free Trade Area (AfCFTA).
AfCFTA covers a market with a combined GDP of USD2.5 trillion and a population of 1.2 billion. By 2050, the African Union predicts the population will more than double to represent one-quarter of the world’s working age population. The significance of this development cannot be understated – AfCFTA will be one of the world’s largest free-trade areas and is forecasted to boost generic African intra-regional trade by approximately one-third.
Businesses currently face higher tariffs when they export within Africa than when they export outside it. AfCFTA will progressively eliminate tariffs on intra-African trade, making it easier for businesses to trade within the continent.
One of the main challenges within Africa is accessing liquidity – there are many instances where markets freeze due to a lack of liquidity, creating a non-functioning interbank market. However, with countries across the continent making huge efforts to develop economically, and with the implementation of AfCFTA, demand for FX services will inevitably increase.
Currency management strategies
Today, currency management strategies among African central banks fall into four brackets: pegged currencies; managed regimes; basket-linked currencies; and offshore freely-traded currencies.
Pegged currencies include the likes of the West African CFA franc – the currency of eight independent states – and the Central African CFA franc, which is used in six different markets.
Managed regimes are where the central bank manages FX levels and provides liquidity by way of intervention; in these markets, FX transactions need to demonstrate economic value.
In the third category are countries where the currency is linked to a basket of currencies, for example the Botswana pula or the Namibian dollar, the latter of which is strongly correlated to the South African rand.
Finally, examples of offshore- traded currencies include the Ugandan shilling and the South African rand.
African currencies tend to be US dollar-denominated, but as AfCFTA develops, the volume of pan-African trade will increase significantly, and we will see more trading in local currency pairs. Understanding these changes – and potential shifts in regime from the aforementioned strategies – typically requires an on-the-ground presence.
And in a period where isolationist policies are prominent in many parts of the world, Africa will likely look to its domestic market for growth – creating an even greater need for local experience.
Electronic execution efficiencies
Increased efficiency in FX trading will be an important enabler for this anticipated regional expansion. An ongoing global shift towards electronic execution continues to improve the efficiency of African FX markets for both transparency and pricing. A number of banks have gone to great lengths to engage with clients who have historically been more comfortable speaking to a familiar voice on the phone – and for who it is culturally acceptable to try and negotiate a better price.
Small businesses in particular now have a greater understanding of the efficiencies of trading on an electronic platform. The availability of market data allows them to compare rate, which provides assurance that they are getting the best price.
Electronic FX trading has also helped reduce the cost of doing business. Negotiating rates over the phone means a client waiting to get through to someone to discuss market conditions and then speaking to a sales person, who then relays that conversation to a trader, before the client can obtain a price.
This is much less efficient than accessing pricing with a single click from a desktop, where the client can see what the rest of the market was doing when they executed their transaction.
The move to electronic trading has also been welcomed by regulators because they want to have real-time visibility of markets – particularly illiquid markets.
Navigating regulatory requirements
While electronic trading is expected to reduce the FX cost of doing business across multiple jurisdictions, working with a counterparty that understands all the market nuances remains critical.
The FX regulatory landscape in Africa is constantly changing, and central banks strategies are diverse. In Nigeria, for example, it’s possible to move revenue out of the country, but a certificate of capital importation is required – so obtaining guidance from an onshore bank is vital.
Given the intricacies and changing nature of the varying markets across the continent, banks operating in Africa do well to partner with regulators when it comes to product development – to ensure they are fit for market. Standard Chartered has worked with many central banks to develop FX products. In Nigeria, for example, Standard Chartered was instrumental in the creation of the futures market in conjunction with FMDQ Securities Exchange.
And in this diverse market, management of risk – and particularly the ability to ‘warehouse’ risk where necessary – is essential for smoothing out currency fluctuations. This is where having both an onshore and offshore presence is crucial. With 15 onshore locations across the continent, Standard Chartered has African clients’ FX needs covered.