Analysis of headline GDP figures in Africa would presuppose a region going through a period of prolonged stagnation, with growth slowing down to 2.2% in 2016 (1) off the back of falling commodity prices and tighter Chinese economic conditions - but this needs to be put into proper context. Nigeria and South Africa are the two biggest regional economies and the main bulwarks behind the continent’s growth, and both markets have contracted. Slowdowns in these two countries tend to have a disproportionate weighting on the overall region’s growth figures.
Nigeria has very specific problems related to the decline in oil price, and this has been exacerbated by various currency and policy decisions.(2) South Africa’s economy is under strain due to a combination of different factors including drought, declining political confidence, reduced business confidence and a commodity slowdown. Just because growth has been sluggish in these two markets though does not mean there is a universal slowdown(3) across the entire Africa region. A number of other African markets have recorded strong growth presenting opportunities for foreign investors. Côte d’Ivoire’s economy is forecast to expand by 7.5% in 2019(4) while World Bank data stated Senegal was the second fastest growing West African market. East Africa is a strong performer too, with Kenya, Ethiopia, Uganda and Tanzania all forecast to grow 6% and above for the decade.(5)
Flows into Africa
Foreign Direct Investment (FDI) recovered in 2016 after a slight decline in 2015. Ernst & Young (EY) analysis indicates capital investment into Africa increased by 31.9% in 2016.(6) The continent’s share of capital flows grew from 9.4% in 2015 to 11.4% in 2016 while (7) EY added Africa was the second-fastest growing destination when measured by FDI capital.(8)
Despite the recent economic uncertainty, South Africa, Egypt and Nigeria still account for significant FDI flows, but there has been a pivot to smaller markets in East and West Africa such as Ghana, Senegal and Côte d’Ivoire.(9) Much of this investment has been in infrastructure, energy, pharmaceuticals and technology and it has been driven by Asian investors, particularly out of China.(10)
Easing access and building infrastructures
African markets were often seen as frontier, and there are problems with investing in such jurisdictions, namely low levels of liquidity, regulatory opacity and a lack of market depth, but this is likely to change. This is because a number of countries in the region are introducing positive market reforms to advance the needs of institutional investors and meet their regulatory obligations and reporting requirements. (11)
Institutions need guarantees that when they invest into a market, their money is recoverable in crises, and that the infrastructures are aligned with international standards and best practices. Major efforts have been made across Africa to bring markets in line with these expectations.
Ghana – through the Securities Industry Act – has introduced securities borrowing and lending, and Kenya will do so later in 2017. Over-the-counter (OTC) derivative trading is gradually being adopted in countries beyond South Africa and Nigeria, namely Kenya. Ghana is also looking at setting up an OTC regime although the Ghana Stock Exchange (GSE) has yet to implement the operational processes.
These OTC flows are small though, at least relative to US, European or developed Asian markets, and there is sharp industry disagreement as to whether CCPs need to be introduced in these markets.
In a market where OTC volumes are considerable, industry consensus, international best practice and regulation would infer protections in the form of a CCP are necessary. There is less unanimity around inaugurating CCPs in emerging economies which do not have scalable OTC markets, as it introduces costs that could potentially restrain growth and development.
East Africa through the EAC (East African Community) and West Africa via the ECOWAS (Economic Community of West African States) have both sought to enact regional harmonisation programmes of securities markets modelled somewhat on the EU. Efforts have been ongoing to standardise rules around cross-border brokerage activities and dual listings of securities. A number of market infrastructures across Africa are involved in integration and standardisation discussions. CSD linkages, for example, will make account openings and know your customer (KYC) checks simpler, although some markets are disinclined to consolidate into regional exchanges and CSDs, as they view such national infrastructures as a sovereign right. However, efforts around cooperation are making progress.
Securities settlement is one area where progress has been made, particularly through the accentuation of SWIFT connectivity and automation across East African CSDs including Uganda, Rwanda and Tanzania. Efforts are being made at Kenya’s Central Depository & Settlement Corporation (CDSC) to enable Swift connectivity and this is likely to go live in the second half of 2017.
In Ghana, Swift communication between the CSD and its settlement bank – the Bank of Ghana – is in place but there is presently no MT54X series SWIFT communication for securities between market participants, the exchange and the CSD. Discussions on MT54X Swift connectivity between stakeholders began earlier in 2017, but implementation could take time, and the costs of setting up such a system may be off-putting to some brokers.
Harmonisation efforts are also in motion at stock exchanges, where there are ambitious plans to enable connectivity between exchanges in South Africa, Kenya, Nigeria, Côte d’Ivoire, Mauritius and Morocco through the Africa Exchanges Linkage Project (AELP). (12) This initiative will help cement liquidity in these markets, although experts are conscious that divergent regulations across these disparate countries will present issues around governance and best practices.
A lot of work still to be done
Cross-border harmonisation initiatives in Africa should be applauded, but there are limitations. Harmonisation of settlement in the EU through the Central Securities Depository Regulation (CSDR) and Target2-Securities (T2S) was possible because many of the markets possess a shared currency and have broadly similar regulations, levels of economic development, and common regulators, namely the European Securities and Markets Authority (ESMA). This is not the case in Africa. An absence of a single currency and conflicting regulations and legal systems will make it difficult to drive an African T2S equivalent.
Regulation and change in Africa markets can also be unexpected, arriving without warning or consultation. The Uganda Securities Exchange (USE) switched to an Automated Trading System in July 2015 with a resultant trade settlement time-frame changing to T+3 from T+5. This decision was executed precipitously and caught a lot of market participants by surprise. Experts have warned that it is essential that regulators give sufficient notice about when they intend to execute market change otherwise it can cause major disruption.
Asset safety is a key criterion for foreign investors, and it is reinforced through regulations such as the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V, which impose sanctions on depositaries which fail to effectively monitor assets in custody. As such, the ability to repatriate funds out of a country is critical. Nigeria has imposed currency controls and restrictions around FX in reaction to its recent market volatility. The situation appears to be calming following the retraction of some of these FX controls and the introduction of Naira non-deliverable FX futures, enabling investors to hedge Naira futures against USD.(13)
Looking towards a bright future
Africa should not be viewed through the lens of South Africa or Nigeria by international investors. Both of these markets have underperformed, but the region – when observed holistically – has a positive growth story to tell. Economic stability – coupled with efforts to implement market infrastructure standardisation projects – will help encourage investors and liquidity into the region.
(8) EY’s Attractiveness Program Africa (May 2017) – Connectivity Redefined
(9) EY – (May 3, 2017) Africa presents a mixed picture for foreign direct investment
(10) EY’s Attractiveness Program Africa (May 2017) – Connectivity Redefined
(11) This Day – (May 10, 2017) – Convergence of Africa Capital Markets as Panacea to Illiquidity
(12) This Day – (May 10, 2017) – Convergence of Africa Capital Markets as Panacea to Illiquidity
(13) Reuters – Nigerian non-deliverable dollar naira forwards fall on central bank FX reforms