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Africa - playing with a home advantage

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Scales Tim
Tim Scales

Partner

London

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08 September 2014

In the difficult years since the global financial crisis, attitudes to investing in Africa have evolved significantly, particularly in key sectors such as energy and infrastructure. While political and regulatory risks remain high, local and international investors are taking a much more bullish view of the risks and rewards of investing here, says Tim Scales.

Africa may ultimately prove to have benefited from the global financial crisis.

The investment picture across the continent has been transformed in the last four or five years, as investors have been forced to take stock in the wake of the crisis. With what were once regarded as safe-haven investments in stable markets such as Europe looking decidedly more risky, investors have been reassessing the relative risks and rewards of investing in Africa.
 
At the same time, a number of African governments have been taking a much more pro-active approach towards facilitating and encouraging private investment. This is particularly true in the power and infrastructure sectors, which remain underdeveloped across the continent and yet hold the key to unlocking economic potential.
In the past, private investment in these sectors has been limited. Government policy has often been ambivalent, with opposition to private investment coming from various quarters, including incumbent state utilities and other vested interests, notably, in the power sector, the so-called “diesel lobby”, who have benefited from reliance on emergency and small-scale self-generation. Partly as a result of this, the legislative and regulatory environment has been slow to evolve to accommodate private sector involvement.
 
There have also been some fundamental macro-economic hurdles to overcome. It has taken (and continues to take) a long time to pass the cost of investment in infrastructure through to the end consumer – tariffs are highly politically sensitive. As a result, the utilities to which independent power producers (IPPs) look to sell their power have had to absorb that cost rather than pass it through to their customers, leaving them with significant liquidity and credit issues and requiring robust government support to back-stop their contractual commitments to the IPPs and make projects “bankable”.
 
More recently, however, the picture has improved. Governments have recognised the necessity of private investment to bridge the infrastructure gap and have been far more active in engaging with private investors, development finance institutions and other stakeholders to create a legislative, regulatory and contractual framework to accommodate private investment. Innovation in financing structures, with the development of risk guarantee and liquidity support instruments for example, has also helped to mitigate some of the residual credit and liquidity concerns in these sectors.
 
Political risk remains a significant problem in some countries. The DRC is a case in point – a country vastly rich in natural resources that has struggled to make progress because of inherent political instability. Few investors – the mining companies aside – have the stomach for the risks involved. By contrast, neighbouring Rwanda has made huge strides. There’s been a determined effort, led from the very top, to get the economy moving and the results have been impressive with a boom in private investment across a number of sectors.
 
As the investment environment has improved, the number and appetite of investors has increased, both at an international and a local level. The increasing involvement of local investors has been a significant trend.
 
The power privatisation process in Nigeria, for instance, has been dominated by local investors, hungry for good assets and, thanks to their local knowledge, with a much more developed understanding of and ability to manage local risk.
 
Indeed, African governments are increasingly looking to develop local investment as a matter of public policy. This is partly a reaction to what has sometimes been perceived as a new wave of “colonialisation” by international investors. The political and public reaction to Chinese investment in some countries has been strong –notably in Zambia and Kenya for example. It’s now increasingly common for governments to require a certain percentage of local involvement in investments and projects. A number of countries (Mozambique, Angola, Zimbabwe) are adopting approaches similar to South Africa’s Black Economic Empowerment initiatives. These trends are also driven by a recognition that infrastructure assets are an investment opportunity for local institutional investors and can help to develop and dynamise local capital markets. For foreign investors, partnering with local investors is becoming increasingly important.
 
The mix of foreign investment is shifting too. While China has dominated the inbound story in recent years, there is now growing interest from India, Japan, Korea, the Gulf and Latin America, as well as Europe, the U.S. and Australia. Institutional investors and specialist funds are also joining the search for new assets and there is now a growing secondary market for these assets.
 
Africa’s institutions are also growing stronger and we’re seeing a great deal more cross-border and intra-regional co-operation – the Southern African Development Community, is one example; the 19-nation Common Market for Eastern and Southern Africa (Comesa), with its own competition regime, is another. So investment flows within Africa itself are growing, with a particularly strong trend of investment from South Africa into other parts of Africa.
 
The outlook continues to look positive. There’s a growing trend of urbanisation in key African cities and a burgeoning middle-class, which is driving economic growth. Investment hubs such as Nairobi and Lagos, are expected to continue to grow in importance and to benefit from investment in infrastructure and real estate. The retail environment is changing out of all recognition.
 
As a firm, we have seen exponential growth in work in Africa across the full spectrum of sectors and product lines – project development and finance, leveraged finance, trade and commodity finance, asset finance, equity and debt capital markets, mergers and acquisitions and contentious work. In common with the wider investment picture, a key part of our ability to service clients on the continent is finding the right local partners.
 
We have established a highly successful office in Casablanca with a top quality local team and continue to look at other opportunities elsewhere in Africa. Our best friend network, which we have spent a number of years developing, allows us, through strong relationships with top quality local firms, to offer clients seamless support across the continent.
 
Like Mr Edwin of Dangote, we think the potential in Africa is enormous, and we will continue to strive to be at the forefront of developments.