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Securitization is a financial engineering technique that enables a private or public entity to raise cash by selling its cash-flow producing assets or its future revenues. These assets are sold to a Special Purpose Vehicle (SPV) which, in order to raise the needed cash, issues fixed income securities on the local capital market.
Although widely used in developed countries and in some parts of Africa (Morocco, Tunisia, South Africa and Nigeria), securitization is a new concept in most Sub-Saharan countries. In the WAEMU, asset securitization has been possible since 2010 when the regional regulator (the CREPMF) issued the relevant texts. The law allows for a very large spectrum of FCFA-denominated assets to be securitized: besides traditional mortgages, it is possible to securitize any kind of existing assets and even future cash flows. Moreover, there is no restriction on entities that can sell their assets: they can be financial and non-financial companies, as well as public sector entities. However, no securitization transaction has occurred yet in this part of Africa. This article explores how securitization can contribute to the development of the local bond markets.
The public debt market in the WAEMU presents numerous challenges to both potential issuers and investors. Issuing costs are high relative to other forms of debt financing and almost all corporate issuers need to have their bonds partially or fully guaranteed by a Development Financial Institution (DFI) or a guarantee fund, which further increases costs. Sovereign or quasi-sovereign issues dominate the bond market, and there is little credit discrimination among these bonds and the guaranteed corporate ones, they have more or less the same risk/reward profile. Maturities are concentrated in the 5-year segment with only a couple of bonds issued at 7 or 10 years. In a nutshell, the fixed income universe in the WAEMU is quite homogeneous, offering investors little choice in risk, yield and maturities.
The CREPMF has recently introduced the possibility of substituting a guarantee with a financial rating given by one of the 2 licensed rating agencies. This action would allow for more credit discrimination among securities, since interest rates would reflect the real credit risk of each issuer. However, the first bond without guarantor and with a credit rating is yet to be issued.
Asset securitization can be the solution for private and public sector entities looking to raise cash, as well as for investors keen on diversifying their portfolios, while substantially increasing the depth of the local bond markets. Through securitization, companies can monetize part of their good-quality assets or future revenues by selling them to a Special Purpose Vehicle (SPV), thus raising cash without having themselves direct recourse to capital markets. If the securitized assets are worth more off-balance sheet (translating into lower borrowing costs against the specific assets than against the company’s entire balance sheet), raising cash through securitization is much more cost-efficient than issuing company debt. With the advent of financial rating, securitization can help curb financing costs for companies that are considered risky and thus have a lower credit rating than part of their assets would.
For example, the first securitization transaction in Morocco that took place in 2002 involved a mortgage pool securitization for Crédit Immobilier et Hôtelier (CIH), a bank who wished to restructure its balance sheet. Through the true sale of a quality mortgage portfolio, CIH was able to raise DH500M (approximately $45M) through the indirect issuance of two senior and one junior tranche. The longest (16-year) senior tranche was issued with a 7.32% annual coupon, only slightly above the 7.1% coupon offered on a 15-year Moroccan government bond issued some months earlier. Had the CIH issued under its own signature, its borrowing costs would have been much higher.
Governments could also resort to securitization of existing assets or future flows, in order to reduce budget deficits, as well as to finance future investments. The Italian and Belgian governments in the late 90s both securitized outstanding social security receivables, thus putting them off-balance sheet in order to reduce their budget deficits to comply more easily with the Maastricht criteria. In 2004, the Government of Hong Kong SAR decided to securitize the future toll revenues from state-owned tunnels and bridges, thus raising a total amount of HK$6 bn (approximately $800M). The state government of West Bengal (India) raised Rs.15 bn (approximately $300M) through the securitization of future taxes levied on several fuel products. Apart from instant cash inflow in an alternative way, these kinds of transactions allow public authorities to have a better asset-liability management, by matching public asset cash flows to the repayment of the asset-backed securities, and a more efficient cost-benefit analysis and hence management of public assets, by clearly earmarking revenues to be used to fund them, instead of relying on general tax-backed funding. Moreover, future flow securitizations involve a thorough assessment of the sovereign originator’s legal and institutional environment, notably recovery processes and claim enforcement rules, which can foster necessary institutional reforms. This in turn can have a positive spill over effect on general investor confidence.
Securitized assets are carefully selected and their future behaviour (future cash-flows) is thoroughly modelled. The future cash-flows (and the risk of non-payment associated with them) are then structured into fixed income securities (tranches) of different risk-return profiles. Thus the same asset pool will serve as a funding source for senior (low-risk, low-return) and junior (higher risk, higher return) securities. The basic idea is to spread the risk unevenly among tranches and reward investors according to the amount of risk taken. For example, the above cited Moroccan mortgage-backed securities were issued in 3 different tranches, all offering different risk exposure, maturity and remuneration.
Getting exposure to a specified pool of assets and having the possibility to select the desired risk-return investment profile are clearly two important steps forward in the development of the local bond markets. While until now, investors could basically subscribe to two kinds of risks (sovereign and quasi-sovereign), with relatively low risk profiles, with the introduction of asset-backed securities, investors will not only be able to get exposure to a new risk classes, but they will also be able to select how much of it they want to hold (by choosing either the senior or more junior tranches). The asset-backed securities also introduce the notion of real credit risk: that of not being able to get back 100% of their initial investment or all coupons, based on the underlying asset pool’s overall performance.
Are institutional investors ready for the big change? Definitely. Are companies and national treasuries ready to add securitization to their list of financing options? Not quite so. Securitization, and financial engineering in general, are quite unknown concepts for the majority of companies in the WAEMU. The subprime crisis has not helped much either in popularizing the concepts in a positive sense. Since companies have traditionally raised cash through banks or DFI loans, a large part (if not all) of their asset base is pledged as guarantee, so there is little room left for alternative asset-based financing. Securitization offers a different perspective on assets: they are no longer considered as an end, but rather as a means to optimize a company’s financing. Realizing this concept may take some time and may need a more innovative state of mind.
We believe that education is key to the success of any financial innovation and that applies in the WAEMU as well. Once public and private sector decision-makers thoroughly understand the concept and philosophy of securitization, it will no longer appear as a mystical, complex and ultimately risky alternative. Bonds issued in this fashion will tap into huge reserves of regional savings (through asset managers and insurance companies) and thus further enhance the efficiency of local capital markets.
Anna Selejan has been the Managing Director of ALC Titrisation, the first privately owned securitization SPV management company in the WAEMU, based in Abidjan, Côte d’Ivoire. Prior to setting up ALC Titrisation, she worked as Vice President – Investment Management with IC Securities, a Ghanaian asset management company and as Fixed Income and SRI (Socially Responsible Investment) portfolio manager with Allianz Global Investors in Paris (France) for several years. She holds a Master’s degree in Economics from the Budapest Corvinus University, Hungary and a Master’s degree in Portfolio Management from Université Paris XII, France.
Sub-Saharan Africa has come to represent one of the biggest growth stories in emerging markets private equity. According to the Emerging Markets Private Equity Association, fundraising by fund managers for Sub-Saharan Africa rose from US$800 million in 2005 to over US$2.2 billion in 2008, before falling back to US$960 million in 2009 and rising to US$1.5 billion in 2010. 2011 saw fundraising fall slightly to $1.3 billion, with $490 million raised in the first half of 2012.
Fundraising for Africa has been led by development finance institutions, international commercial banks, pension funds and even foreign private investors (family offices). According to an EMPEA / Coller Capital published in 2011, 38% of LPs planned to “begin or expand Africa commitments”. This compares with just 16% a year earlier. The same study found that 67% of LPs found Africa “attractive or very attractive”, compared with just 37% in 2010. With increasing foreign interest in private equity in Africa, the issue of local capital (or lack of it) in private equity in Sub-Saharan Africa has become a hot topic for the industry.
Long term savings vehicles (mainly pension funds) are uniquely placed to manage the long investment term and limited liquidity of private equity. In the African context, domestic pension funds would also capture a significant performance premium and the benefits of portfolio diversification. Based on latest available figures, if the largest African markets by assets under management were to invest 5% of their portfolio in private equity, a potential US$17 billion could be released to support private sector investment in Africa. Increased local capital could also play a catalytic role in attracting international capital to the continent. With assets under management in major countries like Nigeria increasing at 30% a year, this potential is set to increase still further in future.
Unlocking this potential means addressing the many challenges that African institutional investors face. First among these is the lack of awareness about the asset class across the continent. Even in South Africa, with its sophisticated financial markets, few pension funds have experience of or knowledge of private equity. One of the basic principles of successful investment is “stick to what you know”, so until African pension funds become more familiar with the asset class, the dream of an industry led by or with significant participation from local investors will remain just that. Achieving this requires understanding and openness, from the industry (fund managers and investors), local investors, policy makers, regulators etc. Pension funds, regulators and other stakeholders must be empowered with the right information which enables them to evaluate if and how private equity fits within their investment strategies and objectives.
It is in this context that the Commonwealth Secretariat has worked with the African Development Bank (AfDB), the African Venture Capital Association (AVCA), and Aureos Capital organised a series of regional roundtables on Private Equity in Africa, to:
- Introduce participants to private equity as an asset class;
- Familiarise participants with the private equity industry in Africa and provide the opportunity to meet with fund managers, investors and other stakeholders;
- Provide participants with an understanding of the structure of private equity funds, their operations and governance, and
- Identify next steps to promote increase local participation in the private equity industry in Africa.
Regional roundtables have been held, in Nairobi (for East Africa) in May 2010 and Gaborone (Southern Africa) in October 2010 and Accra (West Africa) in May 2011. A pan-African workshop was also held as part of the AVCA conference in Accra earlier this year. Country events have also been held in Kenya (March 2011) and Nigeria (September 2011) in partnership with their respective pensions regulators.
Feedback from these roundtables has been overwhelmingly positive. The regional approach has worked well in terms of raising awareness of the private equity and the barriers to increased participation in the industry by domestic investors. However, different levels of awareness and country level regulation means that there are different priorities / needs amongst the countries, even within the same sub-region.
Specific recommendations for follow up activities have included:
- Education and capacity building at all levels for all stakeholders (including regulators, other institutional investors, policy makers and lawmakers) Policy makers in particular need a better understanding of private equity kind of environment in which it can thrive;
- Practical assistance for the development of appropriate regulatory regimes and knowledge sharing amongst stakeholders, and;
- Further research into private equity in Africa – areas of focus would include regulatory environment, funding raised, local participation levels etc.
In parallel with this educational effort, several African countries are in the process of reforming and liberalizing the pension sector. The revised Regulation 28 of the Pensions Fund Act in South Africa is probably the best known example of this. Under the regulation, institutional investors can invest up to 10% of assets under management in unlisted equities. This is up from historical figures of 5%, which encompassed all alternative asset classes, to a universal figure of 15% for both private equity and hedge funds. This is indeed a significant development, even more so now that the Public Investment Corporation has announced that it is looking at committing some$3.8 billion to private equity, following these changes.
Reform in Nigeria is also paving the way for pension fund investment in unlisted equities. The regulator, National Pension Commission (Pencom), was established in 2004 to regulate and supervise the pension fund industry. With total pension fund assets of approximately US$13 billion as at December 2010, and a growth rate of close to 30% per annum , Nigeria represents a potentially significant source of funding for the private equity industry.
Prudential limits for private equity and alternative assets have been capped at 5% of assets under management. However, the regulations also require a minimum of 75% of funds need to be invested in companies or projects in Nigeria, and among other requirements, funds need to have multilateral development finance institutions (DFIs) as Limited Partners.
Some commentators have argued correctly, that these requirements are unnecessary and pose a few problems for general partners and pension funds alike. A 75% exposure requirement to Nigeria effectively creates a Nigeria fund, concentrating risk – country, currency and political. The nascent nature of private equity in Nigeria and Africa in general is such that Pencom should be encouraging pension funds to use private equity as a risk diversification tool. In looking at private equity alongside other asset classes – how much diversification is being achieved by pension fund managers? Are potential political and economic considerations coming at a cost to a pension fund’s mandate and returns?
The issue is slightly different from a regulators standpoint. Their first duty is to protect the pensions of their fellow citizens. In that context, it would be unwise (to put it mildly) to allow pension funds unfettered access to invest in an asset class which neither they nor the regulators are fully familiar with. We only have to look to the origins of the global financial crisis to understand the potential damage that could cause. In that context, the slowly slowly approach taken by some regulators seems reasonable. The idea behind the additional restrictions in places like Nigeria is to get the pension funds to learn from experienced LPs (hence the requirement for DFIs) and then slowly lift these restrictions. From a market development point of view, it is hard to argue with that. It is also worth noting that despite these restrictions, some fund managers have successfully raised not insignificant sums from Nigeria. Yes the structuring has been perhaps more costly and complicated, but it can and has been done.
In the end, whether we see increased domestic capital in African private equity (and perhaps who gets that capital) will depend significantly on the willingness and capacity of fund managers to invest time and energy in engaging with and understanding local investors and regulators: What are their issues? What are the risks from their point of view? How can fund managers, existing LPs and industry associations work with them to resolve these? That is the true challenge of unlocking African institutional capital for private investment.
David joined the Commonwealth Secretariat in May 2007. He leads the Secretariat’s investment and private sector development programmes, including the Commonwealth Private Investment Initiative (CPII). CPII has helped to raise US$800 million for investment in Africa, South Asia and the Pacific through a series of private equity funds. David has been leading efforts to unlock local capital in Africa through a series of workshops for institutional investors, regulators and other stakeholders over the past two years. David previously worked for the International Finance Corporation (IFC) in Cote d’Ivoire, Cameroon and South Africa. Prior to IFC, he was a Project Officer responsible for Infrastructure at the Agence Française de Développement in Ghana. David has also worked as an Analyst in the Corporate Finance Department CAL Bank in Accra, where he set up and managed the bank’s brokerage subsidiary.
Sub-Saharan Africa (SSA) has continuously exhibited the lowest savings rate in the developing world. The average gross domestic savings rate1 in SSA was 16% of GDP in 2008 compared to 22% in Latin America and Caribbean and 35% in South East Asia. Although the picture varies significantly across economies with some countries displaying modest domestic savings rates [e.g. Guinea (3%), Burundi (4%), Mozambique and Ghana (7%)] to relatively robust savings rates [e.g. Lesotho (22%), Rwanda (27%) and Mali (28%)]2, the reality is that we need to increase savings rates in Africa to levels consistent with sustainable economic development, which are considered to be above 25% of GDP.
Why have most African countries failed to achieve high savings rates?
The causes of this problem are extensively documented in the economic literature. Savings has long been repressed by controlled low interest rates and high inflation in various countries. Negative real interest rates have really discouraged people from monetizing their savings using formal financial institutions; rather; they favor savings in tangible assets (e.g. livestock, stockpiles, etc.). While we thought these were stories from the past, people have seen their savings completely vanish with hyperinflation as recently occured in Zimbabwe. Nevertheless, we should recognize that financial liberalization measures have helped address the problem in most countries.
However, what has not evolved very much is the scanty regard policy makers in Africa have paid to savings mobilization. And the strong reliance on foreign aid to finance development needs has certainly played a role in this attitude. Initially, aid was supposed to complement domestic financial resources in order to boost development efforts and help countries break away from poverty; instead it has ended up dampening domestic savings and creating dependence in Africa. Despite the pervasive interpretation of the “vicious cycle theory”, no country is indeed too poor to save. Research in microfinance has brought to our attention the variety of savings practices by poor people. These small deposits provided social safety nets to the bottom end of the pyramid during the food and fuel crisis in 2008 since microfinance institutions and savings banks in many African countries experienced serious declines in their deposit balances.
How then to harness this potential and create a dynamic for savings mobilization?
Increasing awareness from policy makers
Greater awareness from policy makers that a low domestic savings rate is a bottleneck to economic growth is essential. Kenya Vision 2030 recognized the need to raise the domestic savings rate above 30% as vital to ensure long-term double digits economic growth. In South Africa, a Savings Institute has been established to promote thrift values and reverse the downward trend, which has seen the domestic savings rate fall from 26% in the 80s to 16% in 2008. In the same vein, the C103 underscores the need to mobilize untapped savings as part of the African countries' efforts to increase domestic resource mobilization4.
Deepening financial sectors
This implies a wide array of transformational changes that positively affect savings rates. Efforts to reduce barriers (e.g. physical distance to banking outlets, high minimum balances, financial illiteracy, disproportionate KYC5 requirements, etc.) certainly deepen financial access. At the institution level, the emergence of non-bank financial intermediaries such as insurance companies and pension firms is instrumental to the development of contractual savings while MFIs and savings banks are vital in canvassing small savings. At the product level, it is important to leverage remittance flows and e-money stores in cellphones for the purpose of increasing savings. Upgrading regulatory and supervisory frameworks shall also instill and preserve confidence in the financial system, which is favorable to savings. Some countries have plans to introduce deposit guarantee schemes, which are often viewed as genuine mechanisms for protecting depositors. Finally, financial market infrastructure should be improved to facilitate financial intermediation.
Would demand-side drive supply-side policy reforms?
Sir John Hicks (Nobel in Economics, 1972) argued that the real challenge is to create the link between potential savings and effective investment. Unlocking the potential of savings is not an end in itself. Most important is to create the conditions for proper financial intermediation. If the environment is conducive for banks to increase lending to individuals and enterprises, they will certainly deploy aggressive strategies for mobilizing savings. Likewise, governments stimulate the mobilization of savings by resorting to domestic markets for the financing of their own needs. Allow me to skip the debate about potential “crowding out effects” on private investment and “budget deficits”. The case is made here against external debt as the alternative. It is well known that African economies are particularly vulnerable to external shocks, which can rapidly render the debt service burden in hard currencies unsustainable.
To conclude, the virtues of savings for economic development are unquestionable. Africa should try to follow the same route taken by industrialized and emerging economies.
 Gross domestic savings (GDS) is defined here as gross national income (GNI) less total consumption (C) + net transfers (NT).
 World Development Indicators (WDI) 2010, World Bank.
 The Committee of Ten African Ministers of Finance and Central Bank Governors (The C-10) was created in Tunis in November 2008. The members of the C-10 are the following countries and institutions: Algeria, Botswana, Cameroon, Egypt, Kenya, Nigeria, South Africa, Tanzania, the Central Bank of West African States (CBWAS), and the Central Bank of Central African States (CBCAS). At its creation the C-10 was charged among other responsibilities to identify strategic economic priorities for Africa and develop a clear strategy for Africa’s engagement with the G-20 through South Africa, the only African representative in this Group. For more information - www.afdb.org/en/topics-sectors/topics/financial-crisis/committee-of-ten/
 See Communiqué of the Meeting of the Committee of African Ministers of Finance and Governors of Central Banks (C 10), October 6, 2010, Washington, D.C, pp. 2-3 (§8).
 Know Your Customer (KYC).
Dr. Hugues Kamewe Tsafack is currently the Stakeholder Relationship Officer at the MFW4A Secretariat . Before joining the Secretariat, he worked for 10 years with the World Savings Banks Institute (WSBI) as Financial Sector Development Advisor in charge of the Africa region.
The views expressed in this article are those of the author and do not represent Making Finance Work for Africa.
Development literature has extensively discussed the nexus between finance and growth. Cross-country research shows that both financial development and stability play a critical role for growth. Less discussed has been what the building blocks for financial stability are, especially in developing economies.
I will highlight how debt management can contribute, directly, to financial stability and development and, by implication, to growth in Africa. The recent global financial crises have underscored how sovereign risks against the backdrop of growing public debt can pose a threat to financial stability in advanced economies. These lessons are instructive even for the emerging and low-income economies in Africa.
Generating sustainable and pro-poor growth in Africa will require investment in both developmental software (financial stability and development, rule of law) and hardware (e.g., infrastructure, investment in strong manufacturing base). The quality and development of the former are critically linked to those of the latter.
How does debt management promote the developmental software – financial stability in particular?
Prudent debt management can help minimize sovereign risks through improving debt structures (e.g., maturity, currency composition) and financial stability. It can also enhance the shock absorbing capacity of public finances (and therefore of the economy) by minimizing the risks to the public debt stock from, inter alia, interest rate and exchange rate risks. As evidenced during previous global crises, developing economies are particularly vulnerable to financial and commodity price shocks through multiple channels – trade, aid, remittance, and cross-border capital flows (both FDI and portfolio). Hence managing market access and growth volatility partly through reducing the sensitivity of public finances to interest and exchange rate shock is of paramount importance.
Financial intermediation in Africa is primarily bank-based and the depth of financial markets is often limited. Given that banks generally are the single largest holder of domestic public debt against the backdrop of limited institutional (both domestic and foreign) investors, prudent debt management becomes a necessary condition for financial stability. This lesson on the link between financial stability and debt management is instructive not only for the advanced economies, as seen in the recent crisis, but also for emerging and developing countries in Africa and elsewhere.