By EMMANUELLE MOORS De GIORGIO

In the wake of the spring meetings of the International Monetary Fund (IMF) and World Bank, the The Economist ran a special three-page story on emerging economies. The article gave a quick overview of recent trends and economic programmes in various regions and particular countries. It also made a few recommendations, with regard to the future role of the IMF in averting crises. What most readers probably failed to notice is that nowhere in the article, not even once, was Africa mentioned.

The article discussed capital controls but ignored South Africa; discussed export-led growth but ignored Mauritius; discussed improved bank supervisory standards but ignored Kenya; discussed inflation but ignored Ghana; discussed privatisation but ignored Egypt; and so on. A total blank on the economic situation faced by over 800m people. It was as if the continent simply did not exist. But then, one week later, Africa was suddenly recalled back to the world by the very same magazine, which ran its cover story on the events taking place in Zimbabwe!

Once more, Africa was in the news because of turmoil. When the subject is not inter-racial tensions, it is a brutal civil war, a natural disaster, the AIDS epidemic and now, sadly again, famine. Thanks to its negative media image, Africa is commonly perceived as a violent and risky place, doomed and better ignored. Foreign investors are therefore keeping at bay - save, of course, to exploit the rich African mining seam, which is too tempting to ignore.

In shunning the ‘dark’ continent, investors overlook the fact that high risk carries along with it two useful corollaries. First and foremost, where there is risk there is opportunity. Every trader in the financial markets knows that the higher the risk, the higher the potential return.

Second, risks can be mitigated. Given today’s risk management techniques, investors making direct investment in foreign countries can retain only the risks that they feel comfortable with. All this means that investors should give high-risk Africa a second thought.

To help them in this direction, in April, the United Nations Conference on Trade and Development (UNCTAD) organised a conference on ‘Structured Finance and Investment in Africa’. By organising a conference on this subject, UNCTAD implicitly recognised that risk mitigation, through structured finance, can enable investors to take advantage of investment opportunities in Africa. The conference was preceded by a practical workshop during which delegates were presented with tools for analysing and mitigating transaction risks.

Identification of risks

Two types of organisations have a role to play in structured finance transactions : risk management providers (insurance companies, commodities exchanges, banks) and legal firms. UNCTAD asked Aon Group International, an insurance broker, and Gide Loyrette Nouel, an international law firm, to sponsor the conference and make contributions in their respective areas. In addition, part of the supporting material for the workshop was extracted from a book written by the author of this article, entitled “Structured finance in the commodity sector; techniques and applications”, published by the African Export-Import Bank in March 2000.

What came out from the workshop is that the first and most crucial stage for building a structured commodity finance transaction is to properly identify the various risks involved in the underlying commercial transaction. The next stage, designing proper risk mitigation schemes, is almost child’s play if the risk identification process has been done correctly.

Take performance risk. The risk involved may, for example, be doubts about an exporting company’s ability to produce or procure the commodity that it is contractually bound to supply. UNCTAD reckons that the best way to deal with this risk was through a satisfactory due diligence study.

Such a study would evaluate a company’s track record; whether it has the facilities and business contacts needed to do the proposed business; whether there is a real risk of social unrest; whether the infrastructure on which the company relies (transport, energy, communications) is adequate, and whether any significant changes in its ownership structure can be expected. If the answer to each or any of these criteria is not satisfactory, there are specific risk mitigation schemes available.

These range from stricter conditions for lines of credit (eg, credit will only be provided once the goods have been received in the warehouse); to taking collateral over productive assets; closely monitoring the use of the credit (eg, through a collateral manager); and taking out insurance coverage.

Particular response for risks

Other risks that must be properly assessed by lenders include the traditional credit risk, management risk, political risk, raw material supply risk, transport risk, price risk, quality risk, marketing risk and transfer risks. Obviously, some of these risks overlaps others.

And each risk requires a particular response. For instance, with regard to transfer risk, ie the risk that the local exporter may not be able to exchange local currency for foreign exchange, one solution is to have an offshore escrow account into which the international buyer pays export proceeds directly. The lending bank would then have the right to take repayment (including related fees) from this escrow account before releasing funds to the lenders.

This mechanism also enables the bank to mitigate certain other risks, for instance price risk, since the funds standing offshore can serve to buy insurance, including commodity hedges.

Unfortunately, tightly structured finance deals are not feasible in all cases. For instance, legal and regulatory requirements (eg, currency repatriation rules) may make escrow accounts difficult in some countries. Moreover, there is an opportunity cost to the borrower if large amounts sit idle on an account offshore. This may be the price to pay, at least initially, for “difficult” borrowers to gain access to financing that would otherwise not be available.

When a structured finance transaction is first designed, lenders would normally require control over the commodities at all times. This involves the assignment of underlying commercial contracts and insurances, pledges of offshore accounts and all supporting government approvals.

Yet this ‘traditional’ structured finance package may not always be sufficient, and this is why creativity has an important role to play in structured finance. Sometimes, the last piece of the puzzle can be put in place from unexpected quarters. For example, Sida, the Swedish development finance institution, has in the past intervened in Africa to guarantee certain portions of medium-term local currency borrowings that both local and foreign lenders did not want to remain exposed to.

While a structured finance transaction is expensive to set up initially, it can be repeated year after year at little extra expense. Moreover, as trust is built between both parties, and a positive track-record established, the most stringent restrictions can be steadily loosened up. After all, as Christophe Jacomin from Gide, Loyrette, Nouel, puts it, “the transaction can never be 100% risk-free; at some point, the bank has to tell its lawyer ‘I know there is a risk here but I accept it’.”

Even then, the very process of identifying risks helps both lenders and borrowers understand better the dynamic of the transactions as well as the specific areas where they should be involved.

Share of African exports declines

Coming back to the UNCTAD conference, the interest generated by the subject was matched by the quality of the speakers. Featured speakers for the two-day conference included Ablass Ouedraogo, Deputy Director General of the World Trade Organisation. In his opening address on the impact of liberalisation on African economies,

Mr Ouedraogo noted that the share of African exports had fallen dramatically and condemned interventions in trade policies biased against the agricultural sector. Looking to the future, Mr Ouedraogo recommended that African countries take advantage of the General Agreement on Trade in Services (GATS) to attract investment in infrastructure and services - especially to attract foreign banks and thus strengthen the financial sector, raise the number of financial instruments and encourage savings.

He stressed that Africa would have to learn to be less dependent on custom duties, especially when it came to information technology. Otherwise, Africa could miss the opportunities offered by the use of the Internet.

But not everyone agreed that production and trade liberalisation are the panacea for Africa’s slow economic growth. John Newman, Chief Executive of Ghana Cocoa Marketing Board, was markedly less pro-liberalisation.

He pointed out four major adverse reactions experienced by countries that had liberalised their cocoa sector : (1) deterioration of the quality of produce as a result of inadequate certification system leading to price discounts and/or loss of premium; (2) inability to take advantage of forward sales as a result of loss of confidence and trust in the local exporter’s ability to fulfil sales contracts; (3) increased foreign participation in the export market in such a way that exporters sell direct to their mother companies overseas; and (4) unacceptably low farm-gate prices when world prices are low.

All these aspects are not only detrimental to the cocoa trade in general but also to the ability of borrowers in the cocoa sector to arrange a structured trade finance transaction.

Mr Newman could have added a fifth item to his list, one which is going to make the structuring of trade finance more problematic : lack of critical mass and track record of the borrower. Newly-created trading companies often don’t have the means to convince lending banks to arrange a structured finance transaction on their back. Oddly, this obvious problem seemed to have eluded the mind of the number one bank, the World Bank, when, more than 10 years ago, it started to press hard for a rapid liberalisation of the means of production and trading of commodities in Africa.

Nevertheless, thanks to the entrepreneurial spirits of Africans, and to the likes of UNCTAD, there is hope that many key actors in the commodity and financial sectors of Africa will continue to share their experience. New ways of structuring commodity financing transactions in Africa will emerge, possibly enabling even the most conservative investors to take a step forward into the risky continent.

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