Untapped Africa: A frontier for ESG

By Catherine Tinavapi, Principal & Regional Head of Market Insights at Standard Chartered Bank Africa & Middle East.

Africa’s capital markets are reputed to be challenging for foreign institutions to navigate. Despite this, the region could be the next frontier for Environmental, Social, and Governance (ESG) investing.

African economies along with many other frontier and emerging markets, suffered from heavy foreign investor outflows during the initial stages of COVID-19. Although recovering somewhat, the recent flurry of macro headwinds is limiting foreign investment into Sub-Saharan Africa (SSA).

In many of the smaller SSA countries, the local equity markets are thinly traded and broadly un-tapped. However, this could give forward-looking international investors a first mover advantage and the ability to identify market mispricing opportunities.

While African fixed income has historically been traded by local investors such as pension funds and insurance companies, global institutions are starting to take an interest. However, many are sitting on the sidelines owing to concerns about inflation and the impact which interest rate hikes could have on the region.

Investing in Africa is not always a straightforward undertaking. For some of the largest institutions, the risk-reward benefits of investing in the smaller, more illiquid African economies do not make sense primarily because their sizeable capital allocations risk saturating the local market.

There are also several logistical and operational challenges investors need to be cognisant of when building up exposures in the region, not least of which is the propensity for certain markets to impose currency controls and FX restrictions.

Take Nigeria, where thin FX liquidity is a persistent challenge for foreign investors repatriating their funds. In this market, the mandatory conditions of FX allocation now include the bundling of spot and forward deals. Intermediaries and foreign investors whose risk management frameworks do not allow FX forward deals in Nigeria have limited access to repatriation funds in the market. Investors in African capital markets have occasionally found themselves being blind-sided by the authorities making sudden changes to tax rules or regulations – often with little forewarning. All of these risks need to be carefully considered by investors in Africa.

ESG opportunity in Africa

Fuelled by an assortment of investor demand and regulatory pressure, ESG assets under management (AuM) have skyrocketed with the Global Sustainable Investment Alliance putting AuM at U$35-trillion in 2020, up from US$30.6-trillion in 2018, and US$22.8-trillion in 2016.

As capital continues to accumulate in ESG funds, Africa is likely to be a major beneficiary, especially as many countries in the region have strengthened their sustainable bond markets.

In 2021, Ghana announced that it was considering issuing US$2-billion worth of green and social bonds, with proceeds being deployed to fund development programmes.

While African markets are giving serious thought to ESG issues, governance continues to be an Achilles heel in certain countries. Without strong governance, companies are at risk of not meeting their ‘E’ and ‘S’ objectives.

If ESG in African markets is to thrive, then governance needs to be urgently improved upon in many countries. African markets show enormous potential as investors increasingly chase ESG opportunities.