Issue 120 • 7 September 2007

Global markets turmoil will test depth of bulge bracket entry

It has seemed to be a marriage made in heaven, albeit between two unlikely partners. Sub-Saharan Africa needs money. Meanwhile bulge bracket banks and other global investors have been looking for new investment plays that offer the potential for big margins and fees at less risk than might at first seem apparent (one reason they need this is because the secondary debt markets that fed fixed income investors for so long have all but collapsed with debt forgiveness and the global commodities boom). Where better to invest than in Africa south of the Sahara, where virgin markets offer huge potential and are now rated as well? (Arguably one of the best uses of donor funds in recent years has been the United Nations Development Programme’s sponsorship of ratings for some of the world’s poorer economies, helping them to gain market credibility.)

So far this has been a positive trend. As African Energy publisher Cross-border Information’s AfricaHardball 2007 report put it: “viewed from hedge fund heaven in Greenwich, Connecticut, or by private equity investors looking to high-risk/high-reward deals, sub-Saharan Africa has become ‘sexy’ – the focus for an apparent increase in investor interest, following debt reduction and global markets’ reassessment of their attitude to African asset classes. This is bringing a dizzying array of new players into African markets, including bulge-bracket banks (New York giants have been searching around for analysts and other talent who can develop this ‘new asset class’), new players like Russian-based Renaissance Capital and local banks, notably in Nigeria, who have significantly raised their performance. Investment funds and corporate debt/equity plays are proliferating, so rejoice!”

This was part of a wider trend, where the entry of new players, return of developers and some other old friends into the African power and other infrastructure sectors is opening up a range of opportunities that African decision-makers can exploit – as Lucy Corkin observes about China elsewhere in this issue. The growing appetite for cross-border deals, and the fact that such critical players as Nigeria are starting to deliver on the promise of new capacity are a practical consequence of reform that will have a positive continent-wide impact.

Further, the drive to improve governance should help new money to chase valid projects by reducing the risk of unforeseen ‘transaction costs’. One Hardball analyst called this a “revolution in citizenry” that is also helping business – in countries like Kenya, where all sides saw that improved governance made for good politics. The impact of a more assertive civil society, as well as more rigorous governance standards, has raised the cost of dodgy deals much higher.

But there are also downsides in these trends. Talking to hedge funds, private equity and other players, there are signs that this is ‘hot money’ entering vulnerable sub-Saharan markets. At the very least some deals could prove very expensive – the partners coming in are looking to million dollar bonuses. But there are deeper problems – not least that a significant proportion of the money now flowing south of the Sahara could leave the moment the going gets tough, possibly through global financial panic, as well as because of the eruption of local difficulties. The escape of the global herd due to a problem ostensibly unrelated to the market in which it is invested is known in the business as ‘correlation’– where a financial collapse in, say, China would lead to investors pulling their money out of, say, Nigeria.

Those talking up the market are determined there is no ‘correlation’ threat in the current sub-Saharan boom. But there are a lot of new faces coming into these markets, who like the message they’re hearing about reformed markets with new discipline and plenty of growth potential. As noted in the Capital Markets article above, hardened veterans are counting ever more newcomers chasing paper and equity – London-based Exotix had counted 34 sub-Saharan funds as of May, 11 emerging this year alone, and there are plenty more to come.

If this summer’s market turmoil is sustained – having been triggered by another recent favoured asset class for margin-hungry investors, the now beleaguered US sub-prime mortgage market – the real test could come quickly, asking what percentage of the committed and expected new money the continent really can expect to hold on to. Despite the upturn in many sub-Saharan economies, they remain very vulnerable to market volatility – and it seems that, all of a sudden, volatility is back.