19 April 2021 – Africa, like the rest of the world, was hard hit by the Covid-19 pandemic. However, the crisis has also sparked positive change in some areas and accelerated the pace of innovation. Africa is slowly emerging from the Covid-19 abyss.
A year ago, investors finally accepted the gravity of the looming Covid-19 crisis. In March 2020, major equity markets collapsed by almost a third, while safe-haven assets – including US Treasury bonds – came under unprecedented strain. Although markets have since recovered, the crisis has taken its toll across the globe, including in Africa. But the pandemic has also sparked positive change in some areas and accelerated the pace of innovation.
Financial market infrastructures in Africa responded quickly to the Covid-19 crisis and proved their resilience in the face of record trading volumes, with minimal disruptions. This was thanks to their robust contingency planning and willingness to embrace and accelerate digitisation, including in areas such as video conferencing and proxy voting. Angola, for instance, is introducing electronic trading for foreign exchange, while Kenya and Tanzania have launched mobile trading platforms.
The crisis exposed deficiencies in manual processes, prompting investments into new digital products and services. This will ensure that financial institutions remain competitive. A number of local financial market infrastructures are trialling technologies such as application programming interfaces (APIs) and distributed ledger technology (DLT), further reinforcing Africa’s reputation as a fertile ground for innovation. The lack of legacy infrastructure also puts Africa in a strong position to leapfrog other markets.
Building up digital assets in Africa
With demand for digital assets – such as cryptocurrencies, central bank digital currencies, stable-coins and tokenised securities – on the rise, a number of African markets are making impressive strides to support trading in these instruments.
South Africa is one such example. Having completed Project Khokha 1 – a proof of concept looking at the feasibility of using blockchain to expedite payments – the Intergovernmental Fintech Working Group has launched Project Khokha 2. This phase will examine the policy and regulatory implications of tokenisation on financial markets. It will see the issuance, clearing and settlement of debentures on a distributed ledger using tokenised money. If successful, many of the settlement risks we face in today’s securities markets will be overcome.
Ending the liquidity shortfall
Global investors continue to be underweight Africa, but local capital markets are attempting to address this through improved connectivity channels. The stock exchange of Mauritius, for instance, has become ‘Euroclearable’, meaning that locally issued debt securities can be more easily accessed by foreign investors.
However, the lack of liquidity in many African equity markets continues to be a problem – so much so that some of the continent’s largest pension funds often invest largely outside of their home jurisdictions. The Africa Exchanges Linkages Project could help deepen equity market liquidity by enabling for simpler cross-border trading and listings across the exchanges of Morocco, Egypt, South Africa, Kenya, Nigeria, Mauritius, and Bourse Regionale Valeures Mobilieres.
The role of regulators is equally critical in driving inward investment. In some countries, there are up to four or five different regulators, so coordination between them is critical. In some cases, a regulator has launched a new initiative – say, the introduction of securities lending and borrowing – without consulting the relevant tax authority, meaning the tax rules around these activities have not been appropriately amended. Encouragingly, however, regulators are increasingly aligning their rules with International Organisation of Securities Commissions (IOSCO) best practices, and this should make local markets more attractive to foreign institutions.
Product diversification and the way forward
Liquidity shortages will remain a challenge in African markets for as long as there is a limited number of tradable investment products.
Encouragingly, a wider range of products are being developed across the region to attract foreign inflows. Kenya and Nigeria are launching their own derivatives industries, for example. For a local derivatives industry to emerge, regulators will need to introduce centralised clearing, as Nigeria is doing. Kenya and Nigeria are also in the process of establishing securities lending and borrowing programmes.
Nevertheless, foreign inflows could be impeded by investor concerns about fund repatriation risks in Africa, especially in markets such as Nigeria, which has been grappling with foreign exchange liquidity challenges.
Meanwhile, with institutional investors taking a keener interest in environmental, social and governance (ESG) matters, a number of African markets are responding by launching green bonds, which have seen exponential growth in recent years.
With vaccines now at hand, Africa is focusing on the Covid-19 recovery phase. Nonetheless, the continent’s financial markets will emerge dramatically changed, with innovative technologies and new asset classes having gained significant ground. If custodians want to retain wallet share and grow their businesses, they will need to adapt and evolve.
With the world having changed incredibly quickly, it is worth considering the old African proverb which goes: ‘Tomorrow belongs to the people who prepared for it today.’
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