Ladé Araba is a seasoned development finance professional with over 17 years of experience and the managing director for Africa at Convergence Finance. In this interview with Endurance Okafor, Araba, who previously served as technical adviser to Nigeria’s former finance minister, shares insight on how Nigeria can leverage policy reform and a more enabling environment to spur economic recovery. Excerpt:
What is your take on the state of blended finance in Africa and, most particularly, Nigeria?
Convergence has built the largest global database of closed blended finance transactions, comprising 600 deals across Africa, Asia, and Latin America and the Caribbean. Our data shows that the global market represents about $144 billion of financing with Africa historically being the region most frequently targeted for blended finance, representing 43 percent of the global market and 33 percent of the global market in 2017-2019. Despite the level of activity in the region (which has primarily targeted East Africa – Kenya, Uganda, and Tanzania; followed by West Africa – Ghana, Nigeria, and Cote d’Ivoire), average deal sizes are smaller than in other regions. Over half (53 percent) of transactions targeting sub-Saharan Africa have been between $10-100 million in size, with a median transaction size of $52.5 million.
Nigeria has seen $8 billion in financing flow towards 51 blended finance transactions. Most of these deals have been in financial services, followed by energy, health, and agriculture. There is scope to significantly increase the volume of financing and the number of transactions reaching financial close and subsequent implementation.
According to your ‘State of Blended Finance 2020’ report, Nigeria was one of the top target countries for transactions in terms of fundraising. Why was that so?
Nigeria is the largest economy in Africa by GDP, with a sizable market and numerous investment opportunities. This makes it a prime target market for blended finance. One-third of the Africa focused transactions currently raising capital on our platform target Nigeria. This further highlights the need to apply blended finance structuring approaches to improve the risk-return profile of deals, and to effectively de-risk them so that they meet the requirements of investors. COVI9-19 has only exacerbated existing macroeconomic challenges facing Nigeria’s economy. With that said, the demand for blended finance has increased as a result, and we expect a sustained appetite from investors in the medium term to stimulate the economy and to drive economic reconstruction by financing projects across various sectors.
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What does a country like Nigeria need to do to attract more investors to bridge its $31 trillion infrastructure deficit?
It’s important to understand why investors are currently not committing capital to infrastructure development in Nigeria. The economy is contracting (it is projected to shrink by 3.4 percent this year), inflation is rising, local currency continues to depreciate, and there is an acute shortage of foreign currency. On top of which, the political situation is volatile, depressing investor confidence. We have already seen some foreign investors unable to repatriate their profits due to the FX crunch, while others reduced their investment portfolios by $15.7 billion in the first quarter of 2020.
Stimulate investment in alternative asset classes: Local investors have traditionally been conservative, with most of their investment portfolios comprising government securities. However, local investors are showing increasing appetite for alternative asset classes, including infrastructure, given the issues mentioned above and the negative real yields on government securities. They will however need to gain confidence and a deeper understanding of infrastructure as an asset class and how to appraise and carry out due diligence on potential infrastructure projects.
Crowd in local investors: Enlisting local investors helps increase the volume of local currency financing to avoid the currency mismatch with foreign investors, while lowering the cost of capital and improving the affordability of infrastructure.
Increase transparency and governance in infrastructure project procurement: Certainty and sanctity in contracts, ease of obtaining the necessary licenses and permits, cost-reflective tariffs and non-political interference will help boost investor confidence and appetite.
What are the key challenges in Africa’s blended finance space?
For starters, there isn’t global consensus on the definition or application of blended finance. At Convergence, we define blended finance as the use of catalytic capital from public or philanthropic sources to increase private sector investment towards sustainable development in developing countries. Applying these approaches to create bankable projects and investable opportunities requires a deeper understanding of blended finance structures. This is one of the drivers of Convergence’s database of historical deals that provides the blended capital structure of transactions, the risk mitigation instruments used, and the funders and investors who participated in them.
In addition, our case studies on specific transactions and data briefs detailing various financial instruments and their use in diverse sectors are designed to deepen the understanding of both the buy and the sell side to ensure that better deals are structured and that they successfully reach financial close. In addition, as I mentioned earlier, ticket sizes in Africa are smaller on average; which means that pooled funds and portfolio approaches are required to achieve the type of scale required by investors and to make the economics of investing worthwhile. Finally, because blended finance enables investors with divergent mandates and objectives (e.g., financial, social, environmental, or a combination) to invest alongside one another, it addresses the issue of information asymmetry for those investors with limited exposure and knowledge of emerging markets.
How can blended finance better mobilise local institutional capital?
Blended finance approaches are useful in de-risking transactions to meet the risk-return requirements of domestic institutional investors. They create investable opportunities that enable these investors to achieve their commercial mandates. For instance, we have seen institutional investors interested in credit enhanced green bonds and blended funds that deliver the types of yields that they seek. The opportunity to create more of these types of transactions is compelling and would help mobilise greater local institutional capital. [NN1]
From our survey, blended finance and general investment in Nigerian companies have been largely driven by foreign investors. How can a country like Nigeria attract more local players?
Investors are rational. They seek attractive risk-adjusted returns. They thrive on certainty. Given that government securities have historically delivered attractive yields, local investors have not needed to consider alternative asset classes. They have enjoyed the low risk, plain vanilla or uncomplicated investment opportunities offered by these securities. However, the current environment presents an opportunity for them to consider and actively invest in alternative asset classes in earnest. [NN2]
What sectors of the Africa/Nigerian economy do you see has the most opportunity for blended finance?
According to our database, most of the closed blended finance transactions in Nigeria have targeted financial services, particularly microfinance. Other frequently targeted sub-sectors include health services, small-to-mid-size enterprises (SMEs), renewable energy, and agriculture. This is consistent with the regional trends observed, and we expect greater investment in these sectors going forward.
In addition, the COVID-19 pandemic has stressed the need to increase investment in healthcare, and we are already seeing an uptick in the number of deals targeting this sector based on deals currently fundraising. At Convergence, we expect this trend to continue. There has also been an increase in the use of credit enhancements, listed fixed income and Development Impact Bonds. There is potential to structure more of these types of transactions to attract both domestic and foreign investors.
What is your outlook for Nigeria and Africa, in terms of blended finance?
Africa will continue to be a hotspot for blended finance given the formidable development challenges in the region. African countries present tremendous opportunities for investors through well-structured deals. As we standardize blended finance structures, achieve scale through portfolio approaches, create more bankable projects, and report on their performance, institutional investors will be further drawn toward investment opportunities targeting sustainable development in the region. With that said, actors on either end of the aisle need to pick up the pace.
