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Trade finance funds boost Africa's GDP

Trade finance funds boost Africa's GDP Anthony Harrington

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One of the problems that any industry involved in export faces in Africa is that local banks tend to be cash-constrained, and this lack of liquidity is compounded by the Basel III regulations. They have to hold additional capital reserves for every risky trade they make. This tends to make providing trade finance and advancing letters of credit to local mining and agriculture businesses to cover freight and shipping costs to overseas markets, less attractive to them and to the major European and US banks who used to lend into Africa.

However, efficient market enthusiasts can draw some support for their (much maligned) theory from the fact that private and institutional capital is finding its way into funding trade financing across Africa in return for reliable low double digit yields.

One of leading companies in this field, is Scipion, founded by Nicholas Clavel in 2007. The firm comprises a group of ex-bankers with deep experience of African markets, and focuses on funding trade financing arrangements. According to Clavel, the key to providing trade financing in Africa is being extremely thorough about your due diligence processes. The funding provider has to know in fine detail what the risks are on every route - and the provider has to be able to approve both the route that the exporter is taking to get the goods to market, and the trucking company concerned. If the cargo has a high value and is easily resold, then the funder needs to be sure that there is sufficient security provided to avoid hi-jacking.

All this sounds pretty demanding, but Clavel points out that one of the beauties of trade finance as an investment is that it comes into play after the production risk for the product, whatever it is, has been resolved. Clavel says:

"You are only providing funding when the ore has been mined, or the crop has been harvested, so you take that risk out of the equation."

Moreover, unlike project financing, for example, trade financing is for a relatively brief duration, which makes it a very liquid form of financing.

A typical contract might be with a mine owner to ship regular truckloads of ore or coal to an overseas market. Each truck load or convoy is a separate trade. So what you have is a constant repetition of short-term deals with limited risk and limited down-side. If conditions in the area suddenly deteriorated because of a local rebellion or political instability, the trade funder can simply withdraw provision until matters settle. So, big macro risks are relatively easy to manage. Trade finance, unlike project financing or even equity investing, is inherently agile. Plus each trade is collateralized on the goods being transported.

Another point is that the funder can choose which types of load it wishes to support. Clavel, for example, will not touch perishable products, so flowers from Kenya are out. He comments:

"When you had that Icelandic volcano blocking flights, flowers rotted at the airport - the same with short life products like strawberries and tomatoes. We like ores and agri-products like potatoes that can tolerate a portside or airport delay."

Investors in Scipion's trade finance funds get their returns quarterly and are not tied in to long contracts:

"When we launched our first trade finance fund in 2007 the aim was to provide a 10% to 12% return to investors with a low degree of volatility. Our average rate of return since launch has been 11%, with no long term lock-in for investors."

The life cycle for any particular trade funding contract tends to be between three to six months.

He points out that trade funding complements mainstream PE project funding in an important way:

"Even a pure infrastructure fund will need trade financing to buy in cement to build whatever it is building."

There is not enough infrastructure supply chain in Africa to provide the materials for major infrastructure projects, so much of that has to be brought in via imports. That too, requires trade funding. The opportunities are many and various.

Major banks are, of course, not blind to the trade financing opportunities that Africa offers. But their real opportunities tend to lie in coming together as consortia to fund large trade financing contracts with state-owned entities, rather than providing financing to individual producers. With exports from Africa hitting $500 billion in 2012, up from $445 billion in 2011, according to press reports, there is more than enough opportunity for African banks, global banks and special purpose trade financing funds to play in this space.

The news site This is Africa Online quotes Yaw Kuffour, lead trade finance specialist at the African Development Bank, as saying that trade makes up around 60% of Africa's GDP. He points out that Africa is competing for trade financing with everyone else, including the USA and Europe, and this is not easy since there is a global shortfall of trade financing of around $1.6 trillion. There is an urgent need, in other words, for more funds like Scipion, but building up the degree of in-country knowledge required to achieve the levels of due diligence on routes, logistics and ports takes time. This bottleneck is not going to go away easily...


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Further reading on trade financing and Africa:

Africa's structural transformation challenge by Dani Rodik
Has Africa outgrown Aid? by Wolfgang Fengler
Africa's mining sector, forcing change and fairness by Anthony Harrington

Tags: Africa , agri-products , funding , mining , Nigeria , Scipion , shipping , trade finance
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