Momentum builds for African repo market

Key Takeaways

• UN-backed finance facility aims to bolster economy
• It helps kickstart repo market, boost sustainable projects
• Economic prospects are improving but there is a long way to go

Emerging markets have come back into the investment fold over the past two years as governments have taken strong measures to get their collective houses in order. However, accessing funds is still problematic which is why the Liquidity and Sustainability Finance Facility (LSF) has been such a landmark initiative helping oil the wheels of finance and kickstarting the repurchase agreement or repo market in Africa.

The LSF was launched three years ago by the United National Economic Commission for Africa (ECA) in association with the African Export-Import Bank (Afreximbank). The facility is seen as key to facilitating funding as it enables investors to use African debt issued in foreign currencies such as dollars and euros in repo transactions to improve the flow of cash as well as reduce borrowing costs.

There is also a focus on United Nations Sustainable Development Goals (SDG)-linked issuance in maturities of up to 25 years. Sustainable debt issuance reached new highs in the region with green, social, sustainability, and sustainability-linked (SLBs) bonds soaring 1,692% to USD 4.9 billion in the first quarter of 2024 from the same period last year. The proceeds of these bonds were used to finance specific projects considered to have positive environmental and social impact.

To date, there have been two USD 100 million deals using the LSF– the first from Citi in 2022 followed by Abu Dhabi Investment Authority (ADIA) late last year. Meanwhile, more recently Euroclear created an interbank repo solution – the LSF GC Africa Euroclear – which will sit within its triparty platform and include over 120 sovereign African Eurobonds that the LSF accepts as collateral in repo transactions.

S&P Dow Jones Indices (S&P DJI) also collaborated with the LSF in June to debut the iBoxx LSF USD African Sovereign, which will be used as a benchmark for its repo facility and can also be replicated to create index-based products like exchange-traded funds or ETFs.

Vera Songwe, founder and chair of the LSF, said “Inclusion in indices is an important step towards increased profile and access to a wider range of investors for African sovereign issuers, and we hope for many other emerging markets as we expand.”

The beginning

The idea of the LSF was formulated during the pandemic and the ensuing fallout, geopolitical tensions and steady stream of negative rating agency reports. However, the macro-economic fundamentals are improving with the International Monetary Fund predicting the continent’s GDP will reach 3.5% in 2024 and 4% in 2025.

The world organization noted many major emerging markets have taken their advice and enhanced central bank independence, improved policy frameworks, built additional currency buffers and whittled down public debt. The result was restoring investor confidence and leading to the opening of the moribund Eurobond market after a two-year hiatus.

Côte d’Ivoire led the way in January, issuing two simultaneous Eurobonds worth a combined USD 2.6 billion: a 9-year sustainable bond and a conventional 13-year Eurobond. This was followed the next month by Benin’s debut dollar bond offering and a USD 750 million 14-year Eurobond deployed to finance the country’s 2024 budget. February also saw Kenya issue a USD 1.5 billion 7-year Eurobond to help repurchase an existing USD 2 billion Eurobond that came to the market in June. A handful of other countries such as Nigeria and Cameron have signaled their intention to follow suit.

More work to be done

Despite the progress that has been made, the region is far from out of the woods and faces high borrowing costs as well as funding squeezes. For example, Côte d’Ivoire, Benin, and Kenya—paid an average coupon of 8.5%, which adds up to USD 4 billion in interest over the next 14 years. This is as much as 200-300 basis points higher than the more advanced countries are repaying.

On average, the 23 African nations that have access to the Eurobond market have paid 170 to 290 basis points more to borrow on international markets relative to comparably rated sovereign issuers, according to estimates from LSF founder Songwe, who is also a nonresident senior fellow in the Africa Growth Initiative at the Brookings Institution.

There is also the view that the stricter Bank for International Settlements adequacy rules have made central banks think twice before lending to less developed capital markets. This is why the LSF and the development of a well-functioning repo market is seen as such a significant step forward. Although it will take a far greater scale of activity to make a meaningful impact on the African sovereign bond market, the outlook for the future is positive. There is no doubt that in the future it will go a long way in supporting liquidity and price discovery in the cash market, as well as improving the cost of funding for firms and governments.

Equally as important the LSF will be instrumental in carving out a clear path to sustainable economic development in Africa and help fund large capital projects that can make progress toward tackling climate change on the continent.

For market participants investing in emerging markets, deploying internal systems that combine efficient collateral management, pricing visibility and risk management is critical to thriving amid volatility and more demanding regulatory reporting.