Rating Africa for investors

The international investor community is hungry for information on African countries, but accessing the market is challenging for credit ratings firms. 

As millions of Nigerians headed to the polls in March’s historic election, optimism among voters was palpable. In a country known for its cheery disposition – a Gallup poll last year found Nigerians more positive than all nations about 2015 – the chance to participate in the contest largely brought good-natured queues and banter to polling stations.

But if there is one sector which proved immune to the tidal wave of Nigerian positivity, it was the credit ratings agencies charged with monitoring the country’s difficult fiscal outlook. Even while voting continued apace, Fitch Ratings cut the country’s outlook to negative – following in the footsteps of Standard & Poor’s, which several days earlier lowered Nigeria by a level.

The negative outlook at a time of high optimism was illustrative of a wider challenge among credit ratings firms in Africa – how to capture the zeitgeist of an emerging continent while eschewing short-term trends in a bid for popularity and new business. With economic headwinds buffeting the continent, and rated countries suffering the consequences from Ghana to South Africa, that problem becomes more acute.

The emergence of ratings agencies in Africa has largely run parallel to the opening up of financial markets. From humble beginnings in the early 1990s focusing on Nigeria and South Africa, agencies have expanded across the continent and now pass judgement on everything from Rwanda Eurobonds to Kenyan sugar producers.

The “Big Three’ of Fitch, S&P and Moody’s – the dominant players who corner the global market – have all made efforts to expand their operations into Africa, where they are joined by local firms eager to promote their specialist credentials.

Marc Joffe, chief executive of Africa-focused rating agency Global Credit Rating Co (GCR), estimates that there are “somewhere in the region” of 500 rated companies in Africa – out of a potential pool of 2,500.

“We’re not at the infant stage but we’re not at the end stage – we’re kind of in between depending on what market you talk about. But the opportunities are immense,” he says.

That demand is being driven by an investor community eager to access up-to-date financial information on Africa countries, regions and companies as the continent becomes increasingly embedded in global markets. Paul Vaaler, an associate professor at the University of Minnesota’s Carlson School of Management, believes that investors see credit ratings as an essential tool for emerging market investment decisions.

“If you talk to the average bond trader for sovereign debt they’ll say they don’t care so much what credit raters think [on the US or Britain]. But on Ghana, they care, because it’s just a less transparent place, so they care more about that expertise”.

Despite an investor clamour for new sources of information, breaking into the remaining African frontier markets is proving a challenge for ratings firms. As well as depending on the broader development of a country’s financial market, firms need to work hard to win the trust of a diverse range of stakeholders – from politicians and regulators to company heads and outside investors.

Olusegun Alebiosu, chief credit risk specialist at the African Development Bank, says that outreach efforts can often be hobbled by mistrust towards the intentions of credit ratings firms.

Alebiosu says that such “negative perceptions” can be alleviated by clear lines of dialogue between ratings agencies and rated countries – and honest discussions on how ratings can be improved.

“It makes life easy for everyone to say, OK, you’ve done ABCD for me, so let me do ABCD (for you). If we don’t have that, there’s no way we can move forward and that is important.”

It is not only in Africa that a trust deficit exists between credit ratings agencies and the financial ecosystem. The reputation of the ‘Big Three’ is struggling to recover from the aftermath of the global financial crisis, when US politicians savaged the industry performance.

Worthless sub-prime mortgages were gifted premium ratings, the strategies of over-leveraged banks went unquestioned, and complacent analysts struggled to spot the signs of impending crisis. Most damningly, credit ratings agencies were accused of being too close to the clients which ultimately paid for their services – a credibility gap which threatened to swallow the industry.

Given such a wretched performance, the reluctance of some African entities to submit themselves for ratings is perhaps understandable.

For Konrad Reuss, sub-Saharan Africa managing director at S&P, an educational approach across Africa is leading to a heightened level of understanding around credit ratings “much better” than the situation five or 10 years ago.

“In many ways the situation over the last couple of years was not that dissimilar to what we encountered in the ’90s in Central and Eastern Europe. We have a lot of educating to do which in our case starts with simple things like ‘What is a rating? What is it good for? How does the process work?’.

He believes that this has filtered into an improved understanding of the benefits of credit ratings – even if the final rating does not end up matching a government or company’s desired outcome.

“The ratings themselves tend to be low ratings but that shouldn’t be a surprise because we are talking about low/middle-income countries that still have issues around building stable institutions and following sustainable policies. [But] both governments that are rated and market participants that use those ratings do understand that they add value,” he says.

Credit ratings firms operating in Africa are keen to dispel the perception, widespread in the aftermath of the crisis in the US, that firms are too close to paying clients. The agencies which spoke to African Business referred to a strict separation of analytical and commercial activities and pointed to beefed-up international regulation surrounding ratings.

AfDB’s Alebiosu believes that client pressure on credit ratings agencies is always a likelihood – but believes that the power of international ratings firms in Africa, allied to rigid analytical templates – means that this pressure may be largely ineffective.

“Nigeria will not be able to pressure S&P or Fitch…they can only massage their ego and see if they will let them off for some time,” he argues.

Marc Joffe says that there are inevitably instances where clients are not happy with the rating, but that a transparent approach and forward guidance on improving a rating can often iron out any problems.

“There are instances where clients don’t and will never derive the rating that they desire and then the relationship terminates for obvious reasons. Our independence and credibility is everything so there’s only so much we can do.”

Forging a credible reputation and a demonstrable track record of accurate ratings is particularly important for emerging African ratings firms hoping to break the stranglehold of the ubiquitous ‘Big Three’, who continue to command a strong brand awareness with the global investor community.

GCR’s Joffe argues that the firm is deploying on-the-ground expertise to “hold its own” with the Big Three in many African markets, but points to particularly fierce competition in Nigeria and South Africa.

Ultimately, the hope is that a greater range of voices in the ratings industry will allow both international investors – and African governments – to make the right financial decisions going forwards.

In 2013, Paul Vaaler and Marek Hanusch released a World Bank working paper arguing that credit ratings agencies act as “guardians of fiscal discipline” in emerging democracies by diminishing politically motivated borrowing by finance ministers at
election time.

“This is where the ratings agencies, for all their other challenges, contribute constructively to diminishing some of the distortions that are inevitable in budgetary finances during election and help finance ministers do the right thing,” says Vaaler, pointing out that there’s ‘every reason’ to believe that this will apply to Africa.

So even if credit ratings firms were not swept up in Nigeria’s unbridled election optimism, there’s a chance that their watchful eye was quietly encouraging a positive electoral process.

For an industry which prides itself on caution and has grown uncomfortably used to the limelight, that may not be a bad outcome.

David Thomas