Capitalising on African financial services

Author: | Published: 3 Nov 2014
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Leapfrog’s general counsel Tom Brunner explains best practice for investing in the continent’s growing financial service sectors, which risks are overhyped and how to best hedge against currency fluctuation

Natural resources have triggered Africa's rise. But the continent's expanding middle class will ensure its growth story continues. Of the canny investors to have capitalised on the increased demand for local financial services, Leapfrog Investments is a pioneer.

The emerging market-focused investment firm has been active in Africa since its inception in 2009. Reflecting on the last five years, Leapfrog's general counsel Tom Brunner explains how the investment climate has changed, dispels some some common misconceptions and clarifies which risks can and can't be mitigated.

In Africa, Leapfrog focuses its investments in the insurance, pension and other financial industries. What are the particular opportunities presented by these sectors?

What we have targeted is the emerging consumer. For the hundreds of millions of people in Africa making their way out of poverty and beginning to establish themselves, insurance and other financial services are incredibly important ways to secure and build upon their financial gains. This creates a tremendous market opportunity for companies that are oriented towards that category of consumers. At the same time, insurance penetration is currently low in emerging markets. Insurance as a percentage of GDP in emerging markets is at an average of 2.9% and the percentage of people benefiting from life, health, accident and disability insurance is typically less than five percent. This is in contrast to markedly higher averages in developed markets. Consider that total life and non-life penetration is 11.6% in the US, 13.4% in the UK and 8.3% in the EU. Given the market's potential is almost unlimited in scale, it is a very exciting opportunity.

Based on Leapfrog's experience, which countries' financial services sectors are the easiest to gain a foothold and operate in?

The biggest macro risk is foreign exchange

The ones we have found to be relatively open and attractive are Ghana, Kenya, South Africa and Nigeria, the last of which may be a surprise to some. They are the four countries we have been most involved with multiple times over the years.

Why would Nigeria surprise people?

There is a perception that because of Boko Haram, Nigeria is a dangerous place. Certainly this has created terrible problems, but our sense is that it's an indication of the difficulty of modernization and rapid maturation. We still view it as an exciting place.

Leapfrog has been active in Africa since 2009. How have you seen the investment environment change over the last five years?

We have certainly seen much more interest in investment from a variety of sources. Major global players in financial services, and in particular private equity firms, are certainly coming into Africa in a way they weren't in 2009. Five years ago, they weren't remotely as interested. For us, this creates possibilities for investment competition, but also very attractive exit opportunities in years to come. Given exit markets are less well established than in developed markets, we need to be conscious of who are our realistic buyers.

We are also seeing bigger deals. In 2009, finding ways to deploy $10 million in African financial services would have been challenging. Today, we are looking at opportunities that are many times that. I think that reflects the growing sophistication in some of the categories of investment we are looking at, and also the level of ambition and scale that people are aspiring to.

For an investment firm focused on Africa, how important is it to have operations on the ground?

It is very important to have your ears to the ground, and with real expertise rather than just a shallow understanding of the markets you are dealing with. But I think it is less critical to have someone resident in, for example, Lagos as opposed to Johannesburg or London. We have operated in many of these countries drawing on people who have significant experience in these markets. That is more important than having people based in these cities.

From a legal perspective, what are the biggest challenges for a foreign investor in Africa?

Certainly the biggest challenge is the potential for abrupt changes in legal regimes. These are still relatively new economies, with new governmental structures. So we would be apprehensive about the possibility of radical change in, for example, tax systems, throughout the course of an investment that alters our basic equation. I think that today that is more of a fear than expropriation or government seizure of assets.

Second, there is always a concern about corruption. We have a zero tolerance policy in this regard – we will not ourselves participate in anything that smacks of corruption nor knowingly invest in a company that is in any way dependent on corruption. And we work very hard in due diligence to make sure we are confident of that. But the concern is that it could emerge further down the road, and that companies would be pushed to the wall. That is something that we are very much focused on.

And for private equity firms, the third thing would be ensuring a path to exit that is realistic and practical. That is a central consideration from the very first conversation when we are looking at a potential investment.

Regarding the risk of abrupt legal changes, is there any way to mitigate this or is it something that must be accepted when making an investment?

There are two levels to that question. First, it is important to really understand the countries you are investing in and put a lot of effort in assessing whether the situation is stable and is likely to be stable over an extended period. That is something we pay a lot of attention to. But on a more technical level, it is possible to take out insurance against certain kinds of regulatory risks. Political risk or tax liability insurance, for example, from the London or New York insurance markets can help.

And what are the most important soft considerations to take into account when investing in Africa?

Number one is governance. The quality of governance in companies that we invest in is absolutely critical in terms of our confidence in the integrity of the investment, and our ability to work with the management and exit the company in time. We will only invest in companies where we think the governance is good, and then we make a big effort to work collaboratively with management to maintain and improve those levels.

The notion that these are countries that investors have to be uniformly nervous about is overstated

Second is social alignment. We are an impact investment fund and are very much concerned with the social progress that can result from the investments that we are making. That complements, rather than clashes with, the financial gains. It is important that company's management and other owners share that alignment.

Finally, openness to genuine collaboration is important. Foreign investors need to be partners; they won't come into companies with all of the answers, or think all the answers are necessarily importable from previous investments. But at the same time we need management that are open to working with us, and want to find imaginative ways to strengthen their products and services.

Which macro risks are the hardest to accept or mitigate?

The biggest macro risk is foreign exchange. We can't control it. And over the periods of time we are invested – and given it is an equity investment – we can't really hedge it. That is just part of the risk profile of these type of investments.

So it's a risk that must just be accepted?

What makes a difference for Leapfrog is that we don't target just one or two countries. We invest in a large number of markets which, in effect, creates a type of de facto hedge. These countries' currencies are not particularly synchronised so if one appreciates, others are likely to be dropping. And over the five years we have been in business, we have found that to work imperfectly but very substantially.

What about political risk?

I wouldn't put that at the top of the list. I would actually say that motivating and keeping your key personnel on board is probably a bigger challenge in these markets. For an investor coming in it is critical to give a lot of thought to who are the people who are the key building blocks of the enterprise and how are they going to be retained and motivated. For a company that is well run, and in a market with a skills shortage of people at that level, the top people can be offered jobs. So that is a significant challenge which has nothing to do with the political environment.

So do you think the notion of political risk's prevalence in Africa is overhyped?

I do. I'm not saying it isn't there, but I think the notion that these are countries that investors have to be uniformly nervous about is overstated. While there are countries that remain failed and minimally functional, I think others that are increasingly attractive are sometimes tarred with the same brush.

What is your top piece of advice regarding investing in Africa?

You cannot overestimate the importance of local expertise. It is not possible to come in and invest in these countries without a genuine depth of understanding of how their economies operate, and of the political, regulatory and tax environment. It's challenging as the number of people providing that expertise is not huge, but getting it is not just invaluable, but a basic entrance requirement.

About the contributor

Tom Brunner
Partner and general counsel, Leapfrog Investments


Tom Brunner is partner and general counsel at LeapFrog Investments, the world's largest dedicated investor in emerging markets financial services. With LeapFrog since 2009, Tom oversees the firm's legal and compliance functions and also plays a lead role on the South Asia team. He has been recognised as one of 'America's Leading Business Lawyers' (Chambers USA; Best Lawyers in America; Lawdragon; Who's Who) and the 'World's Leading Insurance and Reinsurance Lawyers' (Legal Media Group; International Who's Who of Business Lawyers). Tom previously served as the founder and chair of Wiley Rein's insurance practice, representing American and international insurance carriers. Tom has been founding counsel for several industry groups and was recently awarded the Wiley A Branton Award for Civil Rights Advocacy in recognition of his commitment to the pro bono civil rights legal community. He holds a JD from Yale and an AB cum laude from Columbia University.


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