Citi’s surprise gambit for the African debt market

Greetings from New York, where I (and many others) are recovering from the joys of endless feasting over Thanksgiving. This is traditionally a festival that sparks retrospection about the past year, and this seems timely for the environment, social and governance agenda, given that it is currently grappling with two competing — contradictory — trends.

On the one hand, there is a swelling backlash among the rightwing political forces — and some corporate leaders — against the stricter versions of ESG. On the other hand, the renewable energy space continues to spark a wave of fundraising and dealmaking — and this is arguably as important as the soul-searching around the controversial COP27 conference.

In another sign that the energy transition investment wave is intensifying, the fight around the US Inflation Reduction Act — and its $369bn in green spending — is heating up (excuse the pun). Read our discussion about this below. And also take note of the striking saga around Citi’s new move into the green African repurchase market — a topic that has barely been covered anywhere else, but which shows the degree to which the sustainability fight is moving into new corners. (Gillian Tett)

Has executive pay at major corporations reached unjustifiable levels? Or is it a fair reward for hard work and added value? That debate will be the focus of our next Moral Money Forum report — which will, as always, feature the views of our readers. Have your say by answering our short survey here.

Africa is finally getting a ‘repo’ market. Will it work?

In June 2020, Vera Songwe took to the opinion section of the FT to call for an ambitious new move in African credit markets.

Cameroon-born Songwe, then executive secretary of the UN Economic Commission for Africa, had been alarmed by the effect of the Covid-19 pandemic on African governments, which were seeing their borrowing costs surge as the world economy lurched into crisis.

This problem was particularly stark in Songwe’s home continent because of the poor liquidity in African government bonds. In her FT column, she set out a plan for a possible response.

Africa, Songwe declared, needed a “repo” market for its sovereign bonds. In this well-established model, an investor sells a bond to a counterparty, while agreeing to repurchase it (typically at a slightly higher price) after a fixed period. In many ways, it’s similar to a short-term loan, with the bond used as collateral.

While repo markets are a major part of the financial system in developed economies, helping to drive liquidity and reduce credit costs, they’ve been very limited in Africa. This month, however, Songwe’s vision finally started to bear fruit.

In this maiden transaction, Citigroup became the first institution to make use of the recently launched Liquidity and Sustainability Facility, chaired by Songwe and funded, so far, mainly by the Cairo-based African Export-Import Bank. Citi (which has been named as the LSF’s structuring agent for future transactions) used the LSF to borrow against $100mn of African sovereign bonds — using about a third of the fledgling institution’s roughly $300mn capacity.

Songwe told me she hopes that capacity will more than triple in the near future, with much larger-scale growth to follow, as the LSF wins new support from central banks and multilateral institutions. She argues that a well-functioning repo market would dramatically boost liquidity in African sovereign bonds, making these assets more attractive to investors, who would therefore demand less painfully high yields.

This could save African governments as much as $11bn over five years, she estimates — a meaningful sum in a continent where hundreds of millions live on less than $2.15 a day, according to the World Bank.

“When you buy a US treasury or a British gilt, you can go to the secondary market five minutes later and trade it in for cash,” Songwe told me. “If you buy Côte d’Ivoire or Senegal paper, because we don’t have these secondary market repo facilities, you open a drawer and put it there.”

That illiquidity presents investors with an “opportunity cost”, which has been getting passed on to the sovereign borrowers, Songwe noted. This extra cost could start to come down, she hopes, with a serious expansion of the LSF — which has already attracted the involvement and support, in various forms, of major financial institutions including BNY Mellon, Amundi and Pimco. Adding to the appeal is the LSF’s explicit focus on green bonds and other debt instruments supporting sustainable development — a field where trillions of dollars in new finance are needed, as stressed in a recent UN report co-authored by Songwe.

For a healthily sceptical take on this initiative, it’s worth reading this paper by Daniela Gabor, an academic at the University of the West of England. She questions the decision to focus on foreign currency bonds, which are typically more difficult to service at times of economic stress — in contrast with ongoing initiatives to help developing nations to borrow in their own currencies.

There is also a risk of undermining monetary policy autonomy, Gabor warns. For example, if the LSF tightens its standards for repo transactions in Kenyan sovereign bonds, this will “de facto tighten monetary conditions in Kenya, interfering with the central bank’s preferences”.

But Songwe maintains that the LSF is an idea whose time has come. “Emerging market economies have developed much faster than the infrastructure we have for them to succeed,” she told me. “We concentrated on African countries going to the market, which has been expensive, leading to high debt burdens. Now we’re saying: now that they’re going to the market, can we ensure they get cost-effective pricing?” (Simon Mundy)

IRA: The fight heats up

I have to admit that when I first heard about US president Joe Biden’s “IRA” (Inflation Reduction Act) initiative, I was sceptical. Quite apart from the unfortunate connotations of the name for people who grew up exposed to the Troubles in Northern Ireland, the bill is a deceptive piece of branding, since it does little to cut inflation.

But what I initially missed (like many investors) is the potentially dramatic impact that IRA could have on energy transition investments, due to the subsidies in the bill. In recent weeks, I have heard business executives tell me that they plan to increase their investments in technologies such as hydrogen in the US, because of the IRA; friends are choosing to buy Tesla cars over Polestar electric vehicles because the former gets a subsidy for being American-made, but the other does not (because its production is mainly in China); and companies are unveiling green investment plans. Last week, for example, South Korean group LG Chem announced a $3bn investment in a battery plant in Tennessee.

But one key question for sustainability-focused investors now is what the European Commission does next in response — and whether this could block (or blunt) the IRA. European politicians believe that the IRA breaches World Trade Organization rules, and are threatening a formal WTO dispute. It is easy to see why the Commission is upset: not only does the IRA exclude European-made products, but it also gives American businesses a subsidy advantage — and this comes as European companies are losing out to cheap Chinese imports in sectors such as solar panels and wind turbines.

Most European business leaders would probably prefer that the region respond with their own subsidies, rather than start a trade war, and French president Emmanuel Macron and German economy minister Robert Habeck seem minded to do this. Some European politicians are also lobbying for Washington to change the “made in America” provision in the IRA to a “made by American allies” concept — ie a variant of the “friend-shoring” (or “ally-shoring”) principle that Janet Yellen, US Treasury secretary, keeps talking about.

However, Washington seems unlikely to change the IRA, given that the White House views the bill as something of a political triumph, and the European Commission might struggle to match US subsidies. So time is running out for an easy resolution. The next formal wave of US-EU trade talks take place on December 5, with the IRA due to take effect on January 1. So brace yourself for diplomatic jostling, not just in Europe but also from countries such as Australia and Canada that are scrambling to work out their own response. The only silver (or green) lining to the row is that it will probably prod governments around the world to raise total support for renewable investments. Competition works. (Gillian Tett)

Smart read

Is big business getting sick of the net zero agenda? As pressure mounts on companies — notably with a new UN report at COP27 — some are getting conspicuously disgruntled, warns Pilita Clark in her latest FT column.