By Richard Willsher
By Richard Willsher

Electronic FX in African Markets - A giant growth story across both distance and diversity

e-FX in Africa is a huge opportunity. The winners will be those businesses that can span the continent and harness technology to deliver services to a huge and varied range of clients, writes Richard Willsher.

Electronic FX in African Markets -  A giant growth story across both distance and diversity

To understand the African context is to appreciate the scale of the task. Economic activity arises from a population of around 1.3 billion people. The International Monetary Fund (IMF) calculates total African gross domestic product (GDP) amounted to roughly USD2.45 trillion in 2018. Last year, GDP across Africa as a whole grew 3.5 per cent. It is huge but not homogeneous.

There are wide disparities of size, wealth and growth rates among the continent’s 54 countries. And there are also great variations in political stability. The African Development Bank’s (ADB) statistics show that at one end of the spectrum Equatorial Guinea’s GDP growth was well into negative territory at around minus eight per cent. Libya’s meanwhile was in the region of 11 per cent, though whether it continues at this rate will largely depend on its ability to maintain oil and gas exports against a background of civil strife. Moreover, Libya’s dependency on USD priced exports illustrates the historical African story of commodity-dependent economies that are vulnerable to shifts in market pricing and exchange rate volatility. This last point is the principal reason why FX is such a vital component in the pan-African economic picture.

The ADB research shows that GDP growth across the region is generally positive. However inflation is a significant negative as ADB’s research also shows. In addition, lack of efficient systems for collection and investment of tax revenues and prevention of leakage, is also a negative for many countries in the region, which hobbles growth and infrastructure development and this in turn underpins currency behaviours.

Challenges for FX pricing and liquidity

Chris Wilgoss Head of Global Markets Treasury at Crown Agents Bank points out that most African currencies are caught in a continuing trend of decline against the USD as demand for hard currencies increases.  This poses challenges for the Central Banks who are trying to promote stability.

In general, African FX markets have low liquidity levels, even the major markets of South Africa, Kenya and Nigeria. Moreover, as Paul Fenwick Head of Digital Markets for ABSA’s Regional Operations, points out, “Each country has their own policies and regulations that influence the depth of their markets, transparency and capacity.” He adds that there are some glimmers of hope among countries such as Kenya, Morocco and Nigeria that are implementing policies to encourage growth and development in financial markets.

However lack of liquidity also begets lack lustre market activity. “Some currencies,” he says, “can remain static for the entire day and hence the need to make an immediate decision on the currency is not needed like you have in the more traded currencies. Participants in the corporate space have the time to negotiate when executing a deal with the comfort of knowing the currency won’t move in most instances. Product development is always a challenge in FX but there are developments starting to happen in options and forwards with more demand being shown year-on-year especially in the institutional space.”

Paul Fenwick

Paul Fenwick

“Product development is always a challenge in FX but there are developments starting to happen in options and forwards with more demand being shown..”

Standard Bank’s Flow Sales Innovation Lead Irshaan Raghununan notes that where liquidity is a challenge, it is typically a result of concentration risk in the economy. “Usually there are only a few commodities that are exported to earn foreign currency,” he says. “Furthermore, regulation and central bank intervention is important to consider.

From a growth perspective, in relation to our client franchise, we see frontier currencies in East Africa such as the Kenyan and Ugandan shilling poised for significant growth. Interestingly, intra-regional trade in East Africa seems to be increasingly facilitated by local currency trades (UGX/KES and KES/UGX pairs). Trade with China is predominantly settled in USD, but CNY (CNH) continues to grow significantly.”

Mr. Raghununan’s colleague and Digital Trading Solutions Lead, Mpumelelo Makhubu adds that e-FX trading capabilities vary between the Sub-Saharan African countries. “For example, the South African market has developed to the extent that it is fairly sophisticated, as execution methods such as algorithmic trading have begun to gain momentum.

South Africa also has a primary FX market, e.g. central limit order books, whereas the remaining Sub-Saharan African countries are still growing towards this. This innately means there is a lack of market data, which makes the adoption of electronic FX trading challenging. Other challenges faced by many Sub-Saharan countries in this regard are illiquidity, regulatory restrictions and connectivity - or the lack thereof.”

A further significant feature of the Africa FX market landscape is the character of external financing flows. ADB statistics again serve to illustrate how large and how important these are. In large measure, we can say that a dollar of incoming finance from whichever source, translates into a dollar’s worth of local currency of one sort or another. Thus such flows are indicative of FX activity as well as of the need in the continent for hard currency.
A further significant feature of the Africa FX market landscape is the character of external financing flows. ADB statistics again serve to illustrate how large and how important these are. In large measure, we can say that a dollar of incoming finance from whichever source, translates into a dollar’s worth of local currency of one sort or another. Thus such flows are indicative of FX activity as well as of the need in the continent for hard currency.

These last remarks begs the question as to whether South Africa provides a template for the other 53 African countries to follow, in terms of infrastructure and trading behaviour? Would this lead to greater liquidity for currencies other than the ZAR and enable greater stability in pricing, though the volatility of ZAR rates against the G10 has often produced an uncomfortable ride?

Albert Blackburn, Refinitiv’s Senior Transactions Relationship Manager, is upbeat about some aspects of the South African experience. “South Africa is definitely the most developed market on the continent and has been implementing e-FX trading the longest. Some of the lessons that could be transferred to other markets in the region are how to ascertain transparency and price discovery. South Africa can also transfer knowledge on faster and real-time e-FX data coverage and usage as part of pre-and-post transaction services.”

Alison Trace

Alison Trace

“Africa is growing as a market for FX services. Our role is absolutely to support banks in digitising, with fairness and transparency as priorities.”

ABSA’s Paul Fenwick takes a pragmatic view however. “Each country performs in a very different environment to South Africa,” he says, “which aligns to currencies that are more traded like EUR, USD etc. The illiquidity, lack of participants, lack of aggregated pricing and regulator involvement make each country a unique challenge to cater for from an FX perspective”

The practical, infrastructural difficulties of communication are a significant hurdle according to Annette Smyth at SALECAPITAL, the Johannesburg partner of Germany’s BELLIN, the German treasury consultant. She says that South Africa could provide an example to follow but adds, “Operational models will differ in different countries in the region.

The regulatory environment may impede some of these solutions being effectively rolled out. Larger South African banks have managed to roll out e-trading platforms in many countries in Africa but lack of liquidity and the regulatory environment may impinge on the use of these products. Basic Internet access as well as electricity and grid downtime could also impact operational model role out.”

So it’s back to trying to square the circle of the diversity and disparity in the African regional make up.

e-FX and the buy-side

Pressure from buy-side firms on supply-side providers is understandable, given the service quality they see being delivered elsewhere in the global FX market. For this reason a race is on among leading pan-African banks and multibank platforms to come up with broader and more efficient capabilities.

Albert Blackburn

Albert Blackburn

“Developments in FinTech are having a huge impact in the banking sector all over Africa. It is not inaccurate to say that Africa could become a leading innovator in electronic FX.”

“As it is refined, delivering end-to-end capabilities via e-platforms will give buy-side clients the power to manage investing, FX rate transparency, as well as settlement across continent,” says Standard Bank’s Irshaan Raghununan. “Currently, our experience has led us to believe, that global buy-side firms use several intermediaries to navigate these elements in African markets.”

At ABSA, Paul Fenwick says that the major focus is “building a full end-to-end service offering in a single login for clients, which to this point have been fairly broken. New systems are aiming to allow users access to research topics  and currencies for pre-trade service, building out the product set of electronic trading to incorporate optional forwards, drawdowns, extension, settlement capability in terms of payments, as well as confirmation matching services”

At Refinitiv, Albert Backburn says, “Service providers who have been operating on the continent for a number of years now realise the importance of providing holistic pre-and-post services. Refinitiv, for example, provides one of the world’s largest FX platforms for the continent operating in all 48 Sub-Saharan African countries. Our platform provides sophistication, automation and transparency to the market. It also helps countries manage multiple bids at the same time, allowing visibility of trades and ensuring better communication lines between participating banks to better manage of their foreign currency flow.”

Nonetheless, all sell side players that we spoke to for this article are fully aware of the multiplicity of hurdles they confront in trying to offer pan-African services to the buy-side. At the same time, some of the major global FX market players have stepped back from African markets in response de-risking policies from head office. That has, however, left opportunities that local banks and others can take advantage of.

FINTECH

Three emerging themes in African Fintech are mobile money, Regtech and blockchain capability. A key player is pan-African Standard Bank, which has built a blockchain payments solution for cross-border payments.

“We did this with the intention of using the base technology to scale FX and payments across the continent and ultimately, to China, which is Africa’s largest trading partner,” says Irshaan Raghununan.” He notes that in 2018, trade between Africa and China grew 20 per cent to $200bn. “We chose to use Hyperledger fabric, supported by IBM, to be the basis for our blockchain. This gives us the ability to integrate an application programming interface (API) and other cloud based services into the blockchain, basically creating a far more practical application of the technology.” Other services that Standard is working on include optical character recognition technology, addressing the significant documentation burden in many jurisdictions.

Mobile money, commerce and trading is a theme highlighted by Refinitiv’s Blackburn, because it has become a large part of African economies.  “Developments in FinTech is also having a huge impact in the banking sector all over Africa. It is not inaccurate to say that Africa could become a leading innovator in electronic FX. In 2018, Kenya launched its first locally regulated foreign exchange trading platform, which was a good move for the market considering that the Kenyan shilling is one of the most traded currencies in Sub-Saharan Africa.”

FinTech is helping to provide solutions for bureaucracy and red tape as well. This is an obstacle to FX trading in many African countries. Blackburn says that decentralisation and the inclusion of more players is also a large benefit from FinTech, as it will help to grow the economies at scale but he adds a cautionary note. “It is important for the right governing frameworks to be put in place to enable FinTech technologies to help execute with due diligence, transparency and proper conduct,” he says.

Another development has involved Bellin partnering with SWIFT to assist with anti-money laundering checks and regulatory controls. Annette Smyth explains that data gathered in these processes can be held secure using blockchain technology. “There is still a way to go but Bellin, SWIFT, the corporates and system providers can see this as a clear path to digitising know your customer (KYC) and bank mandates.”

The approach adopted by Crown Agents Bank is one of partnering with its local bank network to benefit from their local currency liquidity. The bank is also beginning to expand its business in financial services. Although it does not hold large positions in African currencies, it has processed more than USD15 billion in FX transactions across a wide range of frontier and G20 currencies. “Africa is growing as a market for FX services. It’s still quite new in a lot of areas to electronic trading and digital FX,” explains Alison Trace, Crown Agents Bank’s Digital FX Product Manager. “So, we’re trying to work closely with the banks to help them become digitised in what they do and grow their markets, so that they’re comfortable using the new features and the electronic platforms to make the most of it going forward. Having relationships built on nearly 200 years of trust is very beneficial; we can help support the future because we’ve been there through the past. We also interact with our partner banks on multibank platforms and support them there.” Crown Agents Bank has offered its own trading platform for some time but now is adding its new payments platform to this (see “young, techy and mobile” box).

Annette Smyth

Annette Smyth

“Larger South African banks have managed to roll out e-trading platforms in many countries in Africa but lack of liquidity and the regulatory environment may impinge on the use of these products.”

Looking forward

“Africa has leapfrogged many regions,” explains Albert Blackburn, “largely because the continent did not have legacy systems to begin with. It is therefore able to go straight into the implementation stage. Technology can significantly play a transformative role for the e-FX market in Africa, as well as provide the market with the ability to scale.”
On these points the market participants we spoke to are in agreement. But while South Africa is the most highly developed e-FX market on the African continent, it takes a big leap of the imagination at this stage to see all 54 countries working to a similar level of e-sophistication.

Mpumelelo Makhubu

Mpumelelo Makhubu

Three emerging themes in AfricanFintech are mobile money, Regtech and blockchain capability

However, as anyone who has travelled there will know, in markets which are riven with poor infrastructure, red tape and, frankly, poverty, imagination is plentiful and necessity has always been the mother of invention. Consequently, the spread of Internet access and the growth of mobile technologies, are very rapidly leading the catch up in financial services across the region.
The principal areas for development that will facilitate e-FX at the moment appear to be:

Faster and more secure payments systems. These are already benefiting many people, SMEs, corporates and institutions. There is a race between new and incumbent providers to win market share. The result will surely be greater choice of provider, greater efficiency of delivery and tighter prices for customers.

Liquidity and risk coverage. As yet, even quite large currency markets lack the degree of liquidity, freedom from state intervention, infrastructure support and political stability known in the most of Europe, North America and many parts of Australasia. This is inhibiting growth in risk coverage through forwards, NDFs, swaps, options and futures. However, the growth of FX trading in developing markets in Latin America and Asia has shown how quickly new instruments can be brought forward. On-exchange trading and multibank platforms may well be midwives for the birth of this next generation of African FX services.

Less regulation. This is likely to be a harder nut to crack. One lesson that the Euro currency project has taught markets is the difficulty of reconciling economies of different shapes, sizes and economic performances. How much more difficult is this likely to be in so many different countries in Africa? However, greater foreign investment may lead to increasing economic diversity in future. There are signs that this is happening across the region. If countries can disengage from commodity dependency and from, effectively, being shackled to the USD through commodity and import pricing, they may be able to achieve greater stability, economic prosperity and market freedom.

YOUNG, TECHY AND MOBILE

Burgeoning young populations and the spread of mobile phone usage is propelling banking and trading operations to get smarter and respond to demand.

The poster boy for success in African mobile financial services is Kenya’s M-Pesa, which facilitates USD based remittances for 80 million users. Being able to shift money efficiently and securely is a huge benefit in a continent riven with logistical difficulties for money transfer and where bank account penetration is very low as compared to Europe or North America.

“In South Africa, where smart phone penetration nears half the population (22.5m), there is clear business model to offer financial services to this client base,” explains Standard Bank’s Irshaan Raghununan. “As clients continue to transact, invest, shop, and book travel on their smartphones, it will become important to bring digital foreign exchange to them.”

Paul Fenwick at ABSA adds that, “The tech savvy and young market is causing a mad scramble amongst the digital community to get partnerships formed, new product development to market as quick as possible and with the major focus on mobile banking, competition for market share has increased intensely. I imagine,” he adds, “this will continue even more intensely over the course of the next decade and we will possibly see some form of consolidation happen in due course.”

A significant payments partnership that has recently emerged is that involving Crown Agents Bank. Crown Agents Bank has a long track record of working in Africa. Its specialisms have been wholesale, in the sense that they are involved in acting as conduits for funds from multilateral agencies, governments, charity donors and others to African countries. They work with a network of local banks across the region to facilitate the distribution of Aid flows where local currency controls may make this a difficult task. In April this year, Crown Agents Bank announced that it had acquired Segovia, a US venture capital backed technology firm, whose payment gateway focuses on frontier market payments. The tie up will reduce costs, speed up and add security to the payment flows to and from frontier markets that Crown Agents Bank services.

All in all, it is capabilities such as these that will increasingly leapfrog the traditional banking services and use technology to meet the needs of the young, techy and mobile throughout the region.

Irshaan Raghununan

Irshaan Raghununan

“As clients continue to transact, invest, shop, and book travel on their smartphones, it will become important to bring digital foreign exchange to them.”

China. What effect trade with China and Chinese investment may have on particular economies over the long term remains to be seen. Will China merely supplant traditional post-colonial trade flows or will it add diversity and therefore, potentially greater economic stability? It is not difficult to imagine the RMB becoming a major trading currency across Africa. If so, this will bring a different complexion to FX trading and e-trading venues will be likely to quickly adapt their platforms to enable RMB crosses to local currencies.

All in all, the outlook is one of increased e-activity in financial services across the African continent. E-FX will be a vital component of this seismic shift in commercial activity, as technology enabled commerce vaults traditional barriers, to achieve greater freedom to trade and in wealth generation.

Africa has burgeoning young populations which are increasingly tech savvy
Africa has burgeoning young populations which are increasingly tech savvy

ADDRESSING REGULATION

Many FX deals in the region involve a need to make a cross border payment, whether it’s for institutions, corporates, SMEs or in retail. So any provider of FX services has to be able to offer products that cater for regulation if they are to reach significant customer numbers.

“Some of the African regions we operate in have various regulations including regulation on pricing, the liquidity that can be traded, the types of products that can be traded, documentation and exchange control rules,” says Standard Bank’s Mpumelelo Makhubu. “Our eFX solutions need to be developed and implemented considering these factors, while ensuring that they facilitate our client centricity objectives.”

This is something that the multibank platforms have focused on quite carefully. “Regulation in Africa and the number of exchange controls is a constant challenge for international markets,” explains Refinitiv’s Albert Blackburn. “While local traders are able to manoeuvre the challenging regulatory environment in Africa, they also require specialised expertise to support them through the challenges. The ability to manage the impact these regulations have on price and the way FX is delivered to clients is crucial.”
Meanwhile, there is a trend toward less regulation, albeit limited and this is leading to new product development. Bloomberg’s Global Head of FX Electronic Trading, Tod Van Name highlights some of the successes. “Regulators are implementing solutions to remove counterparty risk from the interbank market through central counterparty clearing (CCP), in key sub-Saharan economies,” he says. “Local stock exchanges and financial markets associations are building awareness about new products, including possible derivatives in Nigeria, Kenya and Botswana. The consolidation in the banking industry means bigger balance sheets and the ability to spend more on technology with FX turnkey and white labelling solutions.”

How soon and to what extent this will spread to a large number of markets across the region remains to be seen. Regulation and currency controls are likely to be a fact of FX life for the foreseeable future.

ADDRESSING REGULATION

Many FX deals in the region involve a need to make a cross border payment, whether it’s for institutions, corporates, SMEs or in retail. So any provider of FX services has to be able to offer products that cater for regulation if they are to reach significant customer numbers.

Tod Van Name
Tod Van Name

“Some of the African regions we operate in have various regulations including regulation on pricing, the liquidity that can be traded, the types of products that can be traded, documentation and exchange control rules,” says Standard Bank’s Mpumelelo Makhubu. “Our eFX solutions need to be developed and implemented considering these factors, while ensuring that they facilitate our client centricity objectives.”

This is something that the multibank platforms have focused on quite carefully. “Regulation in Africa and the number of exchange controls is a constant challenge for international markets,” explains Refinitiv’s Albert Blackburn. “While local traders are able to manoeuvre the challenging regulatory environment in Africa, they also require specialised expertise to support them through the challenges. The ability to manage the impact these regulations have on price and the way FX is delivered to clients is crucial.”

Meanwhile, there is a trend toward less regulation, albeit limited and this is leading to new product development. Bloomberg’s Global Head of FX Electronic Trading, Tod Van Name highlights some of the successes. “Regulators are implementing solutions to remove counterparty risk from the interbank market through central counterparty clearing (CCP), in key sub-Saharan economies,” he says. “Local stock exchanges and financial markets associations are building awareness about new products, including possible derivatives in Nigeria, Kenya and Botswana. The consolidation in the banking industry means bigger balance sheets and the ability to spend more on technology with FX turnkey and white labelling solutions.”

How soon and to what extent this will spread to a large number of markets across the region remains to be seen. Regulation and currency controls are likely to be a fact of FX life for the foreseeable future.