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  • 🚁 Heli view: How mispriced risk keeps investors out of African climate ventures

🚁 Heli view: How mispriced risk keeps investors out of African climate ventures

Funding climate-related ventures on the continent is not only critical but also unusually complex, hampering clear decision-making. 

  • Which is why it’s so refreshing that research from BCG, the global consulting firm, lays out topline numbers and what’s at stake. 

Starting point: While climate funding is growing overall, Africa still receives a low level.

  • The continent requires $2.4 trillion to combat climate change by 2030. 

  • But only 12% ($214 billion) has been availed.

Stumbling block: The origin and nature of green capital in Africa explains this in part. 

  • Many green sectors are capital intensive and have long investment horizons (10+ years). 

  • They need patient capital – yet the wider capital markets can be highly volatile.

Global dimension: Most African ventures rely on foreign direct investment (FDI) to grow their footprint and impact. But African FDI has declined in the past decade.

  • The trend is clearly downwards from $57 billion in FDI in 2012 to $45 billion in 2022. 

Search for explanations: It seems paradoxical that Africa is growing and becoming more relevant to the global economy yet losing ground in capital markets.

  • Some analysts blame US monetary tightening and the Covid pandemic, which coincided with FDI drops of 20% and 10% respectively. 

  • Others point to a failure of local private capital to step in as has happened elsewhere. African money seems unusually shy. 

  • Private climate finance accounts for 14% in Africa, 36% in South Asia and 48% in Latin America. 

Zooming out: To explain a systemic trend though all this seems insufficient. Foreign capital is rational and available but surprisingly little reaches Africa. Why?

  • Market failures show up in pricing, at least in the long run. 

  • For capital markets that usually means interest rates. 

Killer number: Financing costs for green projects in Africa can be significantly higher than in similar emerging markets, according to a report by BCG, 

  • The cost of debt for climate projects in South Africa is 20% compared to Paraguay’s 15%, even though their sovereign ratings are the same (BB) as are GDP per head.

  • The BCG study found consistent evidence for a mismatch of capital costs and credit ratings when comparing African and non-African countries of similar ratings & size.

  • The worse the ratings, the greater the mismatch. For B-rated countries, the Africa premium goes up to 6%. 

The wrinkle: An anomaly in African borrowing may explain part of this. Expected losses for private debt are in line with global averages. But how African borrowers get there is different.

  • Initial losses in Africa are higher (4.9%) than globally (2.7%). But they are balanced out by unusually high recovery rates (83% compared to 75%). 

  • This jumpy journey seems to irk some lenders.

Other risks: Explaining high premiums, lenders also cite a weak exit climate (62%), currency risk (56%), less attractive returns than in other markets (35%), political risk (35%), and unfavourable regulatory environments (32%). 

Beyond return: Structural factors unrelated to financial payback may also limit investment. 

  • Africa has smaller deal sizes, and the global trend is towards bigger deals. 

  • Ever more burdensome "know your customer" rules make Africa trickier for lenders since customers may be less well known. 

Seeking solutions: All of which could explain part of the Africa premium. But 6% compared to (what may look like) other small, distant and unstable emerging markets? 

  • Erasing the mismatch between capital costs and credit ratings in Africa is clearly a thorny undertaking.

  • And green ventures cannot wait until the financial landscape has changed. So now what? 

Action stations: Whatever the reasons for high costs of capital, new solutions are needed.

  • The most likely are innovative finance mechanisms to grow green investment within existing market structures. 

  • "We need to start deploying more smart de-risking instruments for Africa's green industries," said Katie Hill, a BCG partner. Some are listed in our Cheat sheet: Five novel tools to de-risk investments 

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