Frontier Capital Markets and Investment Banking: Principles and Practice from Nigeria 2019004031, 9780367191139, 9780429200519

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Frontier Capital Markets and Investment Banking

This book discusses the role of capital markets and investment banking in Nigeria, the largest frontier market economy in the world by both population size and gross domestic product. Offering a systematic framework combining conceptual principles with real practice, the book enables the reader to gain useful insight into how capital markets and investment banking work in the real world of a frontier market. The book provides a synopsis of the economic attractiveness, financial systems intermediation and capital markets, as well as the regulatory framework within a frontier market. It explores capital raising through equity and underwriting and private equity, paying particular attention to putting capital to work on mergers and acquisitions, project and infrastructure finance and real estate finance. Furthermore, it analyses asset management, pension industry and securities trading in a frontier market. The authors use detailed case studies from Nigeria to illustrate the operations of investment banking in frontier markets.The cases, tables and charts serve as useful illustrations of the topics under discussion. With the authors’ combined experience of more than 50 years as economists, finance and investment professionals and in executive leadership positions in the financial services industry, this book will interest the academic community, professionals in the financial industry, retail and institutional investors interested in frontier markets, development practitioners in international organizations and policy makers including securities and capital market regulators. Temitope W. Oshikoya, PhD, is an economist, finance and investment professional, with more than two decades of experience in private sector, public sector, consulting and academia. He is the managing principal of Nextnomics Advisory, an economic and financial consulting firm. He has held executive leadership positions at Ecobank Transnational Incorporated, the West African Monetary Institute, Africa Finance Corporation and the African Development Bank and as a consultant to various institutions. Kehinde Durosinmi-Etti has more than three decades of management and leadership experience as a chartered accountant and banker. He has held top leadership positions as the managing director and chief executive officer of three different banks in Nigeria: Midas Bank, Eko International Bank and Skye Bank. Having retired in 2014, he now runs a financial advisory and consulting firm based in Lagos, Nigeria.

Banking, Money and International Finance

History of Financial Institutions Essays on the History of European Finance, 1800–1950 Edited by Carmen Hofmann and Martin L. Müller Growth Without Inequality Reinventing Capitalism Henry K. H.Woo Austrian Economics, Money and Finance Thomas Mayer Price and Financial Stability Rethinking Financial Markets David Harrison A Comparative History of Bank Failures From Medici to Barings Sten Jönsson Expert Systems in Finance Smart Financial Applications in Big Data Environments Edited by Noura Metawa, Mohamed Elhoseny, Aboul Ella Hassanien, M. Kabir Hassan Equity Home Bias in International Finance A Place-Attachment Perspective Kavous Ardalan Frontier Capital Markets and Investment Banking Principles and Practice from Nigeria Temitope W. Oshikoya and Kehinde Durosinmi-Etti For more information about this the series, please visit www.routledge.com/ series/BMIF

Frontier Capital Markets and Investment Banking Principles and Practice from Nigeria Temitope W. Oshikoya and Kehinde Durosinmi-Etti

First published 2019 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 52 Vanderbilt Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2019 Temitope W. Oshikoya and Kehinde Durosinmi-Etti The right of Temitope W. Oshikoya and Kehinde Durosinmi-Etti to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Oshikoya, Temitope Waheed, author. | Durosinmi-Etti, Kehinde, author. Title: Frontier capital markets and investment banking : principles and practice from Nigeria / Temitope W. Oshikoya and Kehinde Durosinmi-Etti. Description: 1 Edition. | New York : Routledge, 2019. | Series: Banking, money and international finance | Includes index. Subjects: LCSH: Capital market—Nigeria. | Investment banking—Nigeria. | Banks and banking—Nigeria. Classification: LCC HG5881.A3 O834 2019 | DDC 332/.041509669—dc23 LC record available at https://lccn.loc.gov/2019004031 ISBN: 978-0-367-19113-9 (hbk) ISBN: 978-0-429-20051-9 (ebk) Typeset in Bembo by Apex CoVantage, LLC

To my lovely wife, Patience, who has been an anchor and a pillar of support to me. And to my two glorious children, Morenike and Oluwatobiloba. With all my love. Temitope W. Oshikoya To my loving wife, Abimbola, who has been most reliable and supportive and especially over the last 29 years. To my two sons, Babatunde and Oluseyi, who have been a source of inspiration in writing this book, which will help them become adept business managers in the future. Kehinde Durosinmi-Etti

Contents

List of figuresix List of tablesx List of boxesxii List of abbreviationsxiv Prefacexx Acknowledgementsxxii PART I

Frontier markets’ environment

1

  1 Nigeria: a frontier market economy

3

  2 Frontier market financial system

19

  3 Frontier capital market

38

PART II

Investment banking in frontier markets

57

  4 Investment banking

59

  5 Risk management

80

  6 Regulatory framework

91

PART III

Raising capital in frontier markets

105

  7 Equity underwriting

107

  8 Debt underwriting

130

  9 Private equity

148

viii  Contents PART IV

Putting capital to work in frontier markets

167

10 Mergers and acquisitions

169

11 Infrastructure and project finance

191

12 Real estate finance

214

PART V

Managing capital in frontier markets

231

13 Asset management

233

14 Pension management

249

15 Securities brokerage

262

PART VI

Future direction

273

16 Future trends and prospects

275

Appendix282 Index284

Figures

1.1 1.2 1.3 1.4 2.1 2.2 3.1 5.1 5.2 7.1 7.2 8.1 9.1 9.2 10.1 11.1 11.2 12.1 12.2 13.1 14.1 14.2 15.1

Crude oil price and Nigeria’s real GDP growth, 1991–2018 Q2 Nigeria: capital inflows (US$ millions), 2011–2017 Infrastructure stock as a share of GDP (%) Ease of Doing Business in Nigeria Types of financial markets Overview of the Nigerian financial system Nigeria: long-term trends of the all-share index, 1996–2018 ARM risk management structure The three lines of defence risk management model Estimated timeline for primary market offers Proportion of delisted companies, 2012–2016 Composition of Nigerian bond market Structuring of PE funds Number and value of African private equity deals, by year Trends in global M&A Schematic structure of project finance Infrastructure stock as a share of GDP (%) Real estate sector growth and contribution to GDP Home ownership: Nigeria versus other countries Mutual funds (NAV and NAV contribution to GDP) Nigerian pension assets and ratio of GDP Ratio of pension assets to GDP Foreign and domestic transactions trends, 2007–2017 (₦ billion)

7 9 11 11 22 23 46 86 88 114 127 134 149 157 177 198 203 216 217 237 255 256 268

Tables

1.1 1.2 1.3 1.4 1.5 1.6 2.1 2.2 2.3 2.4 2.5 3.1 3.2 3.3 3.4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 5.1 6.1 6.2 7.1 7.2 7.3 8.1 8.2 8.3 8.4

Features of frontier economies Nigeria: selected economic indicators Domestic savings and capital formation as % of GDP Top 10 destinations by net FDI flows in Africa EODB ranking: Nigeria versus selected countries Productivity growth and level in selected countries Financial institutions licensed by the CBN Assets structure of the Nigerian financial system Economy and financial characteristics Financial soundness indicators Economy–bank credit gap: sector concentration of credit World top stock exchanges, 2017 Listed securities on the NSE, December 2018 Medium-term trends of the all-share index, 2013–2018 Economy-market gap analysis Investment banking business Types of investment banks in Nigeria Financial services holding companies Divested/affiliated investment banking firms Independent full-service investment banking firms Business strategy and financial performance of selected investment banks Career path in investment banking Classification of various types of risks Business and financial laws and regulators in Nigeria Capital market operators: minimum paid-up capital requirement Approved equity offers by issue type Listing requirements of the NSE Cost of public listing of shares Nigeria public debt stock as of 30 June 2018 FGN bonds issuance calendar for the first quarter, 2018 FGN bonds auction results Corporate bonds issuance, 2017–2018

4 7 8 9 12 13 26 30 32 32 33 40 45 47 48 61 65 66 69 71 76 77 85 96 98 110 122 128 132 138 139 141

Tables xi

8.5 8.6 9.1 9.2 9.3 10.1 10.2 11.1 11.2 1 1.3 11.4 12.1 12.2 12.3 12.4 13.1 13.2 13.3 14.1 14.2 14.3 14.4 14.5 14.6 15.1 15.2 15.3

Fixed income primary issuance fees, November 2017 142 FMDQ OTC market turnover report 145 Global largest private equity firms 154 Map of private equity firms in sub-Saharan Africa 158 Venture capital attractiveness index 163 Banking consolidation and M&A, 2006 179 Recent M&A in Nigeria 182 Taxonomy of instruments and vehicles for infrastructure financing194 Global project finance deals and loans by country 201 Global initial mandated lead arrangers 202 Infrastructure funds in Nigeria 210 Comparative real estate indices: Nigeria and South Africa 217 Time and cost to register property 221 PMI consolidated balance sheet, June 2018 223 Listed REITs in Nigeria 226 Top 10 AMCs in the world, 2017 234 FBN Quest Asset Management Mutual Funds 238 Breakdown of Vetiva Sector Series ETFs 244 Number of pension operators in Nigeria 254 RSA registration by age and sector as of second quarter 2018 255 PFA concentration as of 31 December 2016 257 Ranking of PFA by asset size as of Q1 2018 258 Pension funds investment allocation and performance 258 Multi-fund structure investment limits 260 Top 10 brokers by transaction values, 2012 267 Top 10 brokers by transaction values, 2018 267 Top 10 stocks by market capitalization and volume traded 269

Boxes

2.1 2.2 3.1 3.2 4.1 4.2 5.1 6.1 6.2 7.1 7.2 7.3 8.1 8.2 8.3 8.4 9.1 9.2 9.3 9.4 10.1 10.2 10.3 10.4 11.1 1 1.2 12.1 1 2.2 12.3 12.4

The Central Bank of Nigeria 24 The Asset Management Corporation of Nigeria 27 Some recent developments on the NSE 50 NSE strategic execution in 2017 51 Client-facing activities at global investment banks 59 Stanbic IBTC and its investment banking franchise 68 Risk management structure at ARM 87 Securities and Exchange Commission of Nigeria 94 New CAMA, 2018 passed by the National Assembly 96 Right issue at Lafarge 112 Regulatory requirements for public offers 117 MTN Nigeria to raise capital by IPO and list on NSE 125 The Debt Management Office 132 Nigeria’s Eurobonds Issuance 136 GTB: a leading pioneer in issuance of GDR and Eurobonds 141 Lagos State Government Debt Issuance Programme 144 Private equity term sheet 150 AfDB support to private equity in Africa 155 Emerging capital partners closes its fourth Pan-African Fund 159 ABC: private equity in a regional transportation player 160 M&A and Financial Advisory at Chapel-Hill Denham 178 Access Bank PLC: leapfrogging to largest bank via M&A 180 Merger of Nigerian Breweries PLC and Consolidated Breweries183 Merger of Dangote Cement PLC and Benue Cement Company184 The Azura-Edo Independent Power Plant 205 AFC: Africa’s leading multilateral infrastructure finance institution207 Mixta Real Estate PLC 218 Capital Alliance Property Investment Company 223 The Nigerian Mortgage Refinance Company 224 REITs managed by SFS Capital 227

Boxes xiii

13.1 1 3.2 13.3 14.1 15.1 15.2 15.3

First Bank Nigeria (FBN) Quest Mutual Funds 240 The Vetiva Sector Series Exchange Traded Funds (ETFs) 242 STL TRUSTEES LIMITED: Service Built on Trust246 Nigeria’s Pension Reform Acts 253 Meristem Stock Brokers Limited 264 Ecobank Securities Limited 265 CSCS: Securities Clearing and Settlement 269

Abbreviations

ACA ACCA AFC AfCFTA AfDB AFEX Afriexim ALCO AMCON AMCs AML AON ARM ARMHIF ASEA ASeM ATA AUM BA BBWA BCC BDCs BOFIA BOFIA BOI BRICS BVN CAC CAMA CAPIC CB CBN

Africa Capital Alliance Association of Chartered Certified Accountants Africa Finance Corporation African Continental Free Trade Area African Development Bank AFEX Commodities Exchange Limited African Export Import Bank Asset and liability committee Asset Management Corporation of Nigeria Asset management companies Anti–money laundering All or none Assets & Resources Management ARM–Harith Infrastructure Fund African Securities Exchanges Association Alternative Securities Market Agricultural Transformation Agenda Assets under management Bankers’ acceptances British Bank of West Africa Benue Cement Company PLC Bureaux de change Banks and other Financial Institutions Act Cap B3, LFN 2004 Banks and Other Financial Institutions Act, 1991 Bank of Industry Brazil, Russia, India, China and South Africa Biometric verification number Corporate Affairs Commission Companies and Allied Matters Act Cap C20, Laws of the Federation of Nigeria (LFN) 2004 Capital Alliance Property Investment Company Consolidated Breweries Central Bank of Nigeria

Abbreviations xv

CBSITS CD CDC CFA CFT CGRS CGT CIBN CIS CIT CITA CP CSCS CSL CSLS CTR DAS DCF DCM DCP DEG DENHAM DFIs DMB DMO EAD EBAs EBIT EBITDA ECC ECM ECOWAS ECP EIB EMEA EODB EPC ERGP ETFs ETI EV EY FBN FC FCF

Central Bank of Nigeria Immediate Transfer Service Certificates of deposit CDC Group PLC Chartered financial analyst Combating the financing of terrorism Corporate Governance Rating System Capital gains tax Chartered Institute of Bankers of Nigeria Chartered Institute of Stockbrokers Companies’ income tax Companies Income Tax Act Cap C21, LFN 2004 Commercial papers Central Securities Clearing System PLC City Securities Limited CSL Stockbrokers Limited Currency Transaction Report Dutch auction system Discounted cash flow Debt capital markets Dangote Cement PLC Deutsche Investitions- und Entwicklungsgesellschaft ‘Chapel-Hill’ Denham Management Limited Development finance institutions Deposit money bank Debt Management Office Exposure at default Eligible bank assets Earnings before interest and taxes Earnings before interest, taxes and depreciation Electronic cheque clearing Equity capital markets Economic Community of West African States Emerging capital partners European Investment Bank Europe, the Middle East and Africa Ease of doing business Engineering procurement and construction Economic Recovery and Growth Plan Exchange traded funds Ecobank Transnational Incorporated Enterprise value Ernest  & Young First Bank Nigeria PLC Finance companies Free cash flow

xvi  Abbreviations

FCMB FCT FDI FGN FIRS FISD FM FMBN FMCG FMDQ FMF FPI FRCN FSCC FSDH FSS FTR FX GCM GDP GDR GP GTB HHI HNWIs IBD IBRD ICAN ICT IDA IMF IOSCO IPO ISA ISAs ISG IST JOA JSE KKR KYC LBO LCC LDCs LGD

First City Monument Bank Federal Capital Territory Foreign direct investment Federal Government of Nigeria Federal Inland Revenue Financial Information Services Division Frontier markets Federal Mortgage Bank of Nigeria Fast-moving consumer goods Financial Market Dealers Quotation Federal Ministry of Finance Foreign portfolio investment Financial Reporting Council of Nigeria Financial Services Co-ordinating Committee First Securities Discount House Limited Financial system strategy Foreign Currency Transaction Report Foreign exchange Global capital markets Gross domestic product Global depositary receipt General partner Guaranty Trust Bank PLC Herfindahl-Hirschman Index High net-worth individuals Investment banking International Bank for Reconstruction and Development Institute of Chartered Accountants of Nigeria Information and communication technology International Development Association International Monetary Fund International Organization of Securities Commissions Initial public offer Investments and Securities Act International Auditing Standards Intermarket Surveillance Group Investment and Securities Tribunal Joint operating agreement Johannesburg Stock Exchange Kravis Roberts Know your customer Leveraged buyout Lekki Concession Company Less developed countries Loss given default

Abbreviations xvii

LNG Liquified natural gas LSE London Stock Exchange M&A Mergers and acquisitions MBA Master of Business Administration Management buy-in MBI MBO Management buyout MDAs Ministries, departments and agencies MDD Market Development Department MFBs Microfinance banks MFIS Multi-fund investment structure MGI McKinsey Global Institute MIGA Multilateral investment guarantee agency MINT Mexico, Indonesia, Nigeria and Turkey MPS Multiple price system MRC Mortgage refinancing company MSCI Morgan Stanley Composite Index MTNs Medium-term notes MW Megawatt N.V Netherlands’ Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden NACRDB Nigerian Agricultural Co-operative and Rural Development Bank NAICOM National Insurance Commission Nigerian Acceptances Limited NAL NASD National Association of Securities Dealers NAV Net asset value NB Nigerian Breweries NBS National Bureau of Statistics NCCG National Code of Corporate Governance NCX Nigerian Commodity Exchange NDIC Nigerian Deposit Insurance Corporation NEFT Nigeria Electronic Funds Transfer NFIU Nigerian Financial Intelligence Unit NHF National Housing Fund NHTF National Housing Trust Fund NIDF Nigeria Infrastructure Debt Fund NIF Nigeria Infrastructure Fund NIIMP National Integrated Infrastructure Master Plan NIIP National Infrastructure Investment Plan NIPC Nigerian Investment Promotion Commission NIRP Nigerian Industrial Revolution Plan NITEL Nigerian Telecommunications Ltd NLNG Nigeria LNG Limited NMRC The Nigerian Mortgage Refinance Company NNPC Nigerian National Petroleum Corporation

xviii  Abbreviations

NPLs Non-performing loans NSE Nigerian Stock Exchange NSIA Nigeria Sovereign Investment Authority NSITF Nigeria Social Insurance Trust Fund NTBs Nigerian treasury bills NYSE New York Stock Exchange O&M Operations and Maintenance OECD Organisation for Economic Co-operation and Development OFIs Other financial institutions OMA Operation and maintenance agreement OTC Over the counter PAIDF Pan-African Infrastructure Development Fund PAYG Pay as you go PD Probability of default PDMMs Primary dealers market makers PE Private equity PEI Private Equity International PENCOM National Pension Commission PEP Politically exposed persons PFAs Pension fund administrators PFCs Pension fund custodians PIB Petroleum Industry Bill PLC Public limited company PMBs Primary mortgage banks PPP Public–private partnership PRA Pension Reform Act PURPA Public Utility Regulatory Policy Act PwC PricewaterhouseCoopers PWM Private wealth management REITs Real estate investment trusts RSA Retirement savings account RTGS Real-time gross settlement system S&P Standard & Poor’s SAHL Stanbic Africa Holdings Limited SEC Securities and Exchange Commission SFS SFS Financial services SPV Special purpose vehicle SRO Self-regulatory organization SSE Sustainable Stock Exchanges STR Suspicious Transaction Report SUF Scale-up facility TB Treasury bills TFP Total factors productivity TSE Tokyo Stock Exchange UB Universal banking

Abbreviations xix

UBA UH-REIT UNECA V&T VaR VAT VCML VFML VSL VTL WACB WACC WFE WHT WRS

United Bank for Africa, PLC Union Homes Real Estate Investment Trust United Nations Economic Commission for Africa Venture and trust Value at risk Value-added tax Vetiva Capital Management Limited Vetiva Fund Managers Limited Vetiva Securities LTD Vetiva Trustees Limited West African Currency Board Weighted average cost of capital World Federation of Exchange Withholding taxes Warehouse receipt system

Preface

This book is about the roles of capital markets and investment banking in frontier markets (FMs). There is a confluence of global, regional and domestic national trends that are creating opportunities and challenges for the growth of capital markets and investment banking in frontier economies. The book covers a leading FM that is featured in all existing FMs indices – Standard & Poor’s, Morgan Stanley Composite Index (MSCI), Russell Investments and Financial Times (FTSE). Nigeria is the largest world frontier market by population and gross domestic product (GDP) size. Nigeria is also Africa’s largest frontier economy. Global institutions such as Goldman Sachs, McKinsey Global Institute and PricewaterhouseCoopers (PwC) have projected that Nigeria would be among the top 15 to 20 countries in the world by 2050. This book undertakes a comprehensive study of investment banking practices in a frontier market. This book comprises of 16 chapters divided into six parts. Part I on FM environment provides a synopsis of FM economic attractiveness, financial system and capital markets’ intermediation. Part II analyses the major investment banks in Nigeria, the regulatory framework and risk management. Part III explores raising capital through equity underwriting, debt underwriting and private equity (PE) in an FM. Part IV discusses putting capital to work on mergers and acquisitions (M&A), project and infrastructure finance and real estate finance in an FM. Part V on managing capital focuses on asset management, pension industry and securities brokerage business in FMs. The final part is on future trends and prospects for the largest frontier economy and market in the world. The book offers a systematic framework that combines conceptual principles and real-life practice drawn from an FM on topics treated within the chapters. The book combines rigorous academic analysis with practical insights of capital markets and investment banking business. Each chapter starts with the underlying basic principles for the theme of the chapter and then briefly outlines the global context for the theme before discussing in detail the actual workings in an FM. The book utilizes detailed case studies from Nigeria to illustrate the operations of investment banking in FMs. The cases, tables and charts serve as useful illustrations of the topics.

Preface xxi

The book will be useful as a professional reference, a monograph for research and an academic text in a wide range of economics and finance courses as well as for professional certifications in accountancy, banking and securities analysis. The book is intended for a wide audience including academic community comprising students, teachers and researchers; professionals on the buy and sell sides in the financial industry; retail and institutional investors interested in FMs; development practitioners in international organizations; and policymakers including securities and capital market regulators.

Acknowledgements

The book has benefited from valuable insights and comments on various chapters by a number of professional experts and practitioners in their respective fields, including those who provided assistance in obtaining relevant information. We would like to thank the following: • Dr. Adedapo Adenekan, Assistant Director, Central Bank of Nigeria • Olufemi Akinsanya, Chief Executive Officer, Felicity Schemes • Dr. Adesegun Akin-Olugbade, Executive Director and General Counsel, Africa Finance Corporation • Deji Alli, Chairman and Chief Executive Officer, Mixta Africa SA • Tajudeen Ahmed, General Manager, Corporate Strategy, BUA PLC • Abimbola Babalola, Head, Market Surveillance and Investigation, Nigerian Stock Exchange • Kola Ashiru-Balogun, Managing Director, Mixta Nigeria Limited • Ebi Birisibe, General Manager,Variant Advisory • Funmi Ekundayo, Managing Director/CEO, STL Trustees Limited • Prof. Chidozie Emenuga, Manager, African Development Bank • Wilson Erumebor, Senior Economist, Nigerian Economic Summit Group • Babajide Fadahunsi, Head, Corporate Finance, SFS Financial Services Limited • Michael Famoroti, Chief Economist,Vetiva Capital Management Limited • Yemi Gbenro, Managing Director, SFS Financial services • Mamadou M’Baye, Principal Officer, Private Equity, African Development Bank • Stefan Nalletamby, Director, Financial Sector Department, African Development Bank • Adewale Odutola, Managing Director, ARM Pensions Limited • Layi Olaleru, Managing Director, Ecobank (EDC) Securities Limited • Dr. Afolabi Olowookere, Head, Economic Research and Policy Management, Office of the Chief Economist, Securities and Exchange Commission (SEC, Nigeria) • Rotimi Olugbohungbe, Managing Director, Counter House Consultants • Kemi Oluwashina, Executive Director, Premium Pensions Limited

Acknowledgements xxiii

• Patrick Ilodianya, Managing Director, SFS Capital Limited • Mike Omaliko, Associate, Corporate Finance, SFS Financial Services Limited • Muyiwa Oni, Regional Head, Equities Research, West Africa, Stanbic IBTC PLC • Kunle Osilaja, Group Head, Investment Banking, Ecobank Transnational Incorporated. • Oscar Onyema, Chief Executive Officer, Nigerian Stock Exchange • Ike Onyia, Managing Director, FBNQuest Asset Management Limited • Rotimi Oyekanimi, Partner, Apis Partners (Private Equity Firm) • Temitayo Shogbola, Chief Risk Officer, ARM Holdings Company Limited • Eva Umebese, Portfolio Manager,Vetiva Capital Management Limited • Ini Uruah, Director, Africa Finance Corporation Iyabo Assim-Ita ofVariant Advisory provided secretarial assistance, as well as Temitope Babalola.We thank Olatunji Oshikoya,Wale Tijani and Bashir Adeshina for their encouragement. We also thank the Editorial Team at Routledge led by Kristina Abbotts (Editor) and Christiana Mandizha (Editorial Assistant). Temitope W. Oshikoya, PhD  Kehinde Durosimi-Etti

Part I

Frontier markets’ environment

1 Nigeria A frontier market economy

Introduction Frontier economies are developing countries that are more advanced than the less developed countries (LDCs). However, such economies are considered less advanced than emerging economies – China, Brazil, India and Russia. Emerging economies were among the fastest-growing markets in the 1990s and 2000s. Frontier economies is a group of fast-growing lower-middle-income countries that are attracting international investors interest. The International Monetary Fund ( IMF) and the World Bank (2015) classify 14 frontier market (FMs) – countries which receive assistance from these international financial institutions, as those that resemble emerging market economies with regard to international market access. These countries are Bangladesh, Bolivia, Cote d’Ivoire, Ghana, Kenya, Mongolia, Mozambique, Nigeria, Papua New Guinea, Senegal, Tanzania, Uganda,Vietnam and Zambia. Frontier economies are diverse and widespread across regions of the globe. Based on FM indices of Financial Times (FTSE; 2018) and Morgan Stanley Composite Index (MSCI; 2018a and 2018b), they include Bangladesh, Siri Lanka and Vietnam in Asia; Bulgaria, Estonia and Croatia in Eastern Europe; Kenya; Nigeria, Ghana and Cote D’Ivoire in Africa; Argentina and Bolivia in Latin America; and Kuwait and Qatar in the Middle East. Table 1.1 shows the diversity of frontier economies by comparing key economic and market indicators of the largest frontier economies to those of emerging market economies. Among the selected frontier economies, Nigeria has the largest population but the second-largest economy with a market capitalization to GDP ratio of only 7.4 percent. Argentina has the largest economy, while Kuwait has a per capita income of more than $35,000 compared to Bangladesh with only $1,030 of per capita income. Vietnam has the highest market capitalization among frontier economies, which stands at $117 billion coupled with the best ranking in terms of ease of doing business (EODB). Among the emerging market countries, China has the largest with regard to the following parameters of population, economy and market capitalization followed by India. However, South Africa has the largest market capitalization to GDP ratio at more than 320 percent, which dwarfs that of Nigeria at less than

4  Frontier markets’ environment Table 1.1 Features of frontier economies Population (millions) Frontier Nigeria Argentina Vietnam Bangladesh Kuwait

GDP ($ billion)

GDP/ capita ($)

Market capitalization ($ billion)

Market cap/ GDP (%)

Ease of doing business rank

198 44 93 162 4

476 546 117 221 114

2,458 10,148 1,770 1,030 35,490

37 109 116 86 115

7 12 105 37 105

145 117 68 177 96

Emerging China India Russia Brazil South Africa

1,390 1,284 147 208 56

11,199 2,264 1,283 1,796 295

4,401 1,862 11,099 10,826 7,504

8,711 2,331 623 955 1,230

65 70 49 42 323

78 100 35 125 82

Developed US Japan UK Germany

326 128 66 83

18,624 4,872 2,622 3,677

52,195 38,062 39,727 44,301

32,120 6,223 – 2,262

147 16.4 – 5.1

6 34 7 20

Source: World Bank Database (2017).

10 percent. Overall, the table shows that the US economy, per capita income and market capitalization are well ahead of those of emerging markets, which, in turn, are also more advanced than the frontier economies. Frontier economies are growing at a faster pace than some emerging economies. They have been implementing sustained reforms efforts that include deepening their financial markets, building business-friendly environment, lowering trade restrictions to achieve macroeconomic stability and lowering inflation through prudent fiscal and monetary policy. Frontier economies have been able to tap the international capital markets, especially raising capital from the Eurobond markets, while attracting investors to their sovereign and corporate bonds (IMF, 2017). As a region, Africa meets the criteria of an FM as most countries in the continent have low per capita income and small and illiquid financial markets. Nigeria is the largest world FM by population. Nigeria is also Africa’s most populous country with a population of 200 million people in 2018. The recent projection by the United Nations states that Nigeria will more than double its population to about 450 million by 2050 (United Nations, 2015), behind only China and India. Nigeria is also Africa’s largest frontier economy and a member of what Oshikoya (2011) termed as the SANE – South Africa,Algeria, Nigeria and Egypt.These

Nigeria 5

particular countries account for more than half of Africa’s GDP, while the remaining 51 countries constitute slightly less than half of the GDP of the continent. Nigeria’s economy is projected by PwC (2016) to be among the top 15 largest global economies by 2050. Goldman Sachs (2005) projected that Nigeria is one of the identified Next 11 (N11) countries with the potential to be like the BRIC – Brazil, Russia, India and China. O’Neil, 2014), who coined the BRIC acronym, came up with MINT – Mexico, Indonesia, Nigeria and Turkey – which is used to referred to as the next key emerging economies. Criteria for FMs

In 1992, the International Finance Corporation (IFC), an affiliate of the World Bank, first came up with the term frontier markets to describe “emerging markets.” The IFC sold its Emerging Markets Database in 2000 to Standard & Poor’s (S&P, 2018), which created a Frontier Market Index in 2007. There are now three FM indices: Standard & Poor’s, Morgan Stanley Composite Index (MSCI) and Russell Investments and Financial Times (FTSE), with a varying number of countries from Africa, Asia, Eastern Europe, Latin America and the Middle East. The indices move countries from frontier and emerging markets indices and vice versa; a case study is Argentina. The MSCI Frontier Markets Index captures large and mid-cap representation across 29 FM countries. The index includes 109 constituents, covering about 85 percent of the free float–adjusted market capitalization in each country. MSCI Frontier Markets’ largest countries as of March 2018 are Argentina (19 percent), Kuwait (17.7 percent),Vietnam (14.7 percent), Morocco (8.2 percent) and Nigeria (7.8 percent). The other countries, such countries are Bahrain, Bangladesh, Burkina Faso, Benin, Croatia, Estonia, Guinea-Bissau, Ivory Coast, Jordan, Kenya, Lebanon, Lithuania, Kazakhstan, Mauritius, Mali, Niger, Oman, Romania, Serbia, Senegal, Slovenia, Sri Lanka, Togo and Tunisia, make up 32 percent of the indices. FTSE (2018) classification criteria include the depth and breadth of financial markets, legal and regulatory infrastructure and general ease with which foreign investors can do business. FTSE classifies a country as a frontier market based on specific factors, including a formal stock market regulatory authority, no significant restrictions on repatriation of capital, good clearing and settlement practices and a timely trade reporting process. Based on these criteria, FTSE categorizes 22 countries in its FM index: Out of 102 countries that do have the potential to be termed an FM, Nigeria made the list of 22 countries that are referred by the FTSE (2018) as an FM. Bloomberg (2018) used a variety of criteria, from government debt to labour force participation ratios, GDP growth, average annual inflation, and government debt-to-GDP ratio projections from 2013 to 2017, as well as a ranking of how easy it is to conduct business in the nation, to rank 25 FM countries.These 25 countries are dominated by Asian and African nations, including Nigeria, though a few European and South American countries are also represented.

6  Frontier markets’ environment

Nigeria’s opportunities and challenges Nigeria has challenges of consolidating its nascent democracy, the inherent over-dependency on hydrocarbon commodity and overcoming institutional government issues. In spite of these challenges, Nigeria as an FM still has attractive economic fundamentals, a large and young population, a rising middle class, rapid urbanization and abundant natural resources. Such dynamics bode well for accelerating financial intermediation by banks, including investment banks. Nascent democracy and institutional challenges

Nigeria’s democracy, which saw the transfer of power from the military to civilian administration in 1999, is still nascent. The transition of political power from one civilian administration to another, thereby transferring power to the opposition for the first time in 2015.With elections in 2018 and 2019, the sociopolitical environment has heated up. Political factors sometimes do impede structural reform processes as evidenced by the delay of the Petroleum Industry Bill (PIB), which was designed to improve the efficiency and transparency of the hydrocarbon industry. Nigeria ranks low on several global indicators relating to governance, institutional effectiveness, transparency and corruption. Natural resources and oil dependency

Like many frontier markets, Nigeria has an abundant wealth of natural resources, including oil, natural gas, petroleum, tin, iron ore, coal, limestone, niobium, lead, zinc and arable land. It is one of Africa’s major oil producer and exporter, with oil exports contributing to more than 85% of total exports and more than two-thirds of government revenue. Nigeria is the eighth-largest oil exporter, accounting for about 4 percent of the world’s total. It is a key exporter of liquefied natural gas (LNG). Over the last 15 years, Nigeria has exported $85 billion worth of LNG. Agriculture, fishing and forestry contribute significantly to the country’s GDP, making up more than 20 percent of GDP (NBS, 2018b). Although the oil sector contributes only 10 percent to GDP, Nigeria still remains overly dependent on the oil sector for revenue and foreign exchange (FX) earnings. The oil sector solely accounts for more than two-thirds of total revenue and over 90 percent of exports earnings. The impacts of lower oil production and exports combined with terms of trade shocks emanating from the decline in oil prices: Ended up reverberating on almost all various sectors of the economy, fiscal and external balances, financial system, and the capital markets. The sharp decline in oil prices between 2014 and 2016 led to an economic recession as output contracted for the first time in over two decades in 2016. GDP growth, which had averaged 5 percent over the period from 2010 to 2015, declined to −1.6 percent in 2016. FX reserves fell by more than half, while fiscal balances increased sharply. Following five quarters of economic recession, the GDP grew by 0.8 percent in 2017 and is expected to be at 2.1 percent in 2018 as oil prices recovered to a

Nigeria 7 Table 1.2 Nigeria: selected economic indicators Indicators

2013

2014

2015

2016

2017

GDP Growth Rate (%) Oil Share of GDP Non-Oil Share of GDP Inflation Rate Non-Oil Fiscal Deficit/GDP Interest Payment /Revenue Current Account/GDP Foreign Reserves ($ billions) Oil Prices $/Barrel Exchange Rate to $ Unemployment Rate

5.4 13.0 87.0 7.9 −11.6 23.7 4.4 42.9 110.0 159.0 10

6.3 9.0 91.0 8.1 −8.2 27.1 0.2 34.2 100.0 180.0 6.4

2.7 8.1 91.9 8.6 −6.3 33.2 −3.1 28.3 53.1 197.0 10.4

−1.6 8.3 91.7 18.6 −5.8 61.7 0.6 27.0 44.6 305.0 14.2

0.8 7.2 92.8 15.4 – 71.9 2.0 39.2 54.4 350.0 18.8

H1 2018 2.1 9.1 90.9 11.7 59.7 0.1 39.2 67.8 350.0 –

Source: IMF (2018) and NBS (2018b).

120.0

18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0%

100.0 80.0 60.0 40.0 20.0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Q1 2018Q2

0.0

Real GDP Growth (%)

Crude Oil Price (US$ per barrel)

Figure 1.1 Crude oil price and Nigeria’s real GDP growth, 1991–2018 Q2 Source: IMF (2018) and NBS (2018b).

recent high $80 in July 2018, while the IMF projects GDP growth will average 1.9 percent on its current policy stance. However, in the medium term, GDP growth is expected to accelerate to 4.5 percent between 2019 and 2023, with policy adjustment and supportive oil price outlook. Demographics

The fall in GDP growth rate also implies the growing necessity to improve per capita income and reduce unemployment rates and inequality and poverty indicators.The unemployment rate has risen steadily to reach nearly 20 percent in 2017, while the poverty rate estimated at 65 percent and its Gini coefficient, a measure of inequality, is at 0.4.

8  Frontier markets’ environment

Nigeria’s growing population of nearly 200 million is projected to be the third-largest country by population at 440 million in 2050 behind China and India. Nigeria has a median age of 18, with 75 percent of its population under 35 years. Nigeria is witnessing rapid urbanization, with 11 cities of more than 1 million people and a growing middle class. The middle-class household is expected to grow from 4.1 million to 11.7 million by 2030. It is estimated that more than 34 million households, with about 160 million people, are likely to be earning more than $7,500 annually, with a potential rise in consumption from $388 billion annually to $1.4 trillion by 2030 (Collier and Leke, 2014). This demographic advantage means that Nigeria as an FM has favourable long-term growth prospects, but it also implies putting in place policy measures in order to address growing inequality and poverty. Capital formation: savings and investments

Nigeria’s economic fundamentals will be boosted by closing the savings–investment gap (Table 1.3). Most economies that have achieved sustained rapid economic growth and development tend to have relatively high savings and investment rates. In Nigeria, savings and investment rates have been relatively low in the past few decades. Gross national savings as a percentage of GDP averaged 14 percent, with the private sector contributing more than 95 percent of total savings while publicsector savings have been low and outright negative in some years. Nigeria’s investment-to-GDP rates have averaged about 15 percent, with private-sector investment rate contributing 90 percent (IMF, 2018). Nigeria’s savings and investment rates are low even by African standards. For example, between 2010 and 2015, the investment rate in Tanzania averaged about 30 percent, doubling those in Nigeria. Ethiopia, the fastest-growing economy in Africa in the past 10 years, has investment rates of about 40 percent (IMF, 2017a, 2017b). Table 1.3 Domestic savings and capital formation as % of GDP Investment and savings

2015

2016

2017

2018

2019

2020

2021

2022

Gross national savings Public Private Investment Public Private Current account balance

12.3 −0.3 12.6 15.4 1.8 13.7 −3.1

13.1 −1.3 14.5 12.5 1.6 10.9 0.6

13.5 −0.8 14.3 12.5 2.7 9.8 1.0

13.8 −0.2 14 12.8 2.3 10.5 1.0

14.2 0.3 13.9 13.5 2.2 11.2 0.7

14.7 0.4 14.4 14.1 2.1 12 0.6

15 0.8 14.2 14.5 2.2 12.3 0.5

15.5 0.8 14.6 15.2 2.3 12.8 0.4

Source: IMF (2018).

Capital flows

Capital flows to Nigeria comprises foreign direct investment (FDI), foreign portfolio investment (FPI) and other investments. Between 2010 and 2014,

Nigeria 9

Nigeria ranked first in the top 10 destinations by net FDI flows in Africa (Table 1.4). However, given the relative size of its population and economy, FDI to Nigeria is not as competitive compared to countries such as Ghana, with a population and economy a fifth of that of Nigeria. Capital flows into Nigeria surged between 2010 and 2014 at $6.0 billion when it averaged 4 percent of GDP and the country ranked first in FDI destination in Africa (Table 1.4). FDI reached a peak of $3.9 billion in the first quarter of 2014. However, FDI declined sharply in the subsequent period to reach $0.7 billion in the first quarter of 2016. Overall, FDI fell by 46 percent Table 1.4 Top 10 destinations by net FDI flows in Africa Ranking

1 2 3 4 5 6 7 8 9

Country

Nigeria Mozambique South Africa Egypt Ghana Morocco Congo, Republic Sudan Equatorial Guinea Tanzania

10

2010–2014

2017

(US$ millions)

(US$ millions)

Percentage of GDP

6,026 5,000 4,626 4,192 3,247 2,842 2,180 2,064 1,975

3,497 2,319 1,372 7,329 3,255 2,645

0.9 18.8 0.4 3.1 6.9 2.4

1,065

0.9

1,813

1,180

2.3

Source: World Bank (2019).

25,000 20,000 15,000 10,000 5,000 2011

2012 FDI

2013

2014

Porolio Investment

2015 Other Investment

Figure 1.2 Nigeria: capital inflows (US$ millions), 2011–2017 Source: NBS (2018a).

2016

2017

10  Frontier markets’ environment

from $9.64 billion in 2015 to $5.12 billion in 2016 and $3.45 billion or less than 1 percent of GDP in 2017. In contrast, FDI net flows in 2017 to Egypt was at 3.1 percent of GDP, Ghana (7 percent) and Mozambique (19 percent). FDI net inflows to Nigeria in 2017 was 20 times less than that of Brazil, with net inflows of $70.6 billion or 3.4 percent of GDP, four times less than that of Vietnam at $14 billion or 6.3 percent of GDP. Portfolio investments fell by 70 percent between 2014 and 2016 (NBS, 2017). From the second quarter of 2017, capital importation started picking up and increased by nearly 600 percent to $6.3 billion in the first quarter of 2018, with portfolio investment accounting for 72 percent of the increase. Capital inflows have been driven largely by developments in oil prices, interest rate differentials, exchange rate expectations and the degree of risk aversion by foreign investors. Nigeria is the largest recipient of remittances in Africa and the sixth largest globally, with an estimated US$22 billion in remittances from abroad in 2017 (World Bank, 2018a). On per capita basis, remittances to Nigeria at about US$120 is one of the highest in sub-Saharan Africa, which is five times that of South Africa and Kenya. Since 2011, the federal government of Nigeria (FGN) had issued Eurobonds six times. The most recent issuance was in November 2018, when the first triple-tranche issuance of $2.86 billion was oversubscribed by more than three times. The offering is made up of a $1.18 billion (7 years, priced at 7.625 percent), $1 billion (12 years, 8.75 percent) and $750 million (30 years, 9.25 percent), respectively. The Eurobond issuance is aimed at saving on domestic debt servicing. There remains, however, an FX risk. Infrastructure

The challenge of low savings and investment rate in meeting Nigeria’s development challenges is further illustrated by the requirements of the National Infrastructure Investment Plan (NIIP). Infrastructure investment is crucial to development. The value of Nigeria’s total infrastructure stock (road, rail, power, airport, water, telecoms and seaports) represents only 35 percent of GDP, half of what is obtainable in emerging markets countries (Figure 1.3). Nigeria needs to invest US$3 trillion in infrastructure over the next 30 years and need to leverage private capital for infrastructural development (NIIMP, 2015). According to the IMF, implementing the NIIMP alone will an require investment of ₦5 to 8.4 trillion ($30–50 billion) a year. This also implies an increase in investment from 15 percent to 17 percent of GDP. Assuming savings rates do not change, this implies a substantial financing gap. Business environment

Nigeria ranks 146th out of 190 countries in the most recent 2019 EODB Report of the World Bank, one notch down compared to the previous year.The ranking places Nigeria in the bottom quintile of 190 countries. In comparison

Nigeria 11 100 90 80 70 60 50 40 30 20 10 0

70

87

80

76

58 47 30

Nigeria

Brazil

India

Indonesia China

Finland

South Africa

Figure 1.3 Infrastructure stock as a share of GDP (%) Source: NIIMP (2015).

Rank 170

169

169

Score

147

46.4

2013

146

145

131

2014

47.8

46.3

2015

2016

47.9

2017

51.5

2018

52.9

2019

Figure 1.4 Ease of Doing Business in Nigeria Source: World Bank (2018b), Ease of Doing Business Report 2019.

to other frontier and emerging economies, Nigeria ranks 36th out of 48 lowmiddle income countries and 22nd out of 48 sub-Saharan African countries (Figure 1.4 and Table 1.5). A major challenge for businesses is the issue of electricity, which adversely affects their operating environment in Nigeria. Some notable improvements were, however, made in three key areas of starting a business, trading across borders and enforcing contracts. In Lagos, the business capital of the country, contracts enforcement was reinforced by new

12  Frontier markets’ environment Table 1.5 EODB ranking: Nigeria versus selected countries Selected EODB indicators

Nigeria Kenya South Africa Ethiopia Brazil Indonesia

Overall EODB

Starting a business

Getting electricity

Getting credit

Paying taxes

146th  61st  82nd 159th 109th  73rd

120th 126th 134th 167th 140th 134th

171st  75th 109th 131st  40th  33rd

 12th   8th  73rd 175th  99th  44th

157th  91st  46th 130th 184th 112th

Source: World Bank (2018b) Ease of Doing Business Report 2019.

rules of civil procedure for small claims courts, which limit adjournments to unforeseen and exceptional circumstances. A Presidential Enabling Business Environment Council has been established to work with businesses and other stakeholders to improve the business environment for private-sector investors. Productivity

Economic theory (Solow, 1956; Swan, 1956) and history have shown that long-term prosperity is driven mainly by the growth of the labour force and the growth of labour force productivity. Long-term output is determined by the size and quality of labour force, the stock of productive capital workers have at their disposal and total factors productivity (TFP), that is the efficiency with which that labour and capital produce goods and services. The size of the labour force is, in turn, determined by demography, while the stock of capital is driven by investment, and productivity is determined by incentives and innovation over time. Table 1.6 shows the productivity growth and level in selected countries across frontier and emerging markets. Productivity measures by GDP per person employed have been quite low in Nigeria at 14 percent of the level in the US. On average, the BRIC emerging markets had productivity levels that were a quarter of the level in the US, with Russia and Turkey having productivity levels that were at 46 percent and 61 percent, respectively, of the level in the US in 2017. Of main concern is the fact that productivity growth rates, which averaged six percent between 200 and 2007 declined sharply to 3.4 percent between 2008 and 2015. Productivity growth rates entered negative territory between 2015 and 2017, with a marked negative growth rate of 6.7 percent in 2016. Most frontier and emerging market economies have had positive productivity growth rates during the same period, with countries such as China, Vietnam, India and Indonesia recording strong growth rates in productivity.

Nigeria 13 Table 1.6 Productivity growth and level in selected countries Annual average growth 2008–2015

2015

2016–2017

GDP per person employed (% of US)

Frontier Markets Nigeria 5.9 Argentina 1.0 Vietnam 5.0 Bangladesh 4.0 Kuwait 0.5

3.4 0.4 3.9 3.7 −2.7

−2.7 1.0 6.9 5.0 −3.0

−6.7, –2.0 −1.7, 2.0 5.4, 6.1 5.3, 5.1 0.8, –3.1

14% 37% 10% 9% 116%

Emerging Markets Brazil 0.9 China 10.1 India 5.3 Russia 6.4 South Africa 2.9

0.8 8.8 5.7 1.0 0.1

−4.0 7.2 5.8 −3.9 −2.5

−1.8, 1.0 7.0, 7.3 6.1, 4.8 −0.3, 1.5 0.0, –1.1

25% 25% 14% 46% 35%

−0.2 3.9 1.4

0.2 4.5 3.2

0.3, 0.8 3.1, 3.1 1.0, 2.8

37% 22% 61%

2000–2007

MINT Mexico Indonesia Turkey

0.9 3.5 4.8

Source: The Conference Board (2018).

Nigeria’s Vision 2020

Nigeria adopted a long-term approach to development planning and set itself the goal of becoming one of the 20 largest economies of the world by 2020. Vision 20:2020 (NV: 20:2020) is the country’s first long-term strategic plan for the Nigerian economy. NV20:2020 encapsulates the key principles and thrusts of both National Economic Empowerment and Development Strategy (NEEDs) and the Seven Point Agenda of the democratic administration of 2007 to 2011, situating them within a single, long-term strategic planning perspective. Formulated in 2009, the overall target is to place Nigeria in the bracket of the 20 largest economies in the world by 2020, with the utmost goal of achieving a GDP of $900 billion. Vision and themes

The plan aims to achieve a minimum annual per capita income of $4,000 by 2020. The vision is based on three pillars: guaranteeing the productivity and well-being of the people, optimizing the key sources of economic growth and fostering sustainable social and economic development. Key macroeconomic areas of the Vision 2020 include achieving double-digit economic growth rate, single-digit inflation rates and a stable exchange rate and attaining investmentfriendly interest rates.

14  Frontier markets’ environment Critical policy priorities

To ensure robustness and swift implementation, the plan was divided into the following thematic areas: physical infrastructure, productive sector, human capital and social development and developing a knowledge-based economy. The goal of Vision 2020 was decomposed into sectoral targets which led to the formation of the Transformation Agenda (2011–2015), driven by the ministries, departments and agencies (MDAs). For instance, the Ministry of Agriculture developed the Agricultural Transformation Agenda (ATA) while the Ministry of Industry, Trade and Investment produced Nigeria’s first-ever stand-alone industrial plan themed the Nigerian Industrial Revolution Plan (NIRP). The Nigerian economic recovery and growth plan

The Nigerian Economic Recovery and Growth Plan (ERGP) was published in January 2017. It was driven by the need for the Nigerian government to respond to the tough economic situation experienced in 2015 and 2016, following the decline in crude oil price and output, which created huge uncertainties in the macroeconomic environment. The tough macro environment resulted in a negative GDP growth through 2016, an FX crisis and rising inflation. The plan therefore has the broad goals to restore economic growth while leveraging the ingenuity and resilience of the Nigerian people – the nation’s most priceless assets (ERGP, 2017). The vision of the ERGP is to sustain inclusive growth. The plan aims to increase national productivity and ensure diversification of production to attain economic growth and welfare for the Nigerian citizens, with an emphasis on food and energy security.The execution priorities of the ERGP include stabilizing the macroeconomic environment, achieving agriculture and food security, ensuring energy sufficiency (power and petroleum products), improving transportation infrastructure and driving industrialization by focusing on small and mediumscale enterprises.The ERGP will be funded via provisions from the annual budgets. However, the cost required to implement the ERGP is not available. The EGRP was based on several principles highlighted as follows: Focus on tackling constraints to growth. The plan focuses on addressing several constraints to economic growth in Nigeria, such as supply challenges associated with fuel, power, FX, adequate skills and appropriate technology, as well as unfriendly business regulations. Leverage the power of the private sector.The plan aims to leverage the private sector to achieve its broad goal of restoring economic growth and improving welfare. Promote national cohesion and social inclusion. The plan will strengthen social inclusion and ensure economic growth is inclusive and all-encompassing. Allow markets to function. The ERGP allows for the use of market instruments to allocate resources while strengthening the regulatory oversight of government.

Nigeria 15

Uphold core values.The ERGP will upload the core values of discipline, integrity, dignity of labour, social justice, religious tolerance, self-reliance and patriotism in line with the Nigerian Constitution of 1999. Institutional coordination and implementation

The development plans of the 1970s were undertaken during the era of superpermanent secretaries that wielded significant power under successive military regimes.The planning approach for achieving the NV20:2020 involves aligning government activities in line with the goals of the Vision. The process is based on the following guidelines: The National Planning Commission, working with other government agencies, will oversee the preparation of subplans that is three medium-term national development plans, to drive the implementation of the Vision. The medium-term development plans will detail specific goals, strategies and performance targets for all sectors of the economy, in line with the economic transformation strategy of the Vision. The Medium-Term Expenditure Framework (MTEF) will be used as a tool for linking policy, planning and budgeting across all levels of government during this period, in line with the Fiscal Responsibility Act. A national monitoring and evaluation system will be developed to measure progress in the implementation of the Vision, which will be adopted by all levels of government. The process of developing the ERGP was spearheaded by the National Planning Commission. The Nigerian president is the chairman of the National Planning Commission. The private sector was consulted during the process of development. The implementation of the ERGP will be supervised by the Ministry of Budget and National Planning. Furthermore, the federal government aims to establish a Special Delivery Unit in the presidency, which will focus on the major execution priorities and will closely monitor the implementation of the critical initiatives, evaluating the progress against targets and milestones. Future prospects

McKinsey Global Institute (MGI) estimates that, from 2013 to 2030, Nigeria could expand its economy to reach $1.6 trillion – moving it into the global top 20 (Collier and Leke, 2014). PwC (2016) observes that Nigeria would rise 8 places to rank as number 15 among the projected top 30 economies in the world by 2050. The five ingredients for development are essentially institutions, incentive, inclusiveness, innovation and investment.

16  Frontier markets’ environment Institutions

In Why Nations Fail, Acemoglu and Robinson (2013) provide economic perspectives and historical evidence of the critical roles of institutions in creating virtuous circles of innovation, economic growth and shared prosperity. For Nigeria institutional governance remains a key to unlocking the country’s potentials. Effective institutions serve the objectives of good governance, which ensures peace, stability, security of life and properties, which also includes ensuring citizens’ engagement and participation for the realization of the country’s vision and development. An accountable state will ensure a sound public-sector management by strengthening public-sector institutions, transparency, accountability and adherence to the rule of law, which is needed at all levels of government administration in order to realize the strategic vision of the country. Efforts are being made to ensure adherence to the rule of law and combatting corruption with enforcement through improved information systems, which entails supplying quality and timely information to respective government bodies. A capable and efficient public sector that can function effectively is required in key areas of policy formulation and execution, regulatory enforcement, managing natural resources rents, quality service delivery, especially in the social sectors, providing an enabling environment for markets to operate efficiently and strengthening the competitiveness of the country. Incentives

Incentives for productivity is essential for sustainable economic growth. Productivity depends on both incentive structure and innovation. Macroeconomic policies, especially fiscal policies, have an impact on long-term potential output by affecting people’s incentives to work and save and firms’ incentives to invest and by changing productivity. A stable macroeconomic environment characterized by avoiding overvalued exchange rates and high inflation rates is essential for overall economic prosperity, conducive business environment, investment planning and resource utilization. Innovation

In addition to incentives, innovation driven by new technological trends plays a key role in boosting the productivity of the labour force. The rapid scope and scale of technological innovations in information and communication technology (ICT) are changing business models. Nigeria has witnessed the benefits of faster penetration of the internet and mobile phones, with their adaptation to e-banking and e-commerce. There should be incentives for privatesector involvement on long-term investments in research and development, on upgrading the technical skill sets of the next generation and on enhancing the nexus between public research institutions and private industries.

Nigeria 17 Inclusiveness

Improvements in quality of education, healthcare, the involvement of women and other vulnerable groups will be crucial for an efficient and productive workforce. Nigeria’s growth has not been inclusive enough with widespread poverty, inequality and vulnerability of the disadvantaged groups, especially women and children. A recent study by the World Bank observes that Nigeria has become the poverty capital of the world, with 88 million of its 200 million people living in poverty. There is the need for the country’s development plan to emphasize improving the quality of the labour force by building human capacity and creating greater access to economic opportunities, reduce poverty, and foster empowerment. Investment

To achieve the country’s goals of accelerating growth and expansion of the industrial sector, strategic initiatives will include promoting domestic and foreign investment; boosting value-adding industrial production and export, and inter-industry collaboration; and advancing the application of technological advancements in the industry. Attracting both domestic and foreign private investment through the facilitation of public–private participation (PPP) will remain essential in addition to financial support from bilateral and development financing sources. Policies should be geared towards strengthening public– private partnerships in infrastructure financing and managing infrastructure projects.

Bibliography Acemoglu, D. and J. Robinson. (2010), Why Nations Fail: The Origins of Power, Prosperity and Poverty. New York: Crown Publishers, a Division of Random House Bloomberg. (2018), Markets Magazine, March Edition Central Bank of Nigeria. (2017), Financial Stability Report, June Collier, P. and A. Leke. (2014), Why Nigeria’s Future Is Brighter Than You Think. www. weforum.org/agenda/2014/07/nigeria-boko-haram-economic-prospects/ The Conference Board. (2018), Total Economy Database United Nations (2015), World Population Prospects: The 2015 Revision. www.un.org/en/development/desa/news/ population/2015-report.html Federal Government of Nigeria. (2017), Economic Recovery and Growth Plan (ERGP) Federal Government of Nigeria. (2012), Nigeria Vision 2020. www.nv2020.org FTSE. (2018), FTSE Classification of Markets 2018 Interim [Accessed October 2018] FTSE Russell. (2014), Frontier Markets: Accelerating the Next Frontier [Accessed October 2018] Goldman Sachs. (2005), The Next 11 Emerging Economies IMF. (2017a) Ethiopia 2016 Article IV Consultation. IMF Country Report,Washington, DC IMF. (2017b) Tanzania 2016 Article IV Consultation. IMF Country Report,Washington, DC IMF. (2018), Nigeria: 2017 Article IV Consultation. IMF Country Report, Washington, DC

18  Frontier markets’ environment Investopedia. (2018), What Are Frontier Markets? www.investopedia.com/articles/investing/100213/what-are-frontier-markets.asp#ixzz5I8KBYYSy [Accessed April 2018] MSCI. (2018a), MSCI Emerging Markets Index. www.msci.com/emerging-markets [Accessed October 2018] MSCI. (2018b), MSCI Frontier Markets Index. www.msci.com/documents/10199/ f9354b32-04ac-4c7e-b76e-460848afe026 [Accessed October 2018] National Bureau of Statistics (NBS). (2017), Nigerian Capital Importation Inflow for Q1 2017 National Bureau of Statistics (NBS). (2018a), Nigerian Capital Importation Inflow for Q1 2018 National Bureau of Statistics (NBS). (2018b), Nigeria’s Gross Domestic Product Statistics for H2 2018 NIIMP. (2015), Nigeria’s Current Infrastructure Stock and Investment Levels O’Neil, J. (2014), The MINT – Next Economic Giants Oshikoya, T.W. (2011), Rethinking Regional Economic Integration in Africa, Nigerian Journal of Economics and Social Sciences, 52(2) PwC. (2016), The World in 2050. www.pwc.com/gx/en/issues/economy/the-worldin-2050.html [Accessed July 2018] Solow, R.M. (1956), A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, 70(1): 65–94 Solow, R.M. (1957), Technical Change and the Aggregate Production Function, Review of Economics and Statistics, 39(3): 312–320 S&P. (2018), S&P Frontier Indices. https://us.spindices.com/documents/methodologies/ methodology-sp-frontier.pdf [Accessed April 2018] Swan, T.W. (1956), Economic Growth and Capital Accumulation, Economic Record, 32(2): 334–361 United Nations (2015), World Population Prospects: The 2015 Revision. http://www. un.org/en/development/desa/news/population/2015-report.html [Accessed July 2018]. World Bank. (2018a), Annual Remittances Data. www.worldbank.org/en/topic/labormarkets/brief/migration-and-remittances [Accessed April 2018] World Bank. (2018b), Doing Business Report World Bank (2019), Database World Bank and IMF. (2015), Public Debt Vulnerabilities in Low-Income Countries. The Evolving Landscape. World Bank and International Monetary Fund, December

2 Frontier market financial system

Principles Two of the key factors in the growth process of all economies around the world are the availability of human and financial capital and the efficiency in the use of these resources. The availability and efficiency of resources are important for output, income, employment and consumption growth. Without diminishing the roles of other factors, this chapter focuses on the roles of the financial system in mobilizing and allocating financial resources for productive investment and economic development. Fund-raising, through the capital markets, fuels economic growth by enabling job creation, infrastructure building and innovations. Efficient financial intermediation is at the core of the savings–investment process as it contributes to higher economic prosperity. A vibrant financial system is, therefore, an important component of an economy given the crucial role it plays in the process of financial intermediation toward economic growth and development. Why Does Financial Development Matter? In the literature, theoretical analysis and empirical studies have been conducted on why financial system development matter for economic development (De La Torre and Schumkler, 2007). Haber (2010) provides a summary of the theory and evidence of finance-growth nexus and implications for African countries. Honohan (2010) also explores a diagnosis of finance in Africa. From a theoretical perspective, financial development can contribute to economic growth through several mechanisms. Freixas and Rochet (2008) provide a detailed exploration of the theoretical perspectives on financial intermediation. Financial intermediation can help reduce the costs of acquiring information, monitoring and transactions costs, improve corporate governance, improve the evaluation of investment opportunities and mitigate risks through diversification and the allocation of resources to profitable projects, as well as transform short-term liquid savings into long-term illiquid capital investments. At the empirical level, although there is a debate as to the direction of causality between financial development and economic growth, there is overwhelming evidence that the financial system plays important roles in the development

20  Frontier markets’ environment

process. Diverse empirical studies, including cross-country and panel analyses, time-series analyses, individual country case studies and firm- and industry-level analyses, have provided evidence supporting the view that financial development is not just correlated with economic growth, it is actually one of its drivers.1 Most of these studies have shown that financial depth, through both the banking systems and the capital markets, contributes to physical capital accumulation, economic growth and productivity. For example, King and Levine (1993) conducted a pooled cross-country time-series survey of 80 countries for the 1960–1989 period and found a statistically significant relationship between financial development and economic growth. Shittu (2012) also established that financial intermediation has a significant impact on economic growth in Nigeria. It should be noted, however, that there is no single optimal mix of banks and capital markets for providing growth-enhancing financial services to the economy. The banking system and capital market rather work to complement each other, but the capital markets gain more prominence as income level rises. Financial system

A financial system, composed of financial institutions, instruments, markets and regulators, serves as an intermediary that facilitates and channels the flow of funds from surplus units to deficit units. Financial resources could be obtained through the financial system directly from the markets and indirectly through institutions (Cecchetti and Schroenholtz, 2011). With indirect finance, an institution stands between lenders and borrowers, bridging the gap between them – for example, obtaining a loan from a bank to buy a car or a house. With direct finance, borrowers sell securities directly to lenders in the financial markets, such as direct financing provided to the governments to construct roads and other public facilities. Also, companies can grow their businesses and bring new products and services to the marketplace through direct finance. Financial regulators

Financial regulators provide guidelines for the operations of financial markets and institutions. They aim to protect the investors by ensuring the stability and safety of the financial system, as well as ensuring that financial markets are transparent and fair. Typical financial regulators include central banks that regulate mostly deposit money banks (DMBs); a securities and exchange commission that regulates investment banks, asset managers and securities and brokerage companies; and a stock exchange that regulate listing of financial instruments, pension regulators and insurance regulators. Financial instruments

Financial instruments include stocks, bonds, loans, home mortgages, assetbacked securities and insurance. They act as a means of payment or stores of

Frontier market financial system 21

value that can be used to generate wealth and transfer purchasing power into the future. Financial instruments allow for the transfer of risk, such as futures and insurance contracts. Other financial instruments include derivatives such as options and swaps. Financial instruments also communicate information, summarizing certain details about the issuer. The instruments are designed to handle the problem of asymmetric information. Three fundamental characteristics influence the value of a financial instrument: size of the payment, with larger payment being more valuable; timing of payment, with earlier payment being more valuable; and likelihood of the payment, with more likely payment being more valuable (Cecchetti and Schroenholtz, 2011). Financial markets

Financial markets are places where investors buy or sell financial instruments while enabling both firms and individuals to source financing for their activities. Financial markets promote economic efficiency by ensuring that resources are available for productive use and providing liquidity and risk sharing at lower transactions costs. Financial markets are usually categorized based on the maturity of claim – that is a money market, where short-dated and liquid instruments are traded, and capital market, where long-dated instruments are traded (Cecchetti and Schroenholtz, 2011). They can also be categorized by the way they trade – whether through a centralized exchange or not. Capital market can be further divided into primary or secondary markets. The primary markets provide a platform for companies and governments to raise capital by selling newly issued securities to investors, while the secondary markets, where most activities in the capital markets take place, provide a platform to trade previously issued securities. The financial market can be classified, by the nature of the claim, into an equity market and a bond market. An equity market is where long-term finance for capital investment is raised and the equity instruments traded. A debt or bond market is where new debts are issued and bonds and treasury bills (TBs) are traded. Other financial markets including insurance markets, futures and derivatives markets, specializing in providing financial instruments to manage risks. An FX market consists of FX dealings and the changing of foreign currencies (Figure 2.1). Financial institutions

Financial institutions are the intermediaries that operate in the financial markets and provide finance. They provide access to the financial markets for savers buying financial instruments directly, and borrowers selling financial instruments. Two types of financial intermediaries can be broadly identified: depository intermediaries and non-depository institutions. Depository intermediaries take deposits and make loans.These include commercial banks – DMBs, savings and loan associations, and credit unions, in some

22  Frontier markets’ environment

Foreign Exchange Markets

Insurance Markets

Futures Markets

Stock Markets

Financial Markets

Derivaves Markets

Bond Markets

Commodity Markets

Money Markets

Figure 2.1 Types of financial markets

countries. Non-depository institutions are contractual intermediaries, such as insurance companies and pension funds that provide financial instruments for insurance plans, annuities and pensions. Non-depository investment intermediaries specialize in both money and capital markets, which include TBs, commercial bank certificates of deposit, long-term bonds and stocks.These securities firms include brokers, investment banks, underwriters and mutual fund companies. Brokers and investment banks issue stocks and bonds to corporate customers, trade them and advise customers. Mutual fund companies pool the resources of individuals and companies and invest them in portfolios. Hedge funds do the same for small groups of wealthy investors. Overview of Nigeria’s financial system

The financial system in Nigeria includes financial markets (money and capital markets), financial instruments (TBs, treasury certificates, central bank certificates), financial regulatory and supervisory authorities and financial institutions. Over the last five decades, the structure of the Nigerian financial system has undergone changes which span changes in ownership structure from the public to the private sector, the types and length of financial instruments and the number of financial institutions operating in the country (Central Bank of Nigeria, 2016). These structural changes have been influenced by changes in the overall macroeconomic, regulatory oversights and supervisory frameworks.

Frontier market financial system 23

The major regulatory and supervisory authorities are the federal Ministry of Finance (FMF), the Central Bank of Nigeria (CBN), the Securities and Exchange Commission (SEC), the National Insurance Commission (NAICOM) and the National Pension Commission (PENCOM; Figure 2.2). At the apex is the FMF, which chairs the Financial Services Co-ordinating Committee (FSCC) established in 1998. The FSCC coordinates activities of all regulatory institutions in the financial system. It has the primary responsibility to promote a safe, sound and efficient financial sector in the country. Its membership is drawn from the key regulatory and supervisory institutions in the nation’s financial system.

Presidency MOF

CBN Various Operators

Specialised Banks

Commercial Banks

Bank of Industry

Merchant Banks

Devt. Bank of Nigeria

Bureau de Change

Infrastructure Bank

Microfinance Banks

Agricultural Banks

Finance Houses

Nig. ExportImport Bank

Mortgage Institutions

Federal Mort. Bank

DMO

PENCOM NAICOM

NDIC

PFAs Insurance Companies

Reinsurers

PFCs

SEC

CPFAs

SROs NSE

NASD

FMDQ

NCX

CMOs Issuing Houses

Investment Banking Firms

Trustees

Investment Advisors

Merchant Banks

Custodians

Portfolio and Fund Managers

Market Makers

Rating Agencies

Stockbrokers

Registrars

Figure 2.2 Overview of the Nigerian financial system Source: CBN (2016).

Insurance Brokers

24  Frontier markets’ environment

Money market and institutions in Nigeria Money market and institutions constitute the hub of Nigeria’s financial system. The major function of the money market is to facilitate the raising of shortterm funds, from the surplus sectors to the deficit sectors of the economy. The deficit units, which could be public or private, obtain funds from the market to bridge budgetary gaps by either engaging in inter-bank taking or trading in short-term securities, such as TBs, treasury certificates, call money, certificates of deposit (CDs) and commercial papers (CPs).

Connecting principles to practice Box 2.1  The Central Bank of Nigeria The Central Bank of Nigeria (CBN), established in 1959 by the Central Bank of Nigeria Act of 1958, is the apex regulatory authority of the banking system in Nigeria, including the money market.The 1991 Banking Act defines the functions of the CBN to include “promoting price and monetary stability, ensuring a sound financial system and acting as banker and financial adviser to the Federal Government, as well as banker of last resort to the banks.” The CBN Act of 2007, which repealed the CBN Act of 1991, charges the bank with the overall control and administration of the monetary and financial sector policies of the federal government of Nigeria (FGN). The mandates of the CBN are as follows: • • • • •

ensure monetary and price stability; issue legal tender currency in Nigeria; maintain external reserves to safeguard the international value of the legal tender currency; promote a sound financial system in Nigeria; and act as banker and provide economic and financial advice to the federal government.

The bank also encourages the growth and development of financial institutions. The CBN licenses, regulates and supervises money market institutions, including commercial banks, merchant banks, microfinance banks, finance companies, and Bureau de Change that operate in the foreign exchange market. Over the last six decades, the CBN has helped in nurturing the money and capital markets in Nigeria. It introduced treasury bills and treasury certificate in 1960 and 1968, respectively,The CBN facilitated the creation

Frontier market financial system 25

of the Lagos Stock Exchange in 1961, which transformed into the Nigerian Stock Exchange. In the early 1970s, the CBN facilitated the capital issue committee, which later became the Securities and Exchange Commission, the main regulatory authority for the capital markets in Nigeria. Source: CBN (2018).

The Nigerian Deposit Insurance Corporation (NDIC)

The Nigerian Deposit Insurance Corporation (NDIC) complements the activities of the CBN. It began operations in 1989 and was set up to provide deposit insurance and related services for banks, in order to promote confidence in the banking industry. The NDIC derives its powers principally from the Nigeria Deposit Insurance Corporation Act, 2006 (NDIC Act) and is empowered to examine the books and affairs of the insured banks and other deposit-taking financial institutions. Licensed banks are mandated to pay 15/16 of 1 percent of their total deposit liabilities as insurance premium to the NDIC (Central Bank of Nigeria, 2016). The regulatory powers of the CBN are derived mainly from the CBN Act, 2007 and the Banks and Other Financial Institutions Act, 1991 (BOFI Act). Based on their respective acts, the CBN and NDIC regularly issue rules and regulations pursuant to their powers. Banking supervision in Nigeria is also impacted by other legislative instruments. These include the Failed Banks (Recovery of Debts) and Other Malpractices in Banks Act, 2004; the Economic and Financial Crimes Commission Act, 2004; and the Money Laundering Prohibition Act, 2011 (IMF, 2013c). Commercial banking

Formal commercial banking in Nigeria predates the establishment of the CBN by more than six decades. The first commercial bank in Nigeria, the African Banking Corporation, opened in 1892,2 which was renamed British Bank of West Africa (BBWA) in 1893 and became the precursor to the current First Bank Nigeria PLC (FBN). The colonial period witnessed the establishment of two other banks – the Barclays Bank DCO in 1917 and British and French Bank in 1949. The current Union Bank, Nigeria PLC and the United Bank for Africa, PLC (UBA) traced their initial origins to these two banks respectively. These three banks – First Bank, Union Bank and UBA – dominated commercial banking in the colonial period, with nearly 90 percent share of total banking deposits (Idrisu and Lawal, 2017). Several indigenous banks were created during the colonial period. By 1959, however, 21 out of the 25 indigenous banks had failed due to

26  Frontier markets’ environment

poor capitalization and competitive pressures from the three dominant foreign banks.3 Banks were regulated by the West African Currency Board (WACB) before independence. With the establishment of the CBN in 1959, the licensing of banks was subject to a minimum paid-up capital. Over the next four decades, banks grew in bounds, especially with the liberalization of the banking industry in the mid-1980s. By 2004, there were 89 banks operating in Nigeria.The banking consolidation exercise of 2005, which increased minimum paid-up capital to ₦25 billion, pruned the number of banks to 25 with a wave of mergers and acquisition that encouraged universal banking (UB) system (Central Bank of Nigeria, 2016). The UB model adopted in 2001, allowed banks to diversify into non-bank financial businesses. Following the consolidation programme in 2005, the number of banks reduced to 24 from 89. After the financial crisis of 2008/2009, which impacted more than 40 percent of the assets of the banking sector, the CBN implemented a comprehensive set of banking measures, including a review of the UB model in 2009 to direct banks to focus on their core banking business only. As part of the sweeping financial reforms in 2008 and 2009, the 24 banks were streamlined, using the differentiated capital base to form international banks, national banks, regional banks and financial holding companies (Sanusi, 2010). Under the new model, licensed banks are authorized to carry the following types of business4: commercial banking (with either regional, national and international authorization), merchant (investment) banking, specialized banking (microfinance, mortgage, non-interest banking (regional and national) and development finance institutions (DFIs). As of the end of June 2018, there were 22 commercial banks licensed by the CBN. There were nine commercial banking licences with national authorization, two commercial banking licences with regional authorization and one non-interest banking licence with national authorization. The total number of other financial institutions (OFIs) stood at 4,409 at end of June 2017, comprising 6 DFIs, 34 primary mortgage banks (PMBs), 999 microfinance banks (MFBs), 77 finance companies (FCs), 3,292 bureaux de change (BDCs) and 1 mortgage refinancing company (MRC; see Table 2.1). Table 2.1 Financial institutions licensed by the CBN Institution Type

Licensed in 2017

Total at end of June 2017

Commercial Banks (DMBs) Merchant Banks Primary Mortgage Banks Development Finance Institutions (DFIs) Finance Companies Mortgage Refinancing Company Microfinance banks Bureaux de change

Nil Nil Nil 1 3 Nil 19 145

22 4 34 6 77 1 999 3292

Source: CBN (2017).

Frontier market financial system 27

Connecting principles to practice Box 2.2  The Asset Management Corporation of Nigeria The Asset Management Corporation of Nigeria (AMCON) was created by AMCON Act 2010 to resolve the non-performance loan (NPLs) assets of banks in Nigeria. AMCON was established as a bad bank with a focus on troubled bank resolution by purchasing NPLs of banks. AMCON has a share capital of ₦10 billion contributed evenly by the FMF and CBN. In addition, the CBN provided a debenture of ₦500 billion. AMCON bought eligible assets or bad loans at a discount and exchanged them for medium to long-term bonds guaranteed by the FGN. Bridge banks were created, re-capitalized and sold. AMCON established a sinking fund, which banks contribute to periodically. AMCON issued more than ₦4 trillion in zero-coupon bonds, which, plus 3 years’ accrued interest, provided a total of ₦5.6 trillion for the acquisition of eligible bank assets (EBAs), financial accommodation and recapitalization of eligible banks. The oil and gas sector constitutes the largest debt at 29.3 percent of the total portfolio of restructured loans. General commerce and capital markets and the aviation and manufacturing sectors rank second and third at 20.7 percent and 16.3 percent, respectively, as of 2017 (AMCON, 2018)

Merchant banking in Nigeria

A merchant bank in Nigeria is defined as “a bank whose business includes receiving deposits on deposit account, provision of finance, consultancy and advisory services relating to corporate and investment matters, making or managing investments on behalf of any person.”5 In practice, merchant banking involves wholesale banking with the particular focus on medium-term lending, acceptance of bills of exchange, corporate finance, FX transactions, portfolio, management and equipment leasing. Formal merchant banking licences were granted to two banks in 1960 – Nigerian Acceptance and the Philip Hills (Nigeria) Limited. Both banks merged in 1969 to form Nigerian Acceptances Limited (NAL), later renamed NAL Merchant Bank Limited. By 1984, there were 15 merchant banks in the country. Most of the merchant banks were merged and acquired in the banking consolidation exercise of 2005. First City Merchant Bank Limited, which was established in 1982 was transformed into First City Monument Bank (FCMB), a financial services holdings company with a significant capital market and investment banking arm. Currently, there are five registered merchant banks: Coronation Merchant Bank, RMB Merchant Bank, Nova Merchant Bank, FBN Merchant Bank and FSDH Merchant Bank.

28  Frontier markets’ environment DFIs

The DFIs, in Nigeria, are established to contribute to the development of specific sectors of the economy. They are licensed, supervised and regulated by the CBN. Major DFIs are the Development Bank of Nigeria, the Urban Development Bank, the Nigerian Agricultural and Rural Cooperatives Bank and Primary Mortgage Institutions, among others. Against the backdrop of the reform in the sector, the DFIs in the country have undergone mergers and restructuring, involving the Bank of Industry (BOI) and the Nigerian Agricultural Co-operative and Rural Development Bank (NACRDB). In 2017, the Development Bank of Nigeria (DBN) was established, with a focus on providing long-term financing to small and medium enterprises in key sectors of the economy (Central Bank of Nigeria, 2016; Idrisu and Lawal, 2017). Apart from providing medium- and long-term loans for capital projects in specific areas, development banks render ancillary services including providing technical advice on new and existing projects to their customers, engaging in promotional activities to stimulate interests among their customers on new projects.

Capital markets and institutions in Nigeria The Nigerian capital market is a channel for mobilizing long-term funds for investment. The apex regulatory authority for the capital market is the SEC. The Nigerian Stock Exchange (NSE) is the main listing self-regulatory institution, while the other listing organizations are the FMDQ and NASDAQ. The key private-sector capital market operators include investment banks, the issuing houses, assets managers and the stockbroking firms. Chapters 3 covers the capital market in detail. Chapter 4 is devoted specifically to investment banks. Chapter 6 examines the regulations of the capital markets in Nigeria. The SEC

The SEC supervises the capital market operators and asset managers, as well as other investment banking activities in Nigeria. There are, however, overlaps as some capital operators, in particular financial holding institutions with investment banking arms and merchant banks, require central bank licensing, while others have insurance and pension subsidiaries which require licensing by NAICOM and PENCOM, respectively.The FMF has oversight function on the SEC. Debt Management Office

The Debt Management Office (DMO) plays crucial roles in the debt capital market (DCM) in Nigeria.The DMO was established as an autonomous DMO by the FGN to address the debt problems. The creation of DMO aims at consolidating the debt management functions in a single agency, thereby ensuring proper coordination. The DMO centralizes and coordinates the country’s debt recording and management activities, including debt service forecasts, debt service payments and advising on debt negotiations, as well as new borrowings.

Frontier market financial system 29 The Pension Commission

The Pension Reform Act (PRA) of 2004 transformed the pension industry in Nigeria from a largely voluntary defined benefits and unfunded pay-as-you-go (PAYG) system to a mandatory defined contributions and fully funded system. The PRA governs pension asset management in Nigeria. The act requires private- and public-sector employers to make contributions towards the pension savings of all employees while establishing a scheme for the payment of retirement benefits. The number of approved existing schemes, pension fund custodians (PFCs) and closed pension fund administrators were maintained at 19, 4 and 7, respectively. The insurance industry

The NAICOM is charged with effective administration, supervision, regulation and control of the business of insurance in Nigeria. Its specific functions include the establishment of standards for the conduct of insurance business, protection of insurance policyholders and establishment of a bureau to which complaints may be submitted against insurance companies and their intermediaries by members of the public. NAICOM ensures adequate capitalization and reserve, good management, high technical expertise and judicious funds. In 2007, NAICOM raised the minimum capital for insurers. Current Nigerian minimum capital requirements are as follows: non-life companies: ₦3 billion, life companies: ₦2 billion, composite companies: ₦5 billion and reinsurance companies: ₦10 billion. As of October 2017, there were 13 composite (life and non-life) insurance companies, 28 general insurance companies, 14 life insurance companies and 2 reinsurance companies6 under the supervision of the NAICOM. In June 2018, the capital requirements for insurance companies were increased by as much as 200 percent to take effect from January 2019. The new recapitalization will involve a 3-tier system: Tier 3, Tier 2 and Tier 1. Life insurance businesses, under the Tier 1 category, require capital of ₦6 billion; Tier 2 requires a capital of ₦3 billion; and Tier 3 will retain the existing ₦2 billion capital requirement. Non-life companies, under the Tier 1 category, which include oil and gas and oil and aviation, require capital of ₦9 billion. Tier 2, covering engineering, marine and surety ship business requires capital of ₦4.5 billion, while Tier 3, which include fire, motor and general accident, would retain the minimum capital base of ₦3 billion. For composite insurance firms, Tier 1–related businesses will require capital base of ₦15 billion. Tier 2 will require a capital of ₦7.5 billion, while Tier 3 capital is retained at ₦5 billion minimum capital.

Financial sector assessment The degree of financial structure and development can be assessed using several indicators that cover financial depth, concentration, scope, coverage, inclusion, stability, soundness and internationalization.

30  Frontier markets’ environment Financial sector concentration

The financial system in Nigeria is dominated by the banking sector, especially the DMBs or commercial banks, accounting for 75 percent of the total assets of the financial system (Table 2.2). Total net loans and advances as of the end of June 2017 were 25 percent of GDP, compared to 95 percent in South Africa (World Bank, 2018). The six largest banks in Nigeria – First Bank, Zenith Bank, UBA, Access Bank, GTB, Ecobank – control 58.1 percent and 61 percent of deposits and assets, respectively, as of the end of June 2018, highlighting the oligopolistic market structure of the banking industry in the country. These banks are often referred to as Tier 1 banks, and with Stanbic Holdings are classified as systemically important banks. The market share of the largest bank with respect to deposits and assets stood at 12.6 percent and 14.8 percent, respectively. Nineteen banks had market shares, ranging from 0.01 to 5.5 percent of assets and 0.02 to 5.2 percent of deposits. The Herfindahl–Hirschman Index (HHI) for the industry stood at 3,375 and 3,721 for deposits and assets, respectively, at the end of June 2018 (CBN, 2018). The total assets of the insurance companies stood at ₦1.16 trillion as of December 2016.7 The top five insurance companies accounted for 71.5 percent of gross premium in life insurance. The insurance sector is an underdeveloped part of the Nigerian financial sector, with assets of about 3 percent of GDP in 20168 This is significantly low when compared to countries such as France, Germany and the Netherlands within the euro area, where total assets of the insurance industry amount to 70 percent of GDP (IMF, 2018a). Gross insurance premium grew at an average rate of 23 percent from 2001 to 2010 but remains very small with a total premium income of ₦192 billion, representing 0.7 percent of GDP in 2010 (IMF, 2013b). The gross written Table 2.2 Assets structure of the Nigerian financial system 2006 No.

2011

assets

No.

% (₦ billions) Commercial Banks 25 6,738 Merchant Banks Insurance 107 308 Pension Funds 13 300 Microfinance 757 55 Banks Others 926 354 Total 7,755

2017

assets

No.

% (₦ billions)

86.9

20 18,477

assets % (₦ billions)

78.7

74.6 1.2 2.5 17.0 0.8

4.6 527 1,352 5.8 100 23,477 100

1,827 3.9 46,398 100

4.0 61 3.9 21 0.7 876

662 2,835 191

22 34,593 5 553 2.6 120 1,160 12.1 21 7,890 0.8 1,008 375

Source: CBN (2018), PENCOM (2018) and NAICOM Website (2018).

Frontier market financial system 31

premium is estimated to be ₦232 billion in 2011. Total claims paid increased from ₦87 billion in 2014 to ₦148.3 Billion in 2016.9 Among its African peers, Nigeria has one of the lowest insurance penetration level, measured as insurance gross premium written as a proportion of GDP. Nigeria has 0.3 percent compared to South Africa (14.7 percent), Kenya (2.8 percent), Angola (0.8 percent) and Egypt (0.6 percent). The sector’s insurance density, which measures industry gross premium per capita, is also one of the lowest in Africa at US$6.2, compared to South Africa (US$762.5), Egypt (US$22.8), Kenya (US$40.5) and Angola (US$30.5) (Afrinvest, 2018). Assets of the life business are about a quarter of total assets reflecting a low level of savings and investment insurance product. Around 70 percent of the life business is the compulsory group life. Assets of non-life insurance account for 48 percent of total assets. Non-life insurance is more developed, with motor, marine and aviation and property the dominant lines of business. Life insurance penetration is at about 0.2 percent, while non-life insurance penetration is around 0.5 percent, or only one-seventh of the average penetration of the Organisation for Economic Co-operation and Development (OECD) countries in 2010 (IMF, 2013b). The pension funds administrators (PFAs) have ₦7.89 trillion as assets under management (AUM) in 2017, 7 percent of GDP, compared to the deficit of more than ₦2 trillion accumulated under the DBS in 2004.The pension industry recorded a scheme membership of 7.89 million contributors, with publicsector and private-sector retirement savings accounts (RSAs) accounting for 44.5 percent and 55.5 percent in 2017 (PENCOM, 2018). A review of PFAs’ ranking by size of assets under their management, as of the period under review, showed that the top three and five PFAs accounted for more than half of the total RSA assets at 53.97 and 66.64 percent, respectively, at the end of the fourth quarter of 2017. The top 10 PFAs managed 88.00 percent of the total RSA assets at the end of the reporting period. Financial soundness

The bank z-score, used to measure financial soundness, is calculated as [return on assets (ROA) + (equity /assets)]/(standard deviation of ROA). To approximate the probability that an economy’s banking system defaults, the indicator compares the system’s buffers (returns and capitalization) with the system’s riskiness or volatility of returns (World Bank, 2018). ROA, equity, and assets are economy-level aggregate figures. Nigeria’s z-score is comparable to most of its peers (Table 2.3). The ROA stood at 2.6 percent, while the ratio of non-interest expenses to gross income was at 52 percent at the end of June 2017. The ratio of interest margin to gross income was at 57.8 percent. The soundness of the banking industry is further examined by using capital and asset quality indicators. The ratio of regulatory capital to risk-weighted assets was at 12.08 percent, and the ratio of Tier 1 capital to risk-weighted assets was at 12.4 percent at the end of June 2018 (Table 2.4). Three banks,

Table 2.3 Economy and financial characteristics

Nigeria Argentina Brazil China India Indonesia Kenya South Africa United Kingdom

Private credit/GDP

No. of bank accounts

Interest spread

z-score

12.8 11.7 66.3 132.4 49.7 30.7 31 65.9 145.9

39.3 44.5 66.4 73.9 46.9 30.5 50.9 63.7 98.4

7.9 3.2 24.3 2.9 – 4.5 7.9 3.3 2.7

9.4 7.4 10.5 22.7 8.9 4.1 16.5 13.4 13.6

Source: World Bank (2018).

Table 2.4 Financial soundness indicators Indicators

2013

2014

2015

2016

2017

End of End of End of End of End of End of End of End of End of June December June December June December June December June 1. Asset-Based Indicators Non-performing 3.9 3.4 loans to total gross loans Liquid Assets (Core) 13.7 16.8 to total assets Liquid assets (core) 19 23.1 to short-term liabilities 2. Capital-Based Indicators 18.9 17.1 Regulatory Capital to risk – weighted assets Regulatory Tier 1 18.5 17.1 Capital to risk – weighted assets Non-performing 5.9 5.8 loans net of provisions to capital 3. Income- and Expense-Based Return on asset 2.9 2.3 Interest income to 65.2 63.9 gross income 62.7 68.1 Non-interest expense to gross income Staff cost to non- 39.5 36.9 interest expenses Source: CBN (2017).

3.5

2.9

5

5.3

10.7 12.8

15

11.7 11.4

16.3 18.5

14

16.2

17.2

16.6 16.7

25

27.1

21.6 24.5

25.9

16.4 17.2

17.6 16.1

14.7 14.8

11.5

16.1 15.5

17.4 17.1

15.6 16.3

12.4

23.6 29

31.8

5.6

4.1

7.4

5.9

Indicators 2.5 2.5 62.7 51.2

2.8 2.5 65 62.2

2.3 1.3 61.4 67.6

2.6 57.8

65.5 56.9

64.7 63.1

54.6 62.8

52

38.5 36.6

40.1 35

41.2 36.1

34.5

Frontier market financial system 33

with between 7 to 10 percent of total assets, remain undercapitalized.10 In view of the implementation of International Financial Report Standards (IFRS9,) the CBN requested in 2018 that banks should withhold dividends in other to increase capital buffers. Although capital buffers of banks could sustain shocks, the defaults of the five biggest borrowers could threaten the solvency of the banking industry (IMF, 2018b). The asset quality of commercial banks, measured as the ratio of nonperforming loans (NPLs) to gross loans, was at 12.45 percent at end of June 2018, with the largest bank accounting for a fifth of the NPLs in the banking industry (Table 2.4). The ratio of core liquid assets to total assets was at 17.2 percent at the end of June 2017, while the ratio of core liquid assets to short-term liabilities stood at 26 percent. Overall, the industry liquidity ratio increased to 46.09 percent at the end of the first half of 2018, from 45.8 percent at the end of June 2017 (CBN, 2018). Financial depth and inclusion

Table 2.3 presents aggregate measures of financial depth, scope and inclusion. Private credit by DFIs to GDP ratio measures the domestic private credit to the real sector by DFIs as a percentage of nominal GDP.The banking system’s credit to the private sector in Nigeria was ₦22,275 billion at the end of June 2018. Between 2013 and 2015, private-sector credit averaged 13 percent of GDP compared to two-thirds of GDP in Brazil and South Africa. It compares even unfavourably to 132 percent and more than 140 percent in China and the United Kingdom, respectively. Table 2.5 shows the credit concentration by sector relative to the sector’s share of GDP. The oil and gas sector accounted for the highest share of total private-sector credit at 22.7 percent at the end of June 2018 and 30 percent in June 2017, while it contributes less than 10 percent to GDP. Agriculture, which contributes a fifth of GDP, received a mere 34 percent of banks’ total credit to the private sector. Manufacturing was at 13.2 percent, while the power and energy sub-sectors accounted for 13.2 and 2.7 percent, respectively. Table 2.5 Economy–bank credit gap: sector concentration of credit Sector

Percentage of GDP

Bank credit by sectors (%)

Agriculture Construction/Real Estate Financial Services ICT Industrials Oil and Gas Trade and Commerce Services/Others Total

21 11 3 10 33 9 19 18 100

3 9 5 5 14 29 6 17 100

Source: CBN (2017) and NBS (2018).

34  Frontier markets’ environment

Short-term loans (less than 1 year) accounted for 44.1 percent of total loans. Short-term deposits accounted for 89.1 percent the total deposit liabilities, with deposits of less than 30 days accounting for 70.3 percent as of June 2018. Medium-term loans (between 1 year and 3 years) are at 19.3 percent, while long-term loans accounted for 36.6 percent in June 2018. On the other hand, medium- and long-term deposits constituted 4.0 and 7.3 percent, respectively, of total deposits in the same period. The loans-to-deposit ratio was at 79 percent at the end of June 2017. There is a clear maturity mismatch between bank deposits liabilities and loans assets. However, the maturity and interest rate mismatch between assets and liabilities is contained as long-term assets, including loans, are repriced every 3 months or 90 days. Between 2013 and 2015, the spread between bank lending and deposit rates in Nigeria was estimated at 8 percent compared to 2.9 percent in China and 3.3 percent in South Africa (Table 2.3). Lending rate is the rate charged by banks on loans to the private sector, and deposit interest rate is the rate paid by commercial banks for demand, time, or savings deposits. Average savings deposit rate and term deposit rate were at 4.8 percent and 8.67 percent, respectively, in June 2017. Average prime and maximum lending rates were at 17.35 and 30.05 percent, respectively, in the same period. The spread between the average term deposit and the average maximum lending rates widened to 21.38 percent at the end of the first half of 2017. Real deposit rates were negative, while real prime and maximum lending rates were positive. Four out of 10 adult Nigerians are estimated to have no access to financial services, with the north-west of the country having 70 percent of its adult population excluded from financial services as of June 2017 (EFInA, 2016). Financial inclusion measure by access to bank accounts is much lower than in Brazil, China, Kenya and South Africa (Table 2.3).

Financial System Strategy 2020 The Financial System Strategy 2020 (FSS2020) is an initiative of the FGN aimed at developing a coherent blueprint to develop Nigeria’s financial system to help achieve its vision to be one of the 20 largest economies in the world by 2020 and a major international financial centre. FSS2020 vision was initiated following the prediction of Goldman Sachs that Nigeria is among a group of 11 emerging economies with the potential to be in the top 20 global economies by 2020. The FSS2020 Strategy is fully synchronized and integrated with the NV20–2020 economic blueprint. The overriding objective was to develop and transform Nigeria’s financial sector into a growth catalyst and engineer Nigeria’s evolution into an international financial centre. In addition to this, FSS2020 was designed to strengthen and deepen the domestic markets, enhance integration with the external financial markets and promote sustainable economic development.The broad objectives of Nigeria’s FSS 2020 include developing shared vision and an integrated

Frontier market financial system 35

strategy for the nation’s financial system, developing market and infrastructure strategies that will align fully with the strategic intent of the overall system, creating a performance management framework, building partnership of all key stakeholders to implement the strategy and establishing a harmonious and collaborative environment for development and delivery of the strategy (Central Bank of Nigeria, 2007). The task of implementing the vision was vested in the participating institutions including the NDIC, the SEC, Nigeria Stock Exchange, NAICOM, PENCOM, the DMO, the Financial Reporting Council, the Federal Inland Revenue (FIRS) and the FMF. Several initiatives in the FSS2020 have been implemented especially in respect of the national payments system. The cashless policy of the CBN has been implemented with the adoption of electronic payment channels and the CBN Immediate Transfer Service (CBSITS). Electronic payments transactions have been boosted by the electronic cheque clearing (ECC) system, which allows for a same-day cheques-clearing process; the Nigeria Electronic Funds Transfer (NEFT); the real-time gross settlement system; and the biometric verification number (BVN).

Notes 1 De La Torre, A. and Schumkler, S. L. (2007) provides a good summary of studies on why financial development matter. 2 NOUN, Investment banking. 3 NOUN. 4 CBN (2016) Financial System. 5 The Bank and Other Financial Institutions (BOFI) Decree No. 25 of 1991. 6 NAICOM website. 7 NAICOM Annual Report on the Balance Sheet of Insurance Companies. 8 NAICOM Website (2018) 9 National Insurance Association (NIA). 10 IMF (2008), Article 4.

Bibliography Afrinvest. (2018),The Nigeria Insurance Sector Report: Unlocking the Potential for Growth AMCON. (2018), Loans purchased from various Eligible Financial Institutions (EFIs) http:// www.amcon.com.ng/achievements.php [Accessed December 2018] Ayogu, M. and C. Emenuga. (2008), Central Banking Experience and the Conduct of Monetary Policy in Nigeria, in Ncube, M. (ed.), Financial Systems and Monetary Policy in Africa. Nairobi, Kenya: African Economic Research Consortium (AERC) Cecchetti, A. and K. Schroenholtz. (2011), Money, Banking and Financial Markets, 3rd edition. New York: Tata McGraw-Hill Central Bank of Nigeria. (1991), The Bank and Other Financial Institutions (BOFI) Decree No. 25 of 1991 Central Bank of Nigeria. (2007), Financial System Strategy 2020. www.cenbank.org/OUT/ SPEECHES/2007/GOVADD18-4-07.PDF Central Bank of Nigeria. (2016), The Nigerian Financial System at a Glance

36  Frontier markets’ environment Central Bank of Nigeria. (2017), Financial Stability Report, June Central Bank of Nigeria. (2018), Half-Year Report De La Torre, A. and S.L. Schumkler. (2007), Emerging Capital Markets and Globalization: The Latin American Experience. World Bank and Stanford University Press. http://siteresources. worldbank.org/DEC/Resources/Schmukler_ECMGBookwithdelaTorre.pdf EFInA. (2016), Access to Financial Services Survey Report in Nigeria EFinA. (2010), Financial Services Landscape in Nigeria Freixas, X. and J.C. Rochet. (2008), Microeconomics of Banking, 2nd edition. Cambridge: The MIT Press Haber, S. (2010),The Finance-Growth Nexus:Theory, Evidence, and Implications for Africa, in Quitntyn, M. and G.Verdier (ed.), Africa Finance in the 21st Century. New York: PalgraveMacmillan and IMF Heffernan, S. (2005), Modern Banking. Sussex: John Wiley & Sons Honohan, P. (2010), Finance in Africa: A Diagnosis, in Quitntyn, M. and G. Verdier (ed.), Africa Finance in the 21st Century. New York: Palgrave-Macmillan and IMF Huang,W. (2007), Institutional Banking for Emerging Markets: Principles and Practice. Sussex: John Wiley & Sons Idrisu, I. and O. Lawal. (2017), Investment Banking, National Open University of Nigeria. http://nouedu.net/sites/default/files/2017-10/BFN407.pdf IMF. (2013a), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Implementation of IOSCO Objectives and Principles of Securities Regulation, IMF Country Report No. 13/144 IMF. (2013b), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Observance of Insurance Core Principles, IMF Country Report No. 13/145 IMF. (2013c), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Compliance of the Basel Core Principles for Effective Banking Supervision, IMF Country Report No. 13/146 IMF. (2018a), Euro Area Policies: Financial Sector Assessment Program. Technical Note on Insurance, Investment Firm, and Macroprudential Oversight. IMF Country Report No. 18/230 IMF. (2018b), Nigeria: 2017 Article IV Consultation. IMF Country Report,Washington DC: IMF Kasekende, L. (2010), Developing a Sound Banking System in Sub-Saharan African Countries, in M. Quitntyn and G. Verdier (ed.), Africa Finance in the 21st Century. New York: Palgrave-Macmillan and IMF King, R. and R. Levine. (1993), Finance and Growth: Schumpeter Might Be Right, The Quarterly Journal of Economics, 108: 681–737 Levine, R., N. Loayza and T. Beck. (2000), Financial Intermediation and Growth: Causality and Causes, Journal of Monetary Economics, 46(1): 31–77 Matthews, K. and J. Thompson. (2005), The Economics of Banking. Sussex: John Wiley & Sons National Bureau of Statistics (NBS). (2018), Nigeria’s Gross Domestic Product Statistics for H2 2018 PENCOM (2018), National Pension Commission: 2017 Annual Report. https://www. pencom.gov.ng/wp-content/uploads/2018/12/2017-Annual-Report_1.pdf [Accessed December 2018] Sanusi, L.S. (2010), Global Financial Meltdown and the Reforms in the Nigerian Banking Sector. Public Lecture Delivered at the Convocation Square, Abubakar Tafawa Balewa University, Bauchi, Friday, 10 December Saunders, A. and M.M. Cornett. (2008), Financial Institutions Management: A Risk Management Approach, 6th edition. New York: Tata McGraw-Hill

Frontier market financial system 37 Shittu, A.I. (2012), Financial Intermediation and Economic Growth in Nigeria, British Journal of Arts and Social Sciences, 4(2) Soludo, C.C. (2007), Nigeria’s Financial System Strategy 2020 Plan ‘Our Dream’. www. cenbank.org [Accessed July 2018] World Bank. (2018), Global Financial Development Report 2017–2018 World Bank and IMF. (2005), Financial Sector Assessment, a Handbook. Washington, D.C.: World Bank and IMF

3 Frontier capital market

Principles Financial intermediation between the surplus and deficits sectors of the economy occurs through indirect finance by the banking system and direct finance via the capital market. The capital market is the financial market segment, which provides the platform for mobilizing financial resources for long-term investment and productive activities in the economy. The capital market is essential to the functioning and sustainable development of a modern economy, providing opportunities for funding riskier projects on long-term maturities. The capital market is a source for long-term capital formation and economic growth while providing a hedge against inflation. It serves as a platform for raising capital, authorizing and monitoring market operators, ensuring orderly, fair and equitable market transactions (Laeven, 2014; Senbet and Otchere, 2010; Yartey and Adjasi 2007). It is also a medium of exchange for retail and institutional investors to create, build and preserve wealth as it offers higher risk-return profiles as well as portfolio and risk diversification Capital market provides an avenue for governments to raise funds to finance fiscal deficits by issuing bonds instead of borrowing directly from the banking system. It also complements the money market to facilitate the conduct, operations and transmission mechanism of monetary policy. Financial deepening is enhanced by the growth of capital markets alongside the development of indirect financing through the banking system, which improves the efficiency of capital allocation in the economy. There are also challenges to capital market development, especially in FMs. There must be a good investment climate, a stable macroeconomic framework and adequate regulation for issuers, investors and intermediaries along with, appropriate competition, business and financial laws. Capital markets also operate more efficiently with adequate exchanges and trading platforms, clearing and settlement infrastructure (Narayanaswamy et al., 2017). FMs, also known as “pre-emerging markets,” are capital markets in developing countries that stand between the LDCs and the emerging markets. These markets are more developed than the LDCs but are too small, less capitalized and less liquid in comparison to emerging markets.

Frontier capital market 39

Investors in search of potentially high long-term returns with low correlations with global markets tend to pursue securities of FMs. As recently observed, “Frontier Markets come into their own as a $700 Billion Club. With the combined market value exceeding $700 billion for the first time in a decade, the frontier group has begun to outpace emerging-market stocks after three years of underperformance” (Sivabalan, 2018). However, they also face risks including political instability, poor liquidity, large currency fluctuations and dependency on volatile commodities. Capital market segments

Capital markets usually have two segments: primary and secondary markets. Primary markets deal with issuance and sales of new securities by companies, governments and other public-sector institutions. The instruments used in the primary market are offer for sale, initial public offer (IPO), offer for subscription, rights issue, private placing, issue by tender and stock exchange introduction. New issues are securities raised in the primary market for the first time. An IPO occurs when an unlisted company makes a public issue for the first time and gets its shares listed on a stock exchange. An offer for subscription is an invitation by a company inviting the public to subscribe to new shares; an offer for sale is when existing shareholders offer their shareholding or part thereof for public subscription. Private placement is when the securities are placed with a broker/issuing house, which then sells to prospective purchasers or to qualified investors, instead of being offered directly to the public. A vibrant primary market promotes free float by encouraging companies to list a large percentage of shares outstanding available for trade, encouraging quality companies to list and ensuring the free flow of information and good corporate governance by requiring that companies abide by listing requirements. Investment banks play leading roles through underwriting of new equity and bond securities, which are detailed in Chapters 7 and 8 on equity underwriting and debt underwriting, respectively. The secondary market – also called aftermarket – is a market where previously issued financial instruments are traded. These instruments include bonds, options, stocks and futures. Most of the discussions in this chapter focus on the secondary market for trading securities on the stock exchange.

Practice Global capital markets

In 2018, total domestic market capitalization stood at $82.5 trillion after reaching a new record high of $87.1 trillion in 2017. Global domestic market capitalization and benchmark indices briefly scaled new highs in January 2018, but market valuation declined in subsequent months. The last quarter of 2018 witnessed heightened global stock market correction and a return of volatility.

40  Frontier markets’ environment

There are over 45,000 listed companies on world stock exchanges. Table 3.1 provides a list of the top 20 global stock exchanges, some of which are briefly outlined. The United States has the two largest stock exchanges in the world: NYSE and NASDAQ. They both have a combined market capitalization of $32 trillion in 2017, representing 160 percent of total GDP of the United States and accounting together for slightly more than a third of total world market capitalization. The New York Stock Exchange (NYSE), established in 1792, is the largest stock exchange in the world, with a market capitalization of $23 trillion. It has 2,286 listed companies and is now part of NYSE EURONEXT, which has exchanges in the United States and Europe. The second-largest exchange is also US-based, NASDAQ, with a $10.8 trillion market capitalization and is home to the technology giants Facebook, Apple, Amazon, Netflix and Google (FANNG), as well as Microsoft. In the Americas, the Toronto Stock Exchange in Canada and the São Paulo Stock Exchange in Brazil made the global top 20 list. Nine of the 20 largest exchanges now reside in Asia – Tokyo, Shanghai, Hong Kong, Shenzhen, India National Stock Exchange, Bombay, Korea, Australia and Taiwan – mirroring the rapid economic growth of the region in the last three decades.These stock exchanges in Asia have a total capitalization of $24 trillion. Table 3.1 World top stock exchanges, 2017 Exchange

Market capitalization ($ trillion)

Listed companies

Turnover ($ billion)

NYSE NASDAQ Japan Shanghai Euronext Hong Kong LSE Shenzhen Toronto India NSE Bombay Deutsche Korea Six Swiss Nordic Australian JSE Taiwan Bovespa BME Spain

22.9 10.8 5.7 4.0 3.9 3.9 3.8 2.5 2.1 2.0 2.0 1.9 1.5 1.5 1.4 1.3 0.9 0.9 0.9 0.8

2,286 2,949 3,604 1,396 1,300 2,118 2,485 2,089 1,501 1,897 3,878 502 2,134 264 970 2,147 366 924 343 3,152

57.9 45.1 23.5 31.0 7.5 7.9

Source: World Federation of Exchanges (WFE, 2018a).

37.5 5.0 4.1 5.7 7.8 3.7 3.1 3.3 1.5 3.1 2.7 2.7

Frontier capital market 41

The third largest stock exchange, Tokyo Stock Exchange (TSE) has a market capitalization of $6.2 trillion and 3,604 listed companies. The TSE is estimated to have been established in 1878, and the Nikkei 225 index comprises some of the largest and most successful companies in Japan. The Shanghai Stock Exchange of China is relatively new, having opened in 1990. It has a market capitalization of $5.1 trillion, with 1,396 listed companies. Its twin sister exchange, the Shenzhen Stock Exchange, has $3.6 capitalization and 2,090 listed companies. The Stock Exchange of Hong Kong Limited, with a capitalization of $4.3 trillion and 2,118 listed companies, represents one of the primary avenues for global investors to invest in China. Between 2003 and 2016, China’s market capitalization grew by 1,479 percent compared to 87 percent growth of the NYSE.The phenomenal growth of China’s stock exchanges, in particular, reflect the underlying economic dynamism of the country, which now ranks as the second-largest economy in the world behind the United States. Other Asian stock exchanges that feature in the top 20 global stock exchanges are the India National Stock Exchange and the Bombay Stock Exchange, Korea Exchange and the Taiwan Stock Exchange. Euronext, with operations in Amsterdam, London, Paris and other European cities, is the fifth-largest stock exchange in the world with a capitalization of $4.4 billion and 1,300 listed companies. The London Stock Exchange (LSE; 2015), founded in 1801, is the seventh-largest stock exchange, ranking behind Hong Kong. LSE has an estimated $4.3 trillion in stock market capitalization, with 2,485 listed companies. Deutsche Bourse in Frankfurt, Six Swiss in Zurich, Nasdaq Nordic in Stockholm and Madrid BME in Spain also made the list of top 20 global exchanges. Johannesburg Stock Exchange (JSE), founded in 1890, is the only African stock exchange that made the top 20 list. It has 366 listed companies with $1.2 trillion in market capitalization, representing 0.7 percent of global capital market capitalization but more than 320 percent of South Africa’s GDP. It ranks 17th in the world, after the Australian stock exchange in Sydney, which has $1.5 trillion in capitalization.

The NSE Nigeria is Africa’s largest FM and is in the three key frontier markets indices of FTSE/RUSSELL, MSCI and S&P DOW. In terms of capitalization, however, it is very small compared to global exchanges. There are five exchanges in Nigeria, with the NSE serving as the main hub. The NSE was originally established in 1960 as the Lagos Stock Exchange., which started operations in 1961 with 19 securities listed for trading (NSE, 2018). In 1977, the Lagos Stock Exchange changed its name to the NSE. In addition to the Lagos bourse, the NSE has 13 branches and trading floors in major commercial cities around the country – Port Harcourt, Kano, Kaduna, Onitsha and Ibadan.

42  Frontier markets’ environment

The NSE is a self-regulatory organization (SRO) and a registered company limited by guarantee. It is licensed under the Investments and Securities Act (ISA) and regulated by the SEC of Nigeria. The NSE provides listing and trading services, licensing services, market data solutions and ancillary technology services to investors and other participants in the capital market.1 It is a member of key international and regional securities organizations (NSE, 2018) including: International Organization of Securities Commissions (IOSCO), the World Federation of Exchanges (WFE), the Sustainable Stock Exchanges (SSE) Initiative, and Intermarket Surveillance Group (ISG). The exchange is a founding member and executive committee member of the African Securities Exchanges Association (ASEA). The NSE comprises three segments: the main Board, which is home to Nigeria’s 152 domestic companies and one foreign corporation; the Alternative Securities Market (ASeM), with nine companies, was launched in 2013 to replace the former second-tier market and caters to smaller and growing companies that have been operational for 2 years; and the Premium Board, launched in 2015, hosts seven large companies with an ₦200 billion or more market capitalization. Financial Market Dealers Quotation over-the-counter securities exchange

Financial Market Dealers Quotation (FMDQ) was founded in 2012 and registered by the SEC as an SRO. It became operational in November 2013. It specializes in the listing and trading of debt instruments, FX and derivatives over-the-counter (OTC) securities exchange market. It offers products and services including bonds, CPs, repurchase agreements, currency crosses, FX, forwards and money market derivatives. It has 182 members across the Nigerian financial markets. FMDQ has government debt securities worth $165 billion, corporate debt of $5.7 billion and OTC currency futures traded of about $7 billion as of May 20182 (FMDQ, 2018). NASD OTC securities exchange

National Association of Securities Dealers (NASD) PLC is a securities exchange registered by the SEC. It operates a formal OTC market in Nigeria by providing trading platforms where all instruments not listed on a traditional exchange can be traded through licensed stockbroking houses. The NASD serves as an avenue for investors to trade shares of unlisted public companies and as a centralized source of information and price discovery for those public companies. NASD is currently owned by 59 capital market operators in Nigeria.3 NASD delists securities that have commenced the process of listing securities on a registered stock exchange. NASD has two categories of companies: the Blue Tier and the Pink Tier. The Blue Tier category includes companies with a high level of corporate governance and financial disclosures. The Pink Tier category represents the next level of companies.

Frontier capital market 43 Nigerian Commodity Exchange

The Nigerian Commodity Exchange (NCX), formerly known as the Abuja Securities and Commodity Exchange, was originally incorporated in 1998 and became operational in 2000, with the objectives of ensuring price stabilization and risk mitigations for agriculture products. Most commodity exchange markets around the world specialize in trading agricultural products and other raw materials and contracts based on them, which include derivative products such as spots, forwards, futures and options. Due to a number of issues bordering on low capitalization and liquidity, as well as other operational challenges, NCX was not operational for many years. By 2018, the Bureau of Public Enterprises was already working on privatizing the exchange, with the Nigeria Sovereign Investment Authority (NSIA) injecting some capital for it to be operational. The African Commodities Exchange (AFEX)

AFEX Commodities Exchange Limited (AFEX), a sister company of East Africa Exchange (EAX), was founded in Nigeria in 2014 to establish a warehouse receipt system (WRS) and commodities exchange in Nigeria. AFEX Nigeria was licensed by the SEC in March 2015, under the Investments and Securities Act (ISA), 2007 as a commodities exchange. AFEX is currently operating some warehouses in Nigeria and trading in commodities such as white maize, ginger, paddy rice, soybeans and yellow maize. Other capital market operators

In addition to the stock exchanges, the current ecosystem of the Nigerian capital markets comprises other several key players, including the Ministry of Finance which supervised the SEC, the apex regulator, the issuers, clearing and settlement (the Central Securities Clearing System [CSCS]), custodians, trustees, registrars, brokers-dealers, investors and SROs. A detailed functional responsibility of the SEC is discussed in Chapter 6 on securities regulations and laws. Issuers are entities incorporated under the Company and Allied Matters Act (CAMA, 2004), the country’s company law. Other entities that can issue securities in the primary capital markets are bodies corporate under special acts of the national or state assemblies. The federal government and state governments can also issue securities in the capital market. The issuing houses play key roles in the primary market as they manage overall transactions in issuing various securities for investment, preparing offer timetables and ensuring adherence to them and liaising with other relevant parties to obtain necessary information and documents to be filed with the SEC. Issuers market and distribute offer documents, prepare and file allotment proposal and ensure compliance with rules and regulations. There are 59 issuing houses registered by the SEC as of 2017.

44  Frontier markets’ environment

Brokers-dealers bring issuers to the primary market by preparing and filing listing applications at the NSE; assisting with pricing, marketing and distributing the offers; and acting as receiving agent. They execute securities trades on behalf of clients in the secondary market.There are 164 licensed broker-dealers, 38 brokers, and 2 dealers registered by the SEC as of March 2018. Investors – retail and institutional – provide funds for long-term investment by buying issued securities. Institutional investors include mutual funds, pension funds, and asset managers. They can be domestic and foreign investors. Trustees are engaged for debt issues and investment trusts and ensure adherence to the trust deeds. In the secondary markets, they hold assets in trust. The functions that are performed by the Trustees include protecting the interests of the securities holders, ensuring that the assets of the issuers are sufficient for discharging their obligations and ensuring that the issuer abides by the provisions of the trust deed. There are 28 trustees registered by the SEC and under the Trustee Investment Act of 1961. Custodians provide custodial services relating to safekeeping and maintaining of securities for clients and collecting benefits or rights accruing to clients with respect to their securities. There are six custodians registered by the SEC and under the ISA of 2007. Registrars maintain records of registered company shareholders in the secondary markets. In the primary markets, registrars receive all applications forms and reconcile the data on the forms with the application monies. They prepare the allotment schedule and forward it to the issuing house. There are 18 registrars licensed by the SEC and under the ISA of 2007. Reporting accountants and auditors prepare the issuer’s financial statements in accordance with the applicable financial and accounting standards and requirements of the NSE, the SEC and the Financial Reporting Council of Nigeria. Rating Agencies provide independent assessments of specific securities issued by issuers as well as the companies themselves. They provide quantitative and qualitative appraisals of issuers to ascertain their ability to meet their obligations to investors.The three global rating agencies are Standards & Poor, Moody’s and Fitch. In Nigeria, there are two key well-established rating agencies: Agusto and Global Credit Ratings (GCR). Capital market solicitors are SEC-registered law firms that play crucial roles in the capital market, including providing legal advisory on transactions and ensuring effective documentation and proper perfection (Obianwu, 2014).The equity issuer’s legal counsel would, for example, advises on various legal aspects of preparing for listing and ensuring that necessary changes to the issuer’s authorized share capital and constitutional documents are duly implemented. The solicitor will review all offerings and transactions documents, assist with ensuring compliance with regulatory requirements and assist with obtaining all regulatory approvals and negotiating all transaction documentation on behalf of the issuer.

Frontier capital market 45

The Capital Market Committee (CMC) provides a platform for the exchange of ideas among market participants, operators and stakeholders on how to improve the market activities and regulation. It is an industry-wide committee comprising members of the commission, representatives of capital market operators and trade groups and other stakeholders. The CMC meets quarterly to deliberate on various issues affecting the market and other policy matters. Other participants in the capital markets include receiving banks and receiving agents.

Nigeria’s capital market size and efficiency Market size and trends

By the end of the fourth quarter of 2018, the market capitalization was at ₦22.3 trillion ($61.5 billion). Equities of the 178 listed companies accounted for 53.5 percent ($33 billion) of aggregate market capitalization, while debt accounted for 46.48 percent, with exchange traded funds (ETFs) accounting for only 0.02 percent (Table 3.2). The number of listed companies represents only 0.006 percent of the total 2.3 million registered companies in Nigeria. Large-cap companies, with more than ₦1 billion in capitalization accounted for two-thirds of the total equity market capitalization, mid-cap companies with between $150 million and $1 billion accounted for a fifth of the total equity market capitalization, while small-cap companies accounted for nearly 10 percent of the total equity market capitalization. Figure 3.1 shows the long-term trend of over two decades for the allshare index of the NSE, which reached its peak at 61,199 in 2008, before the global financial crisis. A decade later, the all-share index has been halved to 31,430 by December 31, 2018. The medium-term 5-year trend of the NSE is shown in Table 3.3. The all-share index fell by a third between 2103 and 2016, Table 3.2 Listed securities on the NSE, December 2018 Listed securities

Number listed

Category Equities Premium Main AseM ETFs FGN bonds Corporate bonds State bonds Supranational Total

7 153 9 9 61 22 23 2 288

Source: Nigerian Stock Exchange (2018).

Market capitalization (%) Naira (billion)

US dollars (billion)

5,574 6,388 7,6 5,9 9,479 274 606 13 22,349

15.3 24.9 17.5 28.5 0.02 0.03 0.01 0.02 26.1 42.5 0.75 1.2 1.7 2.8 0.4 0.06 61.44 100

Source: NSE (various years).

Figure 3.1 Nigeria: long-term trends of the all-share index, 1996–2018

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Frontier capital market 47 Table 3.3 Medium-term trends of the all-share index, 2013–2018 All-Share Index

Market capitalization ₦ (trillion) $ (billion) Value traded ₦ (billion) $ (billion) Volume (billion) Average daily turnover Volume (million) Value ₦ (billion) Value $ (million) Listed securities Companies Equities Bonds Exchange Traded Products (ETPs) Exchange rates

2013

2015

2016

2017

2018

41,239

28,643

26,874

38,243

31,430

19 119

17 85

16 51

23 64

22 60

1,040 7 107

957 5 93

575 4 96

1,271 3.5 100

1,202 3.3 101

426 4 26

375 5 20

406 2 7

407 5.1 14

409 4.8 13

190 198 55 1

184 190 60 4

167 175 64 7

167 172 85 8

164 169 108 9

160

199

315

360

364

Source: NSE (various years).

before recovering by 42 percent to 38,243 in 2017. The all-share index fell by 17.8 percent in 2018. Market capitalization of the NSE in naira mirrored the performance of the all share index. The market capitalization in US dollar terms fell consistently between 2013 and 2016, recovered by a quarter in 2017. Overall, the US dollar market capitalization shows a 46 percent decline over 5 years, with $120 billion in 2013 to $64 billion in 2017. The performance of the market capitalization in US dollar terms was due to three key factors. First, there was a surge of foreign portfolio inflows between 2013 and 2014 and corresponding outflows between 2015 and 2016. Second, the market performance reflected the economic downturn and falling oil prices between 2015 and 2016. The third factor was the devaluation of the naira from 160 to the dollar in 2013 to 360 to the dollar in 2017. Market efficiency

The efficiency of a capital market in the financial intermediation process can be viewed from three different interdependent perspectives – informational efficiency, transactional efficiency and transformational/allocational efficiency (Bauer, 2012).

48  Frontier markets’ environment Transformational and allocational efficiency

In the context of an FM, transformational efficiency measures the depth of the stock market. It is essential in relating the gap between the market and the economy as the capital market may not capture the underlying structure of the economy. The capital market transformational efficiency in Nigeria is relatively low. The NSE is Africa’s largest FM but the second largest on the continent after JSE. The market capitalization of the NSE is below 10 percent of GDP, compared to 320 percent for JSE, 130 percent for the US NYSE and more than 6,000 percent for Hong Kong (WFE, 2018a). The allocational efficiency ensures that firms and sectors with profitable investment opportunities are able to fund their projects at reasonable costs, thereby creating the conditions for economic growth (Bauer, 2012). In this context, the current sectoral structure of the equity market does not reflect the underlying structure of the Nigerian economy. Three sectors – financials, industrials and consumer goods – account for 90 percent of the equity market in value terms while contributing only 30 percent to the GDP (Table 3.4). The dominant real sectors of the economy – agriculture, oil and gas, services, real estate and construction and ICT – which together contribute 70 percent to GDP represent less than 10 percent of the equity market. In particular, financial services, which represent a third of the equity market value, contributes only 3 percent to GDP. The industrial sector, with about 9 percent of the GDP, represents nearly a third of the equity market. In essence, two sectors that account for only 12 percent of the economy represent twothirds of the equity market value (Table 3.4). Agriculture, the largest contributor to the economy with a quarter of the GDP, accounts for 1.2 percent of equity market value. The oil and gas sector that provides 90 percent of Nigeria’s foreign exchange earnings and contributes 10 percent of GDP represents 5 percent of the total equity market value. ICT, Table 3.4 Economy-market gap analysis Sector

Percentage of GDP

Percentage of equity capitalization

Market Cap Agriculture Construction/Real Estate Consumer Goods Financial Services ICT Industrials Oil and Gas Services/Others Total

25.52 11.07 16.45 2.63 8.87 10.01 10.55 14.90 100.0

1.2 0.6 25.0 33.2 0.23 33.3 5.2 1.5 100.0

Source: NBS (2018) and NSE (2018).

Frontier capital market 49

construction and real estate are also under-represented in the equity market value compared to their relative contributions to the economy. As a result, the equity market has not fully captured the sectoral and structural dynamics of the Nigerian economy. The market’s microstructure includes the transactional and informational efficiency and mechanisms that facilitate financial intermediation (Levy and Post, 2005). There are several features of the market’s microstructure, including the type and sophistication of product offerings. Products available in the Nigerian capital markets are dominated by equity shares of companies, with 178 out of a total of 288 (62 percent), and federal government bonds and TBs at 61 (21 percent). State bonds products were at 23 (8 percent). There are some limited corporate bonds products at 22, representing 7.6 percent of the market products (Table 3.2). There are only nine ETF products, four real estate investment trusts (REITs) and no capital market derivatives, but the NSE is working on its rules to commence derivatives. FMDQ provides platforms for FX derivatives. The 74 registered mutual funds in Nigeria have total net asset value (NAV) of ₦551.7 billion ($1.7 billion) in April 2018, a fourfold increase over the last 5 years. However, it is small in relative terms. It is indeed 10 times lower than the portfolio net assets value of Magellan Mutual Fund, the flagship fund of Fidelity, one of the top mutual fund companies in the United States, which stood at $17.5 billion at the end of May 2018.4 Transactional efficiency

Transactional efficiency can be further gauged by the available liquidity and the cost and ease with which transactions are carried out in the capital market. The level of liquidity can be measured as the ease with which securities can be bought or sold without a delay and without an impact on the prices. Nigeria is significantly less liquid than most developed capital markets: 1,500 times less liquid than NYSE and 20 times less liquid than the JSE. The average trading value of NSE is $2.2 billion in 2017. The trading volumes on NYSE and JSE are 1,700 times and 24 times higher than the trading volumes on NSE respectively. Turnover ratio is 10 percent compared to 61 percent in JSE, 115 percent in NYSE, and 180 percent in China (WFE, 2018a). Within the Nigerian capital market assets, FGN bonds are large and more liquid than states and corporate bonds. Stocks of large blue-chip companies like Dangote, Nigerian Breweries, GT Bank and First Bank Holdings are liquid and have market breadth and depth because they are actively traded and their prices are not significantly impacted by a small trading order. On the other hand, the market for small companies with few shares outstanding are thin, shallow and not considered liquid as one or two big orders can move the share price up or down sharply. In January 2018, the NSE commenced the amended rules on par value and pricing, which specify revised minimum par value, share price bands, price

50  Frontier markets’ environment

movements, tick sizes and price limits, aimed at improving liquidity, narrowing spreads and ensuring that price movements are material leading to a more efficient market.Thus, a stock can now trade at a minimum price of 1 kobo per share as against 50 kobo hitherto. This is expected to create liquidity for stocks that have stayed on 50 kobo per share for a long time but may have willing buyers at a lower price. The revised price band classifies shares into three groups (A, B, C). Group A consists of equities priced at ₦100 or above and a minimum of 10,000 units exchanged is required to move the price by 10 kobo. Group B consists of equities priced in the range of ₦5.00 and below ₦100, and a minimum of 50,000 units exchanged is required to move the price by 5 kobo. Group C consists of equities priced in the range of ₦0.01 and ₦5.00, and a minimum of 100,000 units exchanged is required to move price by 1 kobo. The price limit of +/–10 percent is, however, maintained for the three groups under the newly amended rule (NSE, 2018). The transaction costs are the cost of buying and selling securities consisting of brokerage commission, bid–ask spread, SEC fees, and other direct taxes. The brokerage commission covers order delivery and clearing. Nigeria’s capital market pricing is relatively uncompetitive with a transaction cost of about 1.73 percent (value-added tax [VAT] and trade alert exclusive) compared to 0.5 percent in South Africa, 0.25 percent in Brazil and 0.1 percent in India (WFE, 2018a). The execution quality, in terms of fill rate and execution speed, is essential.The NSE operates limit orders and market maker quotes at open auction that last up to 10:00 a.m. It operates limit orders, market orders and market maker quotes in continuous trading up to 2:30 p.m.5 Market maker quotes are then operated in closing auction. An investor who placed a market order is not guaranteed that his or her order will be executed on time. On the other hand, an investor who placed a limit order is not guaranteed that the order will be executed at all. In 1997, the trading platform of the NSE was transitioned from a manual clearing, delivery and settlement system to an electronic settlement system using a central depository operation under the CSCS. The adoption of information technology on the NSE was further deepened in 1999 when the open outcry and call-over or pit manual trading platform of market transactions execution was augmented to the automated trading system (ATS). The NSE has initiated several reforms to improve the operations of the Exchange (Box 3.1 and Box 3.2).

Connecting principles to practice Box 3.1 Some recent developments on the NSE • •

Transition to ATS – 1999 Trade alert scheme – 2005

Frontier capital market 51

• Partnership with Reuters and Bloomberg for publishing real-time data – 2009 • Phone-in telephone service to confirm stockholdings in the depository – 2011 • Direct delivery of real-time and delayed market data feeds – 2012 • Launching of new trading platform (X-gen) – 2013 • Launching of issuers’ portal (X-Issuer) – 2013 • Introduction of the smart trade app – 2015 • Launch Nasdaq SMARTS Trade Surveillance System – 2017 There are new developments; for instance, on July 2, 2018, NSE reviewed the equities market structure to improve liquidity and to offer benefits of best execution and tighter spreads to investors and lower cost of capital. This included (1) opening and closing auctions to be followed by imbalance sessions (where bids exceed offers and vice versa); these imbalance sessions allow market participants enter imbalance orders to address imbalances from the auction sessions; (2) the expansion of participants in the auction period to enhance fairness and competitiveness of the price setting mechanism; (3) the introduction of the size test condition in price determination during the auction period, as it currently applies during the continuous trading session; and (4) changes to the market price volatility mechanism such that daily Limit Up/Limit Down (LULD) price band is now based on a single reference price (i.e. the previous day’s close) to allow for a symmetric up-and-down limit of 10 percent throughout the trading day.

Connecting principles to practice Box 3.2  NSE strategic execution in 2017 Market development • • •

X-Academy: Launched as the NSE’s educational institute in June 2017 to empower financial market professionals in Africa. It has delivered eight programs to 1,279 participants to date. Competitive Pricing Structure: Continued phased implementation of SEC/NSE pricing recommendations Capacity-building events: Hosted the NSE’s inaugural sub-Saharan REITs conference, Green Bond Conference, Market Data Workshop and Derivatives Conference

52  Frontier markets’ environment

•

Stakeholder engagement: Ramped up engagement with key stakeholders (both public/private sectors and domestic/international) to promote market-friendly policies and drive the development of the capital market

Business development • • •

Product Launches: Collaborated with the DMO/FGN to launch the FGN savings bond and started work on building an enhanced mutual fund distribution platform Strategic Partnerships: Signed a memorandum of understanding (MoU) with the Casablanca Stock Exchange (CSE) to promote market integration, new listings and exchange of information MSCI Partnership: Progressed development of NSE/MSCI cobranded indices

Investor protection •

• • •

Corporate Governance Rating System (CGRS): Rolled out CGRS to all listed companies and constituted CGRS Steering Board to approve results of CGRS certification exercise (Q1 2018 announcement) Data Centre Upgrade: Completed a new Tier III–designed data centre E-Dividend Drive: Supported investors to process unclaimed dividends under the E-Dividend Registration Initiative, in partnership with the SEC Investor Protection Fund (IPF): Continued payouts by the IPF board of trustees for substantiated claims pursuant to the NSE IPF rules

Source: Onyema (2018).

Informational efficiency

Informational efficiency refers to the transparency and disclosure of information required to make an informed investment decision (Levy and Post, 2005). Informational efficiency is essential for price discovery. Price discovery in an efficient manner is an essential feature of a well-functioning securities market. With efficient price discovery, market prices for securities will adjust quickly to reflect all the available information about the securities. Inefficient price discovery arises from securities trading at prices that do not reflect their true value leading to overpricing or underpricing.

Frontier capital market 53

Investors should have transparent access to all information in respect of traded securities including prices, volumes, quoted prices, depths and execution quality. Most stock exchanges have listing requirements and enforcement rules6 to ensure that the basic features of the market’s microstructure are in place and respected by listed companies. For instance, the NSE Issuers’ Portal (X-Issuer), launched in 2013, makes it possible for investors to have timely access to companies’ filings of financial and other material information. Demutualization

Stock exchanges have evolved as self-regulated organizations, which are owned, controlled and regulated by their members. Demutualization is the separation of ownership from control and regulation of stock market operation. Demutualization is therefore the transitioning of stock exchanges into public limited companies and profit-making organizations. Over the last 10 years, demutualization of stock exchanges in the world has proceeded rapidly with more than 70 percent of members of the World Federation of Exchanges (WFE) already demutualized. Some of the leading stock exchanges that have demutualized include NYSE Euronext and NASDAQ OMX Group in the United States, Deutsche Bourse and the Athens Stock Exchange in Europe, the Singapore Stock Exchange and the Philippines Stock Exchange in Asia and the Johannesburg Stock Exchange and six other stock exchanges in Africa (Senbet and Otchere 2010; NSE 2018). The Nigerian SEC has issued guidelines on the demutualization. Furthermore, the Nigerian Stock Exchange Demutualization Bill, 2017, has been passed by the National Assembly and signed into law by the president. Demutualization helps stock exchanges to operate on a profit-model basis and provide an opportunity for accessing the capital markets to raise funds for its own infrastructure development. However, it has its own drawbacks. There are concerns about conflicts of interest and reconciling the public interest of appropriate regulatory functions of stock exchanges with the private profit business model (Christiansen and Koldertsova, 2009). A stock exchange operating on a profit-model basis may have listing standards in order to attract new listings and boost its revenues. This could compromise the independence of the stock exchange as a regulator. This concern over independence has been addressed in the United Kingdom. The Financial Services Authority took over the listing functions of the LSE once the latter was demutualized (Christiansen and Koldertsova, 2009).

Future directions In November 2015, the Nigerian SEC mapped out a 10-year plan (2015–2025) for the development of the Nigerian capital market (the Master Plan). It is anticipated that with the implementation of the Master Plan, the Nigerian capital market will be catalysed “to be Africa’s modern, efficient and internationally

54  Frontier markets’ environment

competitive market that catalyzes Nigeria’s emergence as a top 20 Global economy” (Securities and Exchange Commission, Nigeria, 2015). The core objective of the Master Plan was to map out strategies for the improvement of the Nigerian capital market in key areas, such as investor protection and education, professionalism and product innovation, and for the expansion of the capital market’s role in Nigeria’s economy. The strategies for achieving the objectives of the Master Plan include, first, driving capital raising to fund critical sectors of the economy, such as infrastructure, agriculture, small to medium-sized enterprises (SMEs) and solid minerals that will promote the sustainable transformation of the economy. The SEC intends to increase capitalization of the real sector of the economy, in particular the agriculture, real estate and construction, mining, commerce and services sectors. The SEC seeks to encourage companies in the real sector to list on stock exchanges as a minimum licence requirement.The SEC plans to engage the investment community to promote funding to these sectors through the capital markets. The second objective is to align the market structure, size and scale to the requirements of the economy. To increase market size and scale, the SEC plans to diversify available investment products and instruments to include non-interest capital market products, such as Islamic finance, with the goal of increasing noninterest finance contribution to a quarter of the total market capitalization.The issuance of Nigeria’s first sovereign Sukuk was carried out in 2017, with $1 billion raised. To improve the savings culture, the FGN savings bond was introduced in 2017 and was welcomed with enthusiasm by investors. The Green Bond was also issued in 2017. The third objective is to improve the competitiveness, efficiency and attractiveness of the capital market to both domestic and foreign investors. To make investment in the Nigerian capital market attractive to investors, capital market transaction prices must be competitive in comparison to other jurisdictions. Also, processes which eliminate delays in transaction processing must be put in place. Fourth, the SEC looks to create an enabling and facilitative legal and regulatory framework for deepening and developing of the capital market. The SEC has identified favourable regulatory frameworks and proper corporate governance initiatives which are required to facilitate an enabling environment. Several initiatives and efforts have been applied in implementing the Master Plan. Many of the recent achievements in the Nigerian capital market can be traced to the implementation of this plan. These include the exchange demutualization, direct cash settlement, e-dividend, complaint management framework, risk-based supervision, commodity ecosystem and non-interest finance and derivatives, among others.

Notes 1 NSE website. 2 FMDQ website.

Frontier capital market 55 3 4 5 6

NASD website. Fidelity Investments, https://fundresearch.fidelity.com/mutual-funds/summary/316184100. NSE Presentation. The listing rules for different products of the NSE are discussed in the respective chapters.

Bibliography Bauer, G.H. (2012), A Taxonomy of Market Efficiency, Financial System Review, https:// www.bankofcanada.ca/wp-content/uploads/2012/01/fsr-1204-bauer.pdf [Accessed July  2018]. Christiansen, H. and A. Koldertsova. (2009), The Role of Stock Exchanges in Corporate Governance. www.oecd.org/finance/financialmarkets/43169104.pdf Company and Allied Matters Act (CAMA). (2004) Emenuga, C. (1997), Development of Stock Markets in Sub-Saharan Africa, African Development Review, 9(1): 156–185 FMDQ. (2018), FMDQ Website IMF. (2013a), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Implementation of IOSCO Objectives and Principles of Securities Regulation, IMF Country Report No. 13/144 IMF. (2013b), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Compliance of the Basel Core Principles for Effective Banking Supervision, IMF Country Report No. 13/146 Kiyingi, S. and E. Uwaifo. (2015), Nigerian Capital Markets: Legal and Regulatory Review and Recommendations. The Nigeria-UK Capital Markets Project, A Collaborative Report of the Nigerian Capital Markets Solicitors Association, and Law Society of England  & Wales Laeven, L. (2014), The Development of Local Capital Markets: Rationale and Challenges. IMF Working Paper No 14/234 Levinson, M. (2014), Guide to Financial Markets, 6th edition. The Economist https:// media.economist.com/sites/default/files/pdfs/Guide_to_Financial_Markets_6e.pdf Levy, H. and Thierry Post. (2005), Investments. Essex, England: FT Prentice Hall LSE. (2015), Introduction to London Stock Exchange. www.lseg.com/sites/default/files/ content/documents/LSE%20Capital%20Markets%20brochure%202015.pdf Narayanaswamy, M., C. Blitzer and A. Carvajal. (2017), The Importance of Local Capital Markets for Financing Development. www.ifc.org/wps/wcm/connect/4155a5b3-c02a4b70-9027-82c78f452b12/EM+compass+Note+28+Capital+Markets+FINAL+126+FINAL2.pdf?MOD=AJPERES National Bureau of Statistics (NBS). (2018b), Nigeria’s Gross Domestic Product Statistics for H2 2018 Nigerian Stock Exchange. (2015), NSE Rules Book. www.nse.com.ng/regulation-site/ Documents/The%20NSE%20RuleBook%202015.pdf Nigerian Stock Exchange. (2018), Amended Par Value and Pricing Methodology Rules Now Effective Nigerian Stock Exchange. (Various Years), Annual Reports Nigerian Stock Exchange (2018), Website. Obianwu, C. (2014), Role of Solicitors in Capital Market Transactions. www.templars-law. com/wp-content/uploads/2015/05/The-Role-of-Solicitors-in-Capital-MarketTransactions.pdf OECD. (2018), Equity Market Review, Asia 2017. www.oecd.org/daf/ca/OECD-EquityMarkets-Review-Asia-2017.pdf

56  Frontier markets’ environment Okoye, L.U., N.J. Modebe, J.N. Taiwo and U.E. Okorie. (2012), Impact of Capital Market Development on the Growth of the Nigerian Economy. Journal of Economics and Sustainable Development, 3(8). www.iiste.org Onyema, O. (2018), The Nigerian Stock Exchange: 2017 Market Recap and 2018 Outlook, January Scott, H. and M. King. (2004), Efficiency of Canadian Capital Market. www.bankofcanada. ca/wp-content/uploads/2010/06/hendry.pdf SEC. (2006), Nigeria’s Capital Market: Making World-Class Potential a Reality A Report of the Technical Committee of the International Organization of Securities Commissions: Regulatory Issues Arising from Exchange Evolution. www.iosco.org/library/pubdocs/ pdf/IOSCOPD225.pdf Securities and Exchange Commission. (2015), Nigerian Capital Market Master Plan 2015–2025 Senbet, L. and I. Otchere. (2010),Africa Stock Markets: Opportunities and Issues, in Quitntyn, M. and G.Verdier (ed.), Africa Finance in the 21st Century. New York: Palgrave-Macmillan and IMF Sivabalan, S. (2018), Bloomberg Magazine, 19 January. www.bloomberg.com/news/ articles/2018-01-19/frontier-markets-come-into-their-own-as-700-billion-asset-class World Bank. (2018), Global Financial Development Report 2017–2018 World Federation of Exchanges. (2018a), WFE Annual Statistics Guide 2017. www.worldexchanges.org/home/index.php/statistics/annual-statistics World Federation of Exchanges. (2018b), 2017 Full-Year Market Highlights Yartey, C.A. and C.K. Adjasi. (2007), Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges, IMF Working Paper, WP/07/029. www.imf.org/external/ pubs/ft/wp/2007/wp07209.pdf

Part II

Investment banking in frontier markets

4 Investment banking

Principles Traditional commercial banking revolves around indirect finance with deposits taking and loan making, hence they are often regarded as deposits money banks (DMBs). Investment banks are non-depository financial intermediaries. Unlike commercial banks, they do not take deposits directly from individuals. The licensing and regulation of both commercial and merchant banking are done by the central bank, which focused more on the money markets regulations. Merchant banking is a narrower term compared to investment banking, which implies significant fund-based exposure to the capital market (Pratap, 2008). Investment banks provide capital market advisory services to institutions, including companies and governments. As discussed in Chapter 1, investment banks as capital market operators in Nigeria are regulated primarily by the SEC of Nigeria. A typical global investment bank has three distinct functional areas: (1) the front office – client-facing, revenue-generating unit involved with interacting and creating products for clients (Box 4.1); roles such as traders, brokers, asset managers, researchers and so on fall under this category; (2) the middle office – risk management and compliance, which calculates transaction profits and losses; corporate treasury, financial control, corporate strategy; and (3) the back office – this is the engine room of the investment bank. Commonly referred to as the Operations unit, it includes roles such as clearing and settlement, human resources, operations and technology. Chapter 5 discusses risk management, while Chapter 6 focuses on regulations.

Connecting principles to practice Box 4.1  Client-facing activities at global investment banks The client-facing activities of the front office of a global investment bank are typically broken down into various key areas: investment banking

60  Investment banking in frontier markets

(IBD), global capital markets (GCM), markets (also called sales and trading), research and private wealth management (PWM) (Deutsche Bank, 2015; Duke, 2011). IBD undertakes capital raising for governments and companies by selling either equity or debt as well as financial advisory such as mergers and acquisition (M&A) advisory. IBD teams are organized along industry lines and focus on building relationships with clients in the industry groups. The GCM teams in IBD are product groups in debt capital markets, equity capital markets (ECM) and private equity placement. The product group teams are primarily focused on transactions. Relationship management in IBD and GCM involves client coverage and origination. The client coverage bankers act as a bridge between the client and product specialist to ensure client satisfaction is maintained. Senior managers also pitch their firm to potential clients in order to originate deals by winning mandates. IBD organizes a “roadshow” for corporate clients to visit institutional investors in order to raise capital for the clients. Analysts support senior managers by producing pitchbooks or marketing documents and supporting clients and Sales through the book-building phase, which developing a list of potential large acquirers of a new debt or equity issuance. The capital raising function is sometimes organized by large banks under global banking, which provides an integrated geographical, industry and products platform for delivering on equity and debt underwriting and private placement, M&A, project finance, real estate, corporate finance and transaction banking. Markets (often referred to as sales and trading, securities or global markets) is where trading of financial assets takes place. Securities subsidiaries and their sales traders act as market makers to facilitate client transactions in various equity, fixed income, and other products. Sales teams provide a critical link between the bank’s clients and the market based on relationship building. Investment management, especially for institutions and high net-worth families, depends crucially on not only market and products knowledge but also on networking and building long-term relationships with clients. Sales and distribution are more integrated across the subsidiaries as these functions are responsible for creating, positioning and selling various investment products that the investment bank has to offer.The sales team packages different investment products and explain how the products fit client needs and portfolios. Source: Deutsche Bank (2015) and Duke (2011)

Overall, investment banking is about providing financial services to clients. All services companies face the adage that no clients, no business and no business, no advisory. Investment banks serve sell-side clients including companies that want to raise equity capital for business expansion and governments that want to raise bonds for infrastructure projects. Investment banks also cater to

Investment banking 61 Table 4.1 Investment banking business Primary markets

Secondary markets

Raising capital • Equity Underwriting • Bond Underwriting • Private Placement • Private Equity • Venture Capital Deploying capital • Financial Advisory • Mergers & Acquisitions • Corporate Restructuring • Real Estate Finance/REITs • Infrastructure and Project Finance

Trading capital • Securities Trading • Broker/Dealer • Market Maker • Sales and Distribution • Research and Analysis Managing capital • Asset Management • Mutual Funds/ETFs • Private Wealth • Pensions Management • Trusteeship

buy-side clients, especially institutional and high net-worth investors, endowment, foundations, insurance companies and pension managers. Investment banking activities involve multifaceted functions. Primary investment banking service offerings include a wide range of services such as underwriting, mergers and acquisitions (M&A) advisory, sales and trading, equity research and asset management. These services can further be divided into four distinct categories: capital raising, financial advisory, capital markets securities sales and trading and capital management activities.

Investment banking and primary capital markets Raising capital

A core investment banking function is to act as an intermediary between potential investors and those who seek capital. Investment banks raise funds in the primary capital markets as underwriting and issuing agents and through private placements, private equity (PE) and venture capital. Investment banks act as intermediaries between investors and governments or companies who try to raise bonds and equity in the capital markets. Investment banks provide underwriting services by purchasing securities from the issuers with the objective of reselling them to investors in the financial markets. Deploying capital

Investment banking involves identifying capital opportunities, negotiating and structuring capital deals and executing financial transactions. Investment banks also participate in principal investing, raising capital for real estate and infrastructure projects. Investment banks provide financial advisory services by assisting firms with corporate restructuring, as well as M&A activities. M&A, real estate finance and project and infrastructure finance are discussed in Part III.

62  Investment banking in frontier markets

Investment banking and secondary capital markets Trading capital

Investment banks provide capital market services such as trading of listed equity securities, fixed income instruments, FX and commodities. Investors participate in capital markets for different reasons. Short-term investors deal to make quick returns from the markets, while long-term investors buy and hold securities to achieve a return over a longer period.1 Other investors are interested in trading as a financial risk management tool. Sales, trading and structuring are the principal capital market functions of investment banks. The sales team in investment banks offer financial opportunities and products generated by the research team to clients while liaising with the trading team.The trading team executes the actual buying and selling of financial securities with the objective of earning decent profits from each trade. The structuring team provides more complex OTC financial instruments to clients (Duke, 2011). Equity instruments of companies are traded on listed exchanges and OTC. Debt or fixed income instruments of governments, companies and institutions are traded for regular interest payments that are received before the instrument matures and the debt is repaid. Investment banks also trade in currency and commodity markets on a daily basis for clients and for their proprietary portfolios. Managing capital

Capital management in investment banking involves managing funds for investors – institutional, high net-worth individuals (HNWIs) and retail investors. Asset management functions of an investment bank convert clients’ funds into other financial instruments such as equity, bonds, derivatives and alternative asset instruments, such as real estate and hedge funds, with the goals of capital preservation, high returns and growth. Investment bankers manage funds for institutional investors such as pension funds, companies, insurance companies, foundations and HNWIs, who often invest assets for the long term. Investment banks manage funds for individuals, often through mutual funds and financial products tailored to the needs of retail investors. Investment portfolio managers are responsible for the management, asset allocation and performance of different fund types. Investment banks provide allied businesses including trusteeship, custodian and registrar services. Part IV of the book covers asset management, pension management and allied businesses.

Practice Global budge bracket

The global bulge bracket investment banks are the world’s largest financial investment banking firms. The top 10 bulge bracket investment banks in

Investment banking 63

alphabetical order are Bank of America’s Merrill Lynch, Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, UBS and HSBC (Bloomberg, 2018). These are large multinational banks that facilitate global capital markets (GCMs), capital raising and asset management for large companies, governments, institutions and wealthy individuals across the globe. The bulge bracket terminology comes from the first group of investment banks listed on the “tombstone,” or print advertisement and public notification of a financial transaction prospectus (Liaw, 2006). The bulge bracket is usually the bookrunning manager, or the bank that controls the allocation of securities to investors. It is listed in larger print above all others and on the prospectus cover.Within the bulge bracket banks, there are financial holding companies or universal banks – Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan Chase, UBS and HSBC. Full-service global investment banks include Goldman Sachs and Morgan Stanley. Global bulge bracket investment banks typically provide both financing and advisory banking services. They are also involved in market making, sales and research for equities, FX, commodities and derivatives. They are active in fixed income markets and are primary US Treasury dealers. They have been actively involved in financial product innovations, such as mortgage-backed securities, carbon emission trading, credit default swaps and insurance products.2 In short, they provide both buy-side and sell-side services in capital markets, capital raising and capital management. Revenue numbers, global reach, employee headcount, income and products and services breadth are often used to rank the investment banks (Equity Research, 2018). For most of these criteria, American banks dominate the bulge bracket accounting for 5 of the 10 top global investment banks. JPMorgan Chase had ₦2.5 trillion in assets and reported net revenues of $99 billion for fiscal year (FY) 2017, of which investment banking revenue contributed $34.5 billion (JP Morgan, 2018). JPMorgan is ranked number 1 in global investment banking fees with 8 percent share of worldwide fees. J.P. Morgan ranks first or second globally across all product areas and strong across markets in the United States and in Europe, the Middle East and Africa (EMEA). Goldman Sachs reported net revenues of $32.07 billion for FY 2017, of which the investment banking division contributed $7.37 billion (Goldman Sachs, 2018). The revenue generated in the investment banking division was the highest among all divisions. Bank of America, which bought Merrill Lynch, has a total net income of $18.23 billion in FY 2017, the investment banking division contributed $6.9 billion (Bank of America, 2018). Morgan Stanley reported net revenue of $37.9 billion in FY 2017, of which the investment banking segment contributed $1.4 billion (Morgan Stanley, 2018). Citigroup with businesses and operations in 160 countries reported total revenues of $71.4 billion reported for 2017, with contributions from investment banking of $5.17 billion in FY 2017 (Citigroup, 2018). The Tier 2 investment banks are mainly European banks: Deutsche, Barclays, Credit Suisse, HSBC and UBS, although HSBC is strongest in Asia. Deutsche

64  Investment banking in frontier markets

Bank leads the European investment banks’ league, and it is second globally for credit and securitization trading while remaining in third position globally for credit trading. It ranks in the top four for G10 rates, emerging markets macro and prime services and it’s in the top nine for most other products (Bloomberg, 2018). Barclays’ investment bank has a strong presence in the UK and US markets. The big bang in financial services in the United Kingdom gave birth to Barclays Capital in 1985. Barclays capital presence in the United States was boosted by its acquisition of Lehman Brothers in 2008. Barclays reported a total income of £21.5 billion, with £10.5 billion attributed to the investment banking segment (Barclays, 2018). The two Swiss banks – Credit Suisse and UBS – are strong in assets management. Beyond the first- and second-tier banks, there are also regional, niche and boutique investment banks. These banks are strong in their regional and home markets. BNP Paribas and SocGen are strong in France and Europe, Nomura in Asia, Wells Fargo (US) and RBC (Canada) in the Americas (equity research) and Standard Chartered in emerging markets of Asia and Africa. In addition, there are elite boutiques and industry-specific boutiques: elite boutiques (EBs) – Evercore, Lazard, Greenhill and Rothschild; industry-specific boutiques (ISBs) – Cain (health care), KBW (Financial Services), Marlin & Associates (Technology); and many others. History of investment banking in Nigeria

Formal merchant banking licences were granted to two banks in 1960 – Nigerian Acceptance and the Philip Hills (Nigeria) Limited. Both banks merged in 1969 to form Nigerian Acceptances Limited (NAL), later renamed NAL Merchant Bank Limited. The 1970s and 1980s witnessed the emergence of IMB, CSL, Abacus, Nationwide and FBN Merchant Bank. By 1984, there were 15 merchant banks in the country. In the 1990s, a new generation of investment banks, including IBTC, Afriinvest and FCMB, began to dominate the investment banking landscape. Most of the merchant banks were merged and acquired in the banking consolidation exercise of 2005. First City Merchant Bank Limited, which was established in 1982, was transformed into FCMB, a financial services holdings company with a significant capital market and investment banking arm. Five principal factors have contributed to the growth of investment banking in Nigeria. First, government indigenization program of the 1970s led to the listing of big oil companies such as Mobil and Total, as well as IPOs of other companies, including the Daily Times and Nigerian Bottling Company. Second, the privatization of government parastatals in the 1990s induced a wave of business activities for investment banks. Third, the wireless communication revolution led to the entry of new telecommunication companies such as Econet wireless and MTN into Nigeria, requiring financial advisory services from investment banks. Fourth, the pension reforms, the banking consolidation

Investment banking 65

and the insurance consolidation exercise provided opportunities in the form of M&A and capital raising for investment banks. Fifth, the pension reform has been a catalyst for the asset management businesses of investment banks. Nigeria’s bulge bracket

The functional activities of the front office are performed separately in Nigeria using subsidiaries. The typical subsidiaries will include investment banking, asset management, securities and brokerage, pension and trustees. In Nigeria, the activities of IBD and GCM are typically under one subsidiary – often called capital or investment banking. There is a universe of more than 1,000 firms3 licensed by the SEC of Nigeria as capital market operators providing one type of services or the other. Among these firms, there are about key 20 operators with the brand, size, scale, products, services and business verticals that can be described as among the top investment banking institutions in Nigeria. These firms in alphabetical order are Afrinvest (West Africa) Limited, Asset and Resources Management Company, Cardinal Stone, Chapel-Hill Denham Management Limited (DENHAM), Cordros Capital Limited, Coronation Merchant Bank, Ecobank Development Corporation (EDC), FBN Quest, Fidelity Capital, FCMB, FSDH Merchant bank Limited, Greenwich Trust Limited, Investment One Financial Services, Lotus Capital, Meristem Securities, Morgan Capital, Vetiva Capital Management, SFS Financial Services, Stanbic IBTC, United Capital PLC and Zenith Capital Limited. The previously firms highlighted can be further categorized as investment banks operating under a financial holdings company (UB) structure, investment banks affiliated with major commercial banks, merchant bank licensed by the CBN and stand-alone full-service investment banks. There are also boutique investment banks specializing in particular products and services of investment banking. Table 4.2 presents the types of investment banks in Nigeria. Table 4.2 Types of investment banks in Nigeria Financial holding companies • First Bank of Nigeria (FBNH) • First City Monument Bank (FCMB) • Stanbic IBTC Merchant bank • Coronation • FSDH • RMB • NOVA

Divested/affiliated • Investment One • SFS Financial Group • United Capital • Zenith Capital

Independent full service • ARM • Afrinvest • Chapel-Hill Denham • Vetiva

Small/boutique • Cordros Capital • Greenwich • Lotus Capital • Meristem

Foreign firms • Citibank • Standard Chartered • Renaissance Bank • Exotix Capital • Barclays Capital

Note: FBN Merchant Bank has a merchant banking licence. It is under the umbrella of FBN Quest, which is part of FBNH.

66  Investment banking in frontier markets Financial holdings company (UB) structure

The UB system is the conglomeration of banking and financial services under one institution. As a one-stop shop, it provides a wide range of financial services such as retail and commercial banking and wholesale investment banking, and insurance activities. Nigeria adopted UB in 2001. In 2005, the banking consolidation exercise reduced the number of banks from 89 to 24 and several investment banks with licences from the CBN were forced to merge with larger commercial banks to form universal banks. In 2010, the CBN issued Regulation 3 (Scope of Banking Activities and Ancillary Matters, No. 3, 2010), which required banks to divest from non-banking businesses or adopt a hold-co structure.As a result, some banks divested their investment banks segments, while others consolidated into financial holdings companies. Table 4.3 Financial services holding companies FIRMS/BUSINESS/ SUBSIDIARIES

FBN Holdings Assets, ₦5.2 trillion

FCMB Holdings, ₦1.18 trillion

Stanbic IBTC Holdings, ₦1.39 trillion

COMMERCIAL BANKING1

FCMB ₦1.16 Trillion Retail Banking Commercial Banking Corporate Banking Institutional

INVESTMENT BANKING FINANCIAL ADVISORY

Commercial Banking Assets: ₦4.96 Trillion FBN Nigeria FBN Others2 FBN Mortgages FBN Pension Custodian FBN Merchant Bank FBN Capital FBN Capital Partners

ASSET MANAGEMENT PENSION STOCKBROKING

FBN Asset Management FBN Funds FBN Securities

FCMB Trustees CSL Stockbrokers Legacy Pensions

INSURANCE

FBN Insurance General Insurance Insurance Brokers

Stanbic IBTC Bank ₦227 Billion Retail Banking Commercial Banking Corporate Banking Institutional Stanbic IBTC Capital Stanbic IBTC Ventures Stanbic IBTC Investments Stanbic IBTC Asset Management Stanbic IBTC Pension Stanbic IBTC Stock Brokers Stanbic IBTC Trustees Stanbic IBTC Nominees Stanbic IBTC Insurance

FCMB Capital

Source: FBN (2018), FCMB (2018), and Stanbic-IBTC (2018). 1 Encompasses commercial banking, institutional banking, corporate banking and retail banking. 2 First Bank of Nigeria Limited, FBNBank (UK) Limited FBNBank DRC Limited, FBNBank Ghana Limited, FBNBank The Gambia Limited, FBNBank Guinea Limited, FBNBank Sierra Leone Limited and FBNBank Senegal Limited.

Investment banking 67

There are three top elite investment banks that are part of a UB under a financial holding company structure: FBN Holdings, FCMB and Stanbic IBTC. These three banks regulated by CBN took different routes to the top of Nigeria’s investment banking league. FBN Holdings

FBN Holdings PLC is a financial holding company incorporated in Nigeria on 14 October 2010; however, its origin dates to 1894. The company is listed on the NSE under the ‘Other financial services’ sector and is structured along the following business groups, namely commercial banking, merchant banking and asset management, insurance and others. The commercial banking business comprises First Bank of Nigeria Limited, FBNBank (UK) Limited, FBNBank DRC Limited, FBNBank Ghana Limited, FBNBank The Gambia Limited, FBNBank Guinea Limited, FBNBank Sierra Leone Limited, FBNBank Senegal Limited, First Pension Custodian Nigeria Limited and FBN Mortgages Limited. First Bank of Nigeria Limited is the lead entity of the commercial banking business. The merchant banking and asset management business comprises FBNQuest Merchant Bank Limited, FBNQuest Capital Limited, FBNQuest Asset Management Limited, FBNQuest Securities Limited, FBNQuest Trustees Limited, FBNQuest Funds Limited and FBNQuest Capital Partners Limited. FBNQuest Merchant Bank Limited is the lead entity of the merchant banking and asset management business. The Insurance business comprises FBN Insurance Limited, FBN General Insurance Limited and FBN Insurance Brokers Limited. FCMB

FCMB Group PLC has its roots in investment banking dating back to 1977, with the formation of City Securities Limited (CSL), a stockbroking and issuing house and registrar business (FCMB, 2018). First City Merchant Bank Limited was established in 1982 with seed capital from the success of CSL. It began operations as a licensed deposit taker and merchant bank on 11 August 1983. FCMB Limited soon became a leading merchant bank in Nigeria, as measured by profitability, and, with the advent of UB in 2001, First City Merchant Bank Limited converted into a universal bank. It changed its name to FCMB Limited and commenced commercial banking activities, while its corporate finance activities were spun off into a new subsidiary – FCMB Capital Markets Limited. As a result of the 2010 CBN regulation, the newly created FCMB Group PLC became the holding company, with FCMB Limited, CSL Stockbrokers Limited (CSLS) and FCMB Capital Markets Limited (FCMB-CM) as direct subsidiaries. FCMB Group PLC and its subsidiaries each function as separate and distinct operating companies with separate boards of directors and executives. FCMB Group PLC’s subsidiaries (FCMB, 2018) are FCMB Limited, FCMB Capital Markets Limited, CSL Stockbrokers Limited, CSL Trustees Limited and Legacy Pension.

68  Investment banking in frontier markets Stanbic IBTC

Stanbic IBTC Holdings is a full-service financial institution with roots in investment banking (Box 4.1). Stanbic IBTC was incorporated as Investment Banking and Trust Company Limited (IBTC), a private limited liability company in 1989, with a merchant banking licence which was converted to a UB licence in 2002, and became listed on the NSE in 2005. IBTC merged with Chartered Bank PLC and Regent Bank PLC and changed its name to IBTC Chartered Bank PLC (IBTC Chartered) in 2006 (Stanbic IBTC, 2018). In 2007, IBTC Chartered merged with Stanbic Bank Nigeria Limited (Stanbic Bank), a wholly owned subsidiary of Stanbic Africa Holdings Limited (SAHL), which, in turn, is a subsidiary of Standard Bank Group Limited of South Africa. SAHL acquired a majority shareholding (52.8 percent) in the enlarged bank, which was named Stanbic IBTC Bank PLC. In 2012, Stanbic IBTC officially adopted a holding company structure, providing end-to-end financial solutions which include corporate and investment banking, personal and business banking, stockbroking and wealth management. Under the new structure, the subsidiaries of Stanbic IBTC Holdings PLC are Stanbic IBTC Bank, Stanbic IBTC Capital Limited (Stanbic IBTC Capital), Stanbic IBTC Asset Management, Stanbic IBTC Pension Managers Limited, Stanbic IBTC Trustees, and Stanbic IBTC Nominees. Other subsidiaries are Stanbic IBTC Stockbrokers Limited, Stanbic IBTC Insurance Brokers Limited, Stanbic IBTC Ventures Limited and Stanbic IBTC Investments Ltd.

Connecting principles to practice Box 4.2  Stanbic IBTC and its investment banking franchise Stanbic IBTC is one of the largest full-service investment banks under a financial holding company in Nigeria, which leverages its roots in investment banking, retail branch network and affiliation with the Standard Bank Group Limited of South Africa. It is present in equity and debt capital raising, M&A, financial advisory, asset management, pension management, trusteeship and securities brokerage. Its subsidiaries rank first in mutual fund management, pension management and securities brokerage. Stanbic IBTC Asset Management Limited has a commanding share of 45 percent of mutual fund assets under management in Nigeria. Stanbic IBTC money market fund is the largest fund in Nigeria, with 38.5 percent of the value of total mutual funds and 53 percent of total money market funds. Stanbic IBTC Stockbrokers Limited has, over a period of 10 years, ranked first and accounted for a fifth of the volume and value of securities traded on the NSE.

Investment banking 69

Stanbic IBTC pension managers, who had a quarter of the retirement savings accounts (RSA), accounted for more than one-third (37 percent) of the total pension assets under management (AUM), nearly the same as the AUM of the next six pension fund administrators. Stanbic IBTC Pension Managers Limited has over 1,654,000 registered clients and is managing Nigeria’s largest RSA fund with total AUM worth over ₦2.5 trillion.The company pays out more than ₦2.1 billion to more than 37,000 retirees monthly. The pension managers company is a joint venture between Stanbic IBTC Holdings PLC and Linkage Assurance PLC. Stanbic IBTC Pension Managers Limited is 88.24 percent owned and managed by the Stanbic IBTC Group. Source: PENCOM Annual Report, 2016; NSE (2018); Stanbic IBTC (2018).

Divested/affiliated investment banks

While FBNH, FCMB and Stanbic IBTC opted for a financial holding structure integrating their investment banking services, other large banks in Nigeria chose to divest their investment banking arms. Investment One divested from GTB, SFS Financial Services was divested from Skye Bank; United Capital divested from UBA; and Zenith Capital divested from Zenith Bank (Table 4.4). Table 4.4 Divested/affiliated investment banking firms FIRMS/BUSINESS & SUBSIDIARIES

Investment One Financial Services

SFS Financial Services

United Capital Group

INVESTMENT BANKING

Capital Markets Investment One Vencap Limited:

SFS Financial

ASSET MANAGEMENT PENSION STOCK BROKING

Investment One Stockbrokers Int’l Limited, Investment One Pension Managers, Investment One Funds Management Limited

SFS Capital

Investment Banking Capital Markets, Financial Advisory United Capital Asset Management United Capital Securities, United Capital Trustees.

INSURANCE INFRASTRUCTURE/ PROJECT/REAL ESTATE FINANCE

Union Homes REITs

Source: Investment One (2018), SFS (2018), United Capital (2018).

70  Investment banking in frontier markets Investment one financial services

Founded in 2007, Investment One (then GTB Asset Management Limited) commenced business in 2008 (Investment One, 2018). Investment One Financial Services Limited is registered as an issuing house and financial adviser. Its capital management division provides specialized investment banking and financial advisory services to clients. Its services include equity and debt capital raising, M&A advisory, real estate financing and project and infrastructure financing. Other subsidiaries include Investment One Stockbrokers Int’l Limited, Investment One Pension Managers, Investment One Funds Management Limited and Investment One Vencap Limited. SFS Financial Services

SFS Financial Services Group (SFS Group) is a product of a management buyout of Skye Financial Services Limited, which operated as the investment banking and investment management subsidiary of Skye Bank PLC (SFS, 2018).The divestment followed the CBN directive for commercial banks to divest their non-banking subsidiaries. Furthermore, following the SEC rules preventing asset management company from engaging in other activities, like being the issuing house, the investment management business of Skye Financial Services Limited was ‘carved out’ to form SFS Capital Nigeria Limited (SFS Capital). The SFS Group currently consists of two companies, called SFS Financial Services Limited (SFS Financial) and SFS Capital Nigeria Limited (SFS Capital). SFS Financial is the investment banking division of the SFS Group registered with the SEC of Nigeria as an issuing house/financial adviser. SFS Financial provides capital market advisory and capital raising services in Nigeria to over ₦1 trillion (SFS, 2018). It provides advice on a full range of transactions, including, M&A buy-side advisory, M&A sell-side advisory, company valuation, corporate sales and divestitures, corporate restructuring and recapitalization advisory. SFS Capital is the asset management division of the SFS Group. The company is duly registered as a portfolio/fund manager and investment adviser with the SEC. SFS Capital has AUM and advisory in excess of ₦100 billion (SFS, 2018), with a clientele that includes pension funds, institutional and HNWI clients, non-governmental organizations, endowment, state reserve funds and federal government parastatal funds. SFS Capital manages the second-largest REITs in Nigeria. United Capital PLC Group

United Capital PLC (UCAP) is an investment banking group affiliated with UBA, a bank with a presence in 25 African countries. UCAP was incorporated in Nigeria as a limited liability company in 2002. It became a public company when it was listed on the NSE in January 2013 (United Capital, 2018) after a successful spin-off from United Bank for Africa PLC, a commercial bank in Nigeria. UCAP is the first investment bank in Nigeria to be listed on the NSE.

Investment banking 71

UCAP has three subsidiaries, namely United Capital Trustees Limited, United Capital Asset Management Limited and United Capital Securities Limited. Investment banking business provides advisory services in project finance, capital markets, M&A and structured trade finance. In 2017 UCAP management successfully launched two new mutual funds; the United Capital Nigerian Eurobond (USD) Fund and United Capital Wealth for Women Fund, bringing the total number of its Mutual Funds to six. United Capital Securities is a dealing member of the NSE and is registered by the SEC as a broker/dealer. United Capital Trustees is the other subsidiary. Zenith Capital

Zenith Capital, an affiliate of Zenith Bank, one of the largest financial groups in Africa, is one of the leading investment banking and asset management firms in Nigeria. Its core investment banking business is centred on the key areas of advisory services and corporate finance. Zenith Assets Management Limited is its asset management arm. It manages SEC-registered funds; Zenith Equity Fund, Zenith Ethical Fund and Zenith Income Fund (Zenith, 2018). Zenith Securities Limited and Zenith Trustees Limited are the other subsidiaries.

Independent full-service investment banks Independent full-service investment banks are those institutions that grew organically, not as a result of regulatory-induced divestments (Table 4.5). Table 4.5 Independent full-service investment banking firms FIRMS & SUBSIDIARIES

ARM Holdings

INVESTMENT BANKING

ARM Financial Investment Capital Markets, Advisory Banking Financial ARM Capital Partners Chapel-Hill Advisory Denham Ghana

ARM Investment Manager, ARM Pension Managers Ltd ARM Securities Limited ARM Trustees Limited INSURANCE ARM Life Insurance INFRASTRUCTURE/ Mixta Africa Real PROJECT FINANCE Estate ARM Infrastructure Fund

ASSET MANAGEMENT PENSION STOCK BROKING

CHAPEL-HILL DENHAM

Investment Management Chapel-Hill Denham’s securities

Chapel-Hill Denham Infrastructure Fund

Source: ARM (2018), ChapelHill- Denham (2018), and Vetiva (2018).

VETIVA

Vetiva Fund Managers Limited Vetiva Securities Limited, Vetiva Trustees.

72  Investment banking in frontier markets Afrinvest

Afrinvest is an investment banking firm with a focus on West Africa and active in four principal areas: investment banking, securities trading, asset management and investment research (Afrinvest, 2018). Afrinvest is both a leading provider of research content on the Nigerian market and a leading adviser to bluechip companies across West Africa on M&A and international capital market transactions. It undertakes investment banking as Afrinvest Asset Management Limited and Securities Brokerage. ARM

Founded in 1994, Asset & Resource Management Company (ARM) Ltd is one of Nigeria’s largest non-bank financial services institutions. It is a diversified financial services firm with a primary interest in traditional asset management and alternative asset classes such as real estate and infrastructure through its private funds business. It has diversified businesses involving investment management, securities and financial advisory, trustees, life insurance, PE, real estate and infrastructure financing. The ARM business is organized into two categories.The first category is the asset management business comprising ARM Investment Managers Limited, ARM Pension Managers (PFA) Ltd, ARM Securities Limited, ARM Trustees Limited, ARM Life, and ARM Financial Advisers. The second category is the funds business comprising Mixta Africa Real Estate, ARM Infrastructure Fund managers, ARM Agriculture and ARM Capital Partners, the PE fund manager (ARM, 2017). DENHAM

DENHAM emerged from the combination of Chapel Hill Advisory Partners Limited (Chapel Hill) and Denham Management Limited (Denham) in February 2008. DENHAM commenced business in July 1994 as a registered asset management and broker-dealer firm. Chapel Hill was founded in 2005 as a registered financial advisory firm. Its subsidiaries are in investment banking and investment management securities: DENHAM’s securities and ChapelHill Denham Ghana. Chapel-Hill Denham is recognized as one of the leading independent investment banking firms in Nigeria. The firm was adjudged Euromoney’s “Best Investment Bank in Nigeria,” for 2012, 2013, 2015 and 2016 and ‘Africa’s Best Bank for Advisory’ in 2016 (Chapel-Hill Denham, 2018). VETIVA

Vetiva Capital Management Limited (VCML) is an independent full-spectrum investment banking firm with significant experience in asset management and corporate advisory. The company was incorporated in September 2003 but

Investment banking 73

commenced operations in April 2004. It grew in prominence during the commercial bank consolidation era in Nigeria (2005–2006), playing a role in more than 40 percent of all M&A during the banking reforms. Since then, the company has made further strides in the market, acting as a financial adviser to the largest merger in the history of the Nigerian capital market and as an issuing house to the first Public Islamic Fund. Through its various subsidiaries, the company offers a full range of investment and advisory services spanning brokerage and dealing, asset and portfolio management, trust services, M&A and corporate advisory. Vetiva Fund Managers LTD (VFML) is one of the top asset managers in Nigeria, which provides holistic wealth management services to ultra-high net-worth clients and institutions. Vetiva Securities LTD (VSL) is registered by the SEC as a broker-dealer. The company provides equities and fixed income brokerage services to a diverse range of retail and institutional clientele. Vetiva Trustees Limited (VTL) is registered by the SEC to provide trustee services in the Nigerian capital market. In addition to private trust services, the company acts as corporate trustees to bond issuances, trust schemes, mutual funds and so on. VETIVA has eight registered ETFs, the largest number of ETFs in Nigeria, including 30 index, banking, consumer, industrial and sovereign bonds (Vetiva, 2018). After acting as the sponsoring broker and liquidity provider for the listing of the NewGold Exchange traded fund on the NSE, the first ETF in the Nigerian market, the company launched the Vetiva Griffin 30 ETF, the first equity-based ETF in the country. Subsequently, the company also launched the first fixed-income-linked ETF in the Nigerian market. Merchant banks

In 2010, the CBN issued the Scope, Conditions & Minimum Standards for Merchant Banks Regulations 2010 (the Regulation) to license and regulate merchant banks. Merchant banks are required to have a minimum paid-up share capital (minimum capital base) of ₦15 billion and are not allowed to accept cash deposits unless they are beyond ₦100 million (CBN, 2010). Merchant banks are permitted to act as underwriters, to act as issuing houses and to provide financial advisory services, asset management services, custodial services and debt factoring services. There are currently five registered merchant banks: Coronation Merchant Bank, RMB Merchant Bank, Nova Merchant Bank, FBN Merchant Bank and FSDH Merchant Bank. FSDH

First Securities Discount House (FSDH) Limited was incorporated in 1992 as the first discount house in Nigeria (FSDH, 2018). FSDH Limited became FSDH Merchant Bank Limited in 2012 following CBN authorization. Over the years, the FSDH Group has become a financial services supermarket that

74  Investment banking in frontier markets

delivers expert financial services in the Nigerian market to its select clientele, thereby assisting them in creating long-term, sustainable wealth. It has total assets of ₦151 billion and gross revenue of ₦20 billion. Its subsidiaries are in investment banking, FSDH Asset Management Limited and FSDH Securities Limited. Pensions Alliance Limited is a joint venture between FSDH Merchant Bank Limited – FSDH and African Alliance Insurance Company Limited.

Boutique IB Other medium-sized investment banks include Diamond Capital, Fidelity Capital, Cordros Capital, Cardinal Stone, Meristem, Lotus Capital, Lead Capital, Dunn Loren Merrifield, Kedari Capital and Greenwich Trust, which, like boutique investment banks, are strong in one or two areas of investment banking but do not have the scale, size and scope as the bulge bracket banks.

International banks There are three international banks that are active in executing investment banking functions with respect to international clients. These are Citibank Nigeria, Standard Chartered Bank and Renaissance Bank. Citibank Nigeria and Standard Chartered Bank Nigeria lead investment banking activities that involve cross-border engagements, including capital raising for corporations and governments in the global financial markets. Exotic Capital and Renaissance Bank are prominent in Africa’s FMs research and securities trading. Business strategy and financial performance

Financial holding companies such as FBNH, FCMB Group, and Stanbic IBTC Group have some advantages in their pursuit of investment banking business. They enjoy economies of scale and scope with funding and branch networks that enable them to play more actively as both buy and sell sides. For example, the funding base for FBNH is very strong with a low-cost deposit of 83 percent in FY 2017 and low funding cost of 3.1 percent in FY 2017, which supports improved margins (FBNH, 2018). Financial holding companies play critical roles in capital raising especially through equity underwriting and in funding mergers and acquisition as well as project finance. The financial holding structure enables these institutions to diversify their business portfolio such that investment banking, assets and pension management can leverage retail, commercial and corporate banking. They are able to use their brand names and branch networks as distribution channels for asset and pension products and services while reducing costs through a common and information technology network.

Investment banking 75

A common thread among the three financial services holding firms is that investment banking, asset management and pension business is more lucrative than the commercial banking business. The cost–income ratio for corporate and investment banking business at Stanbic is 33.2 percent compared to 99.9 percent in retail and commercial banking business (Stanbic IBTC, 2018). At FCMB, the return on equity for asset and wealth management at 31 percent is seven times that of the retail and commercial banking business, which is a paltry 4.5 percent (FCMB, 2018). Cost–income ratio is at 51 percent in asset management compared to 67.2 percent in commercial banking business. At FBNH, the return on equity for commercial banking business is 10 percent compared to 17 percent in merchant banking and asset management, and 38.8 percent in the insurance business. The FBN Holdings Group reported total assets of ₦5.2 trillion, a gross income of ₦595 billion and ₦56.8 billion profits before taxes in 2017 (FBNH, 2018). FBN Quest has a balance sheet of ₦217 billion, gross earnings of ₦39 billion, profit before taxes of ₦10.5 billion and a total AUM of ₦245 billion (Table 4.3). The FCMB Holdings Group reported total assets of ₦1.18 trillion, a gross income of ₦170 billion and ₦11.5 billion profits before taxes in 2017 (FCMB, 2018). FCMB Investment Banking and Wealth Management arm has gross earnings of ₦26.7 billion, a profit before taxes of ₦9.3 billion, and a total AUM of ₦260 billion (Table 4.3). Stanbic IBTC Holdings Group reported total assets of ₦1.38 trillion, a gross income of ₦212.4 billion and ₦61.1 billion profits before taxes in 2017.4 Stanbic IBTC Corporate and Investment Bank and Wealth, including the pension arm, has a combined balance sheet of ₦1.14 trillion billion, gross earnings of ₦128.5 billion, profit before taxes of ₦76.5 billion and a total AUM of ₦2.75 trillion, with pension assets accounting for ₦2.71 trillion (Table 4.3). For most non-financial holding companies, businesses are concentrated more in asset management, securities trading, and equity underwriting. Of the independent investment banks, ARM is the most diversified with a presence in the four quadrants of capital raising including PE, infrastructure finance, real estate finance, securities trading, pension and asset management. ARM has total balance sheet assets of ₦188 billion and gross revenues of ₦20.6 billion in 2016 (ARM, 2017). Its AUM is ₦781 billion; ARM is the second-largest pension administrator, with 8.8 percent of total pension assets, ranking below Stanbic IBTC with ₦2.7 trillion in pension assets. Its PE fund achieved its final closure in 2014 with a fund size of US$45 million. ARM has also moved aggressively into infrastructure project and real estate finance. ARM–Harith Infrastructure Fund achieved first its close in 2014 (ARM, 2015). FSDH has ₦151.7 billion in balance sheet assets, gross earnings of ₦20.6 billion and about ₦300 billion in pension assets. FSDH manages the largest REITs in Nigeria. United Capital Group has a balance sheet of ₦136 billion, gross earnings of ₦8.9 billion, profit before taxes of ₦5.5 billion and total AUM of ₦70.5 billion (Table 4.6).

76  Investment banking in frontier markets Table 4.6 Business strategy and financial performance of selected investment banks FBN Quest FCMB1 STANBIC2 UNITED FSDH ARM CAPITAL Balance Sheet Assets 217 (₦ billion) Gross Earnings 39 (₦ billion) IB (₦ billion) Wealth (₦ billion) Profit Before Tax 10.5 (₦ billion) Cost–income Ratio (%) 51.7 Return on Equity (%) 17 Earnings Per Share 1.14 Non-Pension AUM 245 (₦ billion) Pension Assets (₦ billion) N/A RSA (₦ million)

1,140

136

151.7

26.7

128.5

8.9

17.0 9.7 9.33

89 39.5 76

5.5

5.56

503 24.6 0.47 260

33.2 43.64 4.60 2.75

38 28 0.73 70.5

56.8 14.4 1.64 61.5

233

2,710 1.6

N/A

20.6

298.5

188 20.6

102 1,700

Source: ARM (2017), FBN Quest (2018), FCMB (2018), Stanbic-IBTC (2018), and FSDH (2018). 1 The combined FCMB Investment Banking, Asset and Wealth Management. 2 The combined figures for Stanbic’s Corporate and Investment Banking and Wealth.This excludes the figures for personal and business banking. 3 CIR for FCMB Asset and Wealth Management. 4 Return on equity for Stanbic IBTC Corporate and Investment Banking.

Career path in investment banking

Investment banks typically have a hierarchical pyramid system from the lowest positions of graduate trainees and analysts to the top position of managing director and group chief executive director (Table 4.7). Analysts start from the bottom of the pyramid of hierarchy of an investment bank. The entry point into investment banking is mostly through graduate trainee and analyst positions. Within this professional cadre are junior analysts, analysts and senior analysts, whose work involves research, financial modelling, numbers crunching and PowerPoint presentations that are used to communicate ideas to senior bankers and potential clients. Recruitment as analysts are typically from internship programs, and candidates must possess strong credentials, including analytical skills, energy and a bachelor’s degree with second class upper or first class from leading universities in Nigeria and abroad. Associates are typically promoted from within the rank of analysts with 2 to 3 years of experience or are recruited directly as master’s degree holders such as from top Master of Business Administration (MBA) programs in Nigeria and abroad. Associates play supervisory roles over analysts, prepare pitch-book materials for discussion with clients. They must be able to communicate effectively between the analysts at the bottom and the senior bankers at the middle of the hierarchy.

Investment banking 77 Table 4.7 Career path in investment banking Executive Management Group Chief Executive Officer Deputy Group Chief Executive Officer Managing Director Senior Management Executive Director Associate director Management Vice president Assistant Vice President Supervisory Associates Senior Analysts Professionals Analysts Junior Analysts Graduate Trainee Interns

Vice presidents are typically promoted from the rank of associates following 3 to 4 years of experience in the management cadre. The vice presidents manage a group of associates and analysts, approve financial models, pitch books and presentations, interact with clients on progress relating to transactions and play active roles in executing deals. A vice president will aim to cultivate and develop strong relationships with clients and senior bankers. The executive director supports and reports to the managing director on the execution of business strategy, projects and clients’ management. The director has supervisory roles over vice presidents. A vice president enters the senior management level as a director, dealing directly as a bridge between the clients and the team of vice president, associates and analysts. There may be an associate director or a full director; both often spend time travelling, prospecting for new businesses and clients. The managing director is typically like the general who sees the big picture from the top of the hierarchy in investment banking and with full responsibilities for origination, deal sourcing, transaction advisory, deal execution, client relationship management and profitability. Of course, the managing director delegates responsibilities to directors and vice presidents; however, he or she is ultimately accountable and responsible for the profitability of the business. As senior bankers with considerable years of experience, they understand the political, economic and industry terrain that would shape capital raising, M&A and other facets of investment banking. In Nigeria, most subsidiaries, including asset management, securities and pensions, are likely to be headed by managing directors with responsibilities for developing a business strategy and leading its execution.

78  Investment banking in frontier markets

The group chief executive officer, in investment banking with holding structures, is who the managing directors of the subsidiaries will typically report to, as well as his or her deputy.

Summary This chapter discusses the premier investment banking institutions globally and in Nigeria. The global bulge bracket investment banks are the world’s largest financial investment banking firms. The top 10 bulge bracket investment banks in alphabetical order are Bank of America’s Merrill Lynch, Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, UBS and HSBC.These are large multinational banks that facilitate GCMs, capital raising and asset management for large companies, governments, institutions and wealthy individuals across the globe. Bulge bracket elite investment banks in Nigeria in alphabetical orders are Afrinvest, ARM, Chapel Hill, FBNH, FCMB, FSDH, Investment One, Vetiva, Stanbic IBTC, United Capital and Zenith Bank. Other up-and-coming investment banks include Cordros, Cardinal Stone, Coronation, Meristem, Greenwich, SFS, Diamond, Fidelity and Morgan Capital. These firms can be further categorized as investment banks operating under a financial holdings company (UB) structure, investment banks affiliated with major commercial banks, merchant banks licensed by the CBN and stand-alone full-service investment banks.There are also boutique investment banks specializing in particular products and services of investment banking.

Notes 1 2 3 4

Levy & Post. Deutsche Bank (2015). SEC List of Market Operators. Stanbic IBTC 2017 Annual Report.

Bibliography Afrinvest. (2018), Afrinvest Corporate Profile, Website ARM. (2015), ARM Holdings Plc Consolidated and Separate Annual Report, 31 December 2014 ARM. (2017), ARM Holdings Plc Consolidated and Separate Annual Report, 31 December 2016 Bank of America. (2018), Annual Report 2017 Barclays Plc. (2018), Barclays PLC Annual Report 2018 Bloomberg. (2018), Bloomberg Full Year 2017 League Tables and Rankings CBN (2010), CBN: Scope, Conditions, & Minimum Standards for Merchant banks Regulations Chapel-Hill Denham. (2018), Corporate Profile, Website Citigroup. (2018), Annual Report 2017 Deutsche Bank. (2015), The Unofficial Guide to Investment Banking. www.db.com/careers

Investment banking 79 Duke Economics. (2011), Investment Banking Demystified. https://econ.duke.edu/sites/ econ.duke.edu/files/file-attachments/Investment%20Banking%20Demystified.pdf EFINA. (2010), Financial Services Landscape in Nigeria Equity. (2018), List of Top-200 Investment Banks and Boutiques. http://equity-research. com/list-of-top-200-investment-banks-and-boutiques/ FBNH. (2018), First Bank of Nigeria Holdings Plc Consolidated and Separate Annual Report, 31 December 2017 FBN Quest Merchant Bank. (2018), FBN Merchant Bank Consolidated and Separate Annual Report, 31 December 2017 FCMB. (2018), First City Merchant Bank Holdings Plc Consolidated and Separate Annual Report, 31 December 2017 FSDH. (2018), FSDH Plc Consolidated and Separate Annual Report, 31 December 2017 Goldman Sachs. (2018), Annual Report 2017 Idrisu, I. and O. Lawal. (2017), Investment Banking, National Open University of Nigeria. http://nouedu.net/sites/default/files/2017-10/BFN407.pdf Investment One. (2018), Investment One Corporate Profile, Website. Liaw, K.T. (2006), The Business of Investment Banking: A Comprehensive Overview, 2nd edition. Hoboken, NJ: John Wiley & Sons MIXTA AFRICA. (2015), Corporate Presentation: Leading the Transformation of Cities in Africa Morgan, J.P. (2018), Annual Report 2017 Morgan Stanley. (2018), Annual Report 2017 NSE. (2018), Q3 2018 Fact Sheet Osundina, N. (2008), The First City Group: A Financial Monument Built by God. Ibadan: Spectrum Books Limited Pratap, G.S. (2008), Investment Banking: Concepts, Analyses and Cases. New Delhi: Tata McGraw-Hill SFS Financial Services. (2018), Corporate Profile, Website Stanbic IBTC. (2018), Stanbic IBTC Holdings Plc Consolidated and Separate Annual Report, 31 December 2017 United Capital. (2018), United Capital Plc Consolidated and Separate Annual Report, 31 December 2017 Vetiva. (2018), Corporate Profile, Website World Bank. (2000), Nigeria Financial Sector Review Zenith Capital. (2018), Zenith Capital Corporate Profile, Website

5 Risk management

Principles Four cross-cutting issues underpin all business activities in investment banking: relationship management, research and know-how, risk management and regulations. This chapter discusses risk management, while Chapter 6 focuses on the regulatory framework that investment banks face in an FM such as Nigeria. In the process of financial intermediation, financial institutions face different kind of risks, which must be efficiently and effectively managed in a sustainable manner.1 Financial intermediation is based on trust, and when the various risks are not effectively managed, they could impact negatively on the credibility and reputation of the financial institution. The ability to properly identify, assess, monitor and manage each type of risk is important for the survival of financial institutions. Globally, bank failure is often traced to failure to manage risks, and this failure gets magnified, especially during a financial crisis. Risk management was what separated Goldman Sachs from Lehman Brothers and Bear Stearns. COSO’s enterprise risk management framework

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) defines Enterprise Risk Management (ERM) is a process, effected by an entity’s Board of Directors, Management and other personnel, applied in strategy setting and across the enterprise. It is designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. (COSO, 2017) In the risk management process, and as seen in the COSO definition of ERM, it is important for an organization to define its risk appetite and to

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manage and monitor its daily positions to such risk appetite. It is essential to establish a robust risk management framework with supporting policies and processes for identifying, assessing, measuring and managing such risks in line with regulatory requirements, as well as to create an environment where a healthy risk culture is pervasive and embraced across all organizational cadre. Risks in investment banking

Based on its strategic business and operational objectives, an investment bank is exposed to different types of risks such as strategic, market, liquidity, credit, operational, compliance, regulatory and reputational risks. There is conduct risk, given the importance of corporate governance and given that the dependence of the investment banking business on the quality and conduct of its people.

Financial risk management Market risk refers to the risk of loss due to volatility in the pricing of financial assets due to adverse movements of financial market prices. Resulting from adverse financial market movements when liquidating financial transactions, this risk could cause deviations in the mark-to-market value of trading portfolios of financial institutions. Such losses emanate from the volatility of market prices of financial instruments such as interest rate, equities, commodities and currencies. A financial institution may suffer losses from adverse movements of exchange rates (Forex risk) or from selling assets such as bonds before their maturity (price risk). By diversifying their exposures, controlling their position sizes and sometimes employing derivatives to hedge their positions and using valueat-risk models, financial institutions try to manage their market risks. Hull (2007) defines value at risk (VaR) as the potential loss in value of a firm’s positions due to adverse movement in market risk factors over a defined time horizon with a specified confidence interval. Financial firms typically run stress tests to estimate the potential loss under extreme market conditions. Interest rate risk is the exposure of a financial institution to adverse movements in interest rates, which impact negatively on its earnings of the institution and on the economic value of its assets. The net interest income and market value of equity of the institution can be exposed to unexpected changes in market interest rates arising from holding assets and liabilities with varied principal amounts, maturity dates and repricing dates. In a floating interest rate environment, a variation in net interest income can arise from movements in yield curve when a financial institution uses different instruments with different maturity dates to price its assets and liabilities.

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A useful example is the pricing of liability based on a 90-day T-bill, while the asset it is funding is based on a 364-day T-bill, with non-identical increases in both rates as a result of non-parallel movement of the yield curve.There is also a basis risk due to a decrease or increase of interest rates with a varied magnitude between interest rates on assets and interest rate on liability. Interest rate risk can arise from prepayment risk and reinvestment risk which would affect cash flow management. The underlying value of balance sheet items such as assets, liabilities and earnings can be impacted adverse changes in interest rates. Financial institutions use various techniques including duration gap analysis, earnings at risk, interest margin analysis, maturity gap analysis, sensitivity and scenario analysis to measure, monitor and manage interest rates risks. Liquidity risk arises from the inability of a financial institution to raise cash flows to meet its maturing obligations in a timely fashion. With financial intermediation, liquidity risk can be attributed to a mismatch between shortterm deposit liabilities and long-term loans assets maturity. Liquidity risk can also arise from the inability to sell assets to meet its maturing obligations without incurring huge costs and at substantial prices below market. A solvent financial institution could still face a liquidity risk due to poor liquidity management. Investment banks often set up asset and liability committees (ALCOs) to effectively manage their liquidity and to ensure compliance with regulatory requirements. Liquidity risks management would involve daily monitoring of liquidity positions, cash flow projections, maturity and duration gap analysis, diversification of funding sources and periodic liquidity stress testing. Investment banks trade securities for their own proprietary accounts and on behalf of clients. The techniques for managing the securities trading book typically include daily and periodic valuation of securities, position limits and duration loss limits in addition to stress testing and VaR. Credit risk arises when a borrower or counterparty defaults by not meeting its obligations under the agreed terms. A financial institution can suffer losses of either or both interest and principal from a default borrower, giving rise to NPLs. For commercial banks, it is the most significant risk as loans are the largest source of credit risk and can erode a bank’s capital. Counterparty risk is another form of default risk. For investment banks, counterparty risk arises due to non-performance of the trading partners as the counterparty is unable to meet its obligations. Financial institutions try to manage credit risks by ensuring that there are adequate collaterals, by assessing the creditworthiness of clients and by monitoring credit exposures across industries, sectors and maturities. Business units are typically responsible for monitoring and managing all credit risks in their portfolio. However, banks often have a risk management committee (RISCO), which undertakes regular review of credit quality and

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performance; the internal audit unit also undertakes regular audits of business units. In assessing and measuring credit risk, investment banks develop models to quantify the probability of default (PD) by the counterparties on their contractual obligations.The results can be used to derive the exposure at default (EAD) and the loss given default (LGD). These provide the likelihood of defaults occurring, of the associated loss ratios and of default correlations between counterparties. Operational risks management

Operational risk is the risk of loss due to inadequate and failed internal policies, processes, people and systems as well as from external developments. Operational risk can be caused by internal and external fraud, failed business processes, lack of business continuity due to human error, scam and breakdown of information technology (IT) systems. Financial institutions manage operational risk by investing in and maintaining IT systems, having a disaster recovery plan, training their personnel and putting in place efficient and effective internal controls and procedures. An enterprise-wide approach to strategic and operational risks are typically deployed in investment banking. This involves risk incident reporting, risk mapping and assessment and risk controls throughout the various hierarchies of the institution. Business continuity management policies and procedures for contingency plans to mitigate against business disruptions are usually put in place. The robustness of the contingency plans can be tested on a regular and periodic basis. Strategic, legal and compliance risks

Strategic risk arises from poor business goals, plans, decisions, resource allocation and executions, as well as responses to changing business environment. The performance and development of a bank can be impacted considerably by how strategic risks are managed by the institution. Legal risk occurs when financial institutions undertake contractual agreements that they expect will be enforceable under relevant law and regulatory framework. They also provide services and products that can be subject to litigation. Legal risks arise from the fact that contractual agreements may not be enforceable, products may be subject to litigation and laws may also be changed. Financial institutions guard against legal risks by establishing appropriate procedures, policies and practices that conform to regulatory requirements and by undertaking due diligence on counterparties and customers. Legal documentation is checked against applicable laws, including the Company Act, Securities laws, banking and finance laws.

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Compliance risk involves compliance and the adherence to the requirements of statutory laws, regulations, rules, principles, standards and codes, in a broad sense. Compliance promotes legal and ethical conduct in business conduct while preventing and detecting violations of relevant provisions of several laws. Compliance ensures enforcement of regulations and helps protect and maintain the integrity and reputation of an investment bank. Effective compliance fosters market conduct and good governance.

Practice While the individual list of risks in an investment banking business is shown in Table 5.1, mature risk practices ensure that the business, aided by the risk management team, considers and manages the interrelationships of risks. The various risks described earlier do not exist in silos, and while there may be different categories of risks, risks, in practice, are interrelated, and the occurrence of a risk event could trigger another or a myriad of other risks, such as was seen during the subprime mortgage crisis, where poor credit practices and processes (operational risk) and a pervasive corporate culture that seemed to encourage or turned a blind eye to the continuation of such practices (conduct risk), such that financial instruments were being created on the back of such subprime to continue to create capital to the banks to fund yet more subprime mortgages. The eventual market meltdown (market risk losses) were enabled by the preceding operational and conduct risks that existed.

Risk management structure and governance With respect to risk management structure, the risk function has evolved globally such that most leading organizations have embraced the ERM, which eschews an integrated risk management and governance approach, such that there is a central office of risk managers that report to the chief risk officer (CRO), who coordinates firm-wide risk management activities from policy definition (key business policies and risk policies alike) to risk appetite definition, risk identification, monitoring, controlling and reporting, and so on. In global investment banks, the middle office manages risk and calculates transactions profits and losses. This reflects an ERM structure, which Nigerian banks modelled after global banks. In Nigeria, risk management tends to be bank-wide, with a CRO supervising professional risk managers across the investment bank, asset management and securities subsidiaries. In most global investment banks, the back office provides oversight on issues relating to compliance, regulations, operations and technology. In Nigeria, the back office of an investment bank is usually centralized, with professionals

Table 5.1 Classification of various types of risks Risk category 

Description 

Loss characteristics 

Market & investment risk

The risk of loss due to unfavourable movements in the prices of assets.

Credit risk 

The risk of loss arising from counterparty’s inability or unwillingness to fulfil contractual obligations to the group. The risk that the group will not be able to meet its financial obligations as they fall due. 

This could result in loss of value to the group’s proprietary portfolio and a loss of earnings from the reduction in funds under management. This could result in impairment in the group’s credit assets.

Liquidity risk 

Operational risk

Compliance risk 

Strategic risk 

Reputational risk

Project risk 

The risk of loss arising from inadequate or failed internal processes, people, systems and external events. The risk of loss arising from violations of, or nonconformance with laws and regulations.

The risk of loss due to adverse or improper implementation of business decisions, or lack of responsiveness to industry changes. The risk of brand damage due to the failure to meet stakeholders’ expectations with respect to the group’s performance and behaviour. The risk of a negative impact on project quality, cost and/or completion timelines arising from a failed or inadequate predefined scope, unexpected changes in project schedule or inadequate project resources.

Source: ARM Annual Report (2016).

This could result in significant business disruption or could hinder normal operations of the group. This could result in business disruption, litigation costs and/or regulatory penalties.  This could result in adverse reputational impact, significant financial losses arising from regulatory penalties; and in severe cases, loss of business licence. This could result in a significant loss of market share.  This could result in a significant loss of market share, loss of key employees and costly litigation.  This could result in significant project cost overruns, thereby resulting in eroded profit margins on such projects. 

Network Security

Security Operations

Vulnerability Assessment

Operational Risk

Training & Awareness

Risk & Org. Policies

Business Continuity Mgt

Credit Risk Mgt

Source: ARM (2016).

Figure 5.1 ARM risk management structure

ALM & Bal. Sheet Risk

Market & Invvestment Risk

Application Security

Information Security

Operational Risk Mgt.

Head Information Security

Financial Risk Mgt.

Head Risk Management

Glossary Asset & Liability ALCO Management Commiee Markeng & Corporate MCC Communicaons Asset Liability ALM Management

Compliance Department

Compliance Risk

Chief Risk Officer

Group C.E.O.

Board of Directors

Legal Department

Legal Risk

MCC & Business Mgrs.

Reputational Risk

ALCO

Business Managers

Strategic Risk

Board Audit & Risk Committee

Risk Mgt. Committee

All Staff

Risk Champion

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in compliance, operations and technology reporting to the chief compliance officer, a head of operations and the chief technology officer, respectively. A sample risk management structure is shown in Figure 5.1 and framework in Table 5.1 and discussed in Box 5.1.

Connecting principles to practice Box 5.1  Risk management structure at ARM Risk management is essential to making ARM a stable and more sustainable organization. A strong risk management culture therefore underpins its operations and reinforces its resilience. ARM’s board of directors has ultimate responsibility for risk management oversight, playing an important role in defining and reviewing the group’s overall risk appetite and in approving policies and methodologies, either directly or through its Board Audit and Risk Committee (BARC). In addition, there are two management level committees that have specific risk management mandates (Figure 5.1). The ALCO has direct responsibility for managing liquidity risk as well as other forms of balance sheet risk. The Risk Management Committee has oversight and responsibilities for all other domains of risk, as well as in ensuring that the business’s risk practices are upheld at all times. The risk management framework is built around core components such as governance, strategy, systems and people. Risks are managed within clearly defined guidelines applicable to each risk using tools and systems that meet its business requirements per time. However, to capture the interrelationships among different risk exposures, ARM’s risk management approach uses an ERM framework, which addresses the risks it assumes while conducting its businesses in broad risk categories as summarized in Table 5.1. Market Risk Management: ARM’s market and investment risk management practice seeks to achieve an appropriate balance between risks and returns in its investment decisions, thereby reducing the volatility of the company’s earnings and capital. ARM manages market risk by actively controlling investment activities and ensuring that positions are taken in accordance with the investment strategy set for the company. ARM’s investment policy outlines permissible investments, asset allocation limits and other position limits according to the company’s risk appetite and desired risk profile. Additionally, investment decisions go through the appropriate level of authorization before they are implemented. Liquidity Risk Management: ARM has in place a comprehensive liquidity management policy and processes, executed by the Finance & Treasury unit, and monitored by the Management Committee. ARM’s liquidity management framework is designed to ensure that the company always has sufficient liquidity to meet its obligations when these fall due, under both normal and stressed conditions, without incurring unacceptable finance costs. Liquidity

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management activities ensure that the company has sufficient access to the funds necessary to cover insurance claims, withdrawals and maturing liabilities. Credit Risk Management: Credit risk is the risk of loss arising from counterparty’s inability or unwillingness to fulfil contractual obligations to the company. The company has an effective internal control and risk management system that ensures that all applicable guidelines and laws with regard to credit risk are adhered to. Source: ARM (2017).

The three lines of defence risk management model Most investment banks manage risks using the three lines of defence model, composed of risk-taking, risk oversight, and risk assurance (Figure 5.2). The three lines of defence is a risk and assurance governance structure that promotes segregation of duties and explains different functions responsible for risk origination, ownership management, risk advisory responsibility and assurance. In the first line of defence, boundaries for risk-taking, risk culture and the control environment that align such risks with overall business strategic objectives are established by the board of directors in concert with executive management of the institution. The primary responsibilities for identifying and managing risks are delegated to business lines managers. In the second line of defence, the board of directors, working through its various committees, especially the audit and risk committee, has an oversight role Board Audit and Risk Committees

Executive Management and Management Risk Committees Risk taking (First line of defence) • Business Line Management o Promotes risk culture o Owns the risk management process and implements control

o Responsible for daily management of risk

Risk Oversight (Second line of defence) • Risk Management • Internal Control • Compliance • FINCON o Develops policies and standards o Develops the risk management processes and controls o Monitors and report on risk

Figure 5.2 The three lines of defence risk management model Source: FCMB (2018).

Risk Assurance (Third line of defence) • Group Internal Audit • External Audit o Provides independent challenge to the levels of assurance provided by the first and second levels of defence. o Validates processes in risk management framework

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on risk exposures in financial institutions. Functions such as risk management, compliance, internal control, and finance are provided by independent specialized units, which are responsible for developing a risk management strategy, policies, procedures and processes.These units then monitor and report periodically to the board on compliance by business lines managers to risk management framework. In the third line of defence, the internal auditors and external auditors validate risk management processes and provide independent assessment and assurance on their effective implementation to the board of directors through the audit committee. Regulations relating to risk management

Financial services industry is characterized by more complex financial instruments and growing regulations including global and national anti–money laundering (AML) and combating the financing of terrorism (CFT), know your customer (KYC) and politically exposed persons (PEP) measures. Failure to comply with these regulations can cost an investment bank its reputations and even its business. Financial institutions are required to provide certain reports and returns to regulatory authorities.The CBN and the Nigerian Financial Intelligence Unit (NFIU) regularly receive the following reports: Currency Transaction Report (CTR), Foreign Currency Transaction Report (FTR) and Suspicious Transaction Report (STR). The Anti-Money Laundering Act requires financial institutions to report US$10,000 or its equivalent in other foreign currencies in international funds transfers and securities and unusual and suspicious transactions. Financial institutions must also report on lodgement and transfer of funds of more than ₦5 million and above for individuals and ₦10 million and above for corporate bodies. SEC’s risk-based supervision framework

The SEC in Nigeria requires each business entity in the capital market to appoint a compliance officer, distinct from risk officers and legal officers. However, the compliance culture starts with the tone at the top from the board and executive management level and must be embraced by all employees and all departments. The SEC has put in place a risk-based supervision framework (SEC, 2018). The overall objective of the framework is to ensure the safety and soundness of capital market operators (CMOs) by adopting a proactive risk-based supervisory process. This serves to ensure that regulatory resources are optimally allocated according to the risk profile of a CMO. The SEC will be requesting more disclosures from CMOs relating to company profile, strategy and operations and organizational, board and management structure to enable supervisors to have in-depth knowledge of CMOs’ businesses. Based on the information gathered, all significant activities of the CMO and their materiality will be identified. The risk management control functions to be assessed by the SEC include the board of directors, senior management, internal audit, compliance, risk management and financial analysis. Both the net risk for each significant activity

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and the overall net risk for all significant activities are then determined. Using this determination, the robustness and sustainability of capital and earnings to accommodate the overall net risk of all significant activities are assessed. The composite risk-taking of a CMO and the direction of risk over a defined time frame are determined. The SEC will provide and communicate to the CMO the Risk Assessment Summary of the CMO.

Note 1 For more detailed discussion of risks and risks management in banks and financial institutions, see Audu (2014), Hull (2007) and Saunders and Cornett (2008).

Bibliography ARM. (2017), Annual Report 2016, 2014, and 2012 Audu, I. (2014), Risk Management in Financial Services Industry, Understanding Monetary Policy Series, No. 40, CBN COSO. (2017), COSO’s Enterprise Risk Management – Integrated Framework Deutsche Bank. (2015), The Unofficial Guide to Investment Banking. www.db.com/careers Duke. (2015), What Is an Investment Bank? https://econ.duke.edu/sites/econ.duke.edu/ files/file-attachments/Investment%20Banking%20Demystified.pdf FBN Quest Merchant Bank. (2018), Annual Report, 2017 FCMB. (2018), FCMB 2017 Annual Report Goldman Sachs. (2018), Annual Report, 2017 Horcher, K.A. (2005), Essentials of Financial Risk Management. Hoboken, NJ: John Wiley & Sons Hull, J.C. (2007), Risk Management and Financial Institutions. Cranbury, NJ: Pearson Educational Inc Institute of Risk Management. (2018), A Risk Practitioners Guide to ISO 31000: 2018 Meyer, L.H. (2000), Why Risk Management Is Important for Global Financial Institutions. Speech Before the Bank of Thailand Symposium, Risk Management of Financial Institutions, held in Bangkok, 31 August Pyle, D.H. (1997), Bank Risk Management: Theory. Conference on Risk Management and Regulation in Banking, Jerusalem, May Saunders, A. and M.M. Cornett. (2008), Financial Institutions Management: A Risk Management Approach, 6th edition. New York: Tata McGraw-Hill SEC. (2018), Implementation of Risk-Based Supervision (RBS) by the Securities and Exchange Commission. Presentation to Capital Markets Operators

6 Regulatory framework

Principles The need for capital markets’ integrity through regulation and enforcement arises from three rationales: to improve public trust and reduce systemic risk, to minimize information asymmetry and to promote market access and competition. Systemic risk is the risk that the securities market could stop functioning properly as a result of few participants that erode public trust in the capital market with a spillover effect on the economy as the cost of capital issuing increases and liquidity falls. Information asymmetry occurs when small investors have less information on securities than do the issuers and capital market intermediaries. Market access and competition are enhanced when there is little or no barrier to entry while at the same time the investing public is protected. Regulation ensures financial market integrity, which leads to investors’ confidence in the market and, in turn, enhances liquidity. Effective and efficient regulation is achieved by a combination of both primary and secondary market regulations. Regulations in the primary market are generally focused on governance, transparency and disclosure from the onset while issuers are coming to the public. Regulators often require a minimum number of years of company financials, proper registration of company, directors and their dealings, governance requirements, minimum amount of securities to be held by the public and so on. Secondary market regulations focus on both prudential regulation and market conduct to protect investors. Merchant banks, investment banks, and other capital market operators are expected to have adequate capital to support and buffer their investment and securities activities and for the protection of customers. Regulators make and enforce rules relating to market conduct. They monitor, detect, investigate and sanction market abuse, including insider trading. In both the primary and secondary markets, regulators encourage that corporate actions and information that are of interest to the investors are made available publicly in a timely fashion and in a non-discriminatory way as they are crucial for listing, trading and liquidity.

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Practice Global context for regulations

Financial institutions, in general, and investment banking, in particular, have had historical cycles of tidal waves of regulation and deregulation.These historical waves of regulations have been led by advanced economies, in particular in the United States. Following the stock market crash of 1929, the Glass–Steagall Act of 1933 resulted in the separation of investment banking from commercial banking until 1999. Commercial banks were regarded as encouraging very speculative stock market activities both with their clients and proprietary funds. In the United States, the Securities Act of 1933 and the Securities Exchange Act 1934 provided the blueprint for regulation of investment banks in terms of securities underwriting, issuing and syndication of new of securities and of broker-dealer activities. In 1999, the Gramm–Leach–Bliley Act deregulated financial services by repealing the financial holding prohibition, thereby allowing investment banks, commercial banks and insurance companies to operate under one roof and provide a broader range of financial services.This act fostered the creation of financial holding companies and put competitive pressures on stand-alone banks. The financial crisis of 2007–2008 eroded the too-big-to-fail mentality of financial holdings and investment bank. Bear Stearns (founded in 1923) collapsed, Lehman Brothers (1850) filed for bankruptcy and Merrill Lynch (1914) was acquired by Bank of America. Goldman Sachs (1869) and Morgan Stanley (1935) converted into traditional commercial banks. In 2016, a $5.7 billion fine was imposed on Barclays, Royal Bank of Scotland, Citibank, J.P. Morgan and UBS for “breathtaking flagrancy” in the rigging of the FX market and the London Interbank Offered Rate (LIBOR) fixing scandal. The Dodd–Frank Act was passed in 2010 to promote stability, transparency and accountability of the financial system with new regulation for large financial services and higher capital requirements for banks and provisions for executive compensation clawbacks and restrictions. There have been other relevant laws that impact operators in the US capital markets, including the Investment Companies Act of 1940, the Investment Advisors Act of 1940,The Trust Indenture Act of 1939, Securities Investor Protection Act of 1970, Insider Trading Sanctions Act of 1984 and Sarbanes–Oxley Act of 2002. The European Union (EU) is facilitating the integration of financial markets and the harmonization of security regulations across its member countries to support the objective of creating a single internal market for the EU. The objectives of the harmonization themes outlined by the Lamfalussy Committee are ensuring deep pools of liquid capital within the EU and passporting authorization across the EU such that authorization by the competent authority in one member state shall be recognized in all other member states (Hudson, 2008). The issuer’s home state regulator assumes control and the issuer bears an ongoing disclosure obligation‖ to make reliable information available to the investing public throughout the life of the security.

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The European Commission (EC) is currently pursuing a Capital Markets Union with the objectives of facilitating the flows of savings and investments across the EU for the benefit of consumers, investors and companies.The Capital Markets Union project involves 12 legislative initiatives covering standardized securitization rules, personal pension products, new prospectus regulations, capital requirements, covered bonds, sustainable finance, venture capital funds, infrastructure investments, fintech and crowdfunding, supervisory architecture, cross-border investment distributions and securities ownership (European Commission, 2018). The Capital Markets Union is expected to break down barriers to crossborder investments in the EU and facilitate access to finance for companies as well as for infrastructure projects. The EC recognizes that well-integrated capital markets with strong depth and breadth will be of great benefit to the euro area as they will complement a banking union. In the United Kingdom, securities-related laws include the Transparency Obligations Directive 2004/109/EC include in Part 43 of Companies Act 2006 and FSA – Disclosure and Transparency Rules and the FSMA Act of 2000. The general conditions for admission to listing on the LSE (Hudson, 2008) include a company being duly incorporated, its securities duly authorized for listing under the company’s constitution, its shares being freely transferable, its shares being admitted to trading on the registered market for listed securities, the issuer’s securities having a minimum capitalization and an approved published prospectus. Further conditions for admission to listing are that the company must have published and filed audited accounts for at least three previous years, the company must have an independent business, the company’s business activities must have been continuous for the previous 3 years, the company must have a minimum working capital identified in the rules, the securities themselves must be 25 percent in public hands after the issue within the EU and European Economic Area (EEA), and securities must be capable of electronic settlement. In South Africa, the Financial Services Conduct Authority (FSCA), formerly known as the Financial Services Board,1 is the government financial supervisory and regulatory agency responsible for the non-banking financial services industry. It is an independent body and the market conduct regulator of financial institutions which provide financial products and services and licensed non-bank financial intermediaries. This includes capital markets, collective investment schemes, financial services provider, insurers, nominee companies and retirement funds. It ensures capital adequacy requirements, promotes financial soundness of these entities and protects the investing community. Nigerian capital market regulators

The SEC in Nigeria is the apex regulatory institution of the Nigerian capital market supervised by the federal Ministry of Finance. The commission has evolved from the Capital Issues Committee, established in 1962 within the

94  Investment banking in frontier markets

CBN.With the promulgation of SEC Decree No. 71 of 1979, the SEC became a full-fledged independent regulatory institution. The Investments and Securities Act (ISA) No. 45 of 1999 was promulgated and superseded by the ISA No. 25 of 2007, which underpin the current powers and functions of SEC.2 The key functional responsibilities of SEC are to regulate the capital market with a view to protecting investors and developing the capital market in order to enhance its allocative efficiency and its contributions to economic development. The SEC has been a member of the International Organisation of Securities Commissions (IOSCO) in 1985 and has been benchmarking its market rules and regulations against those of IOSCO, the global international standards setter. In regulating the market, the commission undertakes several activities in order to protect investors, market operators and ensure market integrity. Regulation is carried out through the deployment of several tools (Box 6.1).

Connecting principles to practice Box 6.1  Securities and Exchange Commission of Nigeria The Nigerian SEC is the apex regulatory organ of the Nigerian capital market. Its objectives are to promote an orderly and efficient functioning of the capital market in Nigeria, to register and regulate capital market operators, to ensure fair and appropriate price for stocks and shares and to ensure adequate protection for the investing public. Registration of securities and market intermediaries ensures that only fit and proper persons, institutions and operators are allowed to operate in the market. The SEC regulates the products and instruments offered to the public investors through extensive scrutiny of prospectuses for all securities. Instruments and products registered in the market include securities/commodity exchanges/capital trade points; futures, options and derivatives exchanges; depository, clearing and settlement agencies; securities including equities, debentures and debt instruments and collective investment schemes. Inspection is either done “on-site” or “off-site.” The commission, at regular intervals, calls for information from capital market operators. It also undertakes and conducts inquiries and audits of any participant in the market whenever necessary. Surveillance is carried out over exchanges and trading systems to forestall breaches of market rules as well as to deter and detect manipulations and trading practices which are capable of causing market disruption.

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Investigation of alleged breaches of the laws and regulations governing the capital market and enforcement of sanctions where appropriate. Enforcement actions are taken against market operators who are found wanting after an investigation is carried out, appeals against decisions of the are usually made at the Investment and Securities Tribunal (IST). Enforcement action may be in the form of payment of a fine, a ban, a suspension and referral of allegedly criminal cases to law enforcement agencies. Rules making is done by the commission as developments occur. This is to ensure that the commission meets up with international best practices. Market Development: The Market Development Department ensures that all stakeholders – investors, the academic community, market operators, lawmakers, professional bodies, government functionaries – are appropriately educated on the activities and initiatives of the commission. Source: SEC (2018).

Other regulators in the capital market include the NSE, CBN and CIS. The CBN is a major participant in the Nigerian capital market. It is the apex regulatory institution for both banks and non-bank financial institutions in Nigeria. It also underwrites federal government debt, by taking all unsubscribed portion of the debt.The role of the CBN in regulating banks are discussed in Chapter 2 on the financial system. The NSE is an SRO with powers over broker-dealers. The NSE creates and enforces its own Rules in respect of the securities that are to be listed and maintained on the Stock exchange. It supervises market makers, broker-dealers and is expected to report on the results of its self-regulatory activities to the SEC. Specific NSE rules are discussed under the different themes in subsequent chapters. The IST was established in 2002 to provide a process for resolving the regular court system cases relating to securities markets. The objective of the IST is to ensure speedy and fair resolution of matters, that may take much longer within the regular court system. The decisions of the IST are subject to appeal at the Court of Appeal and subsequently at the Supreme Court. Overview of securities-related laws

Nigeria’s capital markets are underpinned by several business, securities and financial laws that are enforced by the capital market regulators (Table 6.1). The CAMA is Nigeria’s company and business law that deals with company governance and management including the duties of directors. Companies that

96  Investment banking in frontier markets Table 6.1 Business and financial laws and regulators in Nigeria S/N Applicable law 1 2 3 4 5 6 7

8 9 10 11

Companies and Allied Matters Act 2004 Investments and Securities Act 2007 Pension Reforms Act Central Bank Act Banks and other Financial Institutions Act Insurance Act 2007 Nigerian Investment Promotion Commission Act 2004 Asset Management Corporation Act, 2010 Federal Inland Revenue Service Act, 2007 Debt Management Office Act NSE Rules and Codes

Regulatory body

Website

Corporate Affairs Commission (CAC) Securities and Exchange Commission (SEC) National Pension Commission (PENCOM) Central Bank of Nigeria (CBN) Central Bank of Nigeria (CBN)

www.cac.gov.ng www.sec.gov.ng www.pencom.gov.ng www.cbn.gov.ng www.cbn.gov.ng

National Insurance Commission www.naicom.gov.ng (NAICOM) The Nigerian Investment www.nipc.gov.ng Promotion Commission (NIPC) Asset Management Corporation of www.amcon.gov.ng Nigeria (AMCON) Federal Inland Revenue Service www.firs.gov.ng (FIRS) Debt Management Office (DMO)

www.dmo.gov.ng

Nigerian Stock Exchange

www.nse.com.ng

Source: Companies and Allied Matters Act (CAMA, 1990).

desire to operate in Nigeria must be registered under CAMA by the Corporate Affairs Commission (CAC). It sets out the forms of business organization: sole trade, partnership and limited liability companies. It regulates the incorporation of companies, shareholders and the ownership of companies, the classes of shares capital and their issuance, premium and discounts on issues and rights and bonus issues. CAMA promotes disclosure of appropriate information about the company through the publication of annual reports and other information. A new CAMA was passed by the National Assembly in May 2018 to repeal and re-enact CAMA, 1990 and 2004 (Box 6.2).

Connecting principles to practice Box 6.2  New CAMA, 2018 passed by the National Assembly The new CAMA passed by the National Assembly in May 2018 has 860 sections and 16 schedules compared to the 613 sections and 15 schedules in the 1990 CAMA. The act is divided into eight parts as follows:

Regulatory framework 97

Part A – Administrative aspect of the Corporate Affairs Commission Part B – Incorporation of companies in Nigeria and incidental matters Part C – Limited Liability Partnership Part D – Limited Partnership Part E – Business Names Part F – Incorporated Trustees (non-profit organizations) Part G – Administrative Proceedings Committee Part H – Short Tittle of the Act The CAMA (2018) has some new commercial law provisions such as the following: • Electronic (E) registration, signature, notices and annual general meetings • Penalty for carrying on business in Nigeria without registration • Allowing a single person to incorporate a company • Permitting limited liability partnership • Raising minimum share capital 10-fold to ₦100,000 for a private company and fourfold to ₦2,000,000 for a public company • Permitting shares buyback by limited liability companies • Permitting exemptions to the general rule on financial assistance to members • Protection of director’s information relating to residential address • Exemption from annual general meeting for a company with a single shareholder • Exemption from the audit requirement of companies with less than ₦10 million in turnover and ₦5 million on balance sheet in a given financial year • Certification of audited financial statements by both the chief executive officer and chief financial officer of a company other than a small company • New provisions on company voluntary arrangement, administration and insolvency.

Central Bank of Nigeria Act, No. 24 of 1991 and the Banking and other Financial Institutions Act, No. 25 of 1991

Finance and banking operations are governed by rules and regulations which are reviewed regularly to reflect the changing economic environment. Over the years, some acts and statutes, which provide the general framework and primary underlying power of the CBN, were enacted which include3 The CBN Decree No. 24 of 1999 as amended, Bank and other Financial Institutions (BOFI) Decree No. 25 of 1991 as amended, the Dishonoured Cheque (Offenses)

98  Investment banking in frontier markets

Decree of 1977; the Failed Bank (Recovery of Debt) Decree No. 18 of 1994 as amended and the Money Laundering Decree No. 3 of 1995 (CBN, 2016). The CBN makes rules and regulations that operationalize these acts that empower it to supervise and regulates banks and other financial institutions. Investments and Securities Act

The Investments and Securities Act (ISA) No 45 of 1999 was promulgated and superseded by the ISA No. 25 of 2007 The Investments and Securities Act (ISA) is directly important to the work of SEC on securities regulation. Deriving from the ISA, the SEC has prescribed rules and regulations made up of 14 parts and 11 schedules, which enables the SEC to effectively and efficiently undertake capital market regulation. They contain both rules of general and specific applications governing securities exchanges; capital market operators; securities offered for sale or subscription; mergers, acquisitions and combinations; collective investment schemes; borrowing by federal, states and local government and other government agencies, as well as supranational bodies, amongst other things. Registration requirements

The SEC places emphasis on companies being properly registered in accordance with the Company and Allied Matters Act. An application for registration by issuers and most capital market operators requires that Form S.E.C. 3 should be filed with SEC (SEC, 2013).These forms must be accompanied by a copy of Certificate of Incorporation certified by the CAC; a copy of the memorandum and articles of association certified by the CAC which, among others, shall include the power to act as a broker/dealer; a copy of the CAC form containing particulars of directors certified by the CAC; and a profile of the company covering, among others, a brief history of the company organizational structure, shareholding structure, principal officers and so on. The evidence of the required minimum paid-up capital must be provided (Table 6.1).

Table 6.2  Capital market operators: minimum paid-up capital requirement Operators

Minimum Paid-Up Capital N’Million

1 2 3 4 5

Issuing House Underwriter Market Maker Broker/Dealer Clearing and Settlement Agent

2,000 2,000 2,000 1,000 1,000

Regulatory framework 99 Operators

Minimum Paid-Up Capital N’Million

6 7 8 9 10 11

Stock/Commodity Exchanges Funds/Portfolio Manager Registrar Corporate Sub-Broker Trustees Rating Agency

500 500 500 60 40 20

Source: SEC (2018).

The SEC has prescribed forms for the registration and regulation of the different types of market operators including issuing houses/merchant bankers, underwriters, broker-dealers; sub-brokers, receiving bankers, registrars, trustees, investment advisers (corporate and individuals), fund/portfolio managers, rating agencies, market makers and custodian. Only corporate bodies are qualified to file applications for most of these functions. Transparency requirements

The SEC has in place requirements for transparency and disclosure of Audited Financial Statements, annual, quarterly report, and half-year financial reports that are more in line with the Sarbanes–Oxley provisions.The requirements for annual reports for public companies include the following: filing of periodic annual reports that meet the SEC’s format and comply with relevant accounting standards, which is the IFRS within 90 days after the financial year end in line with the provisions of CAMA; appointment of a compliance officer, along with a chief financial officer, to ensure compliance with all regulatory requirements; the chief executive officer and chief financial officer or officers or persons performing similar functions in a public company shall in filing the annual account, attach a duly signed certification letter to the matters specified in section 60(2) of the ISA (2007); and the auditor to the public company shall be registered by the commission in line with Section 62 of the ISA (2007). In addition to the SEC, company information disclosure is further regulated by the exchanges on which the securities of relevant companies are traded. For instance, the NSE Issuers’ Portal (X-Issuer), which was launched in 2013, gives access to up to date financial and material information filed by listed companies. For unlisted public companies, however, it is relatively more difficult to have access to such information in a central repository, except when such companies are traded on the unlisted securities platform of The National Association of Securities Dealers Over-the-Counter (NASD OTC). In some sectors, particularly banking and insurance, regulators must approve financial statements before being released to the public. For financial holding

100  Investment banking in frontier markets

companies, delays are often encountered as different primary regulators of the subsidiaries must approve the financial statements before a consolidated holding company’s financial statement can be released. The consolidated supervision process under the Financial Services Regulators Coordinating Committee (FRSCC) is expected to solve this problem. Market abuse and insider dealing

The development of capital markets could be hampered by market manipulations and insider dealings as investors’ confidence is eroded. Market manipulation and abuse can arise from conflicts of interest in different forms.To mitigate the impacts of conflicts of interest in the capital markets, the CAMA (2004) stipulates that company directors have a general duty to disclose any direct and indirect interest that they may have in any contract or proposed contract with the company.4 The SEC rules require that the details of conflicts of interest, risk factors and mitigating factors should be submitted to SEC along with the other application documents on the issuance of corporate securities.5 The ISA provides the primary rules regulating insider dealing. In particular, Section 115 of the ISA prohibits the use of insider information and imposes a penalty for contravention of the rule. The SEC rules stipulate that insider dealings at a recognized securities exchange occur when a person or group of persons trade securities for their own accounts and benefits based on confidential and price-sensitive information that is within their possession but is not generally available to the public. It also includes making such information available to a third party that uses it for its own account and benefit. An issuer is required to secure sensitive information and prevent access to insider information by third parties who might use it for their own benefits. A confidentiality covenant should be obtained from all advisers to the issuer who require access to sensitive information during an equity offerings process. Sanctions and penalties of varying degrees are imposed by both the SEC and the NSE rules for the contraventions of market abuse and insider dealings regulations. Corporate Governance

There are various codes of corporate governance in operation in Nigeria. Adeniyi-Akintola (2018) identified five key codes, namely • Code of Corporate Governance for Public Companies (2003, revised in 2011 and 2014, SEC Code); • Code of Corporate Governance for Licensed Pension Operators 2008; • Code of Corporate Governance for Insurance Industry in Nigeria 2009; • Central Bank of Nigeria Code of Corporate Governance for Banks and Discount Houses in Nigeria, 2014; and • Code of Corporate Governance for the Telecommunications Industry 2016.

Regulatory framework 101

Corporate governance codes have been issued by several regulatory authorities including the SEC and NSE for capital market operators. The Code of Corporate Governance of the SEC further stipulates that all directors of companies should participate in periodic continuous education to update their knowledge and skills in their areas of business. The SE’s Code of Corporate Governance stipulates that a director must abstain from discussion and voting on matters in which it has conflicts of interest.6 The NAICOM and the PENCOM have codes of corporate governance for the insurance industry and for the pension industry. The Financial Reporting Council of Nigeria (FRCN) prepared code of corporate governance for all public and private companies. In October 2018, the CBN issued new codes of corporate governance for DFIs, bureaux de change, microfinance, FCs and mortgage refinance institutions. These codes have different levels of compliance and enforcement mechanisms; for instance, while it is mandatory (rule-based) for public companies to comply with SEC code, the FRCN code is principle-based. To address the multiplicity of codes, in 2016, the FRCN published the combined National Code of Corporate Governance (NCCG) for the private, public and non-profit sectors. The implementation of the NCCG was suspended by the FGN to allow for more consultation with various stakeholders. A technical committee was established in January 2018 to lead this consultation and review the NCCG. In June 2018, an exposure draft of the New Nigerian Code of Corporate Governance was published to serve as the template for the consultation with stakeholders. Market integrity

Capital markets’ integrity is further enhanced through corporate governance code, accounting and auditing standards and anti–money laundering laws. Public companies are required to prepare their audited financial statements in accordance with the auditing and financial reporting standards stipulated by the FRCN. The FRCN has responsibilities for issuing accounting standards. It also monitors the accuracy and fairness of financial accounting reports of public companies to ensure conformity with key accounting standards and regulations. The FRCN, the CBN, and the SEC collaborated in implementing the adoption of International Financial Reporting Standards (IFRS) and International Auditing Standards (ISAs) in the Nigerian financial sector. In 2012, the banking industry produced financial statements that are IFRS compliant. Capital market operators have since followed suit in preparing financial statements that are IFRS compliant. There are also SROs that prescribe a code of ethics/advocacy for their members (IMF, 2013b). They include the Chartered Institute of Bankers of Nigeria (CIBN), Institute of Chartered Accountants, Association of National Accountants, Chartered Institute of Stockbrokers (CIS), Association of Stockbroking Houses of Nigeria, Association of Issuing Houses of Nigeria, Association of

102  Investment banking in frontier markets

Capital Market Registrars, Association of Corporate Trustees, Financial Market Association of Nigeria and the Capital Market Solicitors Association. The CIS is a non-profit organization chartered by the Act 105 of 1992, which regulates the conduct and practice of the stockbrokers in Nigeria. There are other self-regulatory bodies focusing on particular segments of the capital markets. AML/CFT

Financial institutions including investment banks are required to comply with the provisions of the Anti-Money Laundering Act. There are, however, deficiencies in respect of specific action plans in implementing issues regarding the criminalization of money laundering and terrorist financing. Nigeria still features very high in the global corruption index of Transparency International. Effectiveness of regulations

Out of 140 countries, Nigeria is currently ranked 47th on the World Economic Forum Global Competitive Index 2015–2016 for regulating its securities exchange and 55th for the strength of its investor protection measures. However, it is 109th for the burden of regulation. These rankings, particularly that of the regulatory environment, will need to be improved to boost investor confidence and increase the number of sizeable investments made through the capital markets.

Notes 1 2 3 4 5 6

South Africa. SEC website. Central Bank of Nigeria (2016) Financial System. Section 277 of CAMA. SEC Rule 567(n)(vi). SEC Code of Corporate Governance Article 16 (1)(b).

Bibliography Adeniyi-Akintola, R. (2018), Developments in Corporate governance Regulation in Nigeria: A Step Forward, Two Steps Back, Journal of Corporate Governance, 10(1), July Awrey, J.A., P. Davies, J. Gordon, C. Mayer and J. Payne. (2014), Principles of Financial Regulation Law. Working Paper N° 277/2014. http://ssrn.com/abstract=2526740 CAMA. (1990), Companies and Allied Matters Act 1990 CAMA. (2004), Companies and Allied Matters Act 2004 CAMA. (2018), Companies and Allied Matters Act 2018 Caprio, G. Jr. (2009), Financial Regulation in a Changing World: Lessons from the Recent Crisis Central Bank of Nigeria. (2016), The Nigerian Financial System at a Glance

Regulatory framework 103 Etomi, S. (2003), Public Offer of Company Securities: The Legal Perspective. A Paper Presented at the Alpha Juris Workshop Series in Port Harcourt, Rivers State, Nigeria, on the 6–7 February. http://geplaw.com/wp-content/uploads/2014/11/Public-Offer-ofCompany-Securities.pdf European Commission. (2018), Delivering on Capital Markets Union Hahn, F.R. (2010), Financial Market Regulation, Australian Economic Quarterly, 1. Hudson. (2008), Securities Law, Sweet and Maxwell IMF. (2013a), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Implementation of IOSCO Objectives and Principles of Securities Regulation, IMF Country Report No. 13/144 IMF. (2013b), Nigeria: Financial Sector Assessment Program: Detailed Assessment of Observance of Insurance Core Principles, IMF Country Report No. 13/145 ISA (2007), Investment and Securities Act 2007Levy and Post. (2009), Investments, FT Prentice-Hall Nigerian Capital Markets. (2015), Legal and Regulatory Review and Recommendations, March.The Nigeria-UK Capital Markets Project. A Collaborative Report of the Nigerian Capital Markets Solicitors Association, and Law Society of England & Wales Obianwu, C. (2014), Role of Solicitors in Capital Market Transactions. www.templars-law. com/wp-content/uploads/2015/05/The-Role-of-Solicitors-in-Capital-Market-Transactions.pdf Oshikoya,T.(2015),MTN –A Case Study for Market-Supporting Institutions.www.proshareng. com/news/Fintech/MTN – A-case-study-for-market-supporting-institutions/29164 SEC (2013), SEC Nigeria’s Consolidated Rules and Regulations as at 2013 SEC (2018), Website Society for Corporate Governance Nigeria. (2014), Directors’ Handbook on Corporate Governance Wang, F. and F. Hu. (2010), The Application of Customer Relationship Management, Asian Social Science, 6(10), October

Part III

Raising capital in frontier markets

7 Equity underwriting

Principles Raising capital for companies is at the core of investment banking. Companies raise capital through issuing of bonds, equity and quasi-equity. Raising equity capital comes in a variety of ways: IPOs, flotations, rights issues, and private placement. Rights issues or offerings

In most jurisdictions, companies are obligated to offer shares to existing shareholders who have a pre-emptive right before issuing additional stocks to external parties. Rights offerings are the selling of additional stock issues to existing shareholders, usually at a discount to the current market price (if the company shares are listed).With private placements, companies sell shares to a select group of investors, typically institutional investors who invest in large blocks of shares. IPOs involve the selling of new shares to the public by a previously unlisted company. It is often labelled as going public as the company will be publicly listed on a stock exchange after the IPO. A company planning to go public via an IPO go through certain steps, which include selecting an investment bank that undertakes due diligence and regulatory filings, pricing, stabilization and transition. Companies use IPOs to obtain equity capital infusion to fund new projects to improve credit standing and reputation, for working capital and for mergers and acquisition. Founders of a company may view it as a means of cashing out some of their investments locked up in the company by way of an offer for sale of shares. Equity underwriting in investment banking is the process of selling new stocks to investors in the form of IPOs or follow-on offerings. Underwriting has three main types of commitments (CFI, 2018). First, in a firm commitment, the investment bank underwriting the IPO commits fully to purchasing the entire issue and would be financially liable for unsold shares. Second, the best efforts or marketed deals preclude the underwriting bank from being

108  Raising capital in frontier markets

financially liable for unsold shares. Third, the underwriting bank will not be compensated in an all-or-none commitment unless the entire issue is sold at the offering price. There is another form of underwriting known as the Standby Basis where the agreement is to sell shares in an IPO in which the underwriting investment bank agrees to purchase whatever shares remain after it has sold all the shares it can to the public. Price setting consists of three main mechanisms for pricing and distributing securities: (a) open price (book-building), (b) fixed price and (c) auctions (Iannotta, 2010). In open-priced offerings, the investment bank canvasses potential investors and then sets an offer price. In contrast, in fixed-price offerings, the offer price is set prior to requests of shares being submitted. In auctions, a market-clearing price is set after bids are submitted. The market-clearing price is similar to the equilibrium price, and it is the lowest bid price at which the total collated subscriptions at a public offering is equal to the units of shares being offered. Investment bank underwriting typically goes through five phases (Iannotta, 2010; Liaw 2006). First, the planning and preparation phase involves defining the investment themes and rationales and a projection of demand by potential investors. In the second phase, the underwriting bank would approach the market after evaluating economic and market conditions, investor appetite and previous offerings to determine the best timing and demand for an offering and, after completing regulatory filing requirements, undertake a roadshow.Third, at the going-public stage, the underwriting bank would structure the issue based on the targeted investors. Fourth is the stabilization stage, and fifth is the transition to market competition stage.

Practice Global equity underwriting market

League tables provide the rankings of the key players in the investment banking industry. They cover specific business segments, including equity underwriting, bond underwriting, syndicated loans, project finance, PE and M&A. League tables serve as important marketing tools for investment banks. Bloomberg league tables are some of the widely used. Bloomberg (2018) indicates that global equity and equity-linked and rights volume in 2017 increased by a third to US$740.8 billion while deal count increased by nearly a fifth to 4,875 offerings year on year. Global Equity IPO volume and deal count increased by 45 percent year on year to US$196.4 billion and 1,654, respectively. Global Equity Linked volume increased by a fourth year on year to US$99.5 billion over 382 deals. Financial services account for a third of deals followed by consumers and industrial good with 12 percent and 11 percent, respectively

Equity underwriting 109

In line with the discussion in Chapter 4, three US banks dominated the league tables, accounting for a quarter of the total equity underwriting in 2017. Morgan Stanley ranked as the top global equity and equity linked and Rights underwriter in 2017 with 8.84 percent market share and 413 deals; it was followed closely by J.P. Morgan and Goldman Sachs, which ranked second and third with 8.21 percent and 8.03 percent market share, respectively.They were followed by Citigroup and Bank of America Merrill Lynch with 6 percent and 5 percent share, respectively, bringing the combined total share of US banks to 36 percent. The next four banks on the league tables are European banks: UBS, Credit Suisse, Deutsche Bank and Barclays, followed by the Royal Bank of Canada. Nigeria’s primary equity market

Issuers in Nigeria are typically entities incorporated under the Company and Allied Matters Act (CAMA, 2004), the country’s company and commercial law. Other entities that can issue securities in the primary capital markets are bodies corporate under special acts of the national or state assemblies. The federal government and state government can also issue securities in the capital market. In Nigeria, Rule 40(A) of the Rules and Regulations of the SEC provides that securities offered through the following medium must be registered: offer for subscription, offer for sale, rights issue, bonus issue, private placement by public companies, securities arising from conversion of private company to public limited company (PLC), debenture/loan stock, state and local governments bonds and listing by introduction (SEC, 2017) IPO/Offer for subscription

Since 2000, there has been significant growth in the Nigerian primary capital market as major domestic companies became publicly listed and with impetus from the bank consolidation exercise discussed in Chapter 2. From Table 7.1, new equity issues in Nigeria grew from 35 deals to 897 as a result of the regulatory-driven re-capitalization of banks. New equity issues from the nonbanking sectors also grew significantly but at a slower pace than that of the banking industry. In 2006 and 2007, further tremendous growth of new equity issues was witnessed, nearly doubling the deals count in 2005 to 1,504, respectively, due to a second level of capital raising by banks and regulation-driven insurance sector consolidation. The new equity issues in the real sectors of consumer and food, pharmaceuticals and aviation industries also contributed to the growth witnessed in the period. Furthermore, an estimated ₦650 billion was raised via private placements in as many as 300 transactions in the period 2004 to 2008 (SEC, 2018). Equity issuance gained momentum in 2007 and 2008 to 1,339, 313 and 1,495,906, respectively, led mostly by banks’ offer for subscription. In 2011, private placement by banks dominated equity issuance.

Offer

Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: SEC (2018).

3,261.71 96,485.30 25,776.36

92,273.50 102,152.42

Initial public offer

 

Offer for sale

1,808.75

4,426.86 825.10 10,511.44 20,718.25 10,124.95 106,138.09 305,221.23 157,142.40 509,924.22 715,795.03 179,870.89

N

Offer for subscription

Table 7.1 Approved equity offers by issue type

1,148.00 1,192.73 11,567.89 39,278.76 30,960.27 23,532.54 21,893.99 2,677.75 49,940.77 928,715.66 23,613.35 91,390.31 48,220.96 14,775.94 5,108.88

49.22 8.97

Private placement 7,207.61 4,873.74 22,168.58 11,763.91 18,112.18 27,541.80 50,140.52 47,689.61 139,844.56 88,580.45 149,112.41 47,874.87 131,034.53 66,448.84 34,813.54 198,342.69 26,369.16 4,813.86 306,494.59

Right issue

38,470.69 11,198.98 19,892.26 405,296.36 395,342.88

128.83

Supplementary offer

168,442.44 172,141.97

Others

11,684.38 5,707.81 32,680.02 33,758.99 29,429.86 183,718.47 405,839.49 255,684.54 1,339,313.62 1,495,906.74 331,661.05 97,815.64 1,059,750.19 90,062.19 129,465.56 343,048.95 66,921.46 11,731.49 306,494.59

Grand total

Equity underwriting 111

In the primary segment of the Nigerian capital market, there were 26 new issues worth ₦554.77 billion in the first half of 2018, compared with 24 valued at ₦808.06 billion in the first half-year of 2017 (SEC, 2018). Ten new issues approved by the commission in the review period amounted to ₦93.36 billion and comprised six equities made up of three rights issues at ₦54.36 billion, two private placements at ₦5.99 billion, one offer for sale at ₦0.01 billion and four corporate bonds at ₦33.33 billion. In the fixed income primary market, 16 bonds, worth ₦461.08 billion, were issued and allotted in the review period, compared with 16 bonds, worth ₦829.42 billion, in the first half-year of 2017. The impressive growth in equity primary market notwithstanding, there are still only 178 publicly listed companies on the NSE, compared with more than 2.3 million companies registered with the CAC. There are several challenges to growing the primary markets. First, the issuance process is relatively long as the mandatory regulations in issuing an IPO or public offering in Nigeria take time to be approved: 27 weeks, relative to 10 weeks in the United States and an average of 15 weeks in emerging markets. For a long time, public issues were undertaken on a fixed price that was determined sometimes without reference to market appetite. A book-building rules system was introduced in 2008 which provided for more market-led pricing of public issues. At least 80 percent of all public issues were required to be underwritten on a firm basis, although the market appears to favour discretionary underwriting. Transaction costs were higher relative to emerging markets, which deterred access to the primary market. Rights issue

Rights issue, as a primary source of funds for listed companies, is very common in Nigeria. In 2000, a total of 4,850 rights issue with a value of ₦4,874 million was done. In 2017, a total of ₦306,495 million was done (Box 7.1). A company offers a right issue to its existing registered shareholders as of a record date, which entitles the latter to make an application for and receive additional shares of the company. The shareholders, however, are not obligated to exercise the rights and may decide to renounce, trade the rights and not subscribe. Rights issues may be fully subscribed, undersubscribed or oversubscribed. The pre-issue shareholding structure is not affected with full subscription. In the case of under-subscription, the promoters of the company may decide to take those shares, whose rights are not exercised, thereby increasing their stake in the company. With oversubscription, a pro rata allotment to shareholders would be made. The capital structure of the company will be affected by the pricing of the rights issue along with the volume. A rights issue is usually priced below the market trading price of the shares to make it attractive for existing shareholders to take up their rights. The market price, earnings prospects and the price– earnings ratio are therefore major considerations for shareholders as investors in rights issues. For the company doing a rights offer, it must consider other

112  Raising capital in frontier markets

factors, including the objectives of the rights issue, floatation costs and alternative sources of equity capital raising, such as PE, private placement, or debt capital (Pratap, 2008).

Connecting principles to practice Box 7.1  Right issue at Lafarge Established in 1959 as West African Portland Cement, Lafarge Africa is formed through a consolidation of Lafarge S.A.’s assets in Nigeria and South Africa in 2014. Lafarge Africa is the second-largest cement producer in Nigeria. Lafarge Africa is rated A+ by two leading creditrating agencies: Global Credit Ratings and Agusto & Co. Lafarge Africa embarked on a debt restructuring program through a right issues. The rights issue has four key objectives: reduce the impact volatility in foreign exchange on Lafarge Africa’s earnings, provide greater headroom to raise additional capital to further capitalize on the emerging opportunities in Africa, ensure cash flow preservation-reduction in interest expense and provide short-term liquidity support through financing working capital (Lafarge, 2017). The terms of the rights issues are as follows: Offering Structure: Lafarge Africa PLC as issuer. Listing of new ordinary shares on the NSE. Offering Size: ₦131,65 billion through an offering of 3,098 million new ordinary shares. Subscription Ratio: Five rights for every nine shares held as of 1 November, 2017. Use of Proceeds: To pay convertible loan, shareholder loan or any other loans facility due from the company. Key Dates: Qualification Date: November 1, 2017. Rights trading and subscription period: November 24 to December 15, 2017. Issuing Houses: Lead Issuing House: Chapel-Hill Denham Advisory Ltd. Joint Issuing House: Standard Chartered Capital & Advisory Nigeria Ltd. Source: Lafarge (2017).

Private placement of equity

Nigerian companies have raised capital through private placement as an alternative to public offers of shares. Private placements are often made to institutional and HNWI investors. Private placement can be in the form of preferential allotment to selected strategic investors.

Equity underwriting 113 Investment banking and equity underwriting

Investment banks as issuing houses play key roles in the primary market as they manage overall transactions in issuing various securities for investment, prepare offer timetable and ensure adherence to it, and liaise with other relevant parties to obtain necessary information and documents to be filed at the SEC. Issuers market and distribute offer documents, prepare and file allotment proposal and ensure compliance with rules and regulations.There are 59 issuing houses registered by the SEC as of 2017. In Nigeria, some of the leading local equity underwriting investment banks include Chapel Hill-Denham, FBN Quest, FCMB and Vetiva. There are other boutique houses, which provide services to smaller companies and in some specific sectors. For equity distribution targeting international institutional investors, Citibank, Stanbic IBTC, and Standard Chartered Bank are the three leading banks. The IPO process

The IPO process and timeline in Nigeria can be divided into broad terms to three stages. First is the pre-offer stage, which lasts between 1 and 4 months. Second is the offer stage that takes between 1 and 2 months. Third is the postoffer stage, which takes between 1 and 2 months. These stages can be further subdivided into six phases for elucidation. In practice, a typical IPO process can take between 6 and 8 months but the actual length of time depends on the readiness of the issuing company, the active role of the underwriters or issuing house, the level of compliance with relevant laws and regulations and delays by the regulatory authorities. Phase I: advisory, planning and preparation

The preparation phase includes the issuing company deciding the amount to be raised, the types of securities to be used and the selection of a team to manage the process. The team would include investment bank, reporting accountants, legal advisers, trustees, registrars and public relations firms. A board resolution authorizing the issues and the appointment of the team must be kept. Investment banks play the leading role in the equity underwriting process. The investment banks perform functions relating to underwriting, distribution and advice and counsel (Iannotta, 2010). Indeed, the success of the IPO depends crucially on the capabilities of the investment banking team selected to manage the process.The preparation and planning phase of the underwriting process involves the selection of the investment banking team that would advise the issuing company on the IPO, administer the registration with the regulatory authorities and manage the entire process on behalf of the client. The issuing company will select the investment bank after several pitch meetings, where investment banks present their services and capabilities to

114  Raising capital in frontier markets

Advisory

Packaging

2 weeks  Determine timing and size of required funding

8 weeks  Appoint parties to the Offer  Develop Prospectus and other Offer Documents

 Conduct valuation and  File Offer determine Document with optimal Offer regulators for structure approval

 Attend Quotations Committee meeting of the NSE  Receive SEC approval to hold completion Board meeting

Open Offer

Markeng

6 weeks  Open Offer (28 days max)  Pay underwriting to Issuer (on the Offer opening day)  Maintain marketing drive  Liaise with Stockbrokers to monitor market reception of Offer

Close Offer

Lisng

8 weeks

3 weeks

 Conduct  Close Offer customer forums/dinner  Receiving in strategic agents make locations returns across the country  Prepare Allotment  Facility schedule visitation  Obtain  Identify and Directors’ market approval of potential high Allotment net worth investors  Submit Allotment proposal to SEC

 Listing of the shares

 Hold completion Board meeting

 Commence Trading

 Receive SEC’s approval of the Allotment

 Receive approval for the Offer to open

Figure 7.1 Estimated timeline for primary market offers Source: SEC (2006).

the client. The criteria for selecting an investment bank as an issuing house include understanding of the company and the securities markets, reputation, quality of research and expertise, distribution capabilities and track record of previous experience with public offerings of securities. By the Nigerian SEC Rules 315 (1), it is no longer mandatory but optional and at the discretion of the issuer for issuing houses to underwrite all public issues. The notable exceptions are rights issues or where the issuing company requests for non-underwriting. Phase II: packaging: the due diligence phase and regulatory approval The due diligence phase

Following the selection and assembling of the team, the investment bank would undertake due diligence on the company in order to ensure the success of the issue. A letter of intent will be signed by both parties. It will typically indicate the underwriter’s commitment to enter an underwriting agreement

Equity underwriting 115

with the issuing company, a commitment by the issuing company to cooperate in all due diligence efforts by providing all relevant information, examining the issuer’s books and records to evaluate its financial viability and assessing the state of the market for the new issue. Some of the due diligence issues will include reviewing the company’s financial records, tax compliance, legal documents, intangible assets, potential liability, and market and industry research. The issuing company and the selected underwriting bank will review the initial size of shares and the amount to be issued and the risk and financial responsibilities for unsold shares using an Underwriting Agreement. The terms of the underwriting contract, along with the types of commitments, amount and timing of the underwriting, are set out by the SEC under Rule 186. For firm underwriting, the amount must be made available within five days after the Completion Board meeting. The commission is a maximum of 2.3% of the offer size according to the SEC New Rules and Sundry Amendment 2017. The registration documents should state if listing requirements of the NSE have been complied with in case the application has already been made. The agreement will define the underwriting arrangements, which are usually in three main forms. Firm Commitment: The underwriting bank purchases the entire offer at a discount, which will be resold to the investing public at a fixed public offering price. The firm commitment is the most common form of underwriting arrangement among large investment bank as it is more lucrative for them. It also guarantees the issuing company the specific amount that will be raised, while the underwriter assumes all the risk of the offering, including the liability of any unsold shares (Liaw, 2006). Best Efforts or Contingency Agreement: The underwriting bank will not guarantee the amount that will be raised for the issuing company. It will only sell the securities on behalf of the company using its best efforts. The underwriter is not financially responsible for the unsold shares. The issue offering will be cancelled if a certain portion of the allotted shares had not been sold at the end of the subscription period. The bank will return the securities to the issuer, while the investors get their money back. Smaller and less wellknown issuing companies may engage in a best-efforts commitment with its underwriter. Major investment bankers rarely participate in best efforts offerings, because the size of the offering is often small and offers limited profitability. All-or-none (AON) commitment: The underwriting bank will have to sell all shares on offer or void the offering. In this case, the underwriting bank receives all shares offering by a certain date is expected to sell them within a specified period or return them. Syndicate of Underwriters: The selected underwriting bank may not want to bear all the risks relating to the offering. In practice, underwriting syndicate among multiple underwriters is often formed to diversify the financial risks of a

116  Raising capital in frontier markets

public offering. In this case, the main underwriter will be appointed as the lead underwriter, syndicate manager or bookrunner. In the case of two lead managers, they will be termed as the co-managers to the issue. The lead underwriter organizes the syndicate with other banks, undertake share allotment to be sold by each underwriter to investors and establish the retention fees.The lead manager also tries to stabilize bids in the aftermarket. Vending Agreement: The vending agreement is an agreement between the issuer and the issuing house for the packaging and marketing of the issue, which will be reviewed and approved by the SEC. This agreement will state the obligations of the issuing house in the marketing the offerings, preparing the necessary documentation and obtaining the approvals from the SEC and circulating and advertising the prospectus and the application form. The obligations of the issuer will include providing all necessary information to the issuing house; bearing all necessary costs, fees and expenses of the offerings; and indemnifying the issuing house against any liability to any interested party for non-disclosure of material fact or for false and misleading statements in the prospectus. Securing the Approval of the Regulatory Authorities

Registration Statement: The next step is the filing of registration and obtaining the approval of the regulatory authorities. The provisions of CAMA and SEC Rule 40 provide that the following equity securities offered to the public must be registered: offer for subscription, offer for sale, rights issue, bonus issue and private placement by public companies. The registration statement therefore provides information regarding the IPO, the company’s management, shareholding structure, financial statements for the past five years and currently pending and potential legal issues. FORM SEC 6: This form is used when filing the registration statement application. Its contents include the nominal value of the company, the nature of its business, its organizational and management structure, its financial structure, bonus and profit arrangement, its schedule of claims and litigation, key management and service contracts, any other material information. FORM SEC 6 should be accompanied by Copy of Certificate of Incorporation, a copy of resolutions by the general meeting of the company authorizing the offer, two copies of the Memorandum and Articles of Association certified by the CAC, signed copy of audited accounts for the preceding 5 years or number of years for which the company has been in operation (if less than 5 years), two copies of draft prospectus and abridged prospectus, two copies of the draft underwriting agreement and the vending agreement and agreement among joint issuing houses (SEC, 2017). This list is not exhaustive but contains the main required items (Box 7.2). Quiet Period and SEC Review: Following the filing of a registration statement, a quiet period is observed to avoid improper disclosure that could jeopardize the issuing process.

Equity underwriting 117

Connecting principles to practices Box 7.2  Regulatory requirements for public offers Documents to be filed with the Commission under Rule 279 (2) • Form SEC 6 to be appropriately completed • Certified copy of shareholders’ resolution authorizing the offer • Certified copy of board resolution authorizing the issue and evidence of increase in share capital where applicable • CAC Certified copy of the Memorandum and Articles of Association (with amendments where applicable) of the company. • Certified copy of the Certificate of Incorporation • 5 years audited accounts or for the number of years in operations (for AseM companies, 3 years accounts are acceptable) • Draft prospectus and abridged prospectus • Draft rights circular • Vending agreement • Draft underwriting agreement (where applicable) • Draft sub-underwriting agreement (if there are sub-underwriters) • Reporting accountants’ reports (optional for rights issues) • Consents letters from parties to the issue • CAC Certified Form CO7 – Particulars of Directors • Technical agreement between issuer and another party • Draft trust deed (if a debt issue) • Evidence of Irrevocable Standing Payment Order (ISPO; for state and • local government bonds) • Law authorizing the issue of the bond (for state or local bonds) • Gazette publishing the bond • Feasibility report of the project (s) expected to be funded by the bond • Result of rating by a registered rating agency (for bonds) • Bridging loan agreements (if any) • List of material contracts, claims and litigations • Stock Exchange certificate of exemption • Any other information which may be required by the Commission Source: SEC (2017).

During this period, promotional publicity is not allowed. The SEC reviews and examines the FORM SEC 6 and the attached documents submitted with it.The purpose of registration is to enable regulatory authorities to review issue documents and ensure that investing public can rely on the documents to make

118  Raising capital in frontier markets

informed decisions relating to the offerings. Following its review, the SEC will send a letter of deficiencies on areas that need to be addressed. Red Herring Prospectus: A red herring is a preliminary prospectus provided by the issuing house or lead manager to a qualified institutional/high networth investor. The red herring prospectus containing all information except the information regarding the price at which the securities are offered and the volume of securities shall be filed with the commission. Under SEC Rule 287, there shall be set forth among other information on the front cover of every prospectus the following statement printed in red ink (hence the red herring): THIS PROSPECTUS AND THE SECURITIES, WHICH IT OFFERS, HAVE BEEN REGISTERED BY THE SECURITIES AND EXCHANGE COMMISSION. THE INVESTMENTS AND SECURITIES ACT, PROVIDES FOR CIVIL AND CRIMINAL LIABILITIES FOR THE ISSUE OF A PROSPECTUS WHICH CONTAINS FALSE OR MISLEADING INFORMATION. THE REGISTRATION OF THIS PROSPECTUS AND THE SECURITIES WHICH IT OFFERS DOES NOT RELIEVE THE PARTIES OF ANY LIABILITY ARISING UNDER THE ACT FOR FALSE OR MISLEADING STATEMENTS OR FOR ANY OMISSION OF A MATERIAL FACT IN THIS PROSPECTUS. (SEC Rule) The prospectus front cover typically contains the name and RC. No. of the issuer; name and RC No. of the issuing house; type of offer; securities being offered, the price and amount payable in full on application; date of the prospectus, which shall be the date of publication; and approval and registration clause. The first section of the prospectus will contain a summary of the offer, directors and parties to the prospectus, chairman’s letter, history and business, management and staff, purpose of issue, future developments and profit prospectus, capital structure, principal shareholders, dividends, underwriting (if any), litigation and related matters, expert opinions (solicitors, accountants, etc.), financial information, plan of distribution (names of receiving banks and names and address of stockbrokers), use of proceeds and statutory and general information. The second section of the prospectus describes the status of the securities being offered and if application has been made to a stock exchange for the listing of and dealing in the shares of the company. It will state the name of the issuer, the issuing house, the type of offer, the number of shares being offered, the price and the amount payable in full on application. The times of opening and closing of the offer, the share capital of the company, issued and fully paid and the indebtedness of the company, stating details of bridging loan, if any (Etomi, 2003). The third section provides for the disclosure of the list of the directors of the issuer and other parties to the issue and their addresses. The other parties include issuing house, brokers, underwriters, trustees, solicitors to the issuer, other solicitors, reporting accountants, auditors, receiving banker(s), registrar and secretary and registered office.

Equity underwriting 119

The final prospectus is both a legal document and a disclosure document as it provides full disclosure of the company’s business and offerings attributes. It is used for marketing purposes aimed at retail investors. An abridged prospectus, which is a simplified version of the main prospectus, is circulated to institutional investors. Phase III: open offer and valuation and pricing economics

Fixed Pricing: Price setting is one of the last steps of the IPO process. There are three mechanisms for setting the offering price: fixed price, book-building and auction. Prior to 2010, public offers in Nigeria were undertaken on a fixedprice basis, which is determined by the issuers and the issuing house, without reference to market demand. Following the approval by the SEC, the issuer and the issuing house decide the offer price and the number of securities that would be sold a day before the effective date. Thus, investors know in advance the offering price of the securities, but demand for the securities would be known only after the closure date. Payment is made at the time of securities subscription. Several factors will influence the determination of the offer price, including the goals of the issuing company, economic and market conditions and the success of the road shows as indicated by the order books. To ensure that the securities are fully subscribed by retail investors, the issuers and the issuing house often deliberately underpriced the IPOs. Underpricing provides a cushion for investors and increases the demand for the securities as most investors buy on the expectation that the price would rise on the securities offerings listing date. A successful IPO would be subscribed by 100 percent or more. The fixedprice method has its disadvantages. It extends the length of the public offering process. Furthermore, it lacks flexibility in terms of the price and size of the securities on offer. Mispricing of fixed-price offers is often common as there is no reference to true market demand. There are two types of fixed-priced offerings (Iannotta, 2010): (a) firm commitment (or underwritten) and (b) best effort (non-underwritten). Book-Building: The second method of determining the offering price is through book-building, which was introduced in 2010 into the Nigeria equity underwriting process following the recommendations of the National Committee on the Review of Capital Market Structure and Processes (SEC, 2006). Book-building is based on an open price and demand discovery in which potential institutional investors reveal their preferences, which enabled the issuing house to determine the IPO price range. The bookrunner builds a book during the roadshow by accepting orders from institutional investors and HNWIs who will make a commitment within the price range and indicate the size of the securities. Once the issue period is over, the bookrunning lead manager and the issuing company would arrive at a market-clearing price. Investors bidding below the market clearing price will be excluded from the share allotments.

120  Raising capital in frontier markets

With book-building, investors will not know in advance the actual offer price, only an indicative range. As the book is built, securities demand will be known sequentially and cumulatively. Payments are made only after allotment of securities. Subscription monies must be paid into separate accounts, one for qualified institutional/high net-worth investors and the other for retail investors. A portion of the securities offer must be reserved for retail investors. The offer to retail investors opens after the completion board meeting and remains open for a period not exceeding 10 working days (Delano et al., 2017). In contrast to book-building, where the price is set after bids are submitted, investors bid for securities in an auction and once the offering is covered, shares are allocated at a single clearing price. Phase IV: marketing and the roadshow

Once the cooling-off period ends, the offering is jointly presented to potential investors, in a series of roadshow by the lead manager and the top management of the issuing company. The roadshow is used to engage institutional investors to obtain indications of interest and to determine the strengths of the market for the issue offering. Due diligence continues during the roadshow while the selling group is assembled among members of the syndicate underwriting the issues.The marketing of the issue offerings to retail investors are through public advertisement and receiving agents including stockbrokers and banks. Tombstone advertisements are placed in newspapers to announce the particulars of the securities being offered to the public. It contains the name of the issuing company, the issuing price and size, the lead underwriter and the underwriting syndicate. Tombstones must be approved and in compliance with the Rules of Nigerian SEC. Phase V: close of offer allotment

Rule 60 of the Rules and Regulations of the Commission provided for the period that an offer would remain open and thereafter close. It provided that an offer shall remain open for a period not exceeding twenty-eight working days from the date of opening stated on the prospectus. Allotment, that is, the distribution of shares or the securities, is the joint responsibility of the Issuing House and the Issuer. The allotment has to be completed and an allotment announcement submitted to the Commission, for information purposes, within six (6) weeks of the close of the issue unless, there is an extension of time (SEC Rule 309 of the Rules and Regulations of the Commission). The overallotment option or Greenshoe enables the underwriter to sell additional shares in registered securities offering if demand for the securities is in excess of the original amount offered. The Greenshoe can vary in size up to 15 percent of the original number of shares offered (SEC, 2006). Stabilization is the buying of shares for the limited purpose of preventing a decline in its open market price in order to facilitate its distribution to the public.

Equity underwriting 121

The lead manager tries to maintain the price of the shares during trading following a public offering due to the heavy trading that often results after. Stabilization activities can only be carried out for a short period of time – however, during this period of time, the underwriter has the freedom to trade and influence the price of the issue as prohibitions against price manipulation are suspended. In Nigeria, while the Greenshoe is in practice, stabilization is prohibited as the Rules of the Nigeria Stock Exchange prohibits a dealing member, either alone or with any other member or person, from effecting, or knowingly assisting in effecting, any series of transactions for the purchase or sale of securities for the purpose of pegging or the price of these securities (NSE, 2018). An issuer must report suspicious price fluctuations of its securities. NSE Rules and Regulations.These apply to all publicly quoted companies and public companies interested in listing their shares on the NSE and to dealing members of the NSE. Phase VI: listing process and requirements on the stock exchange Listing process and requirements on the NSE

The process of listing a company on the NSE involves a number of steps that are intertwined with the IPO steps discussed earlier. The exact steps taken will vary from company to company, by the method of flotation, the industry sector and the market the company joins (NSE, 2018). A meeting of the board and shareholders of the company should give approval to the company to go public and appoint the issuing house to implement the mandate (Delano et al., 2017).The share issue will be packaged by the issuing house along with other professional advisers to the offer. An application for listing is submitted to the NSE for evaluation and approval by the company’s sponsoring stockbroker. All the parties involved in the offering process, including the directors of the company, will sign the offering documents, which hold the parties jointly and severally liable for all information contained in the prospectus and other offer documents. Application forms are distributed to accredited receiving agents and to the council member of the NSE, as well as to its branches. Once the offer period has closed, an analysis of share requests is prepared, the allotment made and both the range analysis and allotment schedule sent to the SEC and the NSE for information purposes.The company must provide a declaration of compliance in respect of legal requirements to the issue. A general undertaking by the company to comply with the post-listing requirements of the NSE must also be submitted to the NSE. On the day of the listing, the shares are listed, with a “facts behind the listing” presentation held at the close of the day trading (Delano et al., 2017). In addition to compliance with the relevant provisions of CAMA, 2004, ISA 2007 and SEC Rules and Regulations, companies must comply with the NSE Rules Book before and after being listed. The NSE Rules Book (2017) sets out the listing requirements for the NSE. Table 7.2 provides a summary of the

Standard A

Main Board

3’ years minimum operating track record

3 years’ financial statements; with the most recent of which must not be more than 9 months old at the time of submission of the listing application

Operating track record

Financials

Pre-tax profits Cumulative pre-tax profits from continuing operations of not less than ₦300 million over the last 3 years, with at least ₦100 million pre-tax profit in 2 of these years Market No requirement capitalization

Criteria​​​

Table 7.2 Listing requirements of the NSE

No requirement

Cumulative pre-tax profits from continuing operations of not less than ₦600 million over the last 1 or 2 years

3 years’ financials (date of last audited accounts must not be more than 9 months); or evidence of a strong technical partner with substantial equity holding and involvement in the Issuers’ management, who has a minimum of 3 years’ operating track record and financial statements

Not less than ₦4 billion at the time of listing, based on the issue price and issued share capital 3 years’ minimum operating track record; or evidence of 3 years’ minimum operating track record of a core investor

Standard C

Standard B

No specific requirement

Dual listing

No requirement

At least ₦28 billion or equivalent at the time of listing, based on the issue price and issued share capital 2 years’ minimum Company must operating track have been in record operation for at least 2 years Minimum of Required to 2 years’ financials have financial (date of last statements (date audited accounts of last audited must not be accounts must more than 9 not be more than months) 9 months)

Requirement for a comprehensive business plan (not less than 2 years)

ASEM

Annual listing fees

Based on market capitalization; subject to a maximum amount as prescribed by the NSE fee schedule (currently ₦4.2 million)

Public The number of the public shareholders shall not be less than 300 (for equity shares). shareholders

(Continued)

Promoters and directors to retain SO% of shares pre-IPO for 12 months from the date of listing The number The number of the public of the public shareholders shall shareholders shall not be less than not be less than 51 (for equity 51 (for equity shares). shares). Subject to Fixed flat rates as applicable prescribed by the listing board fee NSE currently schedule set at a total fee of ₦300 thousand for a new listing (i.e. Application fee for a new or additional listing of ₦100,000; and an Annual fee of ₦200,000)

Promoters and directors to retain SO% of shares pre-IPO for 12 months from the date of listing

No requirement

Not less than ₦3 billion

Shareholders’ equity IPO Lock-Up Period

The public shall hold a minimum of 10% of each class of equity securities. No specific requirement No specific requirement

The public shall hold a minimum of 15% of each class of equity securities. No requirement

The public shall hold a minimum of 20% of each class of equity securities.

Public float

Standard B

Company must be registered as a public limited liability company under the provisions of the Companies & Allied Matters Act

Standard A

Main Board

Company must be registered as a public limited liability company by the provisions of the Companies & Allied Matters Act

Company must be registered as a public limited liability company by the provisions of the Companies & Allied Matters Act

Standard C Company must be registered as a Public Limited Liability Company under the Companies & Allied Matters Act

ASEM

No requirement for operations in Nigeria

Dual listing

Source: NSE (2018).

Accounting International Financial Reporting Standards (IFRS); in line with SEC regulations standard Allotment Securities to be fully paid up at time of allotment in line with SEC requirements for minimum threshold for a successful offer Waived from Submission of quarterly, semi-annual and annual statements. Annual certification on adherence Submission of Continuing having to comply to corporate governance required. quarterly, semiobligation with continuing annual and   requirements listing obligations annual statements. of the NSE’s if listed on Annual Listing, another foreign certification   Disclosure & stock exchange on corporate   Transparency with WFE status. governance Rules Companies is required. require a resident Companies nominated must retain a representative for designated adviser as long as they for as long as they are listed. are listed.

Business operations

Criteria​​​

Table 7.2 (Continued)

Equity underwriting 125

key listing requirements for the NSE’s Premium Board, Main Board and AseM Board, as well as criteria for a dual listing.1 In general, the company is required to submit audited financial statements based on the IFRS for the preceding 3 years, but there could be exceptions. A minimum shareholder’s equity of at least ₦3 billion and pre-tax profits from continuing operation of not less than ₦300 million cumulatively for the last three fiscal years, with a minimum of ₦100 million in two of these years, are required. The NSE requires that a free float of a minimum of 20 percent of the issued share capital of the company are in public hands (there could be exceptions) and must be held by at least 300 shareholders. The potential listing of MTN Nigeria is outlined in Box 7.3.

Connecting principles to practice Box 7.3  MTN Nigeria to raise capital by IPO and list on NSE Nigeria is the largest telecoms market in Africa with 165.2 million mobile subscribers in October 2018, up from about 2 million subscribers in 2002 and a tele-density that has increased by 100-fold in the same period to 118 percent. GSM mobile represents the main technology standard accounting for 99.7 percent of the technology mode. There are four mobile telecom operators in the country. MTN Nigeria is the market leader with over 65.7 million subscribers and 40 percent of the market share. MTN Nigeria commenced operations in Nigeria in 2001 after paying $285 million to obtain a GSM licence and has total assets of more than N 1trillion. MTN Nigeria is a subsidiary of Africa’s biggest mobile telecom operator, MTN Group South Africa. MTN Nigeria accounts for the largest share of the group’s earnings, contributing a third of the total revenue of the group over a 5-year period. MTN Nigeria is 75.8 percent owned by MTN, 18.7 percent by Nigerian shareholders via SPVs, 2.8 percent by MTN NIC B.V., and 1.7 percent by Public Investment Corporation SOC Ltd. The MTN Nigeria initially planned, following regulatory prodding and shareholders’ approval, to list its ordinary shares on the Nigerian Stock Exchange in H2 2018 through an IPO. The Nigerian Communications Commission (NCC) had imposed on MTN Nigeria a fine of $5.2 billion or ₦1.04 trillion in 2015 for non-compliance with directives to disconnect unregistered SIM cards in Nigeria. The advisers include Citigroup, Stanbic IBTC Bank and Chapel-Hill Denham. The potential listing of MTN Nigeria with a projected deal size of 3.5 billion of ordinary shares will raise between ₦140 to ₦180 billion ($400 million to $500 million). With a possible conversion of preference

126  Raising capital in frontier markets

shares to ordinary shares, a total of 5.2 billion shares may be listed. With an indicative free float of 25 percent to 30 percent, the company could be valued at an estimate ranging from $5 billion to $6 billion. The initial listing by H2 2018 has not been adhered to due to market sentiments, with the NSE declining by 17 percent as of September 2018, and due to regulatory issues with the Central Bank of Nigeria. When finally listed, MTN Nigeria will be a premium blue-chip stock on the NSE. The listing will deepen Nigeria’s equity market and attract both domestic and foreign portfolio investors while raising additional capital for MTN Nigeria. The company will account for more than 10 percent of the equity market capitalization of the NSE, pushing the share of the telecom sector to 12 percent and to be nearly at par with the sector’s relative contribution to the GDP. The telecom sector contributes 10.3 percent to GDP in Q2 2018 but represents less than 0.2 percent of the equity capitalization on the NSE. Source: MTN Annual Report (2018), Olowoporoku (2018) and NCC (2018)

Delisting

A company can be delisted compulsorily or voluntarily. The delisting process must be in accordance with the rules on delisting of the NSE and the SEC. An issuer can only apply to the NSE for voluntary delisting if specific conditions are met. NSE (2018) conditions include first that the shares have been listed for a minimum period of 3 years. Second, the shareholders of the issuer approved the delisting by way of a special resolution passed at a duly convened meeting of shareholders. Third, the issuer gave its shareholders notice of the proposed delisting, which must include details of how to transfer the securities. Fourth, the issuer must give shareholders an exit opportunity before the securities are delisted. Fifth, following a voluntary delisting, a company and its promoters cannot seek listing for a period of 3 years from the date of delisting. Compulsory delisting of a company can occur when the company does not comply in a material manner with the listing rules of NSE. Other cases of compulsory delisting can occur where there are insufficient securities in the hands of the public, insufficient level of operations or assets to warrant the continued listing of its securities. The NSE may also determine that the company and its business are no longer suitable for listing. The NSE delisted companies that failed to comply with its listing rules after the expiration of a grace period. From 2002 to 2016, 85 companies had

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Percentage Distribution Voluntary 15%

M&A 9%

Naonalised 3%

Reg Other 10%

Reg NSE 63%

Figure 7.2 Proportion of delisted companies, 2012–2016 Source: NSE (2018).

been delisted from the Daily Official List of the NSE; 55 of those companies were delisted for not complying with the listing rules of the NSE (NSE, 2017). In July 2017, the NSE suspended share trading of another 17 companies due to failing to file their relevant accounts after the initial expiration of the deadline for submitting the accounts and the expiration of a grace period of 90 days beyond the deadline (NSE, 2017). Nearly two-thirds of the delisted companies were due to regulatory infractions of NSE Rules; another 7 percent were due to other actions by other regulators, such as the SEC, while 15 percent were voluntary delisting, and 10 percent were due to M&A. Costs of public listing

The cost of going public include direct costs, underpricing and indirect costs. Direct costs include underwriting fees, usually about 2.3 percent, registration fees paid to regulatory authorities, legal fees, reporting accountant fees, and compensation to other advisory parties to the IPO process. For the most part, these fees are prescribed by Rules of the SEC and NSE and are listed in Table 7.3.

128  Raising capital in frontier markets Table 7.3 Cost of public listing of shares Parties to issues/other costs

Equities (%)

Bonds (%)

SEC NSE CSCS FMDQ Receiving Agent Commission Issuing House Fees** Stockbroker to the Issue* Registrar Application Fee*

Reporting Accountants* Auditors* Underwriting Fee Trustees* Solicitors to the Trustees*

0.15% to 0.30% 0.30% 0.01% n/a 0.75% 1.35% 0.13% ₦30 per old application; ₦40 new application ₦1 million 0.10% subject to a min of ₦1mm 0.05% subject to a min. of ₦500,000 0.10% 0.05% NEGOTIABLE NA NA

Printing* Advertisement* VAT* Total Costs

0.13% per SEC Study For statutory advertisement – Not provided

0.15% 0.30% NIL 0.075% 0.75% 1.35% 0.13% ₦30 per old application; ₦40 new application ₦1 million 0.10% subject to a min. of ₦1mm 0.05% subject to a min. of ₦500,000 0.10% 0.05% NEGOTIABLE 0.035%–0.10% 0.10% subject to a min. of ₦1mm 0.13% For statutory advertisement – 3.9375%

Registrar Take-on Fee* Solicitor to the Issue* Solicitor to the Company*

Source: SEC (2018).   * These fees are negotiable ** This fee is negotiable, subject to a maximum included in the table

Statutes

Companies and Allied Matters Act, Cap 59, Laws of the Federation of Nigeria, 1990. Investments and Securities Act, 1999, Securities and Exchange Commission Act, Cap 4–6, Laws of the Federation of Nigeria, 1990. Securities and Exchange Commission, Rules and Regulations, 2000.

Note 1 Available at www.nse.com.ng/issuers/listing-your-company/listing-requirements.

Bibliography Akoh. (2000), Regulatory Requirements and Procedures for Initial Public Offering of Securities, Modern Practice Journal of Finance and Investment Law, MPJFIL, 4(1), January Bloomberg. (2018), Global Equity Market League Table

Equity underwriting 129 CAMA. (2004), Companies and Allied Matters Act 2004 Cordros Capital. (2018), MTN Nigeria IPO Teaser – Listing and Precursory Information. www. proshareng.com/news/Public-Private-Offers-/MTN-Nigeria-IPO-Teaser-Listing-and-P/ 40207 Corporate Finance Institute (CFI). (2018a), Investment Banking Manual Corporate Finance Institute. (2018b), IPO Process. https://corporatefinanceinstitute.com/ resources/knowledge/finance/ipo-process/ Corporate Finance Institute. (2018c), Underwriting Overview. https://corporatefinanceinstitute. com/resources/knowledge/finance/underwriting-overview/ Delano, O., O. Ajayi-Bembe and N.A. Onabanjo. (2017), Equity Capital Markets in Nigeria: Regulatory Overview. Akindelano Legal Practitioners in Practical Law. https://uk.practicallaw. thomsonreuters.com/7-606-5708?transitionType=Default&contextData=(sc.Default)&fi rstPage=true&bhcp=1 Etomi, S. (2003), Public Offer of Company Securities: The Legal Perspective. A paper presented at the Alpha Juris Workshop Series in Port Harcourt, Rivers State, Nigeria, 6–7 February. http:// geplaw.com/wp-content/uploads/2014/11/Public-Offer-of-Company-Securities.pdf Iannotta, G. (2010), Investment Banking: A Guide to Underwriting and Advisory Services. Berlin, Heidelberg: Springer-Verlag Lafarge Africa. (2017), Lafarge Africa PlcN131.65 Billion Rights Issue: Facts Behind the Offer, 30 November Liaw, K.T. (2006), The Business of Investment Banking: A Comprehensive Overview, 2nd edition. Hoboken, NJ: John Wiley & Sons MTN. (2018), Annual Report 2017 Nigerian Communications Commission (NCC). (2018), Industry Statistics Nnona, G.C. (2007), Private Placement of Corporate Securities in Nigerian Law: Realigning the Perspective on Key Issues of Doctrine and Policy. Social Science Research Network. http://ssrn.com/abstract=887748 NSE. (2017),The NSE Rules Book. www.nse.com.ng/regulation-site/Documents/The%20 NSE%20RuleBook%202015.pdf NSE. (2018), NSE Listing Requirements. www.nse.com.ng/issuers/listing-your-company/ listing-requirements Obianwu, C. (2014), The Role of Solicitors in Capital Market Transactions. www.templarslaw.com/wp-content/uploads/2015/05/The-Role-of-Solicitors-in-Capital-MarketTransactions.pdf Ogundeyi, O. (2017),The Effects of Regulation & Innovation on the Efficiency of the Nigerian Equity Markets. https://quantextive.com/dashboard/insight/effects-of-regulationsinnovation-nse/ Olowoporoku, I. (2018), MTN Nigeria to List on the NSE; A Promise Fulfilled – OTC Equity Research, Vetiva Capital Management Limited. www.proshareng.com/news/ Public%20&%20Private%20Offers20%20/MTN-Nigeria-To-List-On-The-NSE-APromise-Fulfilled--OTC-Equity-Research-/39115 Pratap, G.S. (2008), Investment Banking: Concepts, Analyses and Cases. New Delhi: Tata McGraw-Hill SEC. (2006), Nigeria’s Capital Market: Making World-Class Potential A Reality: A Report of the Technical Committee of the International Organization of Securities Commissions: Regulatory Issues Arising from Exchange Evolution. www.iosco.org/library/pubdocs/ pdf/IOSCOPD225.pdf SEC. (2017), Rules and Regulations SEC. (2018), Database

8 Debt underwriting

Principles A bond is a long-term debt instrument of an entity, who borrows money from investors for a specific period and commits to a periodical coupon (or interest) payment while the principal will be repaid at a future date. The entity could be government, companies, supranationals or a special purpose vehicle (SPV). Governments issue bonds to finance budget deficits, enhance fiscal discipline, refinance maturing debt obligations, establish benchmark yield curve and deepen savings and investment process. Corporates issue bonds to finance long-term obligation, improve liquidity, finance specific projects and undertake M&A. Investors buy bonds to obtain regular income, protect their principal investment and diversify their portfolios. There are different types of debt instruments depending on the classification of bonds. Bonds can be classified broadly into four categories. A fixed-rate type of bond pays a fixed coupon periodically. Zero-coupon bonds repay both interest and principal at the final maturity date of the bond.With a floating-rate bond, coupon payments can vary depending on the reference rate used to index the bond rate. A cap or a floor can be set for the floating rate. Debt securities can be categorized based on the market of issuance: domestic bonds, foreign bonds and Eurobonds. A domestic bond is issued by a domestic entity within its domestic market, while a foreign bond can be issued and registered by the same entity in a foreign market and will now be regarded as a foreign issuer in the foreign jurisdiction. Eurobonds are bonds issued in currencies other than the domestic currencies of the issuing entities. Eurobonds do not require registration and they are bearer bonds as possession of them signify evidence of ownership. Corporate bonds can be fully convertible and non-convertible into equities. Bonds can be securitized by using asset-backed securities such as mortgage loans. There are some principles relating to the pricing of bonds. First, bond prices change with the passage of time. Second, bond prices are related inversely to the yield to maturity. Third, the longer the maturity, the more sensitive the bond’s price to changes in the yield to maturity. Fourth, the sensitivity of the price of a bond to changes in the yield to maturity increases at a decreasing rate

Debt underwriting 131

with the length to maturity. Fifth, there is a linear relationship between a bond’s coupon rate and its price (Levy and Post, 2005). The underwriting process for issuing bonds are similar to that of equity underwriting but with a shorter time from origination to final execution (Iannotta, 2010). Bonds are usually issued through processes including auction, which requires competitive bidding, book-building used for price discovery, syndication and private placements. Credit agencies play a key role in rating the issuer and the bond, which will affect the credit spread. Global DCM

The total global debt outstanding in 2017 was at US$247 trillion, representing more than 318 percent of global GDP (IIF, 2018). In 2017, $21 trillion of debt was issued. Government debts accounted for 70 percent, while corporate debts accounted for 30 percent. The US debt instruments amounted to $50 trillion accounting for 40 percent of total global debt and 105 percent of its GDP. Europe accounted for 30 percent. Bloomberg’s league tables rank the top global arrangers, bookrunners and advisors in the DCMs. Fiscal year (FY) 2017 credited corporate and financial bonds volume increased 4.56 percent to US$4.4 trillion while deal count increased 3.23 percent to 16,668 offerings year on year (Bloomberg, 2018). Corporate bonds volume increased 4.50 percent year on year to US$2.2 trillion while the deal count increased 10.66 percent to 7,082. US corporate bonds volume increased 10.40 percent to US$1.8 trillion while deal count increased 26.42 percent to 3,005 offerings year on year. Financial bonds volume increased 4.62 percent to US$2.2 trillion with over 9,580 deals. European corporate and financial bonds volume increased 4.33 percent to €1.2 trillion while deal count increased 9.67 percent to 5,264 offerings. Asia ex-Japan G3 currency bonds volume increased 61.86 percent to US$327.2 billion, while deal count increased 49.56 percent to 673 offerings. J.P. Morgan ranked as the top corporate and financial Bonds underwriter for FY 2017 with about 6 percent market share, having underwritten 1,719 deals. Citigroup and Bank of America Merrill Lynch ranked second and third with 5.43 percent and 5.41 percent market share, respectively. J.P. Morgan ranked as the top US corporate bonds underwriter for FY 2017 with 11.52 percent market share and 1,264 deals. Bank of America Merrill Lynch and Citigroup ranked second and third with 10.48 percent and 9.90 percent market share, respectively. HSBC ranked as the top European corporate and financial bonds underwriter for FY 2017 with 5.7 percent market share and 474 deals underwritings. Barclays and Deutsche Bank ranked second and third with 5.4 percent and 5.3 percent market share, respectively. HSBC ranked as the top Asia ex-Japan G3 currency bonds underwriter with 7.84 percent market share and 275 deals. Citigroup and Standard Chartered Bank ranked second and third with 6.7 percent and 5.8 percent market share, respectively (Bloomberg, 2018).

132  Raising capital in frontier markets Table 8.1 Nigeria public debt stock as of 30 June 2018 Debt category A. B. C. D.

External Debt Stock (FGN + STATES) Domestic Debt Stock (FGN only) Domestic Debt of States Sub-Total – Domestic Debt (FGN + States + FCT) Grand Total (A+D)

Amount outstanding (US$ million)

Amount outstanding (₦ million)

22,083.44 39,749.55 11,374.95 51,124.50

6,750,907.61 12,151,437.66 3,477,321.00 15,628,758.66

73,207.94

22,379,666.27

Source: DMO (2018).

Nigeria’s DCM

Nigeria has a total debt stock of $71 billion as of December 2017. Domestic debt of the FGN stood at $41 billion or 58 percent of total debt and domestic debt of state government amounted to $10.9 billion or 15.5 percent of the total, while total external debt of both the FGN and the state government accounted for 27 percent of total debt (Table 8.1). Nigeria’s total debts as a share of GDP is at a relatively moderate level but remains high when compared to historical averages. The debt ratio nearly doubled from 12 percent of GDP in 2014 to 22.3 percent of GDP in 2017. It is on an upward trajectory and projected to reach 26.6 percent in 2022 (IMF, 2018). The federal government interest payments to revenue almost tripled from 27 percent in 2014 to an estimated 72 percent in 2017 and may reach an unsustainable level under current policies, to above 80 percent by 2022 (IMF, 2018). Nigeria’s debts are very vulnerable to revenue shocks. The 2017 debt sustainability analysis (DSA) by the DMO (2017b) shows that total public debt to revenue rose from 290 percent in 2017 to 345 percent in 2022, while total debt service to revenue rose from 45 percent in 2017 to 62.8 percent in 2027. These suggest that these indicators are vulnerable to revenue shocks.The DMO (2017b) shows that the most extreme shocks which combine lower GDP growth, weaker exports, a lower GDP deflator and a fall in non-debt-creating flows such as FDIs, would weaken the ratios of total public debt to revenue and total debt service to revenue considerably relative to the baseline projections.

Connecting principles to practice Box 8.1  The Debt Management Office The Debt Management Office (DMO), established in 2000, coordinates and manages Nigeria’s debt on behalf of the FGN. Its creation has helped

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to institutionalize public debt management in Nigeria. The DMO centralizes and coordinates the country’s debt recording and management activities, including debt service forecasts, debt service payments and advising on debt negotiations as well as new borrowings. The DMO plays crucial roles in the debt capital market in Nigeria. Prior to the establishment of the DMO, the Central Bank of Nigeria (CBN) was the dominant holder of the debts of the FGN.The DMO has assisted in diversifying the holding structure of FGN securities towards the private sector, which now predominantly hold nearly all government securities.The DMO has contributed to the deepening of domestic debt capital market by utilizing a market-based approach to raising debt finance by the FGN, streamlining the various types of debt instruments and establishing a sovereign yield curve of 3 months to 20 years. In 2015, a guideline setting out market operations which the DMO undertakes in the FGN Bond market was issued. The guideline draws on the relevant clauses of the DMO Act of 2003. The guideline also builds on the framework for FGN bond market operations, the General Rules and Regulations Governing the Primary Dealer Market Maker System in FGN Securities of 2005, 2009, and 2012, respectively. Source: DMO (2018).

External debt is low at 11.1 percent of GDP and is projected to remain broadly unchanged relative to the size of the economy under IMF baseline projections. However, the external debt-to-exports ratio has more than tripled since 2012 reaching about 120 percent in 2016, mainly due to the decline in oil exports. Gross external financing needs remain small relative to the size of the economy. Overall, stress test scenarios by the IMF highlight the vulnerability of total public debt to shocks related to growth and primary balance shocks, while external debt servicing ratio is particularly vulnerable to oil exports shocks, exchange rate risks and future lumpy redemptions (IMF, 2018). The Debt Management Strategy for 2016–2019, prepared by the DMO, recommends a rebalancing of the debt portfolio from its composition of 84:16 for domestic to external debts as of the end of 015 to an optimal composition of 60:40 by the end of 2019, respectively (DMO, 2016). The debt strategy envisaged that long-term external borrowings of a minimum maturity of 15 years would help ease domestic debt service payments with higher coupon rates and fund priority infrastructure projects. In order to reduce debt servicing and roll-over risk in the domestic debt market, DMO also recommended targeting a domestic debt mix of 75:25 for long and short-term debts, respectively, compared to 69:31 as of the end of 2015 (DMO, 2016). It made a case for tapping international capital markets

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through diaspora bonds, Eurobonds, and international sukuk. The debt strategy recognizes that there are possible increases in the FX risk, due to the rise in external debt relative to domestic debt; and the need to maintain favourable international sovereign ratings by rating agencies. In March 2018, Standard and Poor’s (S&P) Global Ratings affirmed its ‘B/B’ long- and short-term sovereign credit ratings on Nigeria, with a stable outlook. S&P also affirmed its long- and short-term Nigeria national scale ratings at ‘ngBBB/ngA-2’ (S&P Global Ratings, 2018).The S&P ratings on Nigeria were supported by moderate external indebtedness and a relatively low general government debt stock. S&P noted that its ratings were constrained by factors such as high debt-servicing costs, weak institutional capacity and lower real GDP per capita trend growth rates than peers at similar development levels. Types of debt securities

There are various types of debt securities issued in Nigeria’s DCM. The first set of bonds are those of the FGN, which includes FGN domestic bonds, FGN Eurobonds, FGN savings bonds and FGN diaspora bonds. Second, there are special purpose bonds, sukuk and green bonds. Third, there are agency bonds issued by the agencies of the FGN. Fourth, there are subnational bonds. Fifth, there are supranational bonds. Corporate debt securities include bonds, medium-term notes (MTNs) and CPs. FGN sovereign bonds are debt securities of the FGN, which are considered as risk-free debt instruments as well as the safest of all investments in Nigeria’s domestic debt market as they are backed by the ‘full faith and credit’ of the federal government. Most FGN bonds have fixed interest rates which are paid

Sub-Naonal Bonds 4%

Corporate Bonds 4%

FGN Bonds 92% Figure 8.1 Composition of Nigerian bond market Source: FMDQ (2018).

Debt underwriting 135

semi-annually, while some FGN bonds have floating rates of interest which fluctuates around a reference rate based on specified parameters. Zero-coupon bonds have not yet been issued in Nigeria. The minimum tenor is 2 years, and there are bonds with maturities of 3, 5, 7, 10, 15 and 20 years (DMO, 2018). Special purpose FGN bonds are bonds issued to meet the specific needs of the federal government. Special purpose bonds were issued to selected banks for settlement of ₦75 billion pension arrears in 2006 (DMO, 2018). The FGN floated bonds for the payment of debt owed to local contractors worth ₦91.7 billion in 2006. Recently, FGN has indicated interest in raising funds through bonds for funding specific projects such as methanol plant, revival of textile industry, terminal wages of workers, building of infrastructural facilities. Sukuk bonds are a class of securities that are structured in accordance with Sharia law that prohibit interest payment on debt but grant shares to investors in an asset with the assumption of profit and risk sharing. Nigeria’s first FGN sukuk of ₦100 billion was issued in 2017 with the objectives of diversifying FGN’s funding sources, deepening the country’s DCM and promoting financial inclusion, in particular to ethical investors who would ordinarily not invest in interest-bearing debt instruments. The proceeds from the sukuk issuance will be used to construct and rehabilitate 25 roads in Nigeria’s six geopolitical zones.1 Despite the strong demand and growing issuance, the market is still in its early days. Liquidity can be low in some issues, especially those that are smaller in size. The overall trend, however, is for greater issuance volumes, a maturation of Sharia interpretation of the various instruments and growing appeal from Western countries to access savings in Islamic countries. However, in order for this potential to be realized, regulatory, supervisory and international coordination will be necessary in order to foster stability. Green bonds are environmentally compliant corporate, project and sub-sovereign bonds that finance green infrastructure assets. From the financial markets’ perspective, green bonds are not different from other project bonds or debt instruments. However, trends in indices such as the Barclays/MSCI Green Bond Index, launched in 2014, is helping to raise the profile of green bonds, and provide a benchmark for investment strategies and mutual funds (OECD, 2015). In Nigeria, the first ₦10,690,000,000 green bond issuance of the FGN was done in 2017 with the support of the World Bank. The issuance of green bonds by the FGN is expected to provide funds for financing the implementation of projects towards the achievement of Nigeria’s commitment to the Paris Agreement on Climate Change. Nigeria’s green bonds have key benefits including providing funds for environment and climate change–compliant project while diversifying government revenue sources. Diaspora bonds are targeted at nationals of a specific country who live in foreign countries. Globalization, rapid information and communication technologies, and increased remittances, coupled with patriotism, have enabled countries, including Ethiopia, India and Israel, to tap their wealthy expatriates for funds worth billions of dollars through diaspora bonds. In June 2017, Nigeria raised

136  Raising capital in frontier markets

$300 million at the rate of 5.625 percent for a tenor of 5 years through diaspora bonds following registration with the US SEC, which requires stringent disclosure, transparency and compliance with its rules and regulations. The bond aimed at retail investors is also listed in the United Kingdom; the bond was oversubscribed by 130 percent. Subnational bonds are long-term debt securities issued by the state and local governments of a nation to finance projects for the public good like building schools, roads, hospitals and sewer systems. Lagos State Government has the largest debt profile among the 36 states of the federation, with more than 40% of total debt among the states (DMO, 2018). Lagos State Government relies more on its internally generated revenue and a relatively large private sector– dominated economy to tap the domestic debt market. Supranational entities are formed by two or more central governments with the purpose of promoting economic development for the member nations. Supranational bonds are debt securities issued by these institutions to finance their activities. Similar to government bonds, supranational bonds are regarded as very safe and have high credit ratings. Examples of supranationals are the African Development Bank (AfDB) and the IFC of the World Bank Group. Agency bonds are bonds issued by the government-sponsored agency, backed by the government. Agencies raise bonds to facilitate access to low-cost financing for specific areas of the economy. Specialized Agencies such as the Development Bank of Nigeria and the Nigerian Mortgage Refinancing Corporation raise bonds to meet their mandate in financing small and medium-sized enterprises (SMEs) and mortgage refinancing in Nigeria, respectively. Eurobonds are bonds issued in currencies other than the domestic currencies of the issuing entities. Eurobonds are attractive financing tools as they give issuers the flexibility to choose the countries in which to offer their bonds determined by the regulatory constraints (Box 8.2).

Connecting principles to practice Box 8.2  Nigeria’s Eurobonds Issuance The FGN had issued Eurobonds six times since 2011. In January 2011, Nigeria’s debut Eurobond issuance of US$500 million, 10-year maturity and coupon rate of 6.75 percent was made. The second issuance of a US$1 billion dual-tranche Eurobonds offering was made July 2013. Other issuance included US$500 million 5-year bond and US$500 million 10-year bond at coupons of 5.125 percent and 6.375 percent, respectively (DMO, 2018). In February 2018, a bond issuance of $2.5 billion was made. In November 2018, the first triple-tranche issuance of $2.86 billion was oversubscribed by more than three times, bringing the total issuance in 2018 to $5.36 billion. The offering is made up of a $1.18 billion (7 years, priced at 7.625 percent), $1 billion (12 years, 8.75 percent) and

Debt underwriting 137

$750 million (30 years, 9.25 percent), respectively. The joint lead managers for the issuance were Citibank Global Markets Limited and Standard Chartered Bank, and the financial advisors were FSDH Merchant Bank Limited. The Eurobond issuance is aimed at saving on domestic debt servicing. There remains, however, foreign exchange risk.

Summary of Nigeria’s US$2.86 billion Eurobonds Issue Amount Tenor Coupon/Yield Issue Date Maturity Date Order Book at Launch

US$1.18billion 7 years 7.625% 15 November 2018 15 November 2025

Coupon Payments Format Ratings B+ Stable

February & August Rule144A/Reg B Stable (S&P)

US$1.0 billion 12 years 7.625% 15 November 2018 14 January 2031 US$5.4 billion or 432% Subscription Same Same B Stable (S&P), B+ Stable (Fitch), B2 Stable (Moody’s)

US$750 million 30 years 9.25% p.a. 15 November 2018 15 January 2049 US$5.9 billion or 472% Subscription Same Same B Stable (S&P), B+ Stable (Fitch), B2 Stable (Moody’s)

Source: DMO (2018).

FGN bonds issuing process and auction

Auctions constitute the primary means of FGN bond issuance. As part of the budget process, the federal Ministry of Finance (FMF), coordinates the process of determining the financing needs for the coming year.The DMO then draws up a debt issuance programme for the year, which includes information on volume, tenor and auction dates. The DMO releases auction calendars on a quarterly basis or as may be determined from time to time for each fiscal year. The auction calendar will indicate the number of auctions to be held during the quarter, the dates planned for each auction, a range for the size of the auctions in terms of amounts and indicative Tenors of the Bonds to be issued. The FGN Bond Issuance Programme, and, in particular, the number and timing of auctions, may be altered during the year in the light of material changes to some variables, which include the forecast of the federal government’s net cash requirements, the FGN bond yield curve, market expectations of future interest rates and inflation and market volatility. At the end of each quarter, the auction calendar for the auctions to be held in the following quarter will be issued. For each bond auction, the DMO will publish an offer circular at least one week in advance of the auction, on the DMO’s website and in major national

138  Raising capital in frontier markets

dailies. The circular will give details of the auction date, the securities, tenor(s), amount(s) to be offered and any other necessary information (Table 8.2). Any reissues (reopening) of existing bonds will usually be fungible with the parent issue from the settlement date of the auction. Structure of auctions

Since 2006, the DMO appointed market operators as primary dealers market makers (PDMMs) and government stockbrokers. Auctions are open to DMOlicensed PDMMs, who will bid for their own accounts and on behalf of other investors. The DMO may employ two basic auction processes: single price (Dutch auction) and multiple price. The DMO currently uses the Dutch auction system (DAS) based on a yield and single price basis. Under the DAS, successful bidders are allotted bonds at the lowest price and highest yield that clears the market.The second option that the DMO may use to conduct its auction is the multiple price system (MPS).

Table 8.2 FGN bonds issuance calendar for the first quarter, 2018 Auction Dates 24-Jan

Particulars Bond Name

14.50% FGN JUL 2021 (Reopening)

Term to Maturity 3 years 6 months Range of amount 45–55 on offer (₦ billion) Original tenor 5 years 21-Feb Bond Name 14.50% FGN JUL 2021 (Reopening) Term to Maturity 3 years, 5 months Range of amount 45–55 on offer (₦ billion) Original Tenor 5 years 21-Mar Bond Name 14.50% FGN JUL 2021 (Reopening) Term to Maturity 3 years 4 months Range of amount 45–55 on offer (₦ billion) Original Tenor 5 years Source: DMO (2018).

16.2884% FGN MAR 2027 (reopening) 9 years 2 months 55–65 10 year

New FGN F 2028 (New Issue) 10 years 45–55

35–45

10 years New FGN F 2028 (reopening) 9 years 11 months 45–55

7 years

10 years

New FGN MAR 2025 (New Issue) 7 years

Debt underwriting 139

With the MPS, bidders are allotted bonds at the prices and yields which they bid. The DMO will refrain from setting a minimum price. However, in exceptional cases where the bid rates do not reflect underlying market conditions, a cut-off rate may be instituted. Bids for FGN bonds start at a minimum of ₦10,000 and increase in multiples of ₦1,000 thereafter. The bids are usually for one amount and at one price, expressed in yield to maturity to four decimal places (DMO, 2016a). Multiple bids are permitted. Bidding procedure

The DMO (2016a) describes its bidding procedure to include the following steps: Bids are submitted to the CBN, the agent for the DMO from 10:00 a.m. on the day of the auction. PDMMs may bid on their own behalf or for clients by filling out the prescribed tender for FGN bonds. The DMO may accept non-competitive bids from designated government agencies or government funds. The DMO may make special allotments to designated institutions, primarily government agencies and funds, at auctions where the request from the bidder is greater than the maximum of 30 percent of the amount of the bond that is being offered at the auction or for any other reason the DMO considers appropriate provided that notice of such special allotments would be included in the offer circular. Bidding closes at 1:00 p.m. on the day of the auction. The DMO allots bonds to individual bidders at its absolute discretion and may refuse to make an allotment to an individual bidder that may lead to market distortion. At any auction, the DMO has a ceiling of 30 percent of the amount of security that can be offered to a PDMM or customer with his or her affiliated entities as a group. The DMO publishes the results of the auction by 4:00 p.m. latest on the day of the auction. The auction results will include the summary statistics indicating the highest and lowest accepted yields/prices and the ratio of bids received to the amount on offer. Table 8.3 shows the auction results for the 12.75 percent FGN APR Table 8.3 FGN bonds auction results

Auction Date: Settlement Date: Maturity Date: Tenors: Term to Maturity: Amount Offered: Total Bids: Successful Bids: Subscription: Amount Allotted: Range of Bids: Marginal Rates: Source: DMO (2018).

14.50% FGN JULY 2021

13.53% FGN MARCH 2025

13.98% FGN FEBRUARY 2028

21 March 2018 23 March 2018 15 July 2021 5 year 3 years, 4 months ₦10.00 billion 30 11 ₦18.85 billion ₦10.05 billion 12.5000%–14.0500% 13.40%

21 March 2018 23 March 2018 23 March 2025 7 year 7 years ₦30.00 billion 38 15 ₦25.21 billion ₦8.91 billion 14.05% 13.53%

21 March 2018 23 March 2018 23 February 2028 10 year 9 years, 11 months ₦30.00 billion 85 30 ₦98.75 billion ₦45.10 billion 12.5000%–14.0000% 13.60%

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2023 (reopening 5-year bond), 13.53 percent, FGN MAR 2025 (reopening 7-year bond) and 13.98 percent FGN FEB 2028 (reopening 10-year bond). Successful bids for the 12.75 percent FGN APR 2023, 13.53 percent FGN MAR 2025 and 13.98 percent FGN FEB 2028 were allotted at the marginal rates of 15.2000 percent, 15.5000 percent and 15.8300 percent, respectively. However, the original coupon rates were maintained. The FGN bond auction for November 2018 was therefore undersubscribed as the DMO was only able to raise a total of about ₦39 billion out of the ₦115 billion on offer amid weak investor appetite. The five-year bond auction was grossly undersubscribed with the amount offered at ₦35 billion as against ₦3.4 billion in subscription and compared to the oversubscription of more than 180 percent in the March 2018 auction. Stop rates ticked higher to 15.20 percent for the year-year bonds, 20 basis points higher than the previous auction, as investors demanded higher yields. The accounts of PDMMs with the CBN will be debited by the settlement date (T + 2) following the auction date to provide funds for the value of the successful bids submitted for their proprietary accounts and on behalf of their customers. On the settlement day, the delivery of bonds securities will be made into the accounts of PDMMs with the CBN via the Scriptless Securities Settlement System and for further transfer to the custodian accounts of their customers that prefer to receive bonds electronically. Customers can also request a “Letter of Allotment” from the CBN in order to confirm their bond investments. The DMO undertakes other activities such as Securities Lending, Securities Buy-Backs and Securities Switches in the Secondary Market for FGN Bonds. These activities contribute to the objectives of DMO in promoting liquidity and transparency of the capital market. Corporate bonds market

Corporate bonds are long-term debt instruments issued by corporations to raise capital for their businesses. Corporate bonds tend to have higher yields than government bonds to compensate for their higher default risks. Corporate bonds are typically rated by ratings agencies such as Agusto, GCR, and their international equivalents, S&P, Moody’s and Fitch. The ratings would affect the credit spread of the bonds, the cost of the bonds and yield returns for investors. Nigerian corporate bonds are quite small at $5.7 billion or 2.8 percent of listed total bonds and 0.3 percent of GDP compared to bank private-sector credit as a ratio of GDP of 16.5 percent. Between 2017 and 2018, slightly more than ₦108 billion of corporate bonds were raised (Table 8.4). Global depositary receipts (GDRs) are securities issued in a jurisdiction other than the issuer’s domestic jurisdiction and administered through a global depositary (Box 8.3).

Debt underwriting 141 Table 8.4 Corporate bonds issuance, 2017–2018 Company

Issue date

Amount (₦ billion)

Rate (percentage)

Mixta Dufil Lapo MFB Viathan Funding NMRC UACN Property C&I Leasing Union Bank Sterling Bank Wema Bank

Jan. 2017 Aug. 2017 Dec. 2017 Dec. 2017 May 2018 April 2018 July 2018 Aug. 2018 Sept. 2018 Oct. 18

4.5 10 3.15 10 10.93 4.36 7.0 20 20 20

17 18.25 17.75 16 13.8 16 16.54 15.75 16.25 17.0

Connecting principles to practice Box 8.3  GTB: a leading pioneer in issuance of GDR and Eurobonds Guaranty Trust Bank PLC (GTB), the most capitalized bank in Nigeria, was incorporated in 1990 as a limited liability company licensed to provide commercial and other banking services in Nigeria. GTB started its operations in February 1991 and has become the most capitalized bank in Nigeria. GTB has been a pioneer in corporate issuance of global depositary receipts (GDR) offer. In 2007, GTB issued a US$350 million regulation S Eurobond issue and a US$750 million GDR offer, the first by a Nigerian bank. GTB became the first Nigerian company and an African bank to be listed on the main market of the London Stock Exchange. In 2009, GTB completed an offering of ₦13.165 billion fixed-rate senior unsecured non-convertible bonds due 2014 (Series I), being the first tranche under the bank’s ₦200 billion Debt Issuance Programme. In 2011, GTB successfully launched a US$500 million bond – the first non-sovereign benchmark bond offering from sub-Saharan Africa (outside South Africa) to the international community. In 2013, GTB issued a US$4 million Eurobond at a coupon rate of 6%, the lowest obtained by a Nigerian company in the international capital market. The Eurobond was issued under the US$2,000,000 global medium-term note programme, which is registered under both regulations in the United States and Rule 144A in the United Kingdom and is sold to investors across Africa, America, Asia and Europe. Source: GTB (2018).

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MTNs or short-term bonds were recently introduced to the DCM in Nigeria by the FMDQ to enable non-sovereign entities raise finance with debt instruments that have tenors of between 1 year and 3 years. They provide opportunities for corporations to bridge funding gaps between short-term money market securities and long-term bonds. CPs by FMDQ are liquid short-term debt financing instruments with tenor less than 270 days traded on the capital market. Large corporations with good credit ratings issue CPs that are unsecured and discounted promissory notes for relatively short maturity period. There are 30 CPs outstanding on the FMDQ with a market value of ₦1 trillion as of June 2018.2 The CBN is encouraging the issuance of CPs, and it is willing to invest in CPs for employment elastic private sectors. TBs are short-term money market instruments issued by the FGN at a discount and redeemed at par for a maturity of 1 year or less for the purpose of funding short-term deficits gaps. They are issued via a competitive bidding process through the CBN. The corporate bond underwriting process is very similar to that of equity underwriting, albeit with a short-term time period.The process includes origination, preparation and planning, packaging and due diligence, SEC approval, pricing, marketing, closer offer, and listing. The process also encompasses credit ratings of the bonds by independent rating agencies. Ratings are traditionally classified into two categories (excluding default): (a) investment grade and (b) speculative grade. Investment grade securities are those with rating BBB– or better, that is, the safest securities. Speculative-grade securities are those below BBB-, also known as “high yield” or “junk.”The primary issuance fees for fixed income in Nigeria is shown in Table 8.5. Table 8.5 Fixed income primary issuance fees, November 2017 S/N

Cost centre

Fee rates

1.

SEC

2.

NSE

3.

FMDQ Listing Fees

4.

ISSUING HOUSE

5. 6. 7. 8.

CSCS RECEIVING AGENT STOCKBROKER REGISTRARS

9.

SOLICITOR TO THE ISSUE

1st ₦500 Mn @ 0.15% Balance above ₦1 Bn @ 0.1425% Companies already having equity listing @ 0% Companies not having equity listing @ 0.0375% States and supranationals @ 0.05% @0.09% of issue size (₦1Bn), ranging to @ 0.002% of issue size (>₦200 Bn) 1st ₦1 Bn @ max of 1.35% Next ₦1 Bn @ max of 1.225% Balance above ₦2 Bn @ max of 1.15% @ 0.0075% of offer, size capped @ ₦5 Mn @ 0.25% of offer size @ 0.13% of offer size ₦30 (existing application) ₦40 (new application) Take on fee of ₦1 Mn @ 0.05% of offer size Subject to a cap of ₦10 Mn

Debt underwriting 143 S/N

Cost centre

Fee rates

10.

SOLICITOR TO THE COMPANY REPORTING ACCOUNTANT

@ 0.01% of offer size Subject to a cap of ₦5 Mn @ 0.05% of offer size Subject to a min of ₦1 Mn Subject to a max of ₦7.5 Mn @ 0.01% of offer size Cap of ₦4 Mn Max of 0.035% of offer size Cap of ₦5 Mn

11. 12.

AUDITORS

13.

TRUSTEES

14. Rule 314 – Cost of Issue [SECRR(A) June 2017]

The total cost of issue shall not exceed 3.17% for equity transactions and 3.9375% for bonds of the gross total proceeds, indemnity fee, advertisement, printing and take on fees for registrars, from the issue or such percentage as the Commission may prescribe from time to time. Source: SEC (2018). Note: Pursuant to section 309 of the ISA which empowers the minister to exempt any person or class of persons from the operation of the provisions of the act, the minister of finance has waived the naira value cap placed on transaction fees payable to solicitors, auditors, trustees, reporting accountants and the depository (CSCS).

Regulations

Any public company, foreign public company or supranational body is eligible to issue corporate bonds by way of an offer for subscription, rights issue or private placement. Rule 567 on registration requirement apply to all bond issuance by any issuer. The registration statement will include the duly completed form SEC 6 and other prescribed documentation, including board resolution, reporting accountant report and rating report by a registered rating agency.There shall be a resolution by the board authorizing the issue of the bond; a general meeting will be required if the amount exceeds the borrowing limit of the directors as stated in the memorandum and articles of association of the issuer or the bond to be issued is convertible. Where the debenture is secured, the issuer shall ensure the assets on which the debenture is secured are adequate, and this should be specifically stated together with the ranking of the charge(s), as well as the associated risks in the offer documents. All issues of corporate bonds shall be rated by a rating agency (optional for private placements). The credit rating for a bond that will be issued through public offering shall not be below an investment grade. No issuer shall offer bond if it is in default of payment of interest or repayment of principal in respect of previous debts issuance for a period of more than 6 months. All necessary approvals (where applicable) in relation to the issue from other regulatory authorities shall be obtained and filed with the SEC. Shelf registration

SEC permits an entity to do a shelf registration of all the securities it expects to issue over a certain period through a single filing. A copy of this shelf prospectus

144  Raising capital in frontier markets

and the documents specified herein shall be delivered to the SEC for clearance and registration (SEC Rules, 2016). The advantages of shelf registration are the flexibility in the timing of an offer and the cost savings that it afforded entities in issuing new securities in tranches. State governments and companies have used shelf registration in the Nigeria debt equity market.

Connecting principles to practice Box 8.4  Lagos State Government Debt Issuance Programme Lagos State has been at the forefront of tapping the capital markets for its infrastructure and budgetary financing. With a population estimated at 21 million, of which 85 percent live in the city of Lagos, Lagos State has a history of issuing bonds to support infrastructure as well as its general budget. In 2012, Lagos State Government published a prospectus of a ₦167.5 billion debt issuance programme for the issuance of a bond or series of bonds with maturities of 5 years and longer. This prospectus was issued in compliance with the provisions of the Investment and Securities Act, the Rules and Regulations of the SEC and the listing requirements of the exchange and contains particulars in compliance with the requirements of SEC and the exchange, for the purpose of giving information to the public with regards to the ₦167.5 billion debt issuance programme by the Lagos State Government.The tenor of a particular tranche shall be determined by the issuer and the joint issuing houses and will be specified accordingly in the applicable pricing supplement issued in respect. A ₦100 billion ($317 million) bond issuance programme and a combination of internal and external loans were budgeted in 2017 by Lagos State. The state issued two sets of bonds in August 2017 amounting to ₦46.37 billion (16.75 percent) and ₦38.72 billion (17.25 percent). Lagos State plans to finance what it describes as fundamental reforms of all modes of transportation, including roads, waterways and pavements, with the issuance of a public transport infrastructure bond during the 2017 financial year. The lead issuing house was Chapel Hill, and the joint issuing houses were Afrinvest, Radix, FBN Capital, FCMBCM, Skye Financial, Stanbic IBTC,Vetiva and Zenith Capital. Source: Lagos State Shelf Registration and ICA (2017).

FMDQ OTC Securities Exchange FMDQ was founded in 2012 and registered by the SEC as an SRO. It became operational in November 2013. It specializes in the listing and trading of debt instruments, FX and derivatives OTC securities exchange market. It offers

Debt underwriting 145

products and services including bonds, CPs, repurchase agreements, currency crosses, FX, forwards and money market derivatives. It has 182 members across the Nigerian financial markets. FMDQ has government debt securities worth $165 billion, corporate debt of $5.7 billion and OTC futures traded of about $7 billion as of May 20183 (FMDQ, 2018). The FMDQ OTC turnover is shown in Table 8.6. The FMDQ OTC Market Turnover Report (2018) shows the turnover on all products traded on the FMDQ secondary market – FX, TBs, money market (repurchase agreements, buy-backs and unsecured placements/takings) and bonds (FGN bonds and other bonds), FX and money market derivatives. These figures exclude primary market auctions in TBs, bonds and FX. Transaction turnover in the markets for the month ended 30 June 2018 amounted to ₦17.23 trillion. The TBs and FX segments jointly accounted for four-fifths of the total turnover in the fixed income and currency (FIC) market in the period. The total turnover in the fixed income market was ₦7.85 trillion. Treasury bill turnover has been a major driver of liquidity in the fixed income market, accounting for 85 percent of the total fixed income market turnover. Total T-bills outstanding as of 30 June 2018 stood at ₦13.76 trillion while total FGN bonds outstanding closed at ₦7.83 trillion. Turnover in the secured money market comprising repos and buy-backs was ₦2.32 trillion. FMDQ recently entered into a strategic partnership with S&P Dow Jones Indices to develop and publish co-branded fixed income indices to be calculated and published in Nigerian naira and US dollars.

Table 8.6 FMDQ OTC market turnover report Product Category

(₦’mm)

($’mm)

Foreign Exchange Foreign Exchange Derivatives Treasury Bills FGN Bonds Other Bonds* Eurobonds Repurchase Agreements/Buy-Backs Unsecured Placements/Takings Money Market Derivatives Commercial Papers Total No. of Business Days Average Daily Turnover

4,387,040 2,617,261 6,669,208 1,181,336 11 12,816 2,321,015 17,661 25,000 – 17,231,350 25 689,254

12,150 7,249 18,471 3,272 0 35 6,428 49 69 – 47,724 25 1,909

*Other Bonds include Agency, Sub-national, Corporate & Supranational Bonds Note: Figures may be subject to change due to potential adjustments from Dealing Member (Banks). $/₦ @ 361.06 mm – million. Source: FMDQ Data Portal as of 4 July 2018. Figures reported by Dealing Member (Banks) on a weekending basis.

146  Raising capital in frontier markets FMDQ listing and quotation of securities for companies

To qualify for listing/quotation on FMDQ, an issuer shall meet the initial standards set forth by the FMDQ rules for various securities below. The issuer shall comply with the documentary requirements of the FMDQ which will include an application form, evidence of being a registered company with 3 year’s operating track record, prescribed pre-tax profit from continuing operations, audited financial statements for 3 years, prescribed shareholders equity and compliance with applicable SEC rules, incorporation law and its memorandum and articles of association. Other conditions will include approved offer documents, resolutions by the board and general meeting, vending agreement, and a certified copy of the underwriting agreement.4

Notes 1 2 3 4

DMO website. FMDQ website. FMDQ website. This list is not exhaustive. Other requirements can be found in various documents relating to the FMDQ rules.

Bibliography Bloomberg. (2018), Global Fixed Income League Tables- FY 2017 DMO. (2015), A Guide to Operations for the Debt Management Office, Nigeria in the Federal Government of Nigeria Bond Market Revised DMO. (2016a), Nigeria’s Debt Management Strategy, 2016–2019 DMO. (2016b), Report of the Annual National Debt Sustainability Analysis DMO. (2017a), The Debut Federal Government of Nigeria Green Bonds Factsheet DMO. (2017b), Report of the Annual National Debt Sustainability Analysis DMO. (2018), DMO Website Fabozzi, F.J. and E. Pilarinu. (2002), Investing in Emerging Fixed Income Markets, edited. Hoboken, NJ: John Wiley & Sons FMDQ. (2014), Bond Listing and Quotation Rules FMDQ. (2018), FMDQ OTC Market Turnover Report Forte Oil PLC. (2016), Medium Term Bond Program: Shelf Prospectus GTB. (2018), Corporate Profile. www.gtbank.com/about/our-company/history Iannotta, G. (2010), Investment Banking: A Guide to Underwriting and Advisory Services. Berlin, Heidelberg: Springer-Verlag IIF. (2018), Global Debt Monitor IMF. (2018), Global Financial Stability Report Infrastructure Consortium for Africa (ICA). (2017), Infrastructure Financing Trends in Africa – 2016 Institute for International Finance (IIF). (2018), Global Debt Monitor Lagos State Government of Nigeria. (2012), Debt Issuance Program: Shelf Prospectus Levy, H. and T. Post. (2005), Investments. Essex: FT-Prentice Hall Liaw, K.T. (2006), The Business of Investment Banking: A Comprehensive Overview, 2nd edition. Hoboken, NJ: John Wiley & Sons

Debt underwriting 147 OECD. (2015), Mapping of Instruments and Incentives for Infrastructure Financing: A Taxonomy. www.oecd.org/finance/private-pensions/Mapping-Instruments-Incentives-Infra structure-Financing-Taxonomy.pdf Oteh, A. (2010), Capital Market as Long-Term Option for Financing Infrastructure Development. www.sec.gov.ng/files/Speech_infrastructure%20development%20-%20cbn.pdf Petitt, B.S., J. Pinto and W.L. Pirie. (2015), Fixed Income Analysis, 3rd edition. Hoboken, NJ: John Wiley & Sons and CFA Institute Pratap, G.S. (2008), Investment Banking: Concepts, Analyses and Cases. New Delhi: Tata McGraw-Hill SEC (2016), SEC Rules SEC (2018), Website S&P Global Ratings (2018), Research Update: Nigeria Ratings Affirmed At ‘B/B’; Outlook Stable. https://www.standardandpoors.com/en_US/web/guest/article/-/view/sourceId/ 10472880. Access December, 2018.

9 Private equity

Principles Private equity (PE) is typically a form of capital committed over a medium term (5–7 years) in private companies. A PE investment is typically made by a PE firm, a venture capital firm or an angel investor. PE firms structure PE investment like a collective investment club composed of funds from principal investors and institutional investors. The PE funds directly invest in private companies, make acquisitions, engage in buyouts of public companies and so on. The case for PE as an alternative model of investing is predicated on addressing market failure, principal–agency problems and information asymmetry (Gilligan and Wright, 2014). PE seeks out and takes advantage of market failures that create mispricing opportunities. PE seeks to address the principal−agent problem arising from a lack of managerial accountability and corporate governance. The economic structure of PE tries to align the interests of managers and shareholders to achieve economic efficiencies. PE can be viewed as a means of enhancing the long-term form of corporate governance, especially in underperforming companies. Information asymmetries are minimized in PE compared to publicly listed companies and other private companies as due diligence is done before investing in the investee companies and ongoing close monitoring of the company is achieved by having seats on the board. Investors in publicly listed companies trade shares based on available public information, and insider laws are designed to prevent trading based on private information that is not widely available to other investors. PE has several attributes. First, PE seeks to create and realize value by amplifying financial returns on equity with leveraging on debt financing. PE funds tend to use debt financing to enhance returns and reduce corporate taxation. Second, PE is designed to align the interest of managers with those of shareholder by using equity incentives to create potentially incentives to motivate managers to generate a high level of capital gains. Third, PE involves active involvement in the investee to improve the performance and management of businesses. Fourth, PE pays great attention to transactional detail through due diligence involving the purchase and sales of a whole company. The investee companies

Private equity 149

are generally unlisted and may not be able to raise capital on the stock exchange at a low cost of capital. These companies may need private capital to expand and achieve their growth prospects. PE serves as a complement to bank’s debt financing for private companies. Commercial banks tend to lend for short term, but PE tends to commit to medium and long-term in a private company. As noted earlier, PE provides hands-on strategic and operational advisory assistance to investee companies. From the perspective of investors, several factors must be considered when comparing PE to other forms of investment. PE involves substantial capital entry requirements, which can be drawn at the manager’s discretion over the first few years of the fund. Private equities are often structured as a limited partnership with “illiquid” investments as capital may be locked up in long-term investments over several years. An investor’s commitment to a PE fund is satisfied over time as the general partner (GP) makes capital calls on the investor. PE is associated with high risks of capital loss in unlisted private companies, but investors also have a high return expectation. PE structure

The PE funds tend to be structured as limited partnerships (LPs),“pass-through” entities for income tax purposes. The LP structure of a PE fund generally involves several key entities as shown in Figure 9.1.

Limited Partners

General Partners

Portfolio Companies

DFI

Fund Manager

Investment A (Company)

Figure 9.1 Structuring of PE funds

HNW Individual

Pension Fund

PE FoF

PE Fund

Investment B (Company)

Investment C (Company)

150  Raising capital in frontier markets

The private equity fund has no direct operations but pools capital from sponsors and investors that acquire interests. The external investors are called LPs as their obligations are limited to only the amount they invest. Co-investment structures are also used by new fund managers who invest in specific portfolio companies or raise funds on a deal-by-deal cases. Private equity firm is, itself, an LP, with a GP that manages the private equity fund. Private equity fund managers have five principal roles: (1) raise funds from investors; (2) source investment opportunities; (3) negotiate, structure and make investments; (4) actively manage investments; and (5) realize returns. The GP has the legal power to advise and act on behalf of the PE fund. The portfolio companies are companies the PE Fund invest in as recommended by the GP and constitute its portfolio of the company. The GP monitors the portfolio companies through board representation and incentive reward system that aligns its interest with those of the managers of the investee companies.

Connecting principles to practice Box 9.1  Private equity term sheet The term sheet will set out the terms of the private equity investment including the following: • The amount that the private equity firm is to invest in the company • The terms of the instrument being used for the investment • Valuation as at pre-money • Capital structure • Liquidation preferences • Dividend rights • Conversion rights • Anti-dilution provisions • Pre-emption rights and Redemption rights • Lock-ups period • Board composition • Consent rights • Information rights • Warranties • Vesting • Options • Milestones • Confidentiality • Exclusivity • Fees and Conditions precedent clauses

Private equity 151

Fund economics There are some common basic economic elements to all PE funds that affect the profitability of the funds and the returns to investors.These elements include investor capital commitments, allocations and distributions of profits and losses of the fund, fees paid to the fund’s GP and expenses of the fund. Capital raising and capital commitments

The PE firms play a role in arranging PE capital raising through private placement. They would assist in preparing the private placement prospectus that includes the sponsors, funds objectives, strategies, business plan, financial model, deal structuring, capital commitment and allocation formula and some prospective investees. The prospectus or private placement memorandum is marketed to potential investors such as pension funds, sovereign wealth funds, endowment funds, insurance companies, banks, funds of funds, family offices and HNWIs, as well as the PE fund managers themselves. Committed capital by investors in PE funds are not drawdown funds until they are needed.The investor makes a capital commitment, which is not deposited in cash, with the fund manager to invest as opportunities arise based on the determination of the fund manager.The investors that limited partners then face an uncertain cash commitment to any particular fund, both in terms of amount and in the timing of drawdown. A fund’s governing documents generally permit the fund to raise capital commitments only during a limited fund-raising period (typically 12 to 18 months), after which the fund may not accept additional investor commitments. During the capital-raising period, the sponsor seeks investors to subscribe for capital commitments to the fund. In most cases, the commitment is not funded all at once, but in separate capital contributions called on an as-needed basis to make investments during the investment period and to pay fees and expenses over the life of the fund. Several factors tend to determine the success of private placement of capital raising by the sponsors of PE funds. The amount being raised, the timing, general macroeconomic environment, sector and industry developments, the specificity of the funds, the track record of its sponsors and the strength and credibility of the investment bank serving as the placement agents. The distribution of funds to investors are governed by distribution waterfalls arrangement, which suggests how proceeds from investment are to be distributed in an order of tiered priority. At each tier of the waterfall, distributions of excess cash are made in a specific ratio (which may be 100 percent to the sponsor, 100 percent to the investors or anywhere in between; Naidech, 2011). Fees

The fund managers have four sources of reward. First, they may receive a return as an investor in the fund in the same way as any other investor in the fund.

152  Raising capital in frontier markets

Second, they receive a salary from the fund management company at a normal market rate. Third, they may receive a share in the profits of the fund management company. Fourth, they may receive ‘carried interest,’ which is triggered once a minimum threshold return is achieved. Traditionally the threshold, or hurdle rate, has been 8 percent per annum over the life of the fund and the share has been 20 percent of the profits above the hurdle rate (Gilligan and Wright, 2014).The PE fund sponsors are also entitled to a profits participation in the form of carried interest, carry or success fee typically set at 20 percent of profits. The distribution waterfall would provide the methods for determining the carried interest, which could be on a Dealby-deal carry. It could also be deal-by-deal carry with loss carried forward and a back-end-loaded carry (Naidech, 2011). Valuation

Private companies tend to have limited data. Nevertheless, efforts must still be made to value them. Investment banks use several valuation methodologies to determine the value of a company and arrive at a suitable price. These can be categorized into five key areas: balance-sheet asset-based methods, marketbased analysis, comparable analysis approach, discounted cash flow (DCF) method and leveraged buyout method. The DCF method is the most common method for valuing portfolio company in Africa. The process of valuing a target company with DCF analysis requires the six key steps: Determine which free cash flow (FCF) model to use for the analysis; develop pro forma financial estimates for each firm; calculate FCFs using the pro forma data; discount FCFs back to the present using an appropriate discount rate, the weighted average cost of capital (WACC); determine the terminal value and discount it back to the present; and add the discounted FCF values to the discounted terminal value. Leveraged buyout (LBO) analysis tries to determine the highest price that an LBO group will pay when the target is a potential LBO candidate. The price is often the target’s floor price. LBO analysis is similar to DCF but incorporates leverage financing options for the LBO, which depends on the timing of cash flows, debt availability, cost of debt and available tax shield particularly during the firm’s restructuring. The value to an investor who is a limited partner would be affected by both the valuation of the portfolio investments, by the timing differences between fees paid to the manager and any value growth, and the yield realized from the portfolio. PE funds’ cash flows typically have a J-curve profile (Gilligan and Wright, 2014). At the initial stages, PE funds’ cash flows would be negative as capital is invested in private companies and become positive when the investments are realized at future dates. The deal structuring would take into consideration valuation at several stages: first, the pre-money valuation, which is the post–money valuation of a company at a financing round minus the amount raised at that round; second,

Private equity 153

a step up in value, which is determined as the pre–money valuation at a round divided by the pre-money valuation at a prior period; and, third, the return on capitalization, which is the annualized change in the pre-money valuation between two financing rounds (Pratap, 2008) Investment strategies

PE invest in businesses can range from venture at the early stage, termed venture capital investments, through growth businesses requiring further development capital to the purchase of an established business with buyout capital. In general, venture capital refers to the early stage of investment in ventures, while PE focuses on later-stage development capital and buyouts and buy-ins capital as well as financially distressed companies (Naidech, 2011). PE funds may focus on investing in specific geographic regions such as the United States, Asia, Europe or Africa, Latin America or in specific industry sectors including technology, real estate, energy, health care or manufacturing. Exit strategies

The ultimate objective of a PE fund is to exit its investment in a private company within its portfolio with a high internal rate of return (IRR) that is a multiple of its initial capital injected into the company. There are various exit strategies, including a sale of the company, IPO and M&A. PE funds aimed at generating capital gains from the sale of their investments in businesses, thereby creating and enhancing shareholders value.

Practices Global PE markets

PE has evolved through a boom-and-bust cycle over the last eight decades. Its history is intertwined with the development of venture capital and LBO. In the first four decades of its history, from the mid-1940s through 1980, PE investment was relatively small and organized by less well-known organizations. Indeed, the term PE became widespread from the 1980s, when there was a dramatic increase in LBO financed by junk bonds. The LBO boom that started around 1982 came to a halt in the early 1990s following the massive RJR Nabisco LBO and the bust in the LBO industry. The recession of the early 1990s and financial crisis gave impetus to more institutionalized PE firms. By the late 1990s and early 2000s, the technology dot-com boom was fuelled by venture capital investments. The late 1990s up through the global financial crisis of late in the first decade of the 2000s witnessed the institutionalized and globalization of large PE firms, larger funds, bigger deals, more complex structures and higher leverage.

154  Raising capital in frontier markets

The financial crisis of 2008/9 severely impacted the PE industry which relies on leveraged debt financing to boost returns. Deals volumes collapsed as banks refused to lend amid Lehman Brothers’ precipitous collapse. Several PE funds faced insolvency crisis due to debt maturity mismatch while some funds started charging fees on uncommitted capital creating a perverse situation between fund managers and partners. LBO, in the form of management buyout (MBO), was increasingly replaced by management buy-in (MBI). The average size of PE deals nearly double every 5 to 6 years between 2000 and 2017. McKinsey (2018) shows that global PE deals totalled $2.6 trillion between 2000 and 2006, averaging $370 billion per annum before reaching a peak of $1.4 trillion in 2007. Between 2008 and 2013, private equity deals totalled $3,8 trillion, with an average of $635 billion per annum. Private Equity International (PEI, 2018) reports that 300 private equity firms have a 5-year fund-raising worth $1.5 trillion, with the top 10 accounting for $400 billion.The top 10 accounted for 26.5 percent in 2018, 23.6 percent in 2017 and 22.9 percent in 2016.The largest private equity firms are ranked by how much capital they raised for private equity investment in the last 5 years.The top 10 private equity firms are Carlyle Group, Blackstone, Kohlberg Kravis Roberts (KKR), Apollo, CVC,Warburg, EQT, Neuberger Berhman, Silver Lake, and TPG. Nine of these world’s largest firms are based in the United States, with five located in New York City, and one firm CVC Capital Partners located in London (PEI, 2018). In 2017, the most active global investors by private equity deal count were KKR ($100 billion), HarbourVest Partners ($92 billion), Audax Group ($85 billion), The Carlyle Group ($79 billion), The Blackstone Group ($67 billion), Ardian ($63 billion), ABRY Partners ($60 billion), EQT ($56 billion), AlpInvest Partners ($56 billion) and Bpifrance ($55 billion). As observed, in addition to KKR, Carlyle and Blackstone, smaller boutique firms featured prominently in the Deals league for 2017 (PEI, 2018). Investment banks offer financial and transaction advisory services to PE firms. The 10 largest global financial advisers in 2017 were Morgan Stanley, Goldman Sachs, Houlihan Lockey, Rothschilds & Co, Lincon International, Credit Suisse, Table 9.1 Global largest private equity firms Rank

Firm

Headquarters

5-year fund-raising total (millions)

1 2 3 4 5 6 7 8 9 10

The Blackstone Group Kohlberg Kravis Roberts The Carlyle Group TPG Capital Warburg Pincus Advent International Apollo Global Management EnCap Investments Neuberger Berman CVC Capital Partners

New York City New York City Washington DC San Francisco New York City Boston New York City Houston New York City London

$58,319.58 $41,623.40 $40,732.73 $36,051.64 $30,812.05 $26,951.37 $23,998.35 $21,220.08 $20,398.43 $19,896.65

Source: Private Equity International (2018).

Private equity 155

J.P. Morgan, DCS Advisory, Evercore and Jeffries. Investment banks not only provide financial advisory to independent PE or venture capital firms but may also have proprietary PE funds of their own, which they manage in-house. J.P. Morgan Partners, Goldman Sachs and Morgan Stanley have their own PE funds as subsidiaries of the larger investment banks. PE markets in Nigeria and Africa History

The development of PE in Africa was actually spearheaded by public-sector bilateral and multilateral DFIs, which had hitherto focused on lending to the public sector. The multilateral DFIs investing in Africa were principally IFC (a World Bank affiliate), private-sector Unit, the European Investment Bank (EIB) and the AfDB (Box 9.2). European bilateral development agencies included the UK’s CDC Group PLC (CDC), Germany’s Deutsche Investitions- und Entwicklungsgesellschaft (DEG), the Netherlands’ Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V (FMO), France’s Proparco and Sweden’s Swedfund, amongst others (AVCA, 2016). The DFIs played key roles in catalysing the PE market in Africa. With the evolving landscape for the private sector–led development approach to stimulating economic growth and creating opportunities for businesses to generate jobs in the 1980s, the DFIs began investing in private-sector businesses and played a catalytic role in fostering the participation of commercial investors in developing countries. Specifically, the DFIs pioneered Africa-focused fund managers that encouraged in the 1990s the first wave of Africa-focused PE firms dedicated to Africa. The DFIs also inspired and partnered with global PE funds, while encouraging the development of local PE funds with seed capital. One of the earlier PE investments by EIB in Africa is the venture and trust (V&T). DFIs has provided strategic and policy direction, working with governments, policymakers, regulators and the development partners to underscore the benefits of privatization of public enterprises and private-sector development investment. To achieve these objectives, the DFIs worked with the governments to remove regulatory barriers that deter the conducive business environment for local and foreign investors in the private sector.

Connecting principles to practice Box 9.2  AfDB support to private equity in Africa The African Development Bank Group (AfDB) has a portfolio totalling $1.5 billion in equity commitments having approved 48 private equity

156  Raising capital in frontier markets

funds presently invested across 694 companies as of 30 June 2018, investing across a broad range of sectors and geographies on the African continent. For every $1 million the bank invests in private equity, a further $6.5 million is invested by other institutions and individuals. By helping to create and sustain this industry, the AfDB can unlock capital from other private- and public-sector investors around the world. Telecommunication: The AfDB has invested in three generations of emerging capital partners’ (ECPs’) funds, with fund approval of more than $100 million. The funds have supported the success of the telecom giant Celtel, as well as being behind turnaround stories, such as Notore Chemical Industries in Nigeria. Agriculture: ECP Africa Fund II invested $23.2 million, with the AfDB indicative investment of $2.55 million in Notore Industries based in Nigeria, an emerging producer and supplier of agricultural products for African markets. The company is a major manufacturer of urea fertilizer in subSaharan Africa. Private equity played a part in the plant’s original foundation in 1981, with the firm Kellogg, Brown and Root taking a 30 percent stake. Health care: The Investment Fund for Health in Africa (IFHA) is backed by a number of partners, including the International Finance Corporation, Netherlands’ Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden, Goldman Sachs and AfDB, which committed approximately $13 million into IFHA in April 2010. IFHA invests in private hospitals and laboratories, health insurance businesses and pharmaceutical supplies companies. Nigerian integrated health care provider Hygeia Limited is one of the portfolio companies. Hygeia is a health care group founded in 1984 by a husband and wife team of physicians, the Elebutes. In 2007, the company received an investment of $1.66 million through IFHA. Small and Mid-sized Companies (SMC): Aureos PE firm was one of the pioneer private equity players investing in the SMC space in Africa. The Aureos family of funds has been investing in SMC in emerging markets since the late 1990s. AfDB approved $30 million in 2008. Aureos has contributed to the success of several companies, such as Voltic Water in Ghana, Brookside Dairy in Kenya and Deli Foods in Nigeria, where Aureos helped a management team to acquire the business and expand its production capacity. The enhanced capacity, distribution network and brands became an attractive platform that was eventually acquired by a large South African fast-moving consumer goods player. Source: African Development Bank (2012 with updates in 2018).

Current practices

By 1997, 12 PE funds had raised US$1 billion collectively to invest in Africa initially with a focus on the relatively developed market of South Africa but

Private equity 157

soon spread to other parts of the continent including Botswana, Côte d’Ivoire, Ghana, Kenya, Mauritius, Zambia and Zimbabwe (AVCA, 2016). Ten years later, by 2017, there were more than 140 PE firms targeting Africa and offering generalist, country-focused, sector or region-dedicated funds, as well as pan-African funds. African PE deals totalled over 950, with $24.4 billion in funds, with the total value of African PE fundraising estimated at US$2.3 billion in 2017 and US$3.4billion in 2016 (AVCA, 2018). Most funds outside South Africa are denominated in US dollars to minimize currency risks arising from volatility of local currencies that are often subject to devaluation. Several features characterized PE in Africa. Equity investments are typically lower than in advanced and emerging markets with a majority of investments less than US$50 million in South Africa. PE deal size is much lower outside of South Africa, and average median deal size of $7 million between 2012 and 2017, due to the size of economies of African FMs and the focus on financing of the growth of small and medium-sized enterprises (SMEs). Deal sizes are expected to increase as the frontier economies, businesses and opportunities requiring larger scale investments come on stream. Limited partnership with a 10-plus-2-year term and a 5-year investment period is the preferred structure for PE fund. These structures have been adopted with the preference of investors, tax and regulatory requirements in mind. The main common jurisdictions for domiciling African PE funds are Mauritius, the Cayman Islands, Cyprus, Jersey and Guernsey (AVCA, 2016). Mauritius is the preferred jurisdiction for PE funds with substantial investment from DFIs, which tend to insist on an African location. Mauritius has specific PE legislation in addition to its low tax regime and tax treaty. PE investment in Africa is primarily growth capital with very little debt financing transactions, which is in sharp contrast to the LBO strategies common with PE in advanced economies. Africa’s PE funds also focus on sustainable development that capitalize on demographic trends, the rise of the middle class in urban centres and industry value chain and distribution channels. As part 183

7.9 150

175 154 4.0

3.9

3.8

2016

2017

2.4

2.3

2012

149

142

2013

2014

Value of PE deals (US$billion)

2015

Number of PE deals

Figure 9.2 Number and value of African private equity deals, by year Source: AVCA (2018a).

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of its investment strategies, PE fund managers also incorporate environmental, social and governance standards, which have been traditionally a focus of DFIs. The growth capital PE funds typically take minority stakes of less than 50 percent in private companies, which allows founders to retain control and management of the companies. Nevertheless, PE funds protect their minority interests in investee companies using contractual agreement that ensure sufficient influence on the key decisions, including strategy and board composition of the investee companies. They also spend considerable time undertaking due diligence, understanding the operations of investee companies and providing hand-holding to management. The average investment hold periods are estimated at about five years. Asoko Insight and Africa Capital Digest (2018) shows that there are 214 PE investment firms with 306 offices in 27 sub-Saharan African markets, with South Africa as the market leader with nearly 40 percent of the PE offices located there, followed by Kenya and Nigeria with 14 percent and 12 percent, respectively. These three countries are followed by Mauritius and Ghana (Table 9.2). The 10 largest firms, defined by AUM exceeding $1 billion include Actis, African Capital Alliance, African Infrastructure Investment Managers (AIIM), Brait, Development Partners International (DPI), Emerging Capital Partners (EPC), Harith General Partners, Helios Investment Partners, Investec Asset Managements and Old Mutual Alternative Investments. There are eight firms with AUM between $500 million and $1 billion (Africinvest, Amethis, Ethos, Leapfrog, The Carlyle Group, Methies and SPE Capital), 65 firms with $100 million to $500 million range (including FBNQuest, Kuramo, Alithea, Apis Partners, ACCION, AFIG Funds) and 71 firms with AUM of less than $100 million, and the remaining firms include investors with unknown fund sizes (Asoko Insight and Africa Capital Digest, 2018). The Abraaj Group, Actis, Blackstone, Carlyle, ECP and Helios Investment Partners are some of the international PE firms that have committed funds to the African market. A near $700 million closed-end fund targeting sub-Saharan Africa was established by the Carlyle Group. The Abraaj Group closed its third sub-Saharan fund at US$990 million in 2015, and Helios Investment Partners

Table 9.2 Map of private equity firms in sub-Saharan Africa Number of companies/fund size

Nigeria Ghana Kenya Mauritius South Africa

Less than 100 m

100–500 m

500–1,000 m

1,000+

Total

4 6 13 2 25

16 4 12 14 36

2 1 1 0 6

4 0 4 0 7

38 14 42 21 118

Source: Asoko Insight and Africa Capital Digest (2018).

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raised the first African $1 billion fund in 2015. ECP announced the close of its fourth pan-African fund in November 2018 (Box 9.3). PE funds provide exposure to private-sector companies that are not represented in the 23 African stock exchanges with a total of about 1,500 publicly listed companies. As noted in Chapter 3, these stock exchanges, exemplified by NSE, are limited in size, scope and depth and dominated by consumer, natural resources and financial services companies.

Connecting principles to practice Box 9.3  Emerging capital partners closes its fourth Pan-African Fund Emerging Capital Partners (ECP) is one of the largest private equity managers focused on Africa since 2000, with offices in Tunisia, Lagos, Abidjan, Douala, Nairobi and Johannesburg. It has raised more than $3.0 billion in growth capital through funds and co-investment vehicles and completed 60 transactions and 40 full exits. In November 2018, ECP announced the final close of its fourth panAfrican fund, ECP Africa Fund IV (AFIV), which has received commitments of more than US$640 million, attracting a broad range of investors based in Africa, Europe and North America. AFIV is focused on four core sectors: financial services, consumer goods, telecommunications and information and communication technology and infrastructure and logistics. AFIV has already closed four investments with operations across seven countries and sustains a strong pipeline. Limited partners in AFIV include public and private pension funds, sovereign wealth funds, funds of funds and private-sector investors, as well as development finance institutions. Within Africa, Nigeria has attracted the attention of PE firms over the last five years and now accounts for nearly a third of the total PE investment into Africa. The number of PE firms grew more than 12-fold from three in 2003 to 38 in 2018. The size of funds grew from $75 million in 2003 to over US$2 billion under management in 2017. South Africa’s ratio of PE investment to GDP is four times higher than in Nigeria, which shows that Nigeria still has potentials for growth of PE investments. PE firms in Nigeria have invested in a wide range of sectors in oil and gas, telecoms, ICT, consumer goods, agriculture, manufacturing, financial services, media and entertainment. The largest PE fund manager in Nigeria is Africa Capital Alliance (ACA), established in 1998 and now has over $1 billion of AUM. ACA has successfully invested in MTN Nigeria, the telecommunication company; Wakanow, an online travel agency; and in ABC transportation company (Box 9.4).

160  Raising capital in frontier markets

Other notable PE firms include Apis Partners, Aitheo, Sahel, Synergy,Verod, Vectis and Ethos. These firms are typically backed by investors that include local PFAs, DFIs, impact investors, and foreign institutional investors looking for some exposure to the continent. ARM, FBN Quest Merchant Bank and Investment One are among the investment banks in Nigeria with venture capital and PE divisions.

Connecting principles to practice Box 9.4  ABC: private equity in a regional transportation player Background: ABC was established in 1993 by an entrepreneur who had run the Student Union Transportation Service at a school. Its primary business is to provide road transportation services between major cities. It started off providing services within Nigeria and eventually West Africa. Its other business lines are cargo and courier services, cash transfer and lodging. Its entry strategy was to target middle- and high-income segment of the market by delivering premium-quality transportation services. It provides a greater level of comfort and convenience and charges a premium. Investment Rationale: Competent entrepreneur with proven track record and significantly invested in the business; a strong historical growth; revenue growth of over 20 percent compounded annual growth rate (CAGR); a leading operator in a niche market; strong cash flows, as customers pay cash in advance or at purchase; and a clear path to exit. Deal Sourcing and Execution: Having successfully executed strategy in the local market, ABC sought expansion capital to fund growth to operate across West Africa and expand product offerings. It sourced through ACA partners’ proprietary network of long-standing relationship with the entrepreneur. ACA made a $2.3 million investment, structured as mezzanine and equity funding, in ABC for 30 percent of the business. Successful Exit: ABC achieved successful regional expansion and public listing. ACA’s IRR 47% – cash invested $2.33 million; cash realized $10.9 million. Source: Africa Capital Alliance (ACA, 2015).

Exit strategies in Africa

Between 2007 and 2016, a total of 350 realizations by African PE fund managers was recorded in a study of exits, with trade sales to regional and international businesses accounting for 45 percent of exits (AVCA, 2018b). South

Private equity 161

Africa accounts for 42 percent of all exits, followed by Nigeria at 9 percent. Most of those exits, about 37 percent were to other financial buyers, mainly other larger PE firms. Sales to original entrepreneurs remain an exit option, with less than 20 percent of portfolio companies being sold back in private deals to them. The shareholders’ agreement makes provisions for sell back and tends to reduce the uncertainty of finding a buyer for the portfolio companies by PE firms. About 10 percent of all exits were made through an IPO on stock exchanges. The trade sale partners are increasingly African companies looking to expand across the continent. Secondary buyouts in the form of sales to other PE firms are also gaining grounds. Recent examples of secondary buyout in Nigeria include GZ Industries Limited partially exited by Verod and Mouka Limited fully exited by Actis (Ogunro, 2017). AXA Group of France bought out the 77 percent indirect shareholding of AfricInvest in Mansard Insurance PLC of Nigeria. PE regulations in Nigeria

In Nigeria, there are no specific regulations on the establishment of PE funds but there are other areas of Nigerian commercial laws that need to be taken into consideration. the recent amendments to the Companies and Allied Matters Act Cap C20, Laws of the Federation of Nigeria (LFN) 2004 (CAMA) now allows for registration as a limited partnership, which hitherto has been available only in Lagos State, the main commercial hub of the country. The fund may also need to be registered with the CAC. In Nigeria, PE funds may do private placement with targeted local investors including institutional investors such as banks, insurance companies and pension funds, as well as high net-worth families and individuals. There is specific legislation relating to banks, insurance companies and pension funds which must be observed. The Banks and Other Financial Institutions Act Cap B3, LFN 2004 (BOFIA) provides guidance on what activities Nigerian banks can undertake and those subject to approval from the CBN. Banks may be able to invest in portfolio company relating to promoting small and medium-scale industries subject to the condition that the bank’s interest does not exceed 20 percent of the bank’s shareholders funds and not more than 40 percent of the investee companies’ paid-up share capital (Adebowale et al., 2016). The Insurance Act Cap I17, LFN 2004 regulates activities of insurance companies in Nigeria. Insurance companies are not expressly prohibited from investing in PE funds but must disclose their investment in periodic returns to the NAICOM that regulates the industry. The pension fund regulations permit a pension fund’s assets can be invested in the investment certificates of closed-end investment funds or hybrid investment funds that are listed on any securities exchange registered under the Investment and Securities Act of 2007 (ISA).

162  Raising capital in frontier markets

In 2017, pension rules further allow pension funds administrator to invest in a variety of alternative asset classes subject to certain limits. The pension fund regulations prescribe for the PFAs the types and mode of PE funds in which pension assets may be invested. The private fund manager must be registered as a fund manager with the Nigerian SEC and three-quarters of the fund must be invested within Nigeria. Where the fund managers engage in loan investments, it may enjoy the benefit of a reduction on tax liability on interest payments. Furthermore, the Companies Income Tax Act Cap C21, LFN 2004 (CITA) grants significant tax exemptions (up to 100% depending on the tenor of the loan, including moratorium and grace period) on interest payments on foreign loans. The SEC rules prescribe that the investment in a PIPE by a foreign investor shall be exited by divesting through the sale of securities on the NSE or other recognized OTC market. with respect to shares traded on that market. Divestment of holdings in securities in any other public company shall be done through Nigerian registered capital market operators, who must notify the SEC of the details of the of the divestment by the foreign investor within five working days of the divestment. Foreign portfolio investors must also comply with the regulations of the Nigerian Investment Promotion Commission Act of 2004 and the Foreign Exchange (Monitoring and Miscellaneous Provisions) Act of 2004. Future directions

PE investment in Africa outperformed public market returns by 70 percent between 2007 and 2017. The prospects for PE in Africa remain bullish among global PE investors with over 75 percent of investors surveyed by (AVCA, 2018c) planning to increase or maintain their provisions to African PE over the next 3 years. Two-thirds of investors would consider investing in a firsttime African fund, while about half anticipated increasing their allocation to Africa. Two-thirds of investors viewed Africa as more attractive for ventures than developed markets over the next 10 years. Nigeria has attracted a significant portion of PE into the continent. In addition, more than four-fifths of investors regard West Africa as the most attractive subregion, with Nigeria, the subregion’s largest PE market, viewed as the most attractive country for PE investment over the next 3 years. Given its entrepreneurial culture, large informal sector and SMEs, there is potential for deepening PE and venture capital business in the country. This potential is, however, challenged as Nigeria ranks low on the PE/venture capital attractiveness index compared to countries such as the BRICS – Brazil, Russia, India, China and South Africa – and with peers in the MINT category, such as Mexico, Indonesia and Turkey (Table 9.3). While relatively large PE firms dominate the PE space, there is a sense of herding effects as several smaller PE firms with limited capital chase the same set of attractive targets.The smaller PE firms also need to prove their mettle and develop a track record with a steep learning curve in other to raise new funds.

Private equity 163 Table 9.3 Venture capital attractiveness index Country

VC/PE Economic Depth Taxation Investor Human Entrepreneurial index activity of capital protection and social culture and deal market and environment opportunities corporate governance

18. China 28. India 35. Turkey 36. South Africa 37. Indonesia 39. Russia 41. Mexico 42. Philippines 54. Brazil 72. Nigeria

80.7 72.2 65.2 64.8 64.3 63.5 62.8 61.3 57.4 50.1

113.5 105.1 94. 3 48.5 95.7 88.1 90.2 91.8 79.2 72.6

89.4 78.1 72.2 78.8 73.1 65.1 68.8 70.5 74.9 56.1

111.3 101.3 107.4 110.9 79.2 97.9 104.4 95.7 21.4 53.9

58.3 67.7 59.1 71.1 46.8 57.2 60.0 47.3 53.5 52.2

55.2 46.6 43.3 40.1 41.0 35.2 29.9 48.5 35.8 33.1

81.4 65.1 55.6 66.3 64.4 69.9 64.4 48.7 54.9 42.1

Source: Alexander et al. (2018).

There are emerging opportunities for partnership. Family businesses are becoming more open in sourcing PE as debt capital is quite risky and costly with very high interest rates. PE firms can partner with Asset Management Corporation of Nigeria (AMCON) and capitalize on portfolio restructurings by banks with the possibility of buying assets at distressed value. PE firms can also partner with impact investing firms, which invest for financial returns along with social and environmental impacts, in helping to scale up businesses in this space. PE can be made more attractive by improving on institutional and corporate governance, taxation and overall business environment. The pace of such PE investments would accelerate with the growing assets of pension funds and recent changes to investment allocation limits by pension funds in Nigeria.

Bibliography Adebowale, F., J. Eimunjeze, E. Onajobi, T. Olowu, M. Jawando and O. Osoka. (2016), Private-Equity-in-Nigeria-Market-and-Regulatory-Overview. Udo Udoma & Belo-Osagie, Practical Law Company. www.uubo.org/media/1362/private-equity-in-nigeria-marketand-regulatory-overview.pdf Africa Capital Alliance. (2015), Considerations for Successful Exits, NASD Private Equity. http://nasdotcng.com/downloads/nasd_publications/Private%20Equity%20Exit%20Con siderations%20Feb%202015%20by%20African%20Capital%20Alliance.pdf Conference African Development Bank (AfDB). (2012), Private Equity Investment in Africa: In Support of Inclusive and Green Growth. www.afdb.org/fileadmin/uploads/afdb/Documents/ Generic-Documents/Private%20Equity%20Investment%20in%20Africa%20-%20In%20 Support%20of%20Inclusive%20and%20Green%20Growth.pdf Alexander, G., H. Liechtenstein, K. Lieser and M. Biesinger. (2018), The Venture Capital and Private Equity Country Attractiveness Index 2018, 9th edition. http://blog.iese.edu/ vcpeindex/

164  Raising capital in frontier markets Allen & Overy. (2015), Private Equity in Africa: Context, Opportunities, and Risks. www. allenovery.com/SiteCollectionDocuments/PE%20in%20Africa%20FINAL%20AO.PDF BVCA. (2012), A Guide to Private Equity. https://www.bvca.co.uk/Portals/0/library/Files/ Website%20files/2012_0001_guide_to_private_equity.pdf Asoko Insight and Africa Capital Digest. (2018), The Map of Private Equity Firms Based in Sub-Saharan Africa AVCA. (2016), Guide to Private Equity in Africa, African Private Equity and Venture Capital Association. www.avca-africa.org/media/1370/avca-guide-to-pe-in-africa2013-2014-avca-member-directory.pdf AVCA. (2018a), 2017 Annual African Private Equity Data Tracker with Regional Spotlights, African Private Equity and Venture Capital Association AVCA. (2018b), PE Exits in Africa 2017 AVCA. (2018c), Limited Partner Survey Banwo & Ighodalo. (2015), The Evolving Nigerian Private Equity Landscape: Finally Coming of Age? www.banwo-ighodalo.com/assets/grey-matter/29a14ef79912f48464cae4c9c 6fbf964.pdf Cendrowski, H., J.P. Martin, L.W. Petro and A.A. Wadecki. (2008), Private Equity: History, Governance and Operations. Hoboken, NJ: Wiley Finance, John Wiley & Son Deloitte. (2017), Africa Private Equity Confidence Survey: Translating Potential into Investment Growth, November. www2.deloitte.com/content/dam/Deloitte/ng/Documents/ finance/ng_africa_PECS_Results_2017.pdf Donnelley Financial Solutions. (2017), Pitchbook Global League Tables 2017 Annual EMPEA. (2018), The Road Ahead for African Private Equity Ernest & Young. (2014), www.ey.com/Publication/vwLUAssets/EY-private-equity-roundupafrica-2014/$File/EY-private-equity-roundup-africa-2014.pdf FMO. (2014), FMO: African Consumers Driving the African Private Equity Opportunity. www.fmo.nl/l/en/library/download/urn:uuid:7a92990b-ebb4-4b9e-bdc0-ebee72c234 eb/fmo-fairview+-+african+consumers+driving+the+african+private+equity+opportu nity.pdf?format=save_to_disk&ext=.pdf Gilligan, J. and M. Wright. (2014), Private Equity Demystified: An Explanatory Guide, 3rd edition. ICAEW Corporate Finance Faculty. www.icaew.com/-/media/corporate/files/ technical/corporate-finance/financing-change/tecplm12976_privateequityiii_full-edition.ashx?la=en Kaplan, S. and P. Stromberg. (2008), Leveraged Buyout and Private Equity, Journal of Economic Perspectives, 22(4). http://faculty.chicagobooth.edu/steven.kaplan/research/ksjep.pdf KPMG Doing Deals in Nigeria: Key Insights from Dealmakers. https://assets.kpmg.com/ content/dam/kpmg/ng/pdf/dealadvisory/ng-doing-deals-in-nigeria.pdf Metrick, A. and A. Yaruda. (2010), The Economics of Private Equity Funds, The Review of Financial Studies, 23(6) McKinsey. (2018), The Rise and Rise of Private Markets. McKinsey Global Private Markets Review Moore, D. (2011), Private Equity in Africa: Key Risks and Risk Management Strategies. https://www.pencom.gov.ng/wp-content/uploads/2017/04/PE-in-Africa-Risks-andRisk-Management-Strategies.pdf. Naidech, S.C. (2011), Private Equity Fund Formation, Practical Law Company. www.msaworldwide.com/Naidech_PrivateEquityFundFormation_Nov11.pdf Nnona, G. (2007), Private Placement of Corporate Securities in Nigerian Law: Realigning the Perspective on Key Issues of Doctrine and Policy, Social Science Research Network, Research Paper 18. http://ssrn.com/abstract= 887748

Private equity 165 Ogunro, S. (2017), Private Equity Transactions in Nigeria: Some Legal Considerations. Banwo and Ighodalo: Euromoney Handbooks Pratap, G.S. (2008), Investment Banking: Concepts, Analyses and Cases. New Delhi: Tata McGraw-Hill Private Equity International (PEI). (2018), PEI-300 Source. www.privateequityinternational. com/pei-300/ Summer Street Capital. (2018), Summer Street Understanding Private Equity. www. summerstreetcapital.com/include/PDF/SummerStreet_Understanding_Private_Equity. pdf Tyson, J. (2015), Sub-Saharan Africa and International Equity: Policy Approaches to Enhancing Its Role in Economic Development, ODI Working and Discussion Papers. www.odi. org/publications/9927-sub-saharan-africa-international-equity-policy-approachesenhancing-its-role-economic-development

Part IV

Putting capital to work in frontier markets

10 Mergers and acquisitions

Principles Financial and strategic advisory on mergers and acquisitions (M&A) forms a key part of the investment banking business globally. This chapter discusses corporate mergers and how it differs from acquisitions, the underlying motivations for mergers, types of mergers, global trends in M&A, structure, trends, regulations and stages of M&A in Nigeria and the valuation and financing mechanisms used by investment banks. In a broad sense, M&A involve different forms of transactions including the purchase and sales of undertakings, alliances, joint ventures, the formation of companies, corporate restructuring and management buy out (MBO) and management buy in (MBI). In a narrow sense, the combination of two or more companies into one new company is referred to as a merger or an acquisition. The difference between a merger and an acquisition is in the way the combination is achieved. A merger is simply the combination of two or more companies in the creation of a new entity. Acquisition aims at managerial control through a significant purchase of shares or assets of another company. A merger involves a negotiation between the companies prior to combination, while acquisition may not necessarily involve a prior negotiation and can be friendly or hostile. The acquirer can purchase the target company shares in the open market. In a hostile acquisition, the target company may oppose the acquirer and may approach a third company often referred to as a white knight to come to its rescue. Types of mergers: There are three types of mergers: horizontal, vertical and conglomerate. First, a horizontal merger involves the combination of two or more companies providing similar products or services with a view to achieving economies of scale and enhancing their combined value. Horizontal mergers are very common in Nigeria, especially with regulatory-induced banking and financial services industry consolidation (Dimgba et al., 2017). Second, a vertical merger is a combination of two or more distinct enterprises operating at different levels of the same market with the objectives of achieving forward or backward integration along the supply chain. It aims at improving operating efficiency, enhancing supply chain, acquiring a new market or customer base or buying into a fast-growing market.

170  Putting capital to work in frontier markets

Third, a conglomerate merger occurs with the combination of two separate companies from different industries and few or no vertical or horizontal relationship. Conglomeration is often used to diversify and spread business risk across a range of different areas. There is a downside to conglomeration as risks may actually increase when the business becomes unwieldy and unfocused. M&A can occur within the domestic economy or across the border. Motivations: Corporate M&A are motivated by several reasons from both the buyers’ and sellers’ perspectives (Roberts et al., 2016). Strategic motivations for M&A intend to achieve long-term goals of growing faster and more quickly than an organic growth rate, increasing market share with economies of scale or scope and product and market diversification. Operational motivations include seeking operational synergies which increase sales volume, cross-selling and pricing power and backward and forward value chain integration. Managerial motivation is associated with acquiring superior managerial skills and unique capabilities. Financial motivation for M&A is the need to maximize both revenue and profit gains and have better access to capital markets and loans, which lowers the cost of capital.Tax motivation in order to lower tax liabilities when a profitable company is acquired by a loss-leading company or when a highly geared company merged with a less leveraged company. Regulatory considerations often drive M&A in specific industries. There may also be speculative reasons for embarking on M&A, such as viewing a target company as being undervalued and seeking to purchase it, turning it around and then selling it for a price higher than the purchase price. Personal motivation driven by prestige, status and higher remuneration associated with managing a large company is another consideration for M&A. From the perspective of the seller or target company, several rationales may be adduced for selling and merging with the buying company.The target company may perceive that changing competitive landscape, due, for example, to rapid new technological development would impact its business model and sustainability. Financial considerations may be at play due to the high cost of capital and inability to secure funding at a competitive rate. The founders and owners of the company may view mergers as an exit strategy to unlock family and personal wealth often tied down in the company. The target company may want to block a hostile takeover by inviting a white knight to block the rival bid. Some mergers and acquisitions occur due to financial distress and forced sales due to pressure from venture capitalists. Private equity funds often use mergers and acquisitions to exit their positions in the target company. Businesses may be divested by large companies who may consider that such businesses no longer fit with their future strategic direction. Takeover Defences: Target companies use several mechanisms as takeover defences to delay or prevent mergers (Coffee et al., 1988). The target company can use a poison pill to dissuade a hostile takeover by using shareholder’s right issues as a mechanism to make a hostile bid very costly. It can also grant large

Mergers and acquisitions 171

benefits to executive management in case their contracts are terminated as a result of takeover restructuring.These golden parachutes come in the forms of a large cash bonus, stock options, a retirement package and a handsome severance pay. These financial packages may dissuade a potential hostile bid. The target company can decide to sell its most valuable assets, the crown jewels, to another company, thereby lessening its attractiveness to a hostile bidder forcing it to withdraw its bid.The target company may choose to invite a friendly company, a white knight, to acquire its business and thwart the hostile takeover from an unfriendly company. Pacman tactics can be used by tendering for the shares of the acquirer in a counterattack. Investment banking and M&A advisory

There are theoretical grounds for using investment banks in M&A advisory. The transaction costs hypothesis suggests that investment banks are more efficient in evaluating deals due to the complexity of M&A, economies of scale for information acquisition and the need to reduce information search costs. The asymmetric information hypothesis argues that due diligence by investment banks can reduce information asymmetry between bidder and target, as both parties may not reveal adverse information. The contracting hypothesis postulates that investment banks provide a signalling effect through the process and certification of transaction valuation. In practice, there are several reasons for using the services of investment banks in M&A transactions. First, by engaging investment banks as M&A advisors, the acquiring or the target firms tap into their specialized knowledge, experience and expertise. Second, investment banks, as M&A intermediaries, provide some degree of anonymity to the parties, especially during preliminary negotiations. Third, investment banks provide strategic advisory services for corporate M&A. Fourth, they assist in raising funds in the capital markets that may be needed to complete the acquisitions. Fifth, there are efficiency gains in relation to the information cost needed to undertake research and gather information about the parties, which an investment bank may already possess in their database. Sixth, the M&A process are also viewed as a distinct and discrete project whose management may require external advisors by the parties. M&A life-cycle process

Investment banks provide key services to the bidding and the target companies during the various M&A transactions stages. Most M&A progress through a clearly identifiable life cycle of six stages starting with an inception and strategy formulation phase. The first phase develops the rationale and formulate the strategy for the M&A and provide a preliminary understanding of the resources required for the strategy.The bidding company will formulate a coherent strategy that takes into consideration the specific motives for the M&A as outlined under principles

172  Putting capital to work in frontier markets

earlier, including acquiring undervalued firms, diversifying to reduce risks and exploiting opportunities for operating and financial synergies.The second stage involves identifying target markets and companies, issuing a letter of intent and offering a letter of confidentiality. Investment banks assist with identifying M&A opportunities. Within the pre-deal stage, the bidder will identify target markets and companies, issue letter of intent and offer letter of confidentiality. It is usual for the parties to enter into several pre-merger agreements such as exclusivity agreements, memorandum of understanding and confidentiality agreements, which regulate the conduct of the parties in respect of the merger process. The third stage is the due diligence stage with thorough investigation and evaluation of the targets by investment bankers and other parties. Investment banks undertake a valuation of the target firm, with premiums for the value of control and any synergy. They also advise how much to pay on the acquisition, how best to raise funds to do it and whether to use stock or cash. This decision has significant implications for the choice of accounting treatment for the acquisition. The fourth stage is the negotiation stage when a firm commitment is made to proceed. At this point the organization commits itself to the merger and allocates funding and resources as necessary. The pre-merger negotiation phase usually starts right after the commitment to proceed. In this phase the senior managers of the two organizations enter into negotiations in order to reach agreement on the structure and format of the newly combined organization. The fifth stage starts once the negotiations are complete. The deal itself takes the form of a detailed merger contract. The contract sets out the rights and obligations of each party (organization) under the terms of the deal. The sixth stage is when the implementation process starts as soon as the contract is in place. The final step in the acquisition, and perhaps the most challenging one, is to make the acquisition work after the deal is complete. Implementation includes the mechanics of actually executing the merger. Valuation

A critical role of investment banks in the M&A process is the valuation of the target company by both the bidder and the target company itself to determine the price to offer and accept. In addition to the financial analysis, a risk and scenario analysis will be conducted to examine the sensitivity of the valuation to different shocks. The impact of the merger on the bidding company is also examined by its investment bank. Valuation helps in determining deal structuring in M&A. Investment banks use several valuation methodologies to determine the value of a company and arrive at a suitable price. These can be categorized into five key areas: balance-sheet asset-based methods, market-based analysis, the comparable approach, the DCF method and the LBO method (Petit and Ferris, 2013; Corporate Finance Institute, 2018a; Aydin, 2017).

Mergers and acquisitions 173

Enterprise value (EV) is the negotiated value between a willing buyer and a willing seller to acquire the business. EV is the present value of the amount to be paid, either in cash or a combination of cash and future payments. Enterprise book value is the sum of the market value of equity, debt and preferred stock less cash and investment. It is also determined as the market value of current assets and long-term assets less market value of current liabilities. Balance-sheet asset-based methods

Balance-sheet-based methods use book value, adjusted book value, liquidation value and replacement-cost value to determine the value of the target firm. These are accounting concepts, which provide an initial estimate of the floor, or minimum and lowest price for the firm. It may however not capture the full earnings power of a company as it ignores considerations of its future potentials and intangible assets such as brand names, patents, loyalty and goodwill. Book value is the enterprise book value of a business calculated by subtracting the debts from the total value of the assets on the balance sheet. It is useful where there is a small difference between the market value and the book value. Adjusted book value takes the book value of the business as the starting point but adds the values of intangibles assets. Replacement-cost value calculates the costs of replacing all tangible assets in the balance sheet of the company. This method also ignores intangible assets. Calculated intangible assets method calculates excess returns on tangible assets, which is used to determine the proportion of return attributable to intangible assets. Liquidation value analysis establishes a valuation floor or the lowest value for the target firm. It is determined by subtracting the firm’s debts from the value realized from disposing all its assets. It is a relevant method when the target company is being purchased for its underlying assets or has a financial loss. Market-based analysis Multiples-based method

The value of the company is determined by considering the income statement and market data, rather than the data on the balance sheet. The market value of a firm is calculated by considering the market prices of their shares. Market-based models help to establish maximum values for the target company. However, the market price may be higher or lower than the real value of the company, especially if the float on the company shares is small. Price/earnings (P/E) ratio is commonly used, particularly in the valuation of non-public companies, where the shares are not traded. Comparable P/E ratios of other traded companies operating in the industry is used when there is insufficient information about the establishment. Bootstrapping is a technique whereby a high P/E firm acquires a low P/E firm in an exchange of stock. The total earnings of the combined firm are

174  Putting capital to work in frontier markets

unchanged, but the total shares outstanding are less than the two separate entities. The result is higher reported earnings per share, although there may be no economic gain. Price/sales (P/S) ratio multiples is another market-based approach. The disadvantage is that the multipliers may not reflect the control premium. Furthermore, earnings are based on the income statement, which may not represent the cash flow from operations. Accounting policies may also differ. Comparable models

Comparable company analysis can also use cash flows with a change of control premium added. This approach works well when there are good comparables for the target company. Comparable transaction analysis uses available data on past and current M&A transactions for companies or industry that are similar to the target firm. Multiples from past acquisitions are calculated and applied to the target firm’s financial results to estimate its value. DCF method

The previous methods described used mostly past or current data and values. The DCF is future-oriented and tries to undertake a firm’s valuation based on the present value of cash flows over its lifetime. Gordon dividends valuation model discounts present and future dividend payments to arrive at the valuation for the companies. Adjusted dividend valuation method assumes that dividends would grow at differing rates in the future. With the FCF model, acquisition is valued by using discounting FCF instead of dividends. DCF valuation should be conducted for both the target and bidding companies separately in order to establish whether it is possible to create a synergy. The process for valuing a target company with DCF analysis requires the following six key steps: determine which FCF model to use for the analysis; develop pro forma financial estimates for each firm; calculate FCFs using the pro forma data, discount FCFs back to the present using an appropriate discount rate, the WACC; determine the terminal value and discount it back to the present; and add the discounted FCF values to the discounted terminal value. LBO analysis tries to determine the highest price that an LBO group will pay when the target is a potential LBO candidate.The price is often the target’s floor price. LBO analysis is similar to DFC but incorporates leverage financing options for the LBO, which depends on the timing of cash flows, debt availability, cost of debt and available tax shield, particularly during the firm’s restructuring. Financing and deal structuring

Investment banks participate in articulating the financing options available in the M&A process. Mergers are predominantly stock purchase transactions and

Mergers and acquisitions 175

essentially cash neutral to both the bidding and target companies. Acquisition and takeovers are usually cash-based transactions requiring the purchase of the shares of the target company. The currency of M&A transactions could also be securities or a combination of cash and securities. Debt could be issued to partly finance the transactions subject to shareholders approval. There are principally four financing methods: all-cash, all-shares, assets purchase, LBO or a combination of these alternatives. The financing details will include all-cash transaction, financed from existing cash resources; all-cash transaction, financed by issuing stock; stock transaction, merger through exchange of stock; mixed stock/cash; leveraged cash transaction, financed through debt issue; LBO, majority of equity replaced by debt; debt transaction, debt offered to selling company shareholders; mixed cash/debt; and preferred stock (Miller and Segall, 2017). The advantages and disadvantages of the various alternatives are briefly outlined. All-cash transactions may be appealing to target company shareholders looking to sell immediately at a premium. All-cash transactions also reach closing faster than other currency methods, but the opportunity cost of not being able to use available cash for other business activities is a major disadvantage. An all-cash acquisition can materially lower the equity to assets ratio of the combined company. The advantages of using shares as the currency for the M&A are that there is no need for cash financing by the acquirer, there is quick and simple documentation procedure in transferring stock certificates, and the transactions can be tax-neutral to shareholders.The disadvantages are that target shareholders may view all shares transaction as not being attractive, and the acquirer shareholders may view the transactions as diluting their ownership, control and earnings. Using assets as the M&A currency enables the buyer to have complete control over the purchased assets and the liabilities it assumes. There may be no need for shareholders to vote in purchasing the assets in the ordinary course of business. It may, however, be difficult to determine the fair value of each asset and creditor agreement may be required for assets transfer and assignments. Debt financing may be part of the financing package and could be a small portion of paying for the agreed buying price or LBO in the form of structural financing of 90 percent or more of the price.The advantage of debt financing is that interest expense is tax deductible and prevents dilution as acquiring firm’s shareholders retain ownership. Leveraging has its own disadvantages. Cash flows may be impacted by principal and interest payments to creditors, who may also have priority claims to the combined company’s assets. Debt financing may raise financing cost and risks, which could impact credit and bond ratings.

Practice Global M&A

Mergers have occurred in waves over several decades, driven by technological progress, market developments and regulatory impetus (Martynova and

176  Putting capital to work in frontier markets

Renneboog, 2008). The first wave was the railroad wave between 1890 and 1903, driven by the development of the transcontinental railway line network in the United States during this period. The 1890s was also a period of the great anti-trusts, with the objective of limiting industrial concentration arising from the dominance of Standard Oil and US Steel. The second wave was the automobile wave, between 1910 and 1929, driven by the widespread availability and use of automobiles. The third wave (1950–1973) was the conglomeration merger wave, driven principally by legislation that hinders horizontal or vertical mergers.The fourth wave was the horizontal mega-merger wave of the 1980s (1981–1989), driven by deregulated measures, rising share prices and low interest rates that encouraged both shares and cash-financed acquisitions of slow-growing companies. The globalization wave of the 1990s was driven largely by the internet and electronic communication, the creation of the European Union common currencies, deregulation of financial institutions, low inflation and pricing power and low interest rates. Cross-border mergers were aided by the need to achieve scale economies and reduce costs in a globally competitive environment. Some of the largest deals on record were made during this period, including the merger of VodafoneMannesmmann AG in 1999 topping $202 billion, Pfizer and Wener Lamber merger of $89 billion in 1999 and Exxon-Mobil merger in 1998 at $78 billion. Mergers in the 2000s maintained their pace starting with the merger of America Online Inc and Time Werner in 2000 at $165 billion. M&A activity reached a peak in 2015 with a value of $5.8 trillion, more than the previous peak of $4.8 trillion in 2014 and $4.7 trillion in 2007.Among these were ABN-AMRO and RFS Holdings at $98 billion in 2007,Verizon combination of $130 billion in 2013, Anheuser-Busch and SAB Miller $101 billion in 2015 and Altice combination of $145 billion in 2015 (IMAA, 2017). In 2017, companies announced more than 50,600 transactions with a total value of more than US$3.5 trillion. Compared to 2016, the numbers of deals grew only marginally by 2.9 percent while the value declined by 2.00 percent and a value of $3.9 trillion (Merger Market, 2018). The Walt Disney Company’s acquisition of Twenty-First Century Fox Inc’s entertainment assets was the largest deal, worth US$68.4 billion along with the US$67.8 billion merger of CVS and Aetna. The telecommunication, media and technology sector led the charge, driven by digitization. It is expected that blockchain technology and autonomous vehicles will drive mergers in the near future. Mergers in the consumer sector recorded a total of six takeovers worth over US$10 billion led by the acquisitions of Reynolds America, Luxottica and Whole Foods. The recent wave of mergers has witnessed the growing emerging market companies from India and China participating actively in cross-border M&A. According to Morgan (2017), China outbound M&A into the United States and EMEA increased by 471 percent and 252 percent in 2015 and 2016, respectively, as Chinese companies sought attractive opportunities abroad; although the Committee on Foreign Investment in the United States

Mergers and acquisitions 177

(especially for semiconductors companies), South-East Asia, India and North Asia (China, Hong Kong and South Korea) are making the strongest contribution. Real estate, materials and consumer and retail sectors are predicted to lead the growth for Asia-Pacific M&A announcements over the next 6 months (Global Finance Magazine, 2018). M&A league table

In 2016, Goldman claimed the largest deal volume, while J.P. Morgan the largest number of deals (Global Finance Magazine, 2018). Goldman Sachs & Co. led the financial advisor rankings, having advised on 325 deals globally worth US$998 billion. Evercore claimed the first spot for investment banking boutiques with $328 billion in announced deals. The US anti-trust laws trace their origin to the Sherman Act of 1890, which restraints on trade and market monopolization. The European Union (EU) is very active in the development and enforcement of regulations relating to M&A to foster competition, prevent price-fixing and protect the rights of employees. Competition laws have become more widespread and internationalized as more than 130 jurisdictions now consider competition laws often modelled along the EU competition laws within their domestic legal system. Nigeria M&A

Afrinvest, DENHAM, FBN Quest Merchant Bank, FCMB, Stanbic and Vetiva are among the leading investment banking institutions active in the M&A and financial advisory space in Nigeria (Box 10.1). These investment banks play important advisory roles in the M&A transactions process, which requires expertise in different functional areas such as strategy, investment, corporate finance, valuation, fund-raising, commercial law, competition law, taxation, accounting and audit. 5,871.0 4,811.9 3,329.6

4,893.0

4,741.0

2016

2017

3,698.9

2012

2013

Figure 10.1 Trends in global M&A Source: Statista (2018).

2014

2015

178  Putting capital to work in frontier markets

Connecting principles to practice Box 10.1  M&A and Financial Advisory at ChapelHill Denham Chapel-Hill Denham is well regarded for its mergers and acquisitions, financial advisory, equity and debt capital market transactions services. Since its creation in 2005, the firm has been involved in over fifty mergers and acquisitions with a transaction size totalling $11.6 billion, over twenty financial advisory transactions worth $80 billion, seventy debt capital market transactions of $62 billion, and equity capital market transactions worth $11.4 billion. The firm played a key role as one of the lead financial advisers to the Central Bank of Nigeria during the banking consolidation exercise of 2009, in the creation of Asset Management Corporation of Nigeria (AMCON), the bad bank, and in the merger and acquisition of Oceanic Bank with Ecobank Transnational, Intercontinental Bank with Access bank, Equity Trust Bank with Sterling Bank and Union Bank’s acquisition by United group. It has served as financial adviser and joint lead arranger in raising debt and equity capital for leading corporate entities in different sectors of the economy including Lafarge Africa PLC, Access bank, FCMB, Custodian and Allied Insurance and so on. Chapel-Hill Denham has also been active in raising debt capital for Federal and State Governments. It served as financial adviser and lead bookrunner to Lagos State Government in bond issuance worth over ₦575 billion. It has been involved in raising funds for Ekiti and Osun State Governments. It was the lead manager and bookrunner for the federal government of Nigeria’s debut sovereign green bond issuance of ₦10.7 billion. The firm has established one of the first Nigerian infrastructure debt funds, described in Chapter 11. As noted in Chapter 4, Chapel-Hill Denham is recognized as one of the leading independent investment banking firms in Nigeria. The firm was adjudged Euromoney’s “Best Investment Bank in Nigeria,” for 2012, 2013, 2015 and 2016 and ‘Africa’s Best Bank for Advisory’ in 2016 (Chapel-Hill, 2018).

M&A in Nigeria is relatively new in comparison to global merger history and trends. Prior to 1973, business regrouping in Nigeria was mainly done in-house. The promulgation of the Indigenization Act of 1973 led to the formation of conglomerates by foreign businesses separately incorporated such as UAC of Nigeria, Paterson Zochonis and Company (PZ) and Associated Industries Limited. There

Mergers and acquisitions 179

was also the amalgamation of Bendel Co Ltd, Bendel Intra-city Bus Service Ltd, and Trans-Kalife to form the Bendel Transport Service Ltd (Ajogwu, 2014). From 1982 when the SEC began its operations, M&A became more regulated. Between 1982 and 1988, the SEC supervised 13 mergers, amongst which are Lever Brothers Nig Ltd and Lipton Nigeria Ltd, SCOA Nigeria Ltd and Nigerian Automotive Components Ltd, John Holt Ltd and John Holt Investment Ltd, with only two being successful (Ajogwu, 2014). In 1983, AG Leventis and Company Limited and Leventis Stores Limited merged in the first recorded large business merger in Nigeria (Richard, 2011). In 2002, Oando PLC emerged from the combination of Agip Nigeria PLC and Unipetrol PLC, two major petroleum companies. M&A gained momentum in 2005 with the mandatory requirements that banks should have a minimum capital of ₦25 billion. The CBN regulation led to mergers and acquisitions among 85 banks that reduced the number of banks to 25 (Table 10.1).The CBN provided forbearance and tax incentives to banks that consolidated and met the minimum capital requirements within the stipulated period. It provided forbearance by negotiating the write-down of its exposure to the distressed banks that would be acquired as a way of improving their balance sheets. In 2011, new banking regulation that deemphasized UB and “too big to fail” mentality led to a new wave of banking business combination, divestment and structure. Access Bank (Box 10.2) merged with Intercontinental Bank, while Oceanic Bank was merged with Ecobank Transnational Incorporated. Several smaller banks merged (Table 10.1). Several banks divested from their non-core banking activities, which created M&A opportunities from 2012 to 2014. Table 10.1 Banking consolidation and M&A, 2006   1 Access Bank PLC

Access Bank, Marina International Bank, Capital Bank International

  2 Afribank PLC

Afribank PLC, Afrimerchant Bank

  3 Diamond Bank PLC

Diamond Bank

  4 Lion Bank

African International Bank

  5 Ecobank

Ecobank

  6 ETB PLC

Equatorial Trust Bank, Devcom

  7 FCMB PLC

FCMB, Co-operative Development Bank, Nig-American Bank and Midas Bank

  8 Fidelity Bank PLC

Fidelity Bank, FSB, Manny Bank

  9 First Inland Bank PLC

IMB, Inland Bank, First Atlantic Bank, NUB

10 Guaranty Trust PLC

G T Bank

11 Stanbic IBTC Bank PLC

Regent Bank, Chartered Bank, IBTC, Stanbic International Bank (Continued)

180  Putting capital to work in frontier markets Table 10.1 (Continued) 12 Intercontinental Bank PLC

Intercontinental Bank, Global Equity, Gateway

13 NIB

Nigerian International Bank

14 Oceanic Bank PLC

Oceanic Bank, International Trust Bank

15 Platinum-Habib Bank PLC

Platinum Bank, Habib Bank

16 Skye Bank PLC

Prudent Bank, EIB, Reliance Bank Coop Bank, Bond Bank

17 Spring Bank

Guardian Express Bank, Citizens Bank, ACB, Omega Bank, Fountain Trust Bank, Trans-International Bank

18 Standard Chartered Bank Ltd

Standard Chartered Bank Ltd

19 Sterling Bank PLC

Magnum Trust Bank, NBM Bank, NAL Bank, INMB, Trust Bank of Africa

20 UBA PLC

UBA, STB, CTB

21 Union Bank PLC

Union Bank, Union Merchant Bank, Universal Trust Bank, Broad Bank

22 Unity Bank PLC

New Africa Merchant, Tropical Commercial Bank, NNB, Bank of the North, CentrePoint Bank, First Interstate Bank, Intercity Bank, Societe Bancaire, Pacific Bank

23 Wema Bank PLC

Wema Bank, National Bank

24 Zenith International Bank PLC

Zenith International Bank PLC

Source: CBN (2018).

Connecting principles to practice Box 10.2  Access Bank PLC: leapfrogging to largest bank via M&A Historical Background: Over the last three decades, Access Bank PLC has evolved from an obscure Nigerian bank into the pivotal position of being Nigeria’s largest bank by assets and deposits, with the proposed merger with Diamond Bank PLC. Access Bank was issued a banking licence in December 1988, commenced operations in February 1989, and became listed on the Nigerian Stock Exchange (NSE) in 1998. Access Bank obtained a universal banking licence from the Central Bank of Nigeria (CBN) in 2001. Mergers and Acquisitions (M&A): As of 2002,Access Bank PLC was ranked the 65th bank in Nigeria. As of 2018, it is now one of the five largest banks in Nigeria in terms of assets, loans, deposits and branch network. By the second half of 2019, it will have 16.5 percent of total assets and 16 percent of the total deposits base of the Nigerian banking system. Access Bank PLC

Mergers and acquisitions 181

has achieved this feat by leapfrogging through M&A. In 2005, it acquired Capital Bank and Marina Bank via merger by absorption and completed integration within 60 days. In 2012, the Access Bank merger with Intercontinental Commercial Bank was judged Africa’s top M&A deal of the year. In the same year, it listed on the London Stock Exchange. Proposed Merger with Diamond Bank: On 17 December 2018,Access Bank announced a proposed merger with Diamond Bank PLC. Based on the merger agreement reached by the boards of the two financial institutions, the proposed merger involves Access Bank PLC acquiring the entire share capital of Diamond Bank PLC in exchange for a combination of cash and shares in Access Bank, worth $200 million. Diamond Bank shareholders will receive a consideration of ₦3.13 per share, composed of ₦1.00 per share in cash and the allotment of two New Access Bank ordinary shares for every seven Diamond Bank ordinary shares held as of the implementation date. The offer represents a premium of 260 percent to the closing market price of ₦0.87 per share of Diamond Bank on the NSE as of 13 December 2018, the date of the final binding offer. Access Bank plans a rights issue of $200 million in additional capital following the merger. Largest Africa’s Bank by Customer Base: Access Bank PLC will be Nigeria’s largest bank by asset (₦6.1 trillion, 16.5 percent of total banking assets), deposits (₦3.5 trillion, 16 percent of total banking deposits) and loan book (₦2,703 trillion, 18 percent of total banking loans) when the merger is fully consummated by the end of the first half of 2019. The integrated Access Bank PLC will have Africa’s largest customer base of 27 million and more than 650 retail branch networks. Diamond Bank’s strong retail franchise, with savings deposit balance of ₦450 billion, is twice the size of savings deposits at Access Bank. This should have positive synergy to the combined Access Bank PLC, with improved low-cost deposit ratio and funding costs. There are, however, efficiency challenges relating to non-performing loans (NPL), with Diamond Bank’s NPL at 12.7 percent compared to 4.6 percent at Access Bank PLC. The cost of risk and cost–income ratio of the combined entity will likely rise as Diamond Bank’s cost–income ratio is over 90 percent. Source: Access Bank (2018) and Diamond Bank (2018).

In other sectors, M&A activities have been in oil and gas, cement, consumer goods, insurance and pension. M&A activities in the oil and gas sector have been encouraged by the Nigerian Oil and Gas Industry Content Development Act 2010, which seeks to encourage indigenous participation in the sector.This has led to a merger between AOS (Africa Oilfield Services Ltd) and Orwell Oil & Gas International, AOS Orwell, in 2011 and Oando Energy resources acquisition of Conoco-Phillips in 2014.1

182  Putting capital to work in frontier markets

In the consumer sector, Singaporean Olam International acquired a company that formed from the business combination of Crown Flour Mills Limited, Mix & Bake Flour Mills Limited and Interstate Flour Mills Industries Limited. SAB Miller PLC acquired two Nigerian companies. In the brewery industry, Heineken NV acquired two holding companies in the Sona Group and in turn its Nigerian subsidiary, Nigerian Breweries PLC acquired Consolidated Breweries (Box 10.3). In the cement industry, Benue Cement Company (BCC) merged with Dangote Cement PLC (DCP; Box 10.4). Another recent M&A transaction in the cement industry was the one between Kalambaina Cement Company Ltd and Cement Company of Northern Nigeria (CCNN) PLC to form a bigger CCNN PLC, which was adjudged as the biggest corporate merger in 2018. shareholders approved the Scheme at their extra ordinary general meeting of November 2018.The merger received the approval of the NSE, the SEC and the federal High Court in December 2018. Table 10.2 shows some of the deals in the consumer, power, financial services, oil and gas and manufacturing sectors between 2015 and 2016. Table 10.2 Recent M&A in Nigeria S/N

Transaction description

Industry

Year

1.

Business combination/merger between the CocaCola Company, SABMiller and Gutsche Family Investments. Kellogg acquisition of 50% in food distributor, Multipro Nigeria (a member of the Tolaram group). Acquisition of BUA Flour Mills Limited and BUA Pasta Limited (owned by the BUA Group, one of Nigeria’s largest food and infrastructure conglomerates) by Olam International Limited Olam International Limited. The Coca-Cola Company’s acquisition of Chi Limited, Nigeria’s leading dairy and juice company. MTN’s acquisition of Visafone, the only surviving Code Division Multiple Access (CDMA) network in Nigeria’s telecommunications industry. Guinness Nigeria acquisition of the distribution rights to McDowell’s No. 1, a mainstream spirits brand of United Spirits Limited, an Indian mainstream spirits business which is also a subsidiary of Diageo PLC. Helios and Netherlands-based Vitol Group teamed up in June to acquire a majority stake in Oando’s Nigeria-based downstream energy business.  Swiss Re’s acquisition of a 25% interest in Leadway Assurance. IFC and Swiss Re consortium’s acquisition of the Hygeia Group, a healthcare group in Nigeria.

FMCG

2015/2016

FMCG

2015/2016

FMCG

2015/2016

FMCG

2016

Telecoms

2016

FMCG

2015/2016

Oil and Gas

2015

Insurance

2016

Healthcare

2016

2. 3.

4. 5.

6.

7.

8. 9.

Mergers and acquisitions 183

The total number of deals stood at 41 in 2015 as Nigeria was named the most attractive African destination by investors. Economic uncertainties in the subsequent year slowed down deals to 28 in 2016 (Elias-Adebowale et al., 2018).

Connecting principles to practice Box 10.3  Merger of Nigerian Breweries PLC and Consolidated Breweries Merger Strategic Objectives: Nigerian Breweries PLC (NB) is the largest brewer in Nigeria, with a majority shareholding by Heineken of Holland. In 2014, Consolidated Breweries (CB) merged with NB. Benefits to be derived from the proposed merger scheme included a broader product offering to customers, operational efficiencies, economies of scale, access to new markets and creating more value for all stakeholders. Financial Advisers: NB appointed FCMB Capital Markets Ltd as financial adviser, while CB appointed Stanbic IBTC Capital Limited as financial advisers. The registrars were First Registrars Nigeria Ltd and Vetiva Registrars Ltd. Valuation Methodology: The financial advisers employed several valuation methodologies in establishing the fair value of NB and CB and in deriving the implied share exchange ratio for the proposed merger. The financial advisers adopted a historical market price approach for Nigerian Breweries since the company is publicly listed and its shares are actively traded on the NSE. The closing price per share of NB on the NSE as of the valuation reference date was ₦149.00. The discounted cash flow approach was adopted for CB as it relies on free cash flows.

Scheme Transfer and Consideration Under the terms of the scheme of merger, it was proposed that a

all the assets, liabilities and undertakings of Consolidated Breweries, including real properties and intellectual property rights, be transferred to Nigerian Breweries; b the entire issued share capital of Consolidated Breweries comprising 496,071,617 ordinary shares of 50 kobo each be cancelled and Consolidated Breweries be dissolved without being wound up; and c in consideration for the transfer of all the assets, liabilities and undertakings of Consolidated Breweries to Nigerian Breweries, it is proposed that each scheme shareholder shall be entitled to receive four Nigerian Breweries shares every five scheme shares of 50 kobo each

184  Putting capital to work in frontier markets

held by them in Consolidated Breweries as of the close of business on the terminal date or pay a cash consideration to the dissenting shareholders and other scheme shareholders who elect to receive the cash consideration. The recommended fair value estimates were ₦150 and ₦120 per share for Nigerian Breweries and Consolidated Breweries, respectively, resulting in a share exchange ratio of four Nigerian Breweries shares for every five Consolidated Breweries shares. Source: Nigerian Breweries PLC (2018).

Connecting principles to practice Box 10.4  Merger of Dangote Cement PLC and Benue Cement Company Dangote Cement PLC (DCP) is Africa’s leading independent cement player with plant footprints in Nigeria, Ethiopia, Cameroun, Benin, Senegal and South Africa. It has grown rapidly with strategic acquisitions within Nigeria and Africa. In October 2010, DCP merged with Benue Cement Company PLC (BCC). Merger Strategic Objectives: The merger was conceived with the goal of consolidating the cement producing entities of DCP in Nigeria under a single entity to capture positive economies of scale and realize significant synergies. The envisaged benefits of the merger included (a) better access to financing, (b) operational efficiencies, (c) improved management efficiencies, (d) economies of scale, (e) value creation and (f) enlarged cement production platform. Financial Advisers: Vetiva Capital Management Limited and Afrinvest (West Africa) Limited acted as financial advisers to DCP while Stanbic IBTC Bank PLC acted as financial adviser to BCC in connection with the scheme. Valuation: In accordance with global best practices in investment banking, Vetiva, Afrinvest and Stanbic IBTC estimated the fair values of BCC’s and DCP’s ordinary shares using various valuation methodologies: trading multiples comparable valuation approach; price-to-earnings (PE) multiple valuation and enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA2) valuation, precedent transaction valuation approach, historical market trading analysis valuation approach and discounted free cash flow (DCF) valuation approach.

Mergers and acquisitions 185

The financial advisers adopted the DCF, acknowledging that DCF is (a) more appropriate for valuing high-growth companies such as BCC and DCP and (b) enabled the financial advisers to ascribe fair values to DCP’s significant greenfield and expansion projects which a transaction multiple approach would ascribe zero value to because they are yet to be earnings accretive to DCP. Given that DCP is the majority shareholder of BCC, with a 74.77 percent stake, a valuation for DCP also incorporated both the values of BCC’s operating businesses and the value of its stake in BCC. The Scheme of Merger: The financial advisers jointly recommended fair value estimates of ₦67.50 and ₦135.00 for BCC and DCP, respectively, resulting in a recommended share exchange ratio of 2 BCC shares for every 1 DCP share. This exchange ratio values BCC at a 7.16 percent premium to the closing share price of ₦62.99 on 27 July 2010. As part of the scheme, the assets, liabilities and undertaking of BCC were transferred to DCP, and the entire issued share capital of BCC was cancelled, which, in consideration, BCC shareholders were issued ordinary shares in DCP. Meetings to Approve the Scheme and Voting Rights: Separate meetings of the shareholders of the two companies was convened by order of the court for the purpose of considering and if thought fit, approving the scheme. At the court-ordered meetings, voting on the resolution relating to the approval of the scheme was by poll. Source: Dangote Cement PLC (2018).

Regulations of M&A in Nigeria

Under regulations in Nigeria, a business combination may take the form of a merger, a purchase of shares, an acquisition of assets or an arrangement, compromise or reconstruction amongst or between companies.2 The principal legislation that regulates M&A is the Investments and Securities Act (ISA) 2007 and the Rules and Regulations issued by the SEC pursuant to the ISA (the “SEC Rules”). The SEC Rules distinguish between mergers and acquisitions. An acquisition of a majority interest in a private or an unlisted public company is subject to the prior review and approval of the SEC, except where either the assets or turnover of the target is below ₦500 million or the acquisition is as a result of a holding company acquiring shares solely for the purpose of investment. Under the provision of Section 120 of ISA, the SEC can proscribe merger thresholds based on the combined annual turnover or assets of the merging companies in Nigeria. First, small mergers are those with a combined annual turnover or assets of less than ₦1 billion of the merging companies. Second,

186  Putting capital to work in frontier markets

intermediate mergers have a combined annual turnover or assets of between ₦1 billion and ₦5 billion of the merging companies. Third, large mergers have a combined annual turnover or assets of ₦5 billion or more of the merging companies. SEC requires prior review and approval of intermediate and large mergers, while in the case of small mergers, the commission only needs to be notified that the merger has been concluded, and the merging entities do not need to make a pre-merger filing to the SEC. The provisions of the listing rules of the NSE (the “Listing Rules”) apply where any of the companies involved in the transaction is listed on the NSE. The Companies and Allied Matters Act, Chapter C20, Laws of the Federation of Nigeria (LFN) 2004 (CAMA – the principal legislation that regulates Nigerian companies), as well as the FIRS (with respect to taxation) would also apply. The Federal High Court orders the merging companies to hold meetings and will sanction the resulting mergers. Depending on the sectors in which the merging companies operate, additional sector-specific laws may be applicable to the M&A deals (Elias-Adebowale et al., 2018). In addition to these laws, there are applicable sector-specific laws and regulation relating to an M&A deal depending on the target company’s industry. There are sector-specific regulators and legislation for the banking, financial services, broadcasting, power, oil and gas and telecommunications industries. As discussed in Chapters 2 and 4, the CBN is the apex regulator for the banking industry. Banks are subject to the provisions of the Banks and Other Financial Institutions Act, Chapter B3, LFN 2004, which prescribes the prior approval of the CBN for acquisition transaction of more than 5 percent in a bank. The prior approval of SEC is required by capital market operators that intend to change their shareholding structure and directors. The prior approval of the NAICOM must be obtained for any acquisition of 25 percent and more of the shares of an insurance company. PENCOM approves all merger, restructuring or amalgamation and acquisition of significant shareholding of pension fund administrator or pension fund custodian. The Nigerian Communications Commission must give prior approval to any mergers in the telecommunications sector, as well as to the transfer or assignment of a licence and transactions involving the acquisition of 10 percent and above of the shares of a licensed operator. Nigeria’s Competition and Consumer Protection Bill has been introduced at the Nigerian National Assembly. The bill seeks to promote competition and economic efficiency and prevent a dominant position of market power and market abuse while protecting consumers. The bill makes a provision for competition regulator and will be applicable to all undertakings and all commercial activities in Nigeria. Due diligence and legal process

Aside from valuation and financing deal structuring, due diligence needs to cover legal-related issues including existing and pending claims and litigations,

Mergers and acquisitions 187

memorandum and article of association, ownership of the company, shareholding/directors of the company, share capital, regulatory compliance issues, insurance and liability; litigation; and employees and related information.These areas could be covered by investment banks’ professionals as well as other outside solicitors, accountants and auditors, and registrars. Some of the legal and regulatory steps to consider in the Nigerian context are outlined by Dimgba et al. (2017), who estimated that it takes 23 weeks to conclude mergers of banks. These steps are briefly described as follows: First, majority shareholders may have initial discussions before a scheduled board meeting to consider a formal resolution of the merger. Second, the authority to proceed must be given by the SEC under the ISA provisions and SEC Rules. The authority to proceed with a bid granted by the SEC is for a period of 3 months, subject to renewal upon application by the person making the bid. Third, the bid is registered with the SEC, which will register the bid once it is satisfied with compliance with the ISA and SEC Rules. In case of refusal by the SEC, an appeal can be made within 30 working days of the refusal notice to the Investments & Securities Tribunal (the Tribunal) for a review of the SEC’s decision. Fourth, the bid is dispatched to the SEC and to the shareholders of the target firm at least seven days before the date on which the takeover bid is to take effect. The directors of the target company are obliged to issue a circular to all shareholders of the company. Each shareholder is entitled to accept or reject the bid. Once 90 percent or more of the shareholders of the target company accept the bid, the acquiring company can start a squeeze-out programme within one month by sending an acceptance notice to dissenting shareholders, who can decide to be paid off or lodge a complaint with the SEC. Fifth, the acquiring company can announce the bid and start market campaigns for the merger and ensure that all post-bid requirements are fulfilled. The SEC requires disclosure requirements, including that a takeover bid be advertised in at least two national newspapers. SEC Rules also require a bidder to announce the intention to bid for the target firm on the floor of the stock exchange. Amendment to the SEC Rules provides for a penalty for non-compliance with the provisions of section 118(1) of the ISA and Rule 423(1) with respect to seeking the approval of the SEC prior to commencing any form of business combination in Nigeria. Documentation for M&A

The SEC Rules require extensive documentation in respect of a merger, acquisition or takeover. These documents can be categorized into three sets. First are the company constitutional documents, which will include the certified copies of the certificate of incorporation, copies of Forms CAC 7 and CAC 2 and a memorandum and articles of association of the merging companies. The second set of documentation is the merger-related documents. These will include an information memorandum takeover bid, board resolutions of

188  Putting capital to work in frontier markets

the merging companies, copies of letters notifying the trade union of the relevant industry of the intention of the companies to merge, signed and notarized consent letters of directors and parties to the merger, copy of merger implementation, draft proxy forms for each of the merging companies, a list of claims and litigation of the merging entities, evidence of appointment letter and financial services for financial advisers, a financial services agreement between the acquirer and target companies, a letter of no objection from relevant regulatory institutions and court applications. The third set of documentation is the financial-related documents, which include the annual audited accounts of the parties for 5 years or the corresponding period of existence if less than 5 years, evidence of payment of filing fees, evidence of an increase in authorized share capital, evidence of the intention to settle all tax liabilities of the FIRS, a certificate of capital importation (when applicable) and a reporting accountant’s report on the financials and forecast of the merging entities. In 2015, the SEC made extensive amendments to the SEC Rules governing M&A transactions, the most significant being the streamlining reduction of the filing process form a three-stage to a two-stage procedure to fast-track approvals of such transactions. Thresholds for transactions requiring regulatory approval and penalties for non-compliance were also increased. Challenges of M&A

Making mergers work requires careful post-merger integration of cultures, management, personnel, organizational structure, processes, policies and procedures while addressing administrative and logistical challenges (Hoang and Lapumnuaypon, 2008). M&A do fail, especially when measured by financial value creation in the short term. Mergers can fail due to overestimation of the true value of the target company, a failure to realize potential synergies identified from the onset, poor implementation and integration, conflicting cultures, a lack of personnel, processes and technological fit. The failure of Skye Bank can be partly explained by some of these factors, which feature with the acquisition of Mainstreet Bank. On the other hand, GTB and Zenith Bank – two successful banks in Nigeria – have generally avoided M&A strategy, preferring organic growth. Future directions

M&A in Nigeria will be significantly influenced by market-oriented reforms and the privatization of government parastatals such as in oil and gas, energy and infrastructure sectors. The banking industry may witness another round of mergers and takeovers among the second- and third-tier banks that are struggling to raise capital to meet regulatory requirements.The new risk-based capital requirements in the insurance industry will lead to another round of capital raising and insurance consolidation through M&A. The securities brokerage

Mergers and acquisitions 189

business is witnessing the entry of foreign brokers that are acquiring securities brokerage firms in order to get a foothold in the Nigerian market.

Notes 1 Ajogwu (2014) provides a listing of the various M&A up to 2014 in Nigeria. 2 More detailed legal requirements for M&A in Nigeria are provided in Ajogwu (2014), Elias-Adebowale et al. (2018), Dimgba et al. (2017), Oladosu and Alex-Adedipe (2015) and Bucknor (2015). In particular, Ajogwu (2014) provides comprehensive appendices on the various documentation, procedures and legal cases on M&A in Nigeria.

Bibliography Access Bank. (2018), Access Bank Plc Signs Memorandum of Agreement Diamond Bank Plc Adebayo, O. and O. Olalekan. (2012), An Analysis of the Impact of Mergers and Acquisitions on Commercial Banks Performance in Nigeria, Research Journal of Finance and Accounting, 3(7) Ajogwu, F. (2014), Mergers & Acquisitions in Nigeria: Law & Practice, 2nd edition, Lagos: Center for Commercial Law Development Akinrewa, O. (2017), An Overview of Mergers and Acquisitions Under Nigerian Law. Unilag Law Review, 1(1) Aydin, N. (2017), Mergers and Acquisitions: A Review of Valuation Methods, International Journal of Business and Social Science, 8(5) Bloomberg. (2017), Global Capital Markets League Table, www.bloomberg.com/ professional/blog/global-equity-capital-market-league-tables-full-year-2017/ Bloomberg. (2018), Global M&A Market Review, Financial Advisory Rankings Bucknor, O. (2015), Mergers and Acquisition in Nigeria: Laws and Procedure, ACAS LAW. www.slideshare.net/AcasLaw/mergers-and-acquisitions-in-nigeria-laws-and-procedureby-olujimi-bucknor Central Bank of Nigeria CBN. (2018), Website Chapel-Hill Denham. (2018), Mergers and Acquisition, Financial Advisory, Debt and Equity Raising Deals, Provided by Chapel-Hill Denham Coates IV, J.C. (2014), Mergers, Acquisitions and Restructuring: Types, Regulation, and Patterns of Practice, Discussion Paper No. 781, 07/2014, John M. Olin Center for Law, Economics and Business, Harvard University Coffee, J.C. Jr., L. Lowenstein and S. Rose-Ackerman. (1988), Knights, Raiders, and Targets:The Impact of the Hostile Takeover. New York: Oxford University Press Corporate Finance Institute. (2018a), Investment Banking Manual. https://corporatefinanceinstitute.com/resources/ebooks/investment-banking-book-pdf/ Corporate Finance Institute. (2018b), Overview of the M&A Process. https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma-process/ Elias-Adebowale, F. and O. Chinedu-Eze. (2017), 2017 Mergers and Acquisitions Report: Nigeria. www.iflr.com/Article/3673251/2017-Mergers-and-Acquisitions-Report-Nigeria.html Elias-Adebowale, F. and M. Ekemezie and C. Sijuwade. (2018), Corporate M&A 2018, Udo Udoma & Belo Osagie. https://practiceguides.chambersandpartners.com/practice-guides/ comparison/329/1586/2368-2372-2379-2382-2383-2384-2385-2386-2387-2388-2389 Dangote Cement PLC. (2018), Website Deloitte. (2018a), Banking and Securities M&A Outlook: Opportunities Amid Uncertainty Deloitte. (2018b), The State of the Deal: M&A Trends Delta Publishing Company. (2009), A Practical Guide to Mergers, Acquisitions and Divestitures. Los Alaminos: Delta Publishing Company. www.apexcpe.com/Publications/171025.pdf

190  Putting capital to work in frontier markets Diamond Bank. (2018), Statement Regarding Scheme to Merge with Access Bank Dimgba, N., O. Akinola, C. Ihenetu, G.I. Geoffrey, O. Osinubi, A. Ogunsanya and J. Onele. (2017), Law and Practice of Mergers and Acquisition in Nigeria. Olaniwun Ajayi LP. https://olaniwunajayi.net/wp-content/uploads/2016/04/LAW-AND-PRACTICEOF-MERGERS-AND-ACQUISITION-IN-NIGERIA.pdf Galpin, T.J. and M. Herndon. (2000), The Complete Guide to Mergers and Acquisitions. San Francisco: Jossey-Bass Publishers Gaughan, P.A. (1991), Mergers and Acquisitions. New York: HarperCollins Global Finance Magazine. (2018), M&As In 2018 | Expect New Records, More Deals. www.gfmag.com/topics/capital-markets-and-corporate-finance/mergers-acquisitionsoutlook-2018 Hoang, T.V.N. and K. Lapumnuaypon. (2008), Critical Success Factors in Merger & Acquisition Projects: A Study from the Perspectives of Advisory Firms. http://www.diva-portal.org/smash/ get/diva2:141248/FULLTEXT01.pdf Institute for Mergers, Acquisitions and Alliances. (2017), M&A Statistics: Number and Value and Largest M&A Transactions by Region. https://imaa-institute.org/mergersand-acquisitions-statistics/ KPMG. (2017), Doing Deals in Nigeria: Insights from Deal Makers. https://assets.kpmg. com/content/dam/kpmg/ng/pdf/dealadvisory/ng-doing-deals-in-nigeria.pdf Martynova, M. and L. Renneboog. (2008), A Century of Corporate Takeovers: What Have We Learned and Where Do We Stand? http://ssrn.com/abstract=820984 Merger Market. (2018), Deal Drivers Africa. www.mergermarket.com/info/mergermarketreleases-2017-full-year-global-ma-trend-report Miller, E.L. Jr and L.N. Segall. (2017), Mergers and Acquisitions: A Step-by-Step Legal and Practical Guide, 2nd edition. Hoboken, NJ: John Wiley & Sons Morgan, J.P. (2017), 2017 M&A Global Outlook: Finding Opportunities in a Dynamic Market Nigerian Breweries. (2018), Website Oladosu, R. and A. Alex-Adedipe. (2015), Nigerian Mergers and Acquisitions in 2014 and the Outlook for 2015. www.aluko-oyebode.com/resources/nigerian-mergers-andacquisitions-in-2014-and-the-outlook-for-2015/ Petit, B. and K.R. Ferris. (2013), Valuation for Mergers and Acquisitions, 2nd edition. Cranbury, NJ: Pearson Education, Inc Pomerleano, M. and W. Shaw. (2005), Corporate Restructuring: Lessons of Experience. Washington, DC: World Bank Richard, U.A. (2011), Merger and Acquisition as a Growth Strategy in Business Organization, PG/ MBA/10/54776 Project. Enugu: University of Nigeria Roberts, A., W. Wallace and P. Moles. (2016), Mergers and Acquisitions. Edinburgh Business School. https://www.ebsglobal.net/EBS/media/EBS/.../Mergers-Acquisitions-CourseTaster.pdf. Securities and Exchange Commission Nigeria. (2011), Check List: Processing Applications of Mergers, Acquisitions and Takeovers Statista. (2018), Trends in Global Mergers and Acquisitions. www.statista.com/ statistics/267369/volume-of-mergers-and-acquisitions-worldwide/ Umoren, A. and F. Olokoyo. (2007), Merger and Acquisition in Nigeria: Analysis of Performance and Post-Consolidation. Lagos Journal of Banking Finance & Economic, 1(1), July. www.researchgate.net/profile/Felicia_Olokoyo2/publication/264934647_MERGER_ AND_ACQUISITION_IN_NIGERIA_ANALYSIS_OF_PERFORMANCE_PREAND-POST_CONSOLIDATION/links/53f63e760cf22be01c413cfa/MERGERAND-ACQUISITION-IN-NIGERIA-ANALYSIS-OF-PERFORMANCE-PREAND-POST-CONSOLIDATION.pdf?origin=publication_detail

11 Infrastructure and project finance

Principles During the past three decades, project finance has been increasingly viewed as a vehicle for financing investments in high-risk and long-term capital-intensive infrastructure projects, not only in advanced economies but also in emerging and frontier economies. Project finance (PF) has been defined in different ways (Hoffman, 2008; Dentons, 2013; OECD, 2015). A useful functional definition is provided by the OECD (2015), which states that “project finance is the financing of long-term infrastructure, industrial, extractive, environmental and other projects based upon a limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project typically through a special purpose vehicle (SPV).” Project finance has several attributes (Gardner, 2010; Hoffman, 2008). First, project finance and limited recourse finance are often used interchangeably. Project lenders have only limited recourse to the project sponsors with the implication that the project’s risks must be evaluated separately from the risks of the sponsors promoting the project. Second, project financing aims at allocating project risks equitably among all parties and stakeholders involved in the project transaction. Third, the project borrower is a project company set up as an SPV that is financially and legally independent from the sponsors. Fourth, each party in the project transaction signs separate contracts with the SPV. Fifth, the SPV must generate sufficient cash flows needed to cover operating costs and principal and interest payments before dividends can be paid to project sponsors as residual funds. Sixth, sponsors provide project assets and internal cash flows as security collateral to creditors. Project finance differs from corporate finance, where there is the separation of investment decisions based on investment evaluation and then financing decision using internal cash flows from retained earnings and external equity or debt securities. Corporate finance focuses on funding a limited liability company with perpetual life. With project finance, each project is structured and funded separately from all others using the SPV. Project finance deals with the financing of a new separate entity with limited life.

192  Putting capital to work in frontier markets Parties in a project finance

Investment banks working with legal advisors help in defining the parties to project finance.The project finance structure defines the various parties in project financing depending on the type and scale of the project (Hoffman, 2008). The typical parties in project financing are sponsors and equity investors, lenders, off-takers, contractors and suppliers and operators. Other parties include financial advisors, technical advisors, legal advisors, regulatory agencies, bilateral and multilateral agencies and insurance providers. SPV: At the heart of project finance structuring is the project company, an SPV created purposely for a specific project.The creation of the project vehicle company is a crucial seminal step in all project financings. Investment banks and legal advisors work in tandem with the sponsors of the project to design and ensure perfection of the SPV that would be acceptable to all parties involved in the project. Project Sponsors: The project sponsors have the controlling stake in the equity of a project company. The controlling stake could be owned by a single project sponsor or by a group of multiple sponsors. There are four types of sponsors that are often involved in project finance transactions: (1) industrial sponsors who view project finance as being linked to their core business; (2) public sponsors such as government or other public bodies with the goal of promoting social welfare; (3) contract sponsors who develop, build and run the project and provide equity and/or subordinated debt to the SPV; and (4) purely financial sponsors that invest capital with the aim of gathering high returns (Pinto, 2017). Project finance is often highly leveraged with a high debt/equity ratio, which enables the sponsors to inject relatively lower initial equity, obtaining higher returns on the equity, tax deductibility of debt interest expense and diversifying revenue streams. The host government and procuring authority such as state-owned enterprises could be a minority shareholder in the company.The government would likely provide concessions rights and land, as well as credit support or partial guarantee to the project company. Host government participation in project finance would be driven by the desire to optimize fiscal operations due to budget constraint, to achieve both efficiency and effectiveness in the delivery of public services and to minimize performance risks associated with constructing and operating large-scale infrastructure projects. The contractors or the constructing and engineering firms undertake the technical and engineering design of the project and perform the construction, operation and maintenance of the project. Their main obligations are to the project company.They relate to the project company through engineering procurement and construction (EPC) and operations and maintenance contracts, respectively. The suppliers provide the inputs, such as raw materials and fuels in some projects, such as in the electricity, industrial, oil, gas and chemical industries. In other projects, equipment and other services are needed during the project

Infrastructure and project finance 193

construction and operating phases. These inputs or feedstock would be critical to the success of the project and the project finance arrangements. Lenders will be interested in the regular amount, quantity and cost-efficiency of the inputs and feedstocks supplied to the project. Purchasers or off-takers are the customers to the projects. Some projects supply outputs directly to the public. In other projects such as electric power, the project company may identify and seek in advance customers to purchase their outputs on a long-term basis. In electric power projects, the project company may supply to the national grid and would seek and secure a firm off-taker arrangement with the national electricity authority prior to the commencement of the project. Other third parties

In addition to the core project parties, there are typically a host of other advisors who provide due diligence on the sponsors and the project company for lenders and investors in project financing. These experts would include legal advisors, rating agencies, accountants, financial, risk and tax advisors as well as environmental experts. A single participant in a PF deal can take on a number of roles. For example, a contractor can be the sponsor, builder and operator at the same time. Besides the SPV, there are other means of structuring a project by the sponsors such as joint venture (JV), partnership and limited partnership. In a JV, several entities engage in a joint business activity or project. The contractual arrangement would indicate the proportion of each party’s share of equity, funds, costs and revenue stream from the project. The Nigerian National Petroleum Corporation uses a JV structure with leading international oil companies such as Shell and Exxon Mobil for exploration and development of oil fields. A partnership is similar to JV, but liability is unlimited other than for the limited partners in a limited partnership who provide project capital but not involve in project management. Investment banks as project finance advisors

Investment banks are involved in several stages of project finance. They provide advisory services to the government on the policy environment for project finance and PPPs. Investment banks may work with the sponsors in using a financial model to undertake a valuation of the project and sensitivity analysis, which forms part of the project appraisal report used in negotiations with lenders and investors. Investment banks are involved in the various components of project finance appraisal including due diligence, technical, market, environmental, economic analysis, and financial valuation. They work with legal experts on legal analysis, project finance risks mitigation and documentation.

194  Putting capital to work in frontier markets

Investment banks are usually involved in the structuring of the project finance structure including setting up SPVs; establishing financial requirements; identifying funding sources including debt and equity capital; originating, negotiating and arranging finance through syndicated loans and bonds; and working with the legal advisors on project documentation, risk assessment and management. Financiers as parties to project finance

The OECD (2015) provides a structured framework of infrastructure financing instruments and their advantages and disadvantages at different stages of the project life cycle. Infrastructure can be financed by the government, banks and using capital market channels involving different financial structures and instruments. The taxonomy serves to clarify the role of market-based financing for infrastructure across the spectrum of investors and instruments (Table 11.1). Table 11.1 Taxonomy of instruments and vehicles for infrastructure financing Modes

Infrastructure finance instruments

Asset Category Instrument Infrastructure project Corporate balance sheet/other entities Fixed Income

Bonds

Loans

Mixed

Hybrid

Equity

Listed

Unlisted

Source: OECD (2015).

Project Bonds Municipal, Subsovereign bonds Green Bonds, Sukuk Direct/ Co-Investment lending to Infrastructure project, Syndicated Project Loans

Corporate Bonds, Green Bonds

Market vehicles Capital pool Bond Indices, Bond Funds, ETFs

Subordinated Bonds

Direct/ Debt Funds (GPs) Co-Investment lending to infrastructure corporate Syndicated Loans, Loan Indices, Loan Securitized Loans Funds (ABS), CLOs Subordinated Surbodinated Bonds, Mezzanine Debt Loans/Bonds, Convertible Bonds, funds (GPs), Mezzanine Preferred Stock Hybrid Debt Finance Funds Listed Infrastructure YieldCos Listed Equity Funds, infrastructure & utilities stocks, Indices, Trusts, Closed-end Funds, ETFs REITs, IITs, MLPs Direct/ Direct/ Unlisted Co-Investment Co-Investment Infrastructure in infrastructure in infrastructure Funds project equity, corporate equity PPP

Infrastructure and project finance 195

According to the taxonomy, there are broad assets categories in the form of fixed income, hybrid and equity capital that can be used in project finance.The principal instruments for each of the asset categories are then listed. Bonds and loans are the key fixed income instruments. Equity can be in the form of listed and unlisted shares.The financing mode can be a hybrid or mixed combination of both fixed income and equity, such as mezzanine finance. These principal instruments can be further defined by the level of control in an investment, liquidity and the types of contractual claims on cash flows. Private investment for infrastructure projects can be through stand-alone infrastructure or balance sheet finance structures. From the perspective of an investor, the selected instruments will vary depending on the nature and availability of the asset classes, portfolio diversification objectives and regulatory and tax considerations. Banks as lenders in project finance

Globally, fixed income instruments in the form of bonds and bank loans account for more than two-thirds of project finance (OECD, 2015). Banks could provide direct loans to projects held on their balance sheets. Bank loans for project finance are usually syndicated.Traditionally, banks have been major sources of project funding either directly or through syndicated loans. Banks often act as a syndicate to provide syndicated loans to finance project large-scale domestic or international projects requiring a huge amount of funds. Big global investment and commercial banks provide project financing along with local commercial and investment banks. Lead Arranging Banks: The arranging bank usually performs a key role in project financing including due diligence, arranging participating banks, designing optimal loan structure/syndicate, and working with legal specialists to ensure proper legal documentation. They perform the due diligence on the project vehicle company, and the sponsors to ensure project viability and that all potential adverse information is revealed before loan syndication; designing an optimal loan structure and syndicate that will deter strategic defaults but allow for efficient negotiation in the event of liquidity defaults. They also spearhead monitoring of the borrower after the loan closes to discourage the sponsor from strategically defaulting, or expropriating project cash flows. The lead arrangers assist with capital raising by ensuring the participation of banks and other investors that are willing to provide funds to the project. The lead arrangers work with legal teams to ensure an optimal syndication of loans with limited chance for defaults. The lead arrangers also ensure monitoring of the project and loan performance following the closure of the capital raising exercise. In addition to the lead arranger role, investment banks often assist with arranging and issuance of bonds to finance a project. Multilateral development banks

The World Bank or its private-sector lending arm, the IFC; the AfDB; other regional banks; and, most recently, the Africa Finance Corporation (AFC)

196  Putting capital to work in frontier markets

co-finance projects, which enhances the bankability of projects in frontier economies. Their participation provides some level of comfort, not necessarily guarantee, to private-sector parties in project finance that international standards in credit lending, procurement process and construction would be considered in the various phases of the projects. MIGA, an affiliate of the World Bank, provides partial guarantees on political risks including the risk of expropriation. National export credit agencies encourage their national companies to participate in project financing in FMs through subsidized finance or buyer credits. The multilateral institutions especially the World Bank, the AfDB, and the AFC have been active supporters and financiers of infrastructure projects. Market-based financing

Bonds: Debt instruments may also be structured for resale and distribution in the markets through private placement debt or through registered corporate and government bonds. Infrastructure project finance can benefit from clientele effects in debt markets with debt instruments being tailored to fit the needs of institutional investors including pension funds and insurance companies. Third-party equity investors often commit equity investment to the project along with the sponsors with the sole aim of earning long-term returns from the project and, often, as a means of diversifying their investment portfolio into alternative investments. Their involvement in the financing of projects is therefore minimal as they do not participate in the construction or operating of the project but may require a seat on the board of the SPV, depending on their investment level. PE funds may fall into this category. Equity finance is risk capital provided to firms in return for an ownership interest. Insurers play a critical role in project financing by providing insurance coverage for a premium to large-scale projects, which are inherently risky.The sponsors, lenders and the project company would be interested to cover themselves from potential losses arising from some risks. Nigerian insurance law requires that a Nigerian insurance company provides insurance policy coverage for an insurable interest in Nigeria unless there is a lack of capacity to bear the risks within the Nigerian insurance industry. However, project finance in Nigeria often involves reinsurance with foreign insurance entities as local insurance companies do not have the capacity to cover entirely insurable risks associated with large-scale infrastructure projects. Project finance risks and contractual structuring

Project financing is also a risk management tool used to identify, assess, allocate and manage project risks. Projects face a variety of commercial risks. First, completion risks may arise when the project will not be constructed within the agreed timeline and agreed budget leading to risks of cost overrun. Second, inputs supply, in the form of project construction raw materials, is not readily

Infrastructure and project finance 197

available. Third, the market for the output of the project may not meet expectations. Fourth, licences and permits may not be obtained as originally envisaged. Fifth, there may be a declaration of force majeure, where unexpected events outside a party’s control prevent the performance of any or all their obligations. Force majeure has been used by major oil companies that operate in the Niger Delta due to security reasons beyond their control. Sixth, there may be environmental risks associated with the project (Mawutor, 2015). The contractual arrangements described here are used, amongst other purposes, to address and allocate risks involved in project finance. As shown in Figure 11.1, several contractual arrangements would govern the relationships among the various parties in project financing. The key agreements are briefly outlined. The shareholder agreement, akin to the articles of association, is the contractual agreement between the project sponsors relating to the formation of the SPV in a project finance transaction. The agreement will cover corporate governance requirements, ownership, control, and management and termination of the SPV; financial matters include equity contributions, funding, dividend distribution and share disposal and pre-emption rights. Concession deed is an agreement between the project company and the government or other public-sector entity (the procuring authority), which concedes to the project company the use of a government asset such as plots of land for a specified period. A concession deed would be found in most projects which involve government such as in infrastructure projects. In project financing relating to Lekki toll road, the Lagos State Government gave the project company a concession agreement giving it the right to collect tolls/fares from the public as well as some parcel of land to the project promoters (Box 10.2). The construction contract is usually in the form of an EPC contract, which governs the legal, technical and financial terms for the construction of the project. Its terms would include project description, design specifications, completion date, price and payment schedule, and performance guarantees and bonds. The operation and maintenance agreement (OMA) is the contractual agreement between the project company and the operator. It covers the delegation of the operation, maintenance and performance management of the project by the project company to a reputable professional operator.The OMA would include the scope of the services and responsibilities to be rendered by the operator, fees specifications, and conditions for termination. Off-take agreement between the project company and the off-taker that governs the price and volume mechanisms with the objective of providing stable and sufficient revenue streams for liquidating the debt, meet operational expenses and provide required returns to sponsors and equity investors. For example, a power purchase agreement by national electricity authority to buy electricity into the national grid is common in FMs. A supply agreement is between the supplier of raw materials or fuel feedstock and the project company. The supply of required input volume is tied to the output of the project. Supply agreements can be in the form of fixed or variable

Direct

Electricity

Agreement

Land Lease

Security Trustee

Fuel and tolling payment

Budgetary Allocation for payment to Project Co

Agreement

PPA Direct

Tolling Co.

Support

Credit

Government

Power Purchase Agreement (PPA)

O&M and EPC

Agreements

Contracts

Contractor

Security

( SPV)

Project Company

O&M and EPC

Agreement

Loan

Shareholders’ Agreement

Local Sponsor Co

Figure 11.1 Schematic structure of project finance

Lenders

Sponsor 1

Foreign Sponsor Co

Sponsor 1

Procuring Authority

Infrastructure and project finance 199

supply, output and reserve dedication to a specific project and lower-cost interruptible basis. A loan agreement is made between the project company (the borrowers) and the lenders. It governs the contractual relationship between the two parties. The agreement clauses would cover general conditions precedents, financial covenants, the duration of the loan, repayment clause, dividends restrictions, illegality clause, representations and warranties and the interest clause. Prior to the final loan agreement, a term sheet that outlines the key terms and conditions of lending would have been drawn up and used as the basis for further due diligence and negotiations. An inter-creditor agreement is between the project company and the main creditors, usually the first set of lenders. The inter-creditor agreement would contain clauses relating to the common terms, mode of financing of the project, order of drawdown, cash flow waterfall, limitations to the ability of creditors to vary their rights, creditors’ voting rights, notification of defaults and order of applying the proceeds of debt recovery. A tripartite deed is made when the financiers require a direct relationship between themselves and the various counterparties including the operators and the project sponsor. The deed defines the events that would trigger when the financiers can “step in” in order to remedy any arising defaults. It stipulates the confirmation of consents by the contractor or relevant party to the taking over of relevant project contracts by the financiers. The contractor’s obligation is to provide notice of defaults, step-in rights of the financiers, receivership rights to appoint a receiver by the financiers and rights to sell assets or transfer the entitlements of the borrowers under the relevant contract. Project finance documentation

Project financing requires extensive project documentation due to its complexity, risks and the number of parties typically involved. Legal advisors working with the investment bankers and other parties are usually required to prepare several project documents in five key areas: shareholder/sponsor documents, project documents, finance documents, security documents and other project documents. As earlier observed, the shareholder agreement documentation will cover corporate governance requirements, ownership, control, management and termination of the SPV; financial matters including equity contributions, funding, dividend distribution, and share disposal and pre-emption rights. Project finance documents are quite comprehensive covering the concession deed, the construction contract, the OMA, the off-take agreement and the supply agreement. For an upstream energy-sector project financing, the main project documents are usually the oil production licence/mining lease, participation agreement, joint operating agreement (JOA), crude handling agreements (if applicable), crude oil sale and purchase agreements, facility agreement (this is the main loan agreement) and Transfer certificate. The security documents typically used in an upstream project finance include the composite security

200  Putting capital to work in frontier markets

debenture, share charge, bank account charge, hedging agreement, assignment agreement and other agreements (Chibueze, 2017).

Practice Global project finance market

The history of project finance dates back to the Greek and Roman Empires when risk-averse merchants desired to share the risks inherent in merchant trading with local lenders and obtained sea loan on the agreement that such loan repayment is contingent on the sale of cargo brought back by the voyage (Gardner, 2010). This can be described as limited recourse lending as financing would be repaid by the cash flows from the sales of the goods from the cargo. Project finance in modern times can be traced to the financing of railways projects in the Americas and India in the 19th century. In the 1930s, project finance was used for oil exploration and oil drilling in Texas (Gatti, 2008). The enactment of the Public Utility Regulatory Policy Act (PURPA) in 1978 by the US Congress further encouraged project finance in the energy sector. In order to boost alternative energy sources, the PURPA required electricity utilities to purchase electric output from independent power producers, who often use project finance to finance their energy projects (Gatti, 2008). Project finance spread to the petroleum sector in Europe in the 1970s and became popular in extracting North Sea oil in the United Kingdom. By the early 1980s, project financing in the oil and gas fields became popular in financing projects in the UK continental shelf and spread to the Danish and Norwegian continental shelves (Denton, 2013). In the industrial country, project finance became a technique for off-balance-sheet financing for toll roads, leisure facilities and city parking lots. By the 1980s and 1990s, project finance gained ground in developing countries as a means of financing capital-intensive projects in the infrastructure sector and was supported by multinational companies, export credit agencies and multilateral development banks. As a result of budget constraints and huge infrastructure and development challenges, PPP has been advocated and promoted in developing countries by institutions, including multilateral development banks such as the World Bank. PPP is a specific form of project finance requiring a partnership between government and the private sector in funding and operating public infrastructure services under a long-term concession arrangement (World Bank, 2009; Asian Development Bank, 2005). PPP transactions enable governments in FMs to obtain private sector financing while shifting construction and operating risks to the private sector sponsors, which are more efficient in managing the assets (UNESCAP, 2011). Furthermore, project financing involving DFIs, such as the AfDB and the World Bank, often require extensive documentation, environmental assessment and financial, fiduciary and auditing requirements.

Infrastructure and project finance 201

Project finance grew very rapidly in the 2000s. A recent study of project finance deals by Pinto (2017) examined a sample representing about 90 percent of the total $48 billion in global project finance syndicated lending between 2000 and 2014 in the Thomson Reuters Database. Pinto (2017) showed that project finance lending was concentrated in five key industries – utilities, construction, manufacturing, mining and transportation – accounting for 77.3 percent of all lending value and 71 percent of all deals. The EMEA region spurred on by project finance initiatives in the United Kingdom and PPP in other regions, including North America, have traditionally been the focus of the global project financing market. However, since the global financial crisis of 2007 and 2008, transaction volumes in the Asia-Pacific reached nearly half of the total global project finance market, representing a significant shift in the balance of trade flows in the infrastructure market. In aggregate, more than half of project finance lending went to non-OECD countries, where project risks are often higher. Project Finance International (2018) shows that the global project loans market was in 2017 was US$230 billion compared to $236 billion in 2016, and $227 billion in 2015.The US took 18.5 percent of the total value of loans with 131 deals estimated at $42.5 billion in 2017. Australia and the United Kingdom took the second and third positions with 10.7 percent and 9.2 percent, respectively. India and Indonesia came in fourth and fifth with 7.8 and 6 percent, respectively. Mozambique, with $7.6 billion worth of deals, was ranked seventh. Table 11.2 Global project finance deals and loans by country Nation

US$(M)

%

No of deals

United States of America Australia United Kingdom India Indonesia Japan Mozambique Canada Spain France Mexico Germany Italy Philippines Turkey Pakistan South Korea Nigeria Netherlands Israel

42,505.70 24,568.00 21,159.00 17,932.80 13,813.60 8,538.00 7,664.50 7,466.40 5,383.60 5,293.50 4,986.10 4,517.60 3,931.30 3,775.90 3,640.30 2,947.20 2,783.00 2,774.20 2,730.70 2,625.00

18.5 10.7 9.2 7.8 6 3.7 3.3 3.3 2.3 2.3 2.2 2 1.7 1.6 1.6 1.3 1.2 1.2 1.2 1.1

131 66 58 96 12 50 3 28 37 42 15 26 32 6 10 3 11 3 10 3

Source: PFI (2018).

202  Putting capital to work in frontier markets

Nigeria, which attracted $2.7 billion with 10 deals, came in 18th position. Volumes in Africa rose in 2017 to US$11.5 billion, mainly on the back of the Mozambique Coral LNG deals. The key banking players in the project finance field include MUFG, India’s SBI Capital, SMBC, BNP Paribas, China Development Bank, ICBC, Credit Agricole and Mizuho. In addition to loans, project bond and institutional investor activity rose 46 percent to US$63.7 billion from US$43.6 billion in 2016 and US$35.3 billion in 2015. Citibank and J.P. Morgan are key players in the global project finance bond markets (Project Finance International, 2018). Loans from multilateral banks to developing countries was up a third to US$26 billion dominated by the European Investment Bank (EIB), European Bank for Reconstruction and Development (EBRD) and the World Bank with mega-project financing deals in Mozambique, Indonesia, Bangladesh, Pakistan, Turkey and Jordan. On the bilateral side, JICA, JBIC, Sinosure and the Export– Import Bank of Korea dominated the league table. On the advisory side, the big three French banks – BNP Paribas, Credit Agricole and Societe Generale, as well as the global accounting firms, KPMG, Ernest & Young (E&Y) and PricewaterhouseCoopers (PwC) dominate. Macquarie has also been an active participant in infrastructure project finance advisory.

Table 11.3 Global initial mandated lead arrangers

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Mandated arrangers

US$ (millions)

%

No. of deals

Mitsubishi UFJ State Bank of India SMBC BNP Paribas China Development Bank Credit Agricole ICBC Mizuho Financial ING Societe Generale Santander Morgan Stanley Natixis Bank of China RBC Capital Markets Barclays CIBC Korea Development Bank HSBC Bank of the Philippine Islands

12,180.60 10,388.10 9,106.10 6,687.00 6,590.20 6,164.90 6,115.50 5,733.70 5,695.10 5,607.60 5,210.10 4,657.50 4,557.90 3,842.80 3,574.10 3,283.60 3,191.80 2,865.80 2,813.70 2,807.60

5.3 4.5 4 2.9 2.9 2.7 2.7 2.5 2.5 2.4 2.3 2 2 1.7 1.6 1.4 1.4 1.3 1.2 1.2

130 22 107 71 3 71 35 48 78 71 75 15 53 19 26 23 24 24 24 6

Source: PFI (2018).

Infrastructure and project finance 203 Africa’s infrastructure

The Global Infrastructure Outlook (2016) indicates that infrastructure investment levels in Africa cover only about 57 percent of requirements in the region, lower than the global average of 81 percent.The outlook estimates that between $4.3 trillion to $6 trillion is required for infrastructure investment in Africa to 2040. As at 2016, the total commitments to infrastructure investment was $63 billion, with $26.3 billion coming from infrastructure allocations in national budgets in 46 African countries and the remaining amount of $36.3 billion from external finance. Private capital was recorded at $2.6 billion in 2016, which was half the amount recorded in 2014 and less than one-third of the average of $8.8 billion in 2013 and 2012. China, India and South Korea have merged among the key emerging markets, making significant investments in infrastructure in Africa. China is reported to have committed an annual average of $12 billion for the 2011–2016 period. India committed $1.2 billion to African infrastructure in 2016, more than double its 2015 funding ($524 million), while South Korea committed $432 million to four projects in 2016, compared with a single commitment of $81 million in 2015 (Africa Infrastructure Consortium, 2017). Nigeria’s infrastructure status

The National Integrated Infrastructure Master Plan (NIIMP, 2012) takes stock of the status of infrastructure development in Nigeria. It provides the road map for building a world-class infrastructure that will guarantee sustainable economic growth and development. 100 87

90 80

70

70 58

60 47

50 40 30

76

80

30

20 10 0

Nigeria

Brazil

India

Indonesia

Figure 11.2 Infrastructure stock as a share of GDP (%) Source: NIIMP (2012).

China

Finland

South Africa

204  Putting capital to work in frontier markets

Nigeria’s “core infrastructure” stock is estimated to be about 20 to 25 percent of GDP, the equivalent of less than US$100 billion in 2012, compared to international benchmarks of 70 percent according to the NIIMP (NIIMP, 2012). The effect of weak infrastructure is most striking in the energy sector. Per capita power consumption of 136 kWh per annum is less than 3 percent of 4,803 kWh in South Africa (NIIMP, 2012). Road density in Nigeria is only about a fifth of that in India. The Nigerian population’s access to sanitation is about 40 percent of those in Brazil and South Africa. Poor infrastructure status has been historically driven by low public and private spending on infrastructure. According to NIIMP (2012), Nigeria spends $10 billion1 per annum on infrastructure, of which about half is funded by the private sector. The bulk of the spending is concentrated in ICT (28 percent), transport (23 percent), and energy (19 percent). To close its core infrastructure gap, Nigeria would need to spend about $3.0 trillion over the next 30 years. The largest infrastructure investment needs are in energy and transport, which represent more than 50 percent of the required infrastructure investments over the 30-year period. The NIIMP proposed four financing options in the forms of debt, the Sovereign Wealth Fund, public pension funds and PPPs that could potentially generate up to US$145 billion. These financing decisions will need to be made on a project-by-project basis to ensure optimal risk allocation. The government should follow a carefully structured process when considering whether to finance through current accounts, debts, other sources, or PPPs. The NIIMP promotes private-sector participation in infrastructure development and the strengthening of the policy, legal and institutional frameworks for effective infrastructure development, financing, delivery and management of its infrastructure assets. Infrastructure and project financing in Nigeria

In spite of huge infrastructure gaps, project finance is still in its infancy in Nigeria due to limited maturity tenor of loans from local banks and narrow base of investors in infrastructure projects. There are however notable infrastructure projects in the telecom, power and road sectors that have used project financing mechanisms in Nigeria. Nigerian local investment banks have not been very active in large-scale infrastructure project financing space compared to their global counterparts. However, ARM has been a pioneer in the project financing space in Nigeria in recent years with its landmark involvement as a sponsor of Lekki Concession Company Ltd (LCC), the concessionaire responsible for Nigeria’s first PPP Toll Road Concession. The Lekki-Epe Toll Road, initially constructed in 1987, was expanded into a six-lane roadway using project financing under a PPP framework involving Lagos State Government, ARM and LCC. A 30-year concession right was

Infrastructure and project finance 205

granted to the project company to rehabilitate and expand the road, which commenced in 2007. The road was tolled with tolling fees used to finance the operations and maintenance of the road. Lagos State Government bought out the private investors in 2015. An early example of project funding provided by a consortium of international and local banks is the Nigeria LNG Limited (NLNG; 2017), which was incorporated as a limited liability company in 1989 to produce liquified natural gas (LNG) for exports. NLNG (NLNG, 2017) is jointly owned by the Nigerian National Petroleum Corporation (NNPC; 49%), Shell Gas B.V. (5.6%), Total LNG Nigeria Ltd (15%) and Eni International (10.4%). The plant was built by TSKJ consortium and led by former Halliburton’s subsidiary KBR. The first train came into operation in 1999 and the Nigeria LNG now has 6 trains, which cost US$9.4 billion to build and produces about 10 percent of the world’s LNG consumption. LNG exports have reached more than $85 billion over 15 years, and the company paid about $30 billion to shareholders as of 2015 (NLNG, 2017). The privatization of the Nigerian Telecommunications Ltd (NITEL) in 2005 provided the impetus for project financing in Nigeria as leading private sector telecommunication companies – MTN, Glo and Etisalat used project finance via syndicated loans to expand their networks across the country. The power sector privatization in 2011 also witnessed the use of project financing for the acquisition of power generating and distributing assets by private-sector bidders/investors. In 2014, the ₦220 billion power sector intervention fund by the CBN settled all outstanding debts in the power sector to enable private sector power generating and distributing companies to honour their financial obligations in meeting loan obligations and repayments. A recent notable power project financing is the 450-MW open-cycle gas turbine, the Azura Independent Power Plant in Nigeria (Box 11.1).

Connecting principles to practice Box 11.1  The Azura-Edo Independent Power Plant Nigeria has long suffered from a shortage of electricity, with demand for energy is estimated to be at least 6,000 MW, while dependable available capacity stood at around 3,500 MW. To address this energy challenge, the federal government of Nigeria (FGN) embarked on a comprehensive power sector reform in 2010. The Azura IPP project included the construction, operation and maintenance of a 459-MW gas-fired open-cycle power plant near Benin City, Edo State, Nigeria. The Azura IPP is expected to provide electricity to 14 million residential consumers. It is regarded as a groundbreaking

206  Putting capital to work in frontier markets

project set to pave the way and set important benchmarks for future private sector–driven, project-financed IPPs in Nigeria. Azura Power West Africa Ltd. (the project company) includes as project sponsors a consortium of private investors (97.5 percent) and the government of Edo State (2.5 percent).The consortium is composed of a joint venture between Amaya Capital Ltd. and Actis GP LLP (51 percent), AIIF2 Power Holding Ltd. (29 percent), Aldwych Azura Ltd. (14 percent) and ARM–Harith Infrastructure (6 percent). The plant will have a sole off-taker, the state-owned Nigeria Bulk Electricity Trader (NBET) under a 20-year power purchase agreement (PPA) backstopped by a putcall-option agreement (PCOA) with the FGN. Seplat Petroleum Development Company, a Nigerian upstream production and development company, will supply gas to fuel the plant under a 15-year contract. The sponsors raised a total of $868 million through equity contributions from equity investors and debt financing from commercial banks and development finance institutions. Rand Merchant Bank, Standard Chartered Bank, Siemens Bank, Standard Bank and KfW IPEX Bank provided $230.6 million in commercial bank financing.The International Finance Company (IFC), FMO, Deutsch Investitions- und Entwicklungsgesellscaft, Proparco, Swedfund International, Overseas Private Investment Corporation (OPIC), Emerging Africa Infrastructure Fund, the UK government’s development finance institution (CDC Group) and the ICF Debt Pool provided $262.5 million in development financing alongside a $120 million development facility provided by Nigeria’s Bank of Industry. Finally, the IFC, OPIC, Emerging Africa Infrastructure Fund, and Proparco provided $65m in subordinated debt. The World Bank Group’s Multilateral Investment Guarantee Agency (MIGA) provided $492 million in guarantees, while the World Bank Group’s International Bank for Reconstruction and Development (IBRD) provided guarantee coverage of at least $325 million covering commercial lending instruments. The Azura IPP demonstrates how project finance can be arranged in the form of public-sector loans, private-sector finance, syndicated loans, sector and transaction advice and guarantees. The Azura project is a collaborative approach to project finance involving government, the multilateral development banks, bilateral agencies and private-sector institutions. The project also illustrates the important components of project finance, which include high levels of government support, a dedicated lead sponsor, strong technical and engineering support, and being situated both near the country’s main gas trunk line and the national transmission grid. Source: World Bank Group (2017).

Infrastructure and project finance 207

Since 1958, the World Bank Group has supported Nigeria with International Bank for Reconstruction and Development (IBRD) loans and International Development Association (IDA) credits worth about US$14.2 billion (World Bank, 2018). In 2018, the World Bank approved US$485 million for Nigeria’s electricity transmission project.The development objective of the Electricity Transmission Project for Nigeria is to increase the transfer capacity as well as the stability of the transmission network in Nigeria. There are two project components. The first component is transmission network strengthening and improvement. US$408 million equivalent, of which the FGN provided US$4 million and IDA scale-up facility (SUF) provided US$404 million equivalent, excluding contingency. A second component of the project, worth $32 million, is earmarked for capacity building and technical assistance, including consulting services (transaction advisory to support the preparation of transaction documents and procurement of a sponsor, i.e. private developer) for a pilot PPP for the transmission infrastructure and forms part of network expansion phase, and consulting support. The AfDB approved in 2017 a $100 million financing package for the rehabilitation of hydroelectric power plants in Kainji and Jebba in Nigeria. The facility comprises of a loan of $80 million and $20 million in equity investment. The project is expected to increase the electricity capacity by a third, from the current 917 MW to 1,338.4 MW. The AFC has used hybrid investment instruments in several of its project financing. The AFC, based in Lagos, Nigeria, is a multilateral development finance and investment institution specializing in infrastructure development, financing and delivery on mostly project finance basis across Africa. The AFC was established in 2007 as a PPP with an investment banking and infrastructure finance focus. AFC invests in high-quality infrastructure assets that provide essential services in the core infrastructure sectors of power, natural resources (oil/gas and mining), heavy industry, transport and telecommunications (Box 11.2).

Connecting principles to practice Box 11.2  AFC: Africa’s leading multilateral infrastructure finance institution AFC, a multilateral finance institution established in 2007, has a current balance sheet of US$4.2 billion. The AFC is the second-highest investment grade–rated multilateral financial institution in Africa and has put in place a corporate governance framework based on international

208  Putting capital to work in frontier markets

standards. AFC Equity Investments Limited (AFC Equity), a wholly owned subsidiary of AFC, was incorporated in Mauritius in 2013. AFC successfully raised US$750 million in 2015 and US$500 million in 2017. Both Eurobond issues were oversubscribed and attracted investors from Asia, Europe and the United States. AFC has a broad Pan-African footprint. To date, the AFC has invested approximately US$4 billion in projects in 28 African countries across East (17 percent), West (15 percent) and Southern Africa (5 percent) and (10 percent) in others. About one-third of the AFC’s investment portfolio is in Nigeria. These are some highlights of the AFC’s portfolio. Power: The AFC has investments worth $500 million in power projects and with a combined installed capacity of more than 3,000 MW.The AFC was the lead investor in the US$90 million, 26-MW wind power project Cabeolica wind farm in Cape Verde. The launch of Anergi Holdings Limited, a US$3.3 billion power joint venture with Harith General Partners, brings electricity to 30 million people across 5 countries in Africa. It was lead arranger for the US$425 million senior Mezzanine for New Age Africa Global Energy Facility. Natural Resources: The AFC’s investment in natural resources assets was more than US$500 million in 2017. These financings include joint facility coordinator and mandated lead arranger of a US$1.4 billion debt facility for Aiteo Eastern E&P, technical and modelling bank and mandated lead arranger of a US$470 million credit facility for Eroton E&P and mandated lead arranger for a US$720 million facility for Neconde Energy Limited. In 2017, the AFC, as part of a consortium with Orion Mine Finance and Resource Capital Fund, invested US$205 million to develop Alufer Mining’s Guinea-Conakry’s high-grade bauxite reserves. Transport and Logistics: AFC’s transport and logistics infrastructure investment portfolio include Ghana Airport Company Limited, Gabon Special Economic Zone, the Henri Konan Bedie Bridge in Cote d’Ivoire, Conex Tank Farm in Liberia and Ethiopian Airlines. Telecommunications: AFC has supported several companies in the telecom sector, including investment in Main One, which provides undersea cables in Africa as well as the development of terrestrial fibre, data centres and value-added services leveraging on the Main One platform. The AFC has also financed I.H.S Towers, Africa’s leading tower company in Africa and MTN Nigeria network upgrade. Source: Africa Finance Corporation (2017).

Market-based financing in Nigeria

While bank loans and government funding have traditionally been the major sources of funding projects, the liquidity maturity mismatch of local banks

Infrastructure and project finance 209

has constrained their ability to provide long-term funding for project finance in Nigeria. Pressure on government fiscal budgetary resources has led to the search for alternative sources of infrastructure project financing. Market-based financing and private-sector financiers as parties to project finance are now being explored and tapped into. In recent years, sukuk bonds, green bonds and project bonds have been issued to finance infrastructure projects. As discussed in Chapter 7, sukuk bonds are a class of securities that are structured in accordance with Sharia law that prohibit interest payment on debt but grant shares to investors in an asset with the assumption of profit and risk sharing. Nigeria’s first FGN sukuk of ₦100 billion was issued in 2017. According to the DMO, the proceeds from the sukuk issuance will be used to construct and rehabilitate 25 roads in Nigeria’s six geopolitical zones. Green bonds are environmentally compliant corporate, project and subsovereign bonds that finance green infrastructure assets. In Nigeria, the first ₦10.69 billion green bond issuance of the FGN was done in 2017 with the support of the World Bank. The issuance of green bonds by the FGN is expected to provide funds for financing the implementation of environment-friendly projects. Sovereign wealth fund

The Nigerian Sovereign Wealth Fund established The Nigeria Infrastructure Fund (NIF) in 2016. It focuses entirely on domestic investments in selected infrastructure sectors. The Nigeria Sovereign Investment Authority (NSIA) allocates $600 billion of its assets to the Nigeria Infrastructure Fund (NIF). Infrastructure fund

DENHAM promoted the first listed infrastructure debt fund, the Nigeria Infrastructure Debt Fund (NIDF), as a close-ended fund, domiciled in Nigeria and denominated in naira. The NIDF enables investors to access infrastructure asset class primarily in transport, power, energy, utilities, logistics as well as publicprivate-partnership type investments. The NIDF also provides the benefits of predictable risk-adjusted returns from a debt instrument. In October 2018, the AfDB approved an investment of the naira equivalent of US$10 million in the NIDF. Incorporated in 2013, the ARM Infrastructure Fund achieved its first close in January 2015, with total commitments of around US$91 million. The fund has raised commitments from multilateral development bank, commercial investors, High Net Worth Individuals (HNWIs) and the fund management team. ARM, the main investor in ARM–Harith Infrastructure Fund (ARMHIF), committed US$25 million to the fund. Harith, the co-sponsor, together with investors from its pool, committed a matching US$25 million (ARM, 2014). Harith is the fund manager of the South African–based US$630 million Pan-African Infrastructure Development Fund (PAIDF).The AfDB committed

210  Putting capital to work in frontier markets Table 11.4 Infrastructure funds in Nigeria Fund managers

Infrastructure fund (IIF)

Equity/debt Fund type Fund size

ARM–Harith

ARM–Harith Equity Infrastructure Equity Fund Chapel-Hill Nigeria Debt Denham Infrastructure Management Debt Fund Limited (NIDF) Equity African African Infrastructure Infrastructure Investment Investment Managers Fund 2 (AIIM (AIIM) have five other infrastructure funds with a Southern African focus)

Listed vs Investment unlisted jurisdiction

Closed- $250 million Unlisted West Africa end Closed- N/A end

Listed

West Africa

Closed- $1.9 Billion Unlisted African Continent end

$20 million and is playing a key role as a catalyst for investment by the limited partners in the fund. Nigerian pension funds have also made commitments to the fund and regarded it as the first infrastructure investments made by Nigerian pension funds via the PE route. Regulations

Nigeria does not have specific government agencies that focus on regulating project finance transactions.There are, however, agencies of government at both the federal and state levels that monitor infrastructure projects more broadly. For example, the Infrastructure Concession Regulatory Commission (ICRC; 2016) has been tasked with PPP-related projects. All lands are vested in state government, which must grant rights of occupancy to land users. The CAC charges registration fees on security documents. Stamp duties are paid on documents to the Commissioner for Stamp Duties. Nigeria’s Environmental Impact Assessment Act (EIA Act) is the legislation that governs environmental issues and requires environmental impact assessment must be conducted before embarking on projects in Nigeria. The National Environmental Protection Agency enforces the act. The CBN also promotes sustainability practices in banking based on the Equator Principles. There are cross-border risks associated with currency devaluation and convertibility and FX controls, political risks, change of government and laws, expropriation, collateral risks, and bribery and corruption. Nigeria features frequently in the higher ranking on corruption in the Transparency International rankings. The Nigerian Investment Promotion Commission (NIPC) works

Infrastructure and project finance 211

to encourage foreign investment into Nigeria and provides guarantees against expropriation or nationalization of enterprises in Nigeria. In May 2014, the SEC issued rules on an infrastructure fund, defines as a specialized fund or scheme that invests primarily, a minimum 90 percent of its net assets in infrastructure assets. The instruments may be securities or securitized debt instruments of infrastructure companies, infrastructure capital companies, infrastructure projects, SPVs, which are created for the purpose of facilitating or promoting investment in infrastructure, and other permissible assets including revenue-generating projects of infrastructure companies or projects or SPVs. SEC-registered infrastructure funds are required to invest at least 80 percent of their net assets in Nigeria. Infrastructure funds registered by the SEC may be open or closed-ended. It can be structured to mature after 7 years or as an interval scheme with a lockin period of 5 years and an interval period not longer than 1 month as may be specified in the scheme information document. The units of a fully-paid-for infrastructure fund that is registered by the SEC may be listed on a recognized stock exchange. PE infrastructure funds need not be listed. Several laws and legal instruments are applicable to project finance transactions in Nigeria (Chinbueze, 2017). Among these legal instruments are, first, the Secured Transactions in Movable Assets Act 2017, a consolidated legislation providing for secured transactions and registration and regulation of security interests in movable assets and related; second, the Infrastructure Concession Regulatory Commission (establishment) Act 2005, dealing with private-sector participation in federal infrastructure; and, third, the Foreign Exchange (Monitoring and Miscellaneous Provisions) Act, Cap F34, LFN 2004, which applies to international project finance transactions or transactions denominated in foreign currency.

Conclusion FMs need to invest in economic and social infrastructure projects to accelerate the pace of economic growth and development. Project financing is now commonly used for projects in oil and gas, power, transportation, telecommunication and other infrastructure sectors not only in advanced economies in the United Kingdom, Europe, Japan and the United States but also in emerging and frontier economies in Africa, Asia and South America. Project finance arrangement has several parties to it including the SPV, sponsors, host government, lenders, arrangers, contractors, suppliers, customers, advisors, insurers, performance bond issuers and third-party equity investors. Several long-term contracts are used to align long-term incentives among the parties in project finance. Such contracts will include construction, supply, off-take and concession agreements, along with a variety of joint-ownership structures. Private-sector sponsors and governments, in particular, use project finance in infrastructure projects for several reasons. As noted earlier, private-sector project sponsors would like to be insulated from project debt being consolidated in

212  Putting capital to work in frontier markets

their balance sheets. However, with recent International Financial Reporting Standards (IFRS 5) placing emphasis on substance over form, this is now less of a compelling reason for using project finance. Sponsors prefer to share project risks with other parties, including creditors. Sponsors are often constrained in borrowing huge funds for large-scale projects as a result of financial covenants or other restrictions. In JVs, using an SPV to borrow on a limited recourse basis tends to be very attractive, and can have significant attractions in a JV. Tax holidays and concessions for project development offer sponsors advantages for using project finance. Host governments in FMs may use project finance to reduce public sector borrowing requirements, attract foreign investment, and acquire technical skills and know-how. The returns to the private investors from the PPP are obtained from a defined stream of profits over the life cycle of the concession. In spite of its attractiveness, project finance has its own drawback as it is more expensive than raising corporate funding, takes a long time to structure and raise funding and requires specialized skills and expertise to consummate and implement successfully. It is very complex to design the transactions and the documentation required can be very extensive as financing negotiations and operating agreements can be very detailed.

Note 1 With the devaluation of 2016, this should amount to $5 billion.

Bibliography AFC. (2017), Developing to Improve African Economies; An Introduction to AFC, Corporate Brochure AFC. (2018), Africa Finance Corporation, 2017 Annual Report and Financial Statements ARM. (2014), ARM 2013 Annual Report Asian Development Bank. (2005), Public – Private Partnerships Handbook Chibueze, J. (2017), Project Finance in Nigeria: Overview, Adepetun Caxton Martins Agbor & Segun. https://uk.practicallaw.thomsonreuters.com/2-635-7375?transitionTyp e=Default&contextData=(sc.Default)&firstPage=true&bhcp=1 Clive, R. and G. Dunnett. (2015), Sources of Funding in International Project Finance: Law and Practice, ed. By John Dewar. Oxford: Oxford University Press Dentons. (2013), A Guide to Project Finance 2013. www.dentons.com/en/insights/ guides-reports-and-whitepapers/2013/april/1/a-guide-to-project-finance Ekwere, N. (2009), Key Legal Issues in Project Finance in Nigeria Gardner, D. and J. Wright. (2010), Project Finance. www.hsbcnet.com/gbm/attachments/ products-services/financing/project-finance.pdf Gatti, S. (2008), Project Finance in Theory and Practice: Designing, Structuring, and Financing Private and Public Projects. Burlington, MA: Elsevier Hoffman, S. (2008), The Law & Business of International Project Finance, 3rd edition, Cambridge: Cambridge University Press ICRC. (2016), 2016/2017 Public Private Partnerships Projects Opportunities. www.icrc. gov.ng/projects/ppp-projects-pipeline/

Infrastructure and project finance 213 Infrastructure Consortium for Africa (ICA). (2017), Infrastructure Financing Trends in Africa – 2016 Mawutor, J.K. (2015), Contractual Framework of Project Finance. Australian Journal of Commerce Study. SSRN, https://ssrn.com/abstract=2573305 [Accessed 3 February 2017 at 21:07] NIIMP. (2012), National Integrated Infrastructure Master Plan. NLNG. (2017), 2017 Facts and Figures. www.nlng.com/Media-Center/Publications/ 2017%20Facts%20and%20Figures.pdf NSIA. (2018), Nigeria Infrastructure Fund. http://nsia.com.ng/investments/nigeria-infra structure-fund OECD. (2015), Mapping of Instruments and Incentives for Infrastructure Financing: A Taxonomy. www.oecd.org/finance/private-pensions/Mapping-Instruments-Incentives-Infra structure-Financing-Taxonomy.pdf PFI. (2017), 2017 League Tables PFI. (2018), PFI Yearbook 2018, Project Finance International. www.pfie.com/2018-pfiyearbook/21321566.article Pinto, J.M. (2017),What Is Project Finance? Investment Management and Financial Innovations, 14(1) Oyeledun, A. and N. Hayatuddini. (2018), Nigeria Project Finance Report. Detail Solicitors. www.iflr.com/Article/3783399/2018-Project-Finance-Report-Nigeria.html Oyeyemi, O. and M. Olugunwa. (2017), Project Finance 2017: Nigeria, ICLG Project Finance 2017. www.templars-law.com/wp-content/uploads/2017/04/PF17_Chapter-18_ Nigeria.pdf Sinha, S. (2015), Project Finance. https://ppiaf.org/sites/ppiaf.org/files/documents/toolkits/ Cross-Border-Infrastructure-Toolkit/Cross-Border%20Compilation%20ver%2029%20 Jan%2007/Session%202%20-%20Finance/Finance_01%20Project%20Finance%20%2029%20Jan%2007.pdf UNESCAP. (2011), A Guidebook on Public-Private Partnerships in Infrastructure World Bank. (2009), Attracting Investors to African Public-Private Partnerships: A Project Preparation Guide World Bank Group. (2017), Nigeria: Azura Independent Power Project. Multilateral Development Banks’s Collaboration: Infrastructure Investment Project Briefs World Bank. (2018), Nigeria’s Country Profile, World Bank website.

12 Real estate finance

Principles The real estate sector plays crucial roles in most economies. Real estate serves as asset diversification tools to investors and complements other assets classes such as bond and equities, and it is less volatile than the stock markets. Real estate contributes significantly to the wealth of individuals and institutions across the world. It is reported that half of global wealth is in real estate, with other half divided among equities, bonds and other assets.World wealth is estimated at $44 trillion of which 50 percent are in real estate, including residential, agriculture, commercial properties; 27 percent in bonds; 19 percent in equities; and 3 percent in cash (Knight, 2018). Real estate serves not only as an alternate asset class but is associated with the development of basic infrastructure, such as roads, water and electricity. The real estate sector is a leading indicator of economic performance as the sector generates multiplier effects on other sectors. The development of basic infrastructure opens up underdeveloped areas as residential construction tends to spring up in such locations. Real estate construction in FMs tends to be labour-intensive and stimulates the local economy and employment creation. The real estate construction industry especially at low-end is less importintensive and therefore puts less pressure on the balance of payments and exchange rates. The sourcing of local inputs for construction provides the impetus for domestic manufacturing of building materials, broadens the tax base, and boost household consumption. Investment banks are engaging in key areas of the real estate sector by providing advisory, valuation, structuring and financing solutions. These engagements cover developers in the commercial, industrial and retail sectors, single asset and portfolio lending transactions, REITs, residential development and term funding for rental stock (including affordable housing), owner-occupied properties and portfolios and, most recently, secondary market sale or acquisitions of mortgages. Economic valuation of real estate

The valuation of real estate property is primarily determined using three appraisal methods: the replacement-cost method, the sales comparison method

Real estate finance 215

and the income capitalization method. In most cases, the valuers would try to compare and reconcile the values of the appraised property obtained from the three different methods. Each of these valuation methods has its advantages and disadvantages. The valuation of commercial real estate tends to rely more on the income capitalization method, while the sales comparison method is used in appraising single-family houses. The actual cost of replacing a house or building is estimated using the replacement-cost method. It is derived as the sum of the actual value of the land and the current cost of constructing a new building less depreciation, which includes deterioration, functional and external obsolescence. This method is also useful for insuring a property. The sales comparison method is useful for price discovery in the marketplace as it is based on the comparison of most current sales prices of similar properties within a defined neighbourhood. The valuers would look at three to four properties and undertake a valuation adjustment for observed differences. The sales method depends crucially on data on recent sales of properties similar in location, size and other physical attributes to the appraised property (Berges, 2004). The assumption is that buyers in an arm’s-length transaction would not pay more for a property than the cost of buying a substitute property within the same market. The prices that buyers are willing to pay will depend on factors such as real estate market and economic conditions, interest rates, income levels and unemployment rates. The income capitalization method is similar to DCF method in economic and financial analysis used in the valuation of bonds and equity. In this context, real estate is viewed as a capital good, which generates income over a long time. The value of the capital good is based on the present worth of the expected future income derived from the capital good over a specified period. The value of the real property is therefore derived by capitalizing net income either by direct capitalization or a DCF analysis (Berges, 2004). The income capitalization method requires an estimate of a reasonable net operating income, taking into consideration projected potential gross rental income, occupancy and vacancy rates and operating expenses. As noted in DLA Piper and CBRE (2017), real estate valuation in Africa often confronts a range of unusual factors, including a shortage of comparables, development risks, currency volatility and price spikes at the upper end of the market.

Practice Global real estate market

In developed countries, widespread ownership of properties is achieved by an effective and efficient link between residential mortgages and the long-term financial markets. Investment banks play key roles in long-term financial capital markets. The top five investment banks in the real estate sector have been relatively consistent since 2013, and none has captured more than 10 percent of

216  Putting capital to work in frontier markets

the market share (Investopedia, 2018). J.P. Morgan and Bank of America Merrill Lynch have been in the top five for 4 years running. Wells Fargo was in the top five in 2011, 2013 and 2014 but fell out in 2012 and in 2015, when it was replaced by Citigroup. Goldman Sachs, Morgan Stanley and Deutsche Bank, as well as some of the world’s largest PE firms, also have a strong presence in the industry. Ten PE real estate fund managers collectively raised over US$50 billion in 2015 (Ernest & Young, 2016). Nigeria’s real estate sector

The real estate sector is currently the sixth-largest sector in the economy. It contributes 9.6 percent to the GDP and grew by 8.7 percent annually during the 2010–2015 period, but the growth rate suffered a decline of 9.4 percent in the first quarter of 2018 (NBS, 2018). The property market in Nigeria was valued at US$41 billion in 2014 (PwC, 2016), and real estate capitalization was valued in that year at 1.2 percent of total market capitalization. Overall, the growth of the sector over the years has been driven by demographic and urbanization factors, emerging middle class and injections of foreign and domestic capital amongst others. Nigeria has a population of about 200 million people and is projected by the United Nations to reach 440 million people by 2050 (United Nations, 2015), making it the third-most populous country behind China and India. The urban areas have nearly half the population with the urbanization rate estimated at 3.75 percent between 2011 and 2015 by the World Bank. A growing middle class around cities such as Lagos, Abuja and Port Harcourt are fuelling the demand for real estate development in the residential and retail segments of the market. It is estimated that HNWIs in Nigeria 15.0

11.9

10.0

5.1

5.0

2.1

0.0 -5.0

-4.3 -6.9

-10.0 2013

2014

2015

Real Estate Industry Growth

2016 Contribuon to GDP

Figure 12.1 Real estate sector growth and contribution to GDP Source: NBS (2015, 2018).

2017

Real estate finance 217 Table 12.1 Comparative real estate indices: Nigeria and South Africa

Population below national poverty line Price to rent ratio – city centre outside city centre Gross rental yield – city centre outside of city centre Outstanding home loan (% age 15 +) Cost of standard 50-kg bag of cement (in US$) Price of the cheapest, newly built house by a formal developer or contractor (in US$) Ease of doing business rank Number of procedures to register property Time (days) to register property

Nigeria

South Africa

46 5.87 20.35 17.03% 4.8% 6.26 11 16,400

36.40% 10.85% 11.04% 12% 10.96% 9.17% 5.35 26,763

169 12 70

43 7 23

Sources: Fine and Country, Federal Ministry of Land, Housing & Urban Development & 2015 Housing Finance Africa Publication, and World Bank (2014).

62%

67%

68%

US

Turkey

74%

80%

89%

19%

Nigeria

South Africa

South Korea

China

Singapore

Figure 12.2 Home ownership: Nigeria versus other countries Source: World Bank (2014).

invest a quarter of their assets in properties compared to 18 percent in equities and other securities as real estate is still perceived as the strongest store of wealth. Other growth drivers are attributed to the increased interest from both domestic and foreign investors who are deploying capital into real estate development in the country. Pension reforms and regulations now allow workers to access a quarter of their pension contribution towards a purchase of a property. Regulatory changes also increased the amount that PFAs can invest in alternative asset classes including real estate. The World Bank (2014) estimates that there is a housing deficit of 17 million houses at a cost of US$363 billion. This number is expected to increase by 2 million houses per year at the current population growth of 2.8 percent per year. The majority of the residential properties have been built by individuals

218  Putting capital to work in frontier markets

on an incremental basis, which may take several years to complete. There are, however, real estate companies that have been active in building housing estates that cater to the middle class. Mixta Real Estate PLC is one of the leading real estate development companies in Nigeria (Box 12.1). The growth of the middle class is contributing to the development of retail real estate development in Nigeria. Nigeria has an estimated 1 square metre of formal retail space per 1,000 people relative to 480 square metres of retail space per 1,000 people in South Africa (PwC, 2016). Given the current population of 200 million people, there is significant scope for growth of the formal retail sector. The commercial real estate market is not as well developed as the retail sector but it is becoming more actives as a result of more businesses establishing including multinationals in key cities of Lagos, Abuja and Port Harcourt. The supply and availability of office space are improving with increased investment in commercial properties. The Lagos office market had a rental rate of US$85/m2 per month around 2015, among the highest in the world (Mixta, 2016). The Eko Atlantic project in Lagos is expected to boost both the residential and the commercial real estate sectors. Eko Atlantic is divided into ten districts with an expected 250,000 residents and 150,000 commuting to offices. The industrial real estate market is interconnected to the manufacturing sector, logistics business, transportation infrastructure and growth of industrial clusters and free-trade zones. The manufacturing companies need warehouse units to cater to the demand of the middle class and retail outlets for consumer goods. Nigeria has 14 operational free-trade zones to stimulate the export of goods to diversify the economy and sources of FX earnings (Mixta, 2016). A Survey by the NBS (2015) estimated that approximately 7,343 establishments make up the real estate sector in Nigeria with Lagos State and the Federal Capital Territory (FCT), accounting for 31.89 percent and 22.8 percent, respectively. The survey classified real estate establishments as those that deal in own or leased property (53.7 percent) and those that provide real estate services on a fee or contract basis (46.3 percent). Lagos has a majority of establishments dealing in own or leased properties of nearly 60 percent.

Connection between principles and practice Box 12.1  Mixta Real Estate PLC Mixta Real Estate PLC (Mixta Nigeria), formerly ARM Properties PLC, is one of the largest real estate development companies in Nigeria. The company is partly owned by Mixta Africa which has experience in other

Real estate finance 219

African countries – Morocco, Senegal, Tunisia, Cote D’Ivoire, Mauritania, Algeria and Egypt and has successfully delivered over 10,000 housing units across Africa. Mixta Africa is a fully owned subsidiary of Asset & Resource Management Holding Company (ARM) Limited. Mixta Africa was acquired from International Finance Corporation (IFC), Morgan Stanley and Kingdom Holdings. Mixta Nigeria has a diverse real estate portfolio covering the residential, commercial, retail and leisure real estate market in the country with an estimated total asset of ₦133 billion (US$369 million) as of December 2017, up from ₦29 billion in 2010. The company has a land bank of about 16 million square meters valued at ₦100 billion ($277 million).The company has delivered about 3,000 real estate assets, comprising homes, plots and retail outlets to end buyers. It plans to double its assets to more than 6,000 by 2022 (Mixta, 2017). Mixta Nigeria has a pipeline of projects targeting affordable middleincome residential segments, mid-tier shopping centres and markets, and mixed-use developments. It is involved in the Lagos New Town development of a land size of 1,660 ha, 30,000 homes, and transaction size of US$1.1 billion in its phase 1. When completed, the new township would provide housing for over 140,000 people. Mixta Nigeria has issued a shelf prospectus, cleared and registered by the Securities and Exchange Commission, to raise ₦30,000,000,000 medium-term note, bonds and other securities with varying maturities. This shelf prospectus was also issued under the listing and quotation requirements of the Nigerian Stock Exchange. The company has issued ₦4.5 billion in series 1 bonds secured by a guarantee, and ₦6.9 billion in commercial paper. Mixta Nigeria plans to raise an additional ₦6 billion through the capital market in two tranches, under its ₦30 billion bond programme. The debt is to refinance the existing debt facility and partly finance ongoing projects. Real estate developments require a large initial outlay for infrastructure and site enhancement, which can put pressure on liquidity and cash flows. However, this is mitigated by a ‘build to sell’ approach, strong demand potentials and pre-sale track record and access to finance. Source: Mixta (2016 and 2017).

Real estate establishments generally offer services with the three most common products are property management (30 percent), leasing of residential buildings (29 percent) and leasing of non-residential buildings (20 percent).The least common product offered is the leasing of self-storage or mini-warehouses with the lowest share of 9 percent. In terms of the legal structure of real estate establishments, self-proprietors account for 61.6 percent. The other forms of ownership are private limited

220  Putting capital to work in frontier markets

liability (18 percent); partnership (13 percent); public-limited, faith-based organization (FBO); JV; and co-operatives. Real estate development challenges

Real estate development has five to seven phases. Brueggeman and Fisher (2011) discuss five stages that are typically involved in real estate development. First, a developer acquires a land site. Second, the developer develops the site and constructs building improvements. Third, the developer completes the finishing of the property for occupancy by tenants. Fourth, the developer manages the property after completion, and fifth, the developer may eventually sell the project. The developer creates value when the market value of the property exceeds the total cost of land acquisition and development costs. Kohlhepp (2012) identifies seven stages of real estate development as land banking, land packaging, land development, building development, building operation, building renovation and site redevelopment. Each stage in the process further comprises acquisition, financing, marketing, addressing environmental issues, approvals and permits, physical improvements, transportation and accessibility concerns and disposition. In each of these stages, there are challenges to be addressed. In particular, the Nigerian real estate market has a number of challenges relating to access to finance, land titling and documentation, high constructions costs, government policies and infrastructure deficiencies. Real estate developers face the challenge of basic infrastructure deficits in the provision of water, sanitation, roads and electricity. The provision of these amenities by developers contribute close to a third of total real estate development costs. The real estate sector is regulated nationally by the Federal Ministry of Works, Housing and Power. The ministry has oversight responsibilities for the Federal Mortgage Bank of Nigeria (FMBN) and the Federal Housing Authority (FHA), which provides affordable housing through several housing-related initiatives. One of the objectives of the National Housing Policy of 2012 is to build 1 million houses annually in partnership with the private sector targeting low-income earners. At the state government level, some states operate and own property development corporations, while their land bureaus play active roles in the real estate sector. Under the Land Use Act of 1978, all land comes within the jurisdiction of the state and development on the land requires the consent of the governor of the state. The property transfer registry system is cumbersome. In comparison to 2007, some progress has been made on the number of steps required to register properties and the cost of registering properties. Nevertheless, the Doing Business Ranking of the World Bank (2018a) estimated that it takes 91 days to register a property in Nigeria, compared to 9 days and 31 days in China and Brazil respectively. It costs 11 percent of property value to register a property, compared to

Real estate finance 221 Table 12.2 Time and cost to register property

Number of Steps Time (days) Cost (% of value) Ranking

Nigeria

Brazil

Russia

India

China

11.8 (14) 91.7 (82) 11.3 (22.2) 184 (173)

13.6 (14) 31.4 (45) 3.6 (2.8) 137 (110)

4 (6) 13 (52) 0.1 (0.3) 12 (45)

9 (6) 69.1 (62) 8.3 (7.7) 166 (112)

3.6 (4) 9 (29) 4.6 (2.6) 27 (29)

Source: World Bank (2018a and 2007), Doing Business Report.

3.6 percent in Brazil and 4.6 percent in China, respectively (Table 12.2). Overall, Nigeria ranks 184th out of 189 countries for registering property. A project to fast-track land approval procedures in half of the 36 states is underway. Real estate investors have also raised property rights protection as a key concern. Nigeria ranks 94th out of 95 countries ranked globally in the International Property Rights Index in 2014, comparing unfavourably to South Africa (26th), Botswana and Mauritius at 31st jointly (PwC, 2016). Real estate financing models

Real estate development requires a huge capital outlay for land acquisition, provision of amenities, road and infrastructure development and construction of properties. The traditional sources of real estate financing include equity capital contributions by the developers and bank financing. PE financings have evolved as major partners in real estate development. Capital market–based financing includes mortgage-backed securities, bonds, REITs and listing of real estate companies on stock exchanges. Traditional financing Equity capital, remittances and informal financing

Equity capital from personal and household savings are the first port of call of developing family residential housing. Family equity capital is typically very low due to low per capita income and high population (Ogedengbe and Adesopo, 2003). Over 80 percent of the population lives in informal settlements and formal dwellings with houses built by the owners that can take 10 or more years to complete (Boleat and Walley, 2008). Short-term loans obtained by members of Rotating savings and credit associations (ROSCAs) play a role in housing finance. Remittances do contribute to equity capital for housing finance in Nigeria, where annual remittance inflows are estimated at over $20 billion annually according to the World Bank (2018b). Nigeria ranks fifth in terms of remittance inflows globally. It is estimated that about 60 percent of remittances are used for housing development (Boleat and Walley, 2008).

222  Putting capital to work in frontier markets Commercial bank lending

Real estate financing in Nigeria is quite fragmented with the luxury end of the residential sub-sector as well as retail and commercial real estate able to attract financing from banking and PE firms in partnership with developers. The lower-income end of the residential real estate relatively has limited access to finance due to the limited availability of mortgage financing for buyers in Nigeria. Traditionally, commercial banks have provided formal channels for real estate project loans. However, as a result of maturity mismatch between a bank’s short-term liabilities and the long-term requirements of real estate loans assets, commercial banks are limited in the amount of long-term financing that they can underwrite. Commercial bank lending to the real estate sector remains low at less than 1 percent of total assets due partly to a maturity mismatch. Long-term financing gap is quite high as more than four-fifths of liabilities of banks are shortterm deposits while long-term funds are slightly above 10 percent of total balance sheets. Mortgage debt–to–GDP ratio is estimated at less than 1 percent compared to a third in South Africa and more than half in advanced economies (World Bank, 2014). Few income earners, estimated at less than 2 percent, obtain loans for property construction. As a result, only 5 percent of the total 14 million housing units are financed with a mortgage. Lending rates for mortgages are quite high, up to 30 percent. Banks also require extensive documentation about the borrower and the housing project, which include market data, financial statements, project information, project appraisal value, site and building surveys, certificate of occupancy, legal documentation, insurance and status of ground rents, where relevant. FMBN

The FMBN is the apex mortgage finance and secondary mortgage institution that provide long-term financing for real estate in Nigeria. FMBN provides mortgage facilities to PMBs and real estate development companies, and housing cooperatives. The National Housing Fund (NHF) is the main mechanism for raising funds by the FMBN. Employees can contribute 2.5 percent of their salaries. With a down payment of between 10 percent and 30 percent, employees can obtain up to ₦15 million in fixed loans for a period of 30 years from FMBN to purchase a house. To broaden its client base, the FMBN launched the Informal Sector Cooperative Society Loan Scheme in 2013 to facilitate access to home financing by the informal sector participants. In 2013, Lagos established a mortgage board and launched a mortgage scheme with an initial capital outlay of ₦40 billion (US$241 million), raised from banks for 25 years, to serve as an intervention fund for long-term financing. Shelter Afrique, a pan-African real estate development

Real estate finance 223 Table 12.3 PMI consolidated balance sheet, June 2018

Total Assets Loans and Advances Bank Balances Deposits Liabilities Other Liabilities Shareholders’ Funds

₦ MillionEnd 2006

₦ MillionJune 2018

114,393 30,012 64,576 74,215 13,968 12,566

384,370 177,170 36,520 108,830 98,170 109,740

Source: CBN (2018).

institution, in partnership with FMBN and the Real Estate Development Association of Nigeria has committed US$200 million to Nigeria. PMBs

Decree No.53 of 1989 led to the creation of PMBs, which specialize in mortgage lending. They also serve as intermediaries to channel subsidized funds from the National Housing Trust Fund (NHTF).There are 34 licensed Primary Mortgage Institutions (PMIs) as of June 2018, comprising 11 national and 23 state PMBs, with total assets of ₦384.4 billion (CBN, 2018). They have low capitalization relative to commercial banks, and some have limited mortgage loans on their balance sheets. Private equity

Private equity (PE) is emerging as one of the sources of financing of real estate projects in Nigeria by private property developer and other investors. One of the pioneers of PE funding of commercial real estate in Nigeria is Actis Capital. Actis Capital is a PE firm headquartered in London, with offices in selected cities in Africa including Lagos. The firm developed The Palms shopping mall in 2004, with $40 million, as a JV with a local developer (Odusote, 2004). ACA, a leading PE firm, in Nigeria was founded in 1997. ACA has made PE investments in several sectors in Nigeria and other African countries. The firm has a real estate–dedicated fund – Capital Alliance Property Investment Company (CAPIC; Box 12.2).

Connecting principles to practice Box 12.2  Capital Alliance Property Investment Company The Capital Alliance Property Investment Company, L.P. (CAPIC) is a $165 million fund established in February 2008 to invest in real estate and

224  Putting capital to work in frontier markets

real estate related opportunities in West Africa.The fund has a 10-year life and invests in residential, retail, office and hospitality products throughout the region using equity and mezzanine instruments. CAPIC makes opportunistic investments in ground-up developments, distressed assets and value-added plays in major and secondary cities across the region. Its average project sizes are retail (11,690 m2) and office (9,452 m2).

Capital market

The capital market provides a source for secondary market funding for mortgages through securitization, which is the packaging of debts into pools, standardization, pass through security, and derivative securities. The capital market allows investors to earn a long-term fixed return from diversified mortgage portfolios. Borrowers are able to obtain the certainty of fixed rates offer and several refinancing options. Financial institutions use the bond market to supplement short-term deposit base, lend on longer term and balance risk profile. Investment banks play the function of connecting the mortgage market to the capital market. The mortgage market, at the front end, creates mortgages with proper registration, transactions and foreclosure, where necessary.The capital market work to raise capital and put that capital to work in the mortgage market through deals that take mortgages off the balance sheet of mortgage lenders. A common approach is the home loan bank model, which provides mortgage liquidity facility by pooling the mortgage loan portfolio of several banks. The facility provides large-scale financing to the banks with attractive rates. The facility issues long-term bonds with favourable credit ratings, with mortgages pledged as collaterals. The model links the primary mortgages market of private lending institutions to the bond market through the home loan bank. The Cagamas in Malaysia is often viewed as a successful model for developing countries. Other mortgage refinancing initiatives have been set up in Egypt, Jordan and Tanzania.1 Nigeria established the Nigerian Mortgage Refinance Company in 2013 (Box 12.3)

Connecting principles to practice Box 12.3  The Nigerian Mortgage Refinance Company The Nigerian Mortgage Refinance Company (NMRC) was created in 2013 as a public–private partnership institution. It has shareholders which include the private commercial banks, primary mortgage banks, private

Real estate finance 225

equity investors, the federal government, the World Bank and bilateral development institutions. It is set up as a wholesale mortgage liquidity facility. The World Bank provided a US$300 million loan of 40-year and zero-interest terms to serve as Tier 2 capital for NMRC.2 The federal Ministry of Finance, the Nigerian Sovereign Investment Authority (NSIA), mortgage banks, commercial banks, and bilateral development institutions contributed Tier 1 equity capital. The objective is to enhance affordable mortgage loans for home ownership by providing long-term funding to primary mortgage lenders. NMRC operations will help increase mortgage loans maturity structure with long-term capital, reduce mortgage lending rates, and standardize mortgage lending practices. As part of the package of reforms, the NMRC operations include developing common underwriting standards and building the capacity of mortgage lenders to originate loans following international standards. Technical assistance is to be provided to selected states on improving services of land registries by streamlining registration procedures and developing standards for key registration activities. As a mortgage refinance company, the NMRC building on its seed capital will fund itself through issuing of corporate bonds in the capital market. The funds raised will be on lend to primary mortgage lenders and secured by mortgage assets serving as collaterals for the loans. The NMRC operations will reduce maturity mismatch of mortgages and inject more liquidity into the mortgage market by converting illiquid assets into liquid cash. It encourages standardization of mortgage underwriting in a frontier market. The NMRC has already worked on codifying the Uniform Underwriting Standard. The Mortgage Asset Registry framework has been developed by the central bank. Source: World Bank (2014).

REITs

A REIT is both an asset class and a security that provides investors a vehicle for investing in real estate through the transfer of legal interests. REITs can be structured as a corporation or as a trust.They can be privately owned or listed publicly. They specialize in acquiring, improving, operating and disposing of real estate properties. They own real, tangible assets often with long-term tenancy agreements that provide stable and steady income streams. REITs are recognized as an effective structure to finance and manage real estate providing benefits that include regular long-term rental income streams, diversification and capital appreciation. Equity-based REITs invest about 70 percent of their funds in real estate or real estate–related assets. They tend to have a maximum of 10 percent in liquid assets and 20 percent in other assets. Mortgage-based REITs invest about 70 percent in mortgage assets, a maximum of 10 percent in liquid assets and

226  Putting capital to work in frontier markets

20 percent in other real estate assets. Hybrid-based REITs invest at least 40 percent in real estate, another 40 percent in mortgage assets and 20 percent in real estate–related assets. The United States first introduced REIT legislation in 1960. More than 35 countries now have REIT or REIT-like regimes. Ernest & Young (2016) estimated that the global market capitalization of REITs was about US$1.7 trillion in 2017 compared to US$734 billion in 2010. The US REIT market, which grew by nearly 150 percent during the same period, remains the largest globally. Australia and Japan are the second- and third-largest markets for REITs. The African REITs market is presently valued at US$29 billion and is available in four countries (Ghana, Nigeria, South Africa and Kenya). South Africa introduced REIT legislation in 2013 and 31 REITs were listed on the stock exchange in Johannesburg with a market capitalization of $27 billion.3 Nigeria, Kenya, Tanzania, Zambia and Ghana have also established REIT frameworks to encourage investment in real estate. The REIT structure was introduced in Nigeria in 2007 and three types of REITs currently exist – equity REITs, mortgage REITs and hybrid REITs. There are currently four REITs in Nigeria: Union Homes PLC, Sun Trust Hybrid, UPDC and Skye Shelter Fund (Box 11.1). The Skye Shelter Fund REIT and Union Homes Hybrid Real Estate Investment Trust were launched in 2007 and 2008, respectively. Union Homes Hybrid REIT had a market capitalization in January 2015 of US$60 million while Skye Shelter Fund REIT had a market capitalization of US$10.6 million (Table 12.4). The market capitalization of REITs listed on the NSE is about ₦40 billion. The construction/real estate sector of the NSE is valued at a total of ₦96 billion. Nigeria’s REITs market is still in its infancy with a liquidity of 5 percent of the NSE compared to over 200 percent in Singapore and 53 percent in South Africa.4 Several factors contribute to the low depth of Nigeria’s REIT market including unfavourable tax regime and cumbersome legal framework. REITs are required to pay the Companies Income Tax (CIT) at a rate equivalent to 30 percent. However, the dividends of publicly traded REITs are exempt from Table 12.4 Listed REITs in Nigeria FINANCIAL METRICS

UPDC REIT

SKYE SHELTER UNION HOMES FUND

NSE Listing 2013 2008 2009 Market Capitalization (₦ million) 26,683 2,000 11,306 Net Asset Value (₦ million) 31,243 (*2016) 2,246 (*2012) 13352 (*2012) Starting Share Price (₦) 10 100 52 Current Share Price (₦) 10 100 45 Trading Liquidity (LTM) 0.17% 0.04% 200%); South Africa REIT (53%) Source: SFS (2018).

Real estate finance 227

withholding taxes (WHT) in the hands of the investor. The sales of units of REITs are equally exempted from VAT and capital gains tax (CGT) on sales of these units or securities are also not applicable. However, the need to meet housing shortages provide opportunities for the growth of REITs. REITs are being promoted by the NSE so that investor funds can be pooled to develop much-needed real estate assets and provide mortgages.

Connecting principles to practice Box 12.4  REITs managed by SFS Capital The Skye Shelter Fund (the Fund) is an SEC-registered collective investment scheme. The Fund specializes in investing in residential real estate, targeted towards the middle-income class in Abuja and Lagos. The Fund is the first publicly quoted real estate investment trust (REIT) in Nigeria. The Fund had net asset value (NAV) of ₦2.37 billion and ₦2.41 billion at the end of fiscal year (FY) 2017 and 1Q of FY18, respectively. Union Homes Real Estate Investment Trust (UH-REIT) is an SEC-registered collective investment scheme. UH-REIT specializes in luxury residential and commercial real estate in Lagos and Abuja. UH-REIT was recently transferred to SFS Capital by the SEC with a mandate to restore value to its shareholders. The Fund’s objective is to provide investors with a blend of long-term capital appreciation and optimized return through investing in a strategic mix of real estate properties and money market instruments. Union Homes REIT was managed from its launch in 2008 to 2016 by Union Homes PLCc, when the SEC and the trustees of the Fund transferred the management of the Fund from the former manager to SFS Capital. SFS Capital effectively took over the management of the fund in 2017 following the successful resolution of all administrative issues relating to the change in manager. The Fund had an NAV of ₦12.67 billion and ₦12.79 billion at end FY17 and 1Q FY18, respectively. Date Listed Price Quantity Listed Market Capitalization No of Deals to Date Volume Traded to Date Value Traded to Date

SKYE SHELTER FUND PLC

UNION HOMES REITS

26-02-2008 ₦100.00 20,000,000 ₦2 billion 941 5,555,302 ₦572.3 million

22-07-2010 ₦51.5 250,019,781 ₦12.9 billion 142 1,644,138 ₦82.2 million

Source: SFS Financial Services Group (2018).

228  Putting capital to work in frontier markets Regulations of REITs in Nigeria

The primary regulator of REITs in Nigeria is the SEC, which introduced the framework for the establishment of REITs in 2007 as collective investment schemes. The schemes are to be administered by an incorporated entity duly registered as a fund manager by the SEC. The SEC defines real estate investment scheme as a real estate investment scheme which shall wholly acquire and hold legal title to property or chose to hold equitable and beneficial title to such property vide a deed of trust or such other structure as may be acceptable to the commission.5 The use of a deed of trust to transfer property has enabled REITs to acquire properties for their underlying portfolio without the difficulty of paying transfer charges that could be as high as a third of the value of the properties. Specific rules include, first, that sponsors of any scheme will subscribe to a minimum of 5 percent of the registered units of the REIT for the lifetime of the scheme. Second, each scheme pays out a minimum of 25 percent of its annual income.Third, a REIT is restricted from investing more than 20 percent of its funds in high-risk development activity. Fourth, a minimum of 50 percent of the units must have been subscribed before the SEC can provide clearance for the allotment of units under a REIT scheme. Fifth, while underwriting of REIT is optional, the approval by the SEC is required for the underwriting. Sixth, all the underlying assets of the REIT are required to be insured against all known risks by a reputable insurance company. Seventh, the trustees to a REIT may, on the advice of the fund manager, borrow in the ordinary course of the REITs business up to 15 percent of its NAV (Details, 2015). The NSE defines the general requirements for listing of REITs on the Exchange6 to include the REITs being duly registered by the SEC, submission of an application form and appointment of issuer’s board of directors/trustees to include an investment manager and an independent director.The issuer shall be a property investment holding company or property development company, with at least 75 percent of the gross revenue derived from real estate–related sources, including rents from real property, interest on mortgages financing real property or dividends from qualifying equity investments. The issuer must distribute 90 percent of its distributable income as a dividend to its unitholders, which must be at least two unitholders. The issuer shall have minimum full paid-up capital of ₦3 billion. The issuer shall appoint a fund manager as well as a property manager who shall be separate entities. Future prospects

Africa is the world’s fastest-urbanizing region, with an additional 187 million Africans projected to live in cities over the next decade. Between 2015 and 2045, an average of 24 million additional people is projected to live in cities each year, compared with 11 million in India and 9 million in China (McKinsey, 2016).

Real estate finance 229

The fast population and urbanization growth rates in Nigeria are creating opportunities as well as challenges for the residential real estate market in the country, especially in major cities. To meet the needs of a growing and rapidly urbanizing population, emerging and frontier countries are providing strong opportunities in real estate development, from residential developments through to business, retail and manufacturing. There are key mega trends shaping the real estate market in Africa and globally (PwC, 2016). First is the huge expansion in cities as a result of urban migration swelling cities across the fast-growing frontier and emerging and frontier countries in Asia, Africa, the Middle East and Latin America. Second, demographic shifts will affect demand for real estate as the burgeoning urban, middle-class populations in Asia, Africa and South America will need far more housing. Third, the rise of emerging economies and rapid growth in frontier economies are fuelling demand for real estate as an alternative asset class in those economies. Fourth, there is increasing awareness of issues relating to climate change and sustainability, which is putting pressures to make houses and offices more efficient and environment-friendly. Fifth, technology is disrupting real estate economics, forcing real estate developers and the investment community to adapt their modus operandi. Fifth, real estate capital is being influenced by the interplay of private capital, real estate funds, sovereign wealth funds and public–private partnership.

Notes 1 2 3 4 5 6

World Bank (2014). World Bank (2014). South Africa. South Africa PPP. SEC Rules: Under Section J 6, 509 and 510. NSE Listing Rules.

Bibliography Bernard, A. (2014), Pension Fund: A Veritable Source of Financing Real Estate Development in Nigeria. International Letters of Social and Humanistic Sciences Online, 23, 23–40 Berges, S. (2004), The Complete Guide to Real Estate Finance for Investment Properties: How to Analyze Any Single-Family, Multifamily, or Commercial Property. Hoboken, NJ: John Wiley & Sons Boleat, M. and S. Walley. (2008), Nigeria: Financial System Strategy 2020: Housing Finance. www.boleat.com/materials/nigerian_financial_system_strategy_2020.pdf Brueggeman, W.B. and J.D. Fisher. (2011), Real Estate Finance and Investments, 14th edition, New York: Tata McGraw-Hill, Irwin CBN. (2018), Half Year Report Details. (2015), Nigeria Real Estate Guide Vol. 1, 2015 edition, Details Commercial Solicitors DLA Piper and CBRE. (2017), Real Estate Investment in Africa: The Struggle Between Perception and Reality Eldred, G.M. (2012), Investing in Real Estate, 7th edition. Hoboken, NJ: John Wiley & Sons

230  Putting capital to work in frontier markets Godman, C. (2017), Developing Sustainable Capital Flows for Financing Real Estate Assets. Prepared for the Nigerian Stock Exchange REIT Conference. www.nse.com.ng/NSEPresentation/Real%20Estate%20Investment%20Trust%20in%20sub-Sahara%20Africa%20 -The%20role%20of%20The%20Capital%20Market.pdf Ernest & Young. (2016), Global Perspectives: 2016 REITs Report Investopedia. (2018), Top Investment Banks in the Real Estate Industry (TOC, BAC) | Investopedia. www.investopedia.com/articles/investing/092815/top-investment-banksreal-estate-industry.asp#ixzz5IBpBIb3k Knight Frank. (2018), The Wealth Report. www.knightfrank.com/wealthreport [Accessed 15 November 2018] Kohlhepp, D.B. (2012), The Real Estate Development Matrix. www.ccimef.org/pdf/2012299.the-real-estate-development-matrix.4-21-12.pdf McKinsey. (2016), Lions on the move II: Realizing the potentials of Africa’s economies. Mixta. (2016), MIXTA AFRICA Corporate Profile Mixta. (2017), Prospectus for a Medium-Term Note Programme Shelf Registration NBS. (2015), Nigerian Real Estate Sector: Summary Report: 2010–2012 NBS. (2018), Nigeria’s Gross Domestic Product Statistics for H2 2018 NSE. (2018), Position Paper on the Implementation of REITs in Nigeria NSE and Estate Intelligence. (2018), Real Estate Investment Trusts in Sub-Saharan Africa: The Role of the Capital Market Odusote, O. (2004), Stimulating Nigeria’s Emerging Real Estate Markets: Investment Opportunities Through the Public Sector, MIT. https://dspace.mit.edu/bitstream/ handle/1721.1/58651/316064780-MIT.pdf;sequence=2 Ogedengbe, P.S. and A.A. Adesopo. (2003), Problems of Financing Real Estate Development in Nigeria, Journal of Human Ecology, 14(6): 425–431 PWC. (2016), Real Estate 2020: Building the Future Oreagba, F. (2010), Position Paper on the Implementation of REITS in Nigeria (N-REIT), Nigerian Stock Exchange Oyedele, T. (2017), Regulatory, Tax and Role of Capital Market in Developing REITs in Nigeria and Sub-Sahara Africa. www.nse.com.ng/NSEPresentation/Real%20Estate%20 Investment%20Trust%20in%20sub-Sahara%20Africa%20-The%20role%20of%20 The%20Capital%20Market.pdf Solesi, O. (2017), Financing of Real Estate Development in Nigeria. www.academia. edu/4578175/Financing_Of_Real_Estate_Development_in_Nigeria United Nation. (2015), World Population Prospects: The 2015 Revision. http://www. un.org/en/development/desa/news/population/2015-report.html [Accessed July 2018]. World Bank. (2014), Nigeria: Housing Finance Project World Bank. (2007), Doing Business Report World Bank. (2018a), Doing Business Report World Bank. (2018b), Database on Remittances

Part V

Managing capital in frontier markets

13 Asset management

Principles Asset and investment management is an important aspect of capital markets and investment banking globally and in FMs. Asset management companies (AMCs) typically considered as buy-side firms, pool funds from clients and invest them in equity, bonds and alternative investments. AMCs provide investors with professional management, liquidity and diversification by investing in and managing portfolios of securities through mutual funds, ETFs, and hedge funds. AMCs earn income by charging service fees or commissions to their clients. In addition to independent AMCs, investment banking institutions and financial holding banks have moved aggressively into investment management. The rise of institutional investors in the capital markets has been attributed to the need for efficient management and diversification of assets. In turn, the desire for efficient diversification has been influenced by portfolio management theory. Portfolio theory explains that some sources of risk associated with individual assets can be eliminated, or diversified away, by holding an efficient combination of assets. A primary objective of the portfolio theory is to identify an efficient combination of assets that optimize the expected rate of return on an investment for a specific level of risk. There are three alternative approaches to portfolio management: passive, active and quantitative. A passive strategy requires the investor to buy and hold some replica of the market portfolio and accept an expected return equal to the market. Underlying this strategy is the assumption that markets are reasonably efficient and that any attempt to improve the rate of return from risky securities is not likely to succeed. An active portfolio management strategy attempts to “beat the market” by identifying “mispriced” securities and forming efficient portfolios from those securities. This strategy clearly requires more effort from the investor. If such securities can be identified and the market eventually prices them properly, the active portfolio will generate returns in excess of those provided by the market on a risk-adjusted basis.

234  Managing capital in frontier markets Table 13.1 Top 10 AMCs in the world, 2017 Rank

Firm/company

Country

AUM (US$ billion)

1 2 3 4 5 6 7 8 9 10

BlackRock The Vanguard Group UBS State Street Global Advisors Fidelity Investments Allianz J.P. Morgan Asset Management BNY Mellon Investment Management PIMCO Amundi

United States United States Switzerland United States United States Germany United States United States United States France

6,288 4,900 3,101 2,800 2,488 2,268 1,900 1,800 1,690 1,652

Source: Willis Tower Watson (2017). Note: PIMCO is a fully owned subsidiary of Allianz. Allianz’s figure includes PIMCO’s AUM.

A third approach relies on quantitative analysis of securities specified by an investor. An optimization technique can provide an efficient allocation of funds among a given set of alternatives. This approach can be applied to an existing passive or active strategy. Global asset management

Globally, the AUM of the top 500 AMCs totalled US$81.2 trillion at the end of 2016 (Willis Tower Watson, 2017). The share of the top 20 AMCs of the total assets was 42.3 percent. Independent asset managers made half of the top 20–ranked AMCs followed by seven banks and three insurer-owned managers. Among the developed countries, 13 US managers in the top 20 increased their share of total AUM for that group to 73 percent, while 7 European, including UK managers, had the remaining 27 percent. Participation of managers from developing countries was at 3.8 percent in 2016, with AUM of US$3.1 trillion. Table 13.1 shows that the top six AMCs ranked by AUM are Blackrock,Vanguard, UBS, State Street, Fidelity and Allianz of Germany.

Asset management in Nigeria Investment management is typically organized as an asset management subsidiary in Nigeria.Traditional asset management business in Nigeria falls primarily under three different categories: institutional asset management, private wealth management (PWM) and collective investment schemes (mutual funds and ETFs). Institutional asset management

Institutional asset managers provide bespoke investment solutions to institutions ranging from private sector companies, insurance companies, pension

Asset management 235

funds, state governments, foundations and non-profit organizations. They provide investment advisory on cash flow and liquidity management, asset replacement schemes and employee welfare schemes. Investment management, especially for institutions and high net-worth families, depends crucially on not only market and products knowledge but also networking and building long-term relationships with clients. Sales and distribution are more integrated across the subsidiaries as these functions are responsible for creating, positioning and selling various investment products the investment bank has to offer. The sales teams package different investment products and explain how the products fit client needs and portfolios Sales and revenue depend crucially on customer acquisition and retention. Client acquisition and retention are key to business sustainability and financial viability of investment banks. They therefore must build, nurture and grow the relationship with customers. Building a strong relationship implies knowing and understanding clients. Relationship management involves managing a team of specialists that can provide solutions that meet the needs of clients and simultaneously generate sufficient sales and revenue for the investment bank. Acquiring and retaining profitable clients are the indispensable ingredients of successful investment banking. PWM

PWM is targeted to HNWIs, with offerings of traditional and alternative asset classes and discretionary and non-discretionary portfolio services, depending on client’s risk–return profiles. There are few reliable published data on PWM in Africa and Nigeria.According to the latest World Wealth Report, published by Cap Gemini and RBC Wealth Management, the size of the HNWI population in Africa increased from 95,000 in 2008 to 168,000 in 2017.The wealth of HNWI stood at US$1.7 trillion in 2017, accounting for less than 4 percent of the $70 trillion in global wealth of HNWI. PwC (2016) estimated that Africa accounts for less than 3.7 percent of global wealth management, while Nigeria is about 0.4 percent of the global wealth concentration. Nigeria has the third-highest number of HNWIs in Africa, estimated in 2016 to be 10,024 and 120 ultra-HNWIs; this compares to 26,000 and 455 in South Africa, and 13,000 and 149 in Egypt (PwC, 2016). In 2016, the CBN observed that about $20 billion were in domiciliary accounts of Nigerian citizens. Euromoney (2017) observes that J.P. Morgan, Barclays Capital, Citigroup and UBS are four of the global banks that manage significant private wealth for Nigerians. Domestically, two asset management firms under a financial holding structure – Stanbic IBTC and FBN Capital Limited – dominate the business of asset management in Nigeria. The Nigerian private-banking market in Nigeria remains attractive for both local and international banks.

236  Managing capital in frontier markets Collective investment schemes Mutual funds

A mutual fund is a collective investment vehicle that pools funds from different investors with common investment objectives and invests the funds on behalf of the investors in a portfolio of securities. Mutual funds have several benefits. Professional asset managers structure and allocate the mutual fund portfolios in accordance with the objectives of the funds as stated in its prospectus; and based on their professional research and investment strategies. A mutual fund allows for portfolio diversification of investments across sectors, industries, instruments and maturities. A mutual fund provides an opportunity to invest in a less expensive and easier to construct portfolio than what an average retail investor would be able to do. Mutual funds provide economies of scale and affordability while reducing transactions costs. Transaction fees are higher when buying only one security at a time, while mutual funds allow for cost averaging. Mutual funds provide for liquidity and easy access in trading shares, as well as exposure to different investment styles such as value investing, growth investing and income or capital gains investing. There are different types of mutual funds, and they are often classified by their class of assets and instruments. Broadly, capital market instruments funds include equity and bond funds, while money market funds invest in shortterm instruments including TBs, certificate of deposits and CPs. There are also hybrid funds which invest in both equity and bonds, real estate funds, green funds, and ethical funds. Two additional investment vehicles were recently introduced to the markets: the FGN Savings Bond and the FGN Eurobond. The FGN savings bond, which is guaranteed by the government is targeted at small retail investors. The FGN Eurobond is a dollar-denominated instrument listed on the LSE and targeted primarily at foreign institutional investors and high net worth investors. Investing in mutual funds also has its downsides. Unlike deposits in banks, which are insured up to a certain limit by the Nigerian Deposit Insurance Corporation (NDIC), mutual funds in Nigeria are not insured. The value of mutual funds could depreciate and fluctuate in line with the underlying securities instruments that constitute the fund’s portfolios. Professional managers charge fees for their services, which reduce the fund’s overall payout that can be magnified in periods when funds do not make money. Professional managers charge fees ranging from 1 percent to 5 percent of the value of the mutual fund’s portfolio. The unit price of a mutual fund is determined by its NAV, which is obtained by deducting the fund’s total liabilities from its aggregate assets and then dividing by the total number of units of the fund. The fund’s offering price is its NAV plus sales charge, while the redemption price is NAV minus redemption fee. Some mutual fund dividends are taxed, while others are not. For equity mutual funds, the tax is at source on the dividends that the Fund earns.

Asset management 237

The 74 registered mutual funds in Nigeria had a total NAV of ₦551.7 billion in April 2018, a fourfold increase or some 400 percent increase over the last 5 years (SEC, 2018). There are still significant opportunities for the growth of mutual funds, which NAV is very low at less than 2.5 percent of the GDP (Figure 13.1). Money market funds account for about 74.2 percent of the total NAV with ₦409.25 billion. Real estate funds account for 8.3 percent or ₦45.87 billion of the total NAV, while fixed income funds account for 6.8 percent or ₦37.55 billion. Balanced funds account for 5.13 percent or ₦28.32 billion; equity-based funds account for ₦15 billion, about 2.72 percent of the total NAV of mutual funds. Ethical fund account for 1.04 percent of the total NAV. The top four asset managers control four-fifths, or 80 percent, of total AUM in Nigeria. As of April 2018, Stanbic IBTC Asset Management Limited had a commanding share of 45 percent of AUM in Nigeria, followed by FBN Capital Asset Management Limited (20 percent). ARM, an independent full-service investment bank (8.38 percent) ranks third, while a subsidiary of FSDH Merchant Bank, FSDH Asset Management (6.84 percent), came fourth. Stanbic IBTC money market fund is the largest fund in Nigeria, with 38.5 percent of the value of total mutual funds and 53 percent of the total money market funds. FBN money market fund accounts for 18.3 percent, ARM money market fund (7.2 percent) and UPDC Real Estate Investment Fund (5.5 percent). Stanbic IBTC funds also dominate the other different mutual funds segments. Box 13.1 and Table 13.2 highlight key FBN Quest different mutual funds offerings. Besides ARM, Investment One, Zenith Asset Management, United Asset Management, FCMB,Vetiva and Afrinvest, which are among the top-tier investment banks, other investment management firms include Lotus Capital, SFS Capital, Greenwich Trust and Sterling Capital. 700

639

600

2.0%

500

419

1.5%

400

260

300 200

2.5%

146

173

1.0%

220

0.5%

100 0

0.0% Nov-13

2014

2015 Value (N'Billion)

2016

2017

NAV Percentage of GDP

Figure 13.1 Mutual funds (NAV and NAV contribution to GDP) Source: SEC (2018) and NBS (2018).

Jul-18

Offers competitive returns over a 3- to 4-year investment horizon Invests in fixed income securities such as bonds and treasury bills

Offers higher interest rates when compared to rates on bank savings account Money market instruments including treasury bills, bank tenured deposits and commercial papers Low risk Recommended for customers saving for a short- to mediumterm goal

Return profile

Risk Profile Target Audience

Low-medium risk Recommended for conservative unitholders who are looking for a stable income

A medium to longterm investment giving unitholders a consistent regular income

A short to mediumterm investment giving unitholders stability, liquidity and some income

Investment Objective

Asset Allocation

FBN Fixed Income Fund

FBN Money Market Fund

Criteria

Table 13.2 FBN Quest Asset Management Mutual Funds

Medium risk Recommended for unitholders looking to build wealth through a single diversified portfolio, seeking long-term capital growth and competitive returns

High risk Recommended for customers seeking long-term capital growth, require minimal income and can tolerate market volatility

Medium risk Recommended for investors looking to hedge funds against naira volatility whilst earning competitive returns on US dollars

Invests in US dollar– denominated government and corporate bonds

Offers competitive returns over a 3- to 5-year investment horizon

A medium to long-term investment giving unitholders access to income and capital growth from USD debt instruments

A medium to longterm investment giving customers long-term capital growth and assured liquidity

A medium to longterm investment giving unitholders a balanced mix of income and capital appreciation over time Offers competitive returns over a 3- to 5-year investment horizon Invest in equities, bonds and treasury bills Offers competitive returns over a 3-to 5-year investment horizon Invests in equities and fixed income products such as treasury bills

FBN Nigeria Eurobond (US$) Fund

FBN Nigeria Smart Beta Equity Fund

FBN Heritage Fund

None payable on capital gains 90 days Semi-annually

Quarterly

₦10,000 (US$25)

None payable on capital gains 30 days

₦5,000 (US$14)

₦50,000 (US$139)

₦5,000 (US$14)

Source: FBN Quest Asset Management (2018).

Minimum Holding Period Income Distribution

Minimum Initial Investment Subsequent Investment Withholding Tax

Annually

None payable on capital gains 90 days

₦10,000 (US$28)

₦50,000 (US$139)

Annually

None payable on capital gains 90 days

₦10,000 (US$28)

₦50,000 (US$139)

Semi-annually

$2,500 (individual), $100,000 (institutional) $1,000 (individual & institutional) None payable on capital gains 180 days

240  Managing capital in frontier markets

Collective investment schemes shall have an investment committee composed of no fewer than three persons knowledgeable in investment and financial matters one of whom shall be a party independent of the fund manager, trustee and custodian.The sponsor of an authorized scheme shall subscribe to a minimum of 5 percent of the registered units of the Scheme at inception, and such units shall be held throughout the life of the scheme.

Connecting principles to practice Box 13.1  First Bank Nigeria (FBN) Quest Mutual Funds The FBN Money Market Fund: As an open-ended mutual fund, the FBN Money Market Fund invests in a broadly diversified portfolio of shortterm, high-quality money market securities such as treasury bills, commercial papers, bankers’ acceptances and certificates of deposit issued by top-rated banks in Nigeria. Its benefits include a minimum starting investment of ₦5,000, low risk, high level of security, quarterly income distributions to unitholders, competitive returns, higher rates than standard bank savings accounts and the opportunity to add funds to your investment account at any time. The FBN Fixed Income Fund: This fund preserves and maximizes return on capital while maintaining a high level of liquidity. The fund allows exposure to a diversified portfolio of long-tenured debt securities issued by the federal government of Nigeria, state governments and highly rated corporate institutions. The fund may also invest in high-quality money market securities. Benefits of investing in the FBN Fixed Income Fund include a minimum starting investment of ₦50,000, low to medium risk, income distributions to unitholders every 6 months and competitive returns. The FBN Heritage Fund: The FBN Heritage Fund offers exposure to multiple asset classes and aims to reduce investment risk by diversifying across these asset classes – making it an ideal long-term investment vehicle. The fund invests in a diversified portfolio of high-quality Nigerian companies, long-term debt instruments of Nigerian federal and state governments and high-quality money market securities such as treasury bills and commercial papers. The fund, by virtue of its investments, can be subject to some market volatility. Investors in the FBN Heritage Fund stand to enjoy benefits such as a minimum starting investment of ₦50,000, medium risk, annual income distributions to unitholders and competitive returns.

Asset management 241

The FBN Nigeria Eurobond (USD) Fund: This fund provides income and capital appreciation by investing in US dollar–denominated debt instruments issued by the Nigerian government and reputable corporate institutions. The fund is Nigeria’s first US dollar–denominated mutual fund which allows investors to earn an income in US dollars. Benefits include a minimum starting investment of US$2,500 (individuals) or US$100,000 (institutions), competitive investment returns in US dollars, income distributions to unitholders twice a year and higher interest rates than a regular US dollar domiciliary bank account. The FBN Nigeria Smart Beta Equity Fund: This is a pure equity fund that invests predominantly in a portfolio of Nigerian companies, using a rigorous, research-based and tested evaluation system. The fund provides long-term capital preservation by investing at least 75 percent of the fund’s assets in a diversified portfolio of high-quality companies listed on the Nigerian Stock Exchange. In order to manage liquidity, the fund may also invest up to 25 percent in short-term money market instruments and deposits with financial institutions. Investors enjoy benefits from the FBN Nigeria Smart Beta Equity Fund, including a minimum starting investment of ₦50,000, long-term capital growth and competitive returns. Source: FBN Quest Asset Management (2018).

An authorized scheme shall affect the distribution of no less than 25 percent of the scheme’s income annually where such income is realized, provided, however, that this provision shall only apply to schemes with a stated objective of distributing income. Where a meeting of a collective investment scheme is convened, the quorum shall be formed by at least five unitholders holding not less than 25 percent of the issued units of the scheme. The allowable fees and expenses of a scheme as provided in Rule 465(l) may include any of the management fees, trustee fees, custodian fees, auditors’ fees, registrars’ fees, legal fees, brokerage fees/transaction charges, taxes and other duties, valuation fees, advertisement fees and Annual General meetings (AGM) and Extra-ordinary General Meetings (EGM) expenses. Unlisted securities shall be eligible instruments in which the funds and assets of a collective investment scheme may be invested. A fund manager seeking approval to invest assets of a fund in unlisted securities shall have (a) a minimum paid-up capital of ₦5 million unimpaired by losses or such amount as may be prescribed by the commission from time to time and (b) partners, principals and sponsored individuals who have been in the business of PE investment management for a minimum period of 5 years.

242  Managing capital in frontier markets ETFs

An ETF is a marketable security that tracks an index and holds a basket of liquid assets related to the index. It is listed and traded on a stock exchange like stocks. Shareholders do not directly own or have any direct claim to the underlying investments in the fund; rather they indirectly own these assets. ETFs offer the advantages of diversifying their investment at low cost. According to Investopedia, the creation and redemption of ETF are done by authorized participants such as investment banks or other financial institutions. During the creation process, authorized participants assemble a basket of underlying assets of the index that the ETF is designed to track, which is provided to the fund and exchanged for newly created ETF shares. In redemption, the reverse is the case. As of June 2018, there are nine ETFs listed on the NSE, five of which are promoted by Vetiva. These are NewGold ETF,Vetiva Griffin 30 ETF, Lotus Halal Equity ETF, Stanbic IBTC ETF 30,Vetiva Banking ETF,Vetiva Consumer Goods ETF,Vetiva Industrial ETF,Vetiva S&P Nigeria Sovereign Bond ETF and the SIASML Pension ETF 40 (Box 13.2).

Connecting principles to practice Box 13.2  The Vetiva Sector Series Exchange Traded Funds (ETFs) The Vetiva Sector Series ETFs are registered in Nigeria as unit trust schemes under Section 60 of the Investment and Securities Act. Each of the funds is governed by a trust deed with Union Trustees Limited as trustees and UBA PLC (Global Investor Service) as custodian. Each sector series ETF is an open-ended unit trust designed to enable unitholders to gain exposure to underlying securities in the major benchmark sector indices of the Nigerian Stock Exchange: Banking Index, Consumer Goods Index and Industrial Index. The intention of each ETF is to replicate as closely as possible the price and yield performance of the constituent components of the respective sector indices. The fund achieves this by maintaining a portfolio of securities that match, as much as possible, the constituent components of the respective sector indices. Each sector ETF was listed on the Nigerian Stock Exchange (NSE) in October 2015, with a subscription price corresponding to 1/100th of the respective sector index value on the day preceding subscription. The NSE sector indices are price-adjusted market capitalization– weighted indices compiled by the NSE to track the most liquid and capitalized stocks in each sector. Not all listed stocks in a sector are included

Asset management 243

in the NSE sector index – a stock must have been traded on at least 70% of the trading days during the review period. The weighting of each security in the underlying index is determined by the size of its market capitalization relative to the market capitalizations of the other securities represented in the index. The Vetiva Sector Series ETFs enable investors to express their trading views on specific sectors, as well as constituent stocks. Furthermore, it removes the requirement to select stocks within a sector and permits investors to limit their active participation in selecting a sector. As such, it provides an efficient means for investors to benefit from the price and yield performance of multiple stocks within a targeted sector in a passive and permissive way. The Vetiva Sector Series ETFs also provide investors with an alternative exposure route in the event that an investor is unable to gain direct exposure to a particular stock. More generally,Vetiva Sector Series ETFs are a viable tool of asset diversification for investors. The net asset value of the sector ETFs is calculated by dividing the total fund value (total assets plus cash holdings net liabilities) by the total number of units in issue. The sector indices are re-weighted on a semiannual basis in January and July, and the fund manager rebalances the portfolio in order to reflect changes in the underlying index and achieve the goal of replicating the sector indices through the ETFs. However, minor mis-weightings are permitted in the event that the expected transaction costs are greater than the expected mis-weighting. ETF units can either be sold in the secondary market or redeemed with the fund manager and information on underlying securities is published daily on the Vetiva site: www.vetiva.com/funds. Source:Vetiva Capital Management Limited (2018).

Regulation of collective investment schemes

Asset and fund managers that operate within the Nigerian capital markets, as well as other persons who carry on investment and securities business in Nigeria, must be licensed by the SEC. Under the provisions of the Investment and Securities Act (ISA), funds and collective investment schemes that are offered to the public are subject to the regulatory regime and must be approved by the SEC. The main structures used for asset management in Nigeria are (a) limited liability companies – private and public; (b) partnerships – general partnerships and, in Lagos state, limited partnerships or limited liability partnerships; and (c) unit trusts. In June 2017, the SEC revised the current Rules to include, among others, a new three-tiered know-your-customer framework for capital market operators, fund and portfolio management operation rules, and amendments to the

NSE Banking Index

NSE Consumer Goods Index

NSE Industrial Goods Index

Vetiva Banking ETF

Vetiva Consumer Goods ETF

Vetiva Industrial Goods ETF

Source:Vetiva Capital Management Limited (2018).

Index

Name

Table 13.3 Breakdown of Vetiva Sector Series ETFs

15,000,000

40,000,000

100,000,000

Units at issue ACCESSBANK DIAMOND BANK ETI FIDELITYBANK GUARANTY 7UP CADBURY CHAMPION DANGFLOUR DANGSUGAR FLOURMILL GUINNESS HONYFLOUR BERGER BETAGLAS CAP CCNN CUTIX

Constituents

DANGCEM MEYER PAINTCO PORTPAINT WAPCO

STERLNBANK UBA UBN WEMABANK ZENITHBANK INTBREW NASCON NB NESTLE PZ UNILEVER VITAFOAM

Yes – 50% cap on weighting

No

No

Cap on weighting?

Asset management 245

Investor Protection Fund Rules, rules on real estate investment schemes and rules on infrastructure funds. The SEC’s new fund and portfolio management rules provide that funds managed under a discretionary fund portfolio management mandate should only be invested in certain permissible assets and securities such as units of registered collective investment schemes. Regulations of ETFs

The SEC regulates ETFs, which it defines as an undertaking that could be (1) a unit trust scheme or (2) an open-ended investment company, any other such structure, as may be approved by the commission. ETFs issue securities or units listed on a securities exchange recognized by the commission that tracks the performance of a specified security or other assets which includes, but is not limited to, stocks, a basket of assets, indices, commodity prices, foreign currency rates or any other appropriate benchmark approved by the commission from time to time. In accordance with SEC requirements, an ETF shall be subject to the approval, authorization and registration of the commission. No person shall deal in the units of an ETF unless such units have been registered with the commission. The underlying assets of an ETF shall be held by a custodian/ depository on behalf of the fund. The units and underlying assets of an ETF must (a) be sufficiently liquid to satisfy the commission that there will be proper price formation on the ETF or (b) have a NAV that is calculated in a transparent manner and published on the website of the ETF. An applicant issuer of an ETF must (a) provide evidence to the commission that it has the relevant expertise to issue ETF or has access to such expertise and (b) satisfy the commission that a secondary market in the units will be established and maintained. The NSE listing requirements for ETFs include evidence of payment of application/listing fees and CSCS eligibility fees, certified true copies of the certificate of incorporation, the memorandum and articles of association, the vending agreement, the trust deed, the draft prospectus, the memorandum on offer pricing and the estimated issuing costs. Trusteeship

In addition to asset management, most Nigerian investment banks have subsidiaries that provide trustees services in the form of private trust, corporate trust, and public trust. There are also firms that specialize mainly in trust services (Box 13.3 on STL Trustees). Private trust services focus on managing assets for individuals through Wills drafting and executorship, living trusts, custodial/nominee services, custodial and nominee services, administration of estate, trust settlement, education trusts and endowment schemes. A private trust is typically created for the financial benefit of designated individual beneficiaries.

246  Managing capital in frontier markets

Connecting principles to practice Box 13.3  STL TRUSTEES LIMITED: Service Built on Trust STL TRUSTEES LIMITED is a corporate trustee authorized and regulated by the Securities and Exchange Commission to carry out the dual functions of Trusteeship and Funds/Portfolio Management. STL Trustees Limited (STL) was incorporated in 1991. Since its incorporation, STL has carried out its dual capital market functions and has shown remarkable growth evidenced by its involvement in a number of significant bigticket capital market transactions. Trustee Business: STL’s areas of business as a corporate trustee can be divided broadly into three main categories, that is public trusts, corporate trusts and private trusts. The company currently acts as trustee to more than 15 mutual funds amongst other corporate trust businesses with varying transaction sizes and complexities. Bond Trusteeship: The company is particularly dominant in bond trusteeship and in the real estate trusts space. This includes trusteeship of bonds issued by sovereign-backed agencies as well as subnationals. From its first bond mandate, the Lagos State Government ₦50 billion bond, in 2008, STL has grown the size of its bond mandates and currently acts as trustee to more than 23 subnational bonds and four sovereign-backed debt issuances, amongst other big-ticket mandates. The company is Trustee to the first subnational sukuk issued in Nigeria, the first and second sukuk issues by the federal government of Nigeria (FGN), the first FGN local contractors bond issued in Nigeria and the FGN Budget Support Fund. Real Estate Trusteeship: STL trustees provide custodial and nominee services in different real estate transactions depending on the structure of the transaction. In some transactions, STL plays the dual role of security trustee and custodian, while in others it could play either role. The company provides professional trust services in situations where it would be required that title documents be released whilst consideration has not yet fully passed to the vendor. STL stands as an intermediary between the vendor and the prospective buyer, who, more often than not, would want delivery of the title documents before parting with the full purchase price. STL serves as a neutral and independent party monitoring the terms and covenants of the different transaction documents, including a trust deed, to give comfort to the parties in joint ventures for the development of real estate. STL won the Trustees of the Year 2018 at the Business Day Banking and Financial Institutions Awards, Trustee Firm of the Year 2018 at the Nigeria Finance Innovation Awards and Non-Interest Trustee of the Year 2017 at the African International Conference on Islamic Finance. Source: STL Trustees (2018).

Asset management 247

Corporate trust services are provided in various forms. A security trust can be created to secure a bond or other debt security to ensure that bondholders are covered in the event of default on the issue. A syndicated loans finance trust involves creating and executing a security trust deed over all the secured assets, handling title and security registration, holding assets used as collateral and executing the instructions of the secured creditors. Corporate trust services provide trust for nominee services, where a person appoints or nominates another person – the nominee – to act in his or her stead through a trust instrument between the parties. A debenture trust deed must be created by a company offering a debenture to the public for subscription. Corporate trust services extend to providing trust services for employee share ownership schemes (ESOSs) designed to motivate employees. A company can create a share warehousing trust, which transfers all or some of its shares to a trustee for the benefit of the beneficiaries named in the trust deed. Public trust comes in different forms such as serving as trustees to government bonds, endowment/foundation management and collective investment schemes such as mutual funds and unit trust schemes. By regulations of the SEC aimed at protecting the investing public, trustees are typically appointed for collective investment schemes. The trustees monitor the activities of the fund managers to ensure compliance with the prospectus, relevant regulations and the trust deed. Trustees to bonds issued by states and federal governments manage the sinking fund, hold bond security, maintain a list of bondholders, and perform other administrative functions relating to the bonds in accordance with the stipulations of the trust deed. Future directions

The asset management industry in Nigeria is still embryonic, with mutual fund assets, for example, at less than 3 percent of GDP.The industry is highly concentrated with the Top four asset managers accounting for four-fifths of total AUM. Three groups of asset managers with different comparative advantages and value proposition have pulled away from the competitors. The first consists of assets managers that are part of financial holding companies such as Stanbic IBTC and FBN Quest, which together account for two-thirds of AUM in the industry. These firms depend on the integrated business, extensive branch networks and distribution channels of their parent company to gather and manage assets. The second group are the likes of ARM, an independent investment firm, and FSDH, a merchant banking group that is client-centric and providing alternative investment assets class and superior service delivery. The third cluster consists of assets managers, such as Vetiva, providing innovative products including ETFs to clients. Most of the other asset managers compete for assets at the bottom. There are secular trends that favour the long-term attractiveness of the industry: demographic change, economic growth, financial inclusion, anti–money laundering regulations and innovation. Rising working-age population and growing entrepreneur in an expanding economy would bolster wealth creation.

248  Managing capital in frontier markets

There are also challenges. As observed in Chapter 1, gross national savings as a percentage of GDP, at less than 15 percent, have been relatively low in the past few decades with as a result of low per capita income. Nevertheless, the private sector still accounts for more than 90 percent of the total savings.The growth of money market instruments would create competition for the banking industry. The increasing attention to financial literacy and financial inclusion bode well for the industry as well. There is anecdotal evidence indicating that wealthy Nigerians prefer to use foreign assets managers for private banking and wealth management. A favourable macroeconomic, business and financial environment would go a long way to improving confidence in wealth management in Nigeria. At the same time, anti-money regulations at both home and abroad may also encourage the growth of domestic asset management industry.

Bibliography Agbor, D., F. Elias-Adebowale and C. Sijuwade. (2016), Nigeria in Dickson, the Asset Management Review, 5th edition. London: Law Business Research Ltd Cap Gemini. (2018), World Wealth Report. www.worldwealthreport.com/download/ [Accessed 15 November 2018] Euromoney. (2017), Private Banking and Wealth Management Survey 2017: Full results. https://www.euromoney.com/article/b12khp80m17vdy/private-banking-andwealth-management-survey-2017-full-results?copyrightInfo=true FBN Quest Asset Management. (2018), Our Mutual Funds. https://buildingtogether.fbnquest.com/product.phpInternational Banker. (2014), Africa: The Most Promising Private Banking Market. https://internationalbanker.com/banking/africa-promising-privatebanking-market/ [Accessed 10 October 2018]. IPE. (2018), Top 400 Asset Managers. https://www.ipe.com/Uploads/y/f/g/IPE-Top400-Asset-Managers-2018.pdf [Accessed 10 October 2018]. Knight Frank. (2018), The Wealth Report. www.knightfrank.com/wealthreport [Accessed 15 November 2018] National Bureau of Statistics (NBS). (2018b), Nigeria’s Gross Domestic Product Statistics for H2 2018 NSE. (2018), NSE Rules Book PwC. (2016), African Wealth Report. www.pwc.com/ng/en/assets/pdf/african-wealthreport-speech.pdf [Accessed 15 November 2018] SEC. (2018), SEC Database, website STL Trustees. (2018), Corporate Profile Vetiva. (2018), Sector Series ETFs, www.vetiva.com/funds. WillisTowersWatson. (2017), The World’s 500 Largest Asset Managers, https://www.willis towerswatson.com/-/./The-worlds-500-largest-asset-managers-year [Accessed 10 October 2018].

14 Pension management

Principles A pension or retirement plan is an arrangement that provides individuals with a steady income in retirement. There are different types of pension plans. There are public or state pension plans, which provide social security in the form of minimum payment to elderly people.The state plans are typically PAYG system, which provides pensioners income from social security taxes that are deducted from the income of actively working regular employees or self-employed individuals. The social security pension schemes in advanced countries face problems relating to ageing population, a generous public pension payment, and the PAYG system. Mandatory pension plans require an employer and employees of a private or public organization to contribute to a pension fund during the working years of the employees, with the objective of paying benefits, to the employees, upon retirement. Some mandatory plans may include only one or the other contributing, not necessarily both. Contributions made, under this arrangement, are invested in line with the prevailing investment guidelines, typically in capital markets and other investment vehicles. In some cases, there is a voluntary pension pillar which encourages Contributors to top up their pension savings with discretionary amounts within allowable limits. The operations of pension plans can be categorized as defined benefits (DB) or defined contributions (DC). Under a DB arrangement, the employer bears all the funding risk and pensions are typically paid in line with a predetermined vesting arrangement, as employees are promised specific amounts of benefits upon retirement, based on a formula that takes into consideration the number of years of service and salary history. The employer/plan sponsor would absorb the investment risks of investing its contributions and make up the shortfalls that may arise from insufficient funds for benefits payments as they come due. The plan may be underfunded or overfunded, depending on the market value of the assets relative to the liabilities of the plan, at any given point in time. In the case of DC pension plans, both employees and employers contribute specific ratios of the earnings of the employees to a pool of funds. Benefits received by the employees would fluctuate with the performance

250  Managing capital in frontier markets

of the invested funds. Employees, therefore, bear the investment risks associated with the funds, and may therefore prefer their pension contributions invested in funds aligned with their risk profiles. With the DC pension plans, the value of the assets would equal the value of the liabilities from retirement benefits. As a result, the issue of underfunded or unfunded benefits does not arise.

Practice Global pension assets

Overall, DC plans reduce the risks for employers, as sponsors, while providing more flexibility to employees in investment decisions. As a result, since the 1980s, there has been a shift from DB plans towards DC plans as employers tried to limit pension liability. The OECD (2017) provides a taxonomy of different types of pension arrangement available across the OECD countries and in other selected countries. DB plans are still predominantly operated in Germany, Switzerland and Finland, while the majority of OECD countries, including the United States, Canada, France, Japan and the United Kingdom now operate both DB and DC plans. Within a broad universe of global 300 pension funds, North America had the largest AUM, accounting for 42.3 percent of all assets, while Europe and AsiaPacific AUM represents 26.5 percent and 27.3 percent, respectively, according to Thinking Ahead Institute (2018).The United States accounted for 133 of the funds, about 44 percent in the ranking. Sovereign and public-sector pension funds accounted for over two-thirds of the total assets, with 144 funds in the top 300. DB funds accounted for 64.7 percent of the total assets in the ranking. The global pension assets of the largest 22 markets have been estimated to be US$41.3 trillion or two-thirds of global GDP in 2017. The United States is the largest pensions market (over $25 trillion), more than half of total global assets, followed by the United Kingdom and Japan. These three countries together account for more than three-quarters of all pension assets among the 22 countries reported. Australia, Canada, Norway, the Netherlands, Switzerland and South Korea round up the top eight largest pension assets in the world. Over the last decade, pension assets grew very fast in countries such as Hong Kong (8.1 percent), Chile (6.3 percent) and Australia (5.9 percent) in USD terms. The highest ratio of pension assets to GDP (194 percent) was in the Netherlands. Other countries with high ratios of pension assets to GDP include Australia (138 percent), Switzerland (133 percent), the United States (131 percent) and the United Kingdom (121 percent). The top 10 pension funds in Japan account for two-thirds of total assets compared to only 8.6 percent in the United States and 16.8 percent in the United Kingdom. The Government Pension Investment Fund in Japan has

Pension management 251

more than $1.2 trillion in assets. In the United States, the Federal Retirement Thrift, the California Public Employees Retirement System, the California State Teachers Retirement System and the New York State Common have a combined total of $1.18 trillion in assets. The Government Pension Fund of Norway has assets worth $890 billion. South Korea, China, the Netherlands, Canada and Singapore are among the countries with large government pension funds. Since 1997, pension fund managers have increased their allocations to alternative investments, including real estate, from 4 percent to 25 percent while reducing allocation to traditional securities of bonds and equities and cash. Nevertheless, the allocation to domestic bonds has remained high at 76.6 percent in 2017. On average, the top 20 funds invested approximately 42.1 percent of their assets in equities, 36.9 percent in fixed income securities and 21.0 percent in alternatives and cash (Thinking Ahead Institute, 2018). North American funds have predominantly invested in equities while there was a higher preference for fixed income in Asia-Pacific funds. Nigeria’s pension industry History of pensions in Nigeria

Modern formal public pension schemes in Nigeria commenced during the colonial period in 1946 with the introduction of a superannuating (pension) scheme for African employees of the colonial government.1 According to Abdul Azeez (2014), the Pension Ordinance of 1946 contained key information about the public-sector pension scheme, which includes the identification of who a native administration servant is, the nature of pensions and gratuity benefits and eligibility conditions; the minimum annual salaries that qualify for either pension and gratuity or gratuity alone; and rules on misconduct leading to a reduction in or outright forfeiture of benefits entitlements. Pension schemes and other benefits were also set up for employees of government corporations and parastatals. However, the funding modalities varied with non-contributory funded schemes and an applicable rate at 2.5 percent of the salaries of the employees. Railway Corporation and National Electricity Commission (now Power Holding Company of Nigeria), and the Nigerian Ports Authority were among the government parastatals that set up pension schemes. In 1979, the federal government introduced a PRA, which built on the recommendations of the Udoji Public Service Review Commission of 1974. The 1979 Pensions Act (No. 103) realigned the pension, disability benefits and gratitude scales for the armed forces, public service organizations and the pensions schemes operated at the state level with core civil service. Local government system also established pension schemes for its staff, with a separate board known as the local government pension board.

252  Managing capital in frontier markets

The Nigerian Breweries pioneered the first private-sector pension scheme in Nigeria in 1954. The private-sector pension scheme for the United African Company (UAC) was created in 1957. In 1961, the National Provident Fund (NPF) was created was for the non-pensionable private-sector employees. In 1993, newly created Nigeria Social Insurance Trust Fund (NSITF) took over the NPF Scheme with the objective of providing an enhanced pension scheme to private-sector employees. Pension reforms and regulations

The pension schemes in Nigeria up to 2004 faced several challenges. Budgetary allocations for pensions by both the federal and state governments were inadequate to cover the benefits for pensioners. According to Abdul Azeez (2014), in fiscal year 2001, there was a shortfall of ₦4.3 billion, more than two-thirds of the amount required to pay ₦6.4 billion in pensions to military personnel. There was poor record keeping of actual pensioners, breeding corruption within the system. There were also disbursement flaws. In 2004, a comprehensive PRA was passed in Nigeria. The PRA 2004 was, however, repealed and replaced in 2014. The PRA 2014 governs pension funds asset management in Nigeria.The act is applicable to persons in the permanent employment of the public sector and the private sector with three or more employees. A private firm with fewer than three employees can still opt to participate in the scheme. The PRA requires private- and public-sector employers to make contributions towards the pension savings of all employees while establishing a scheme for the payment of retirement benefits. The PRA provides every employee with the flexibility to choose a pension fund administrator (PFA) and maintain a retirement savings account (RSA). The employee is expected to maintain only one RSA and is responsible for notifying the employer with his or her RSA details. The custodian is responsible for receiving and warehousing pension contributions from employers on behalf of employees. Upon receipt of contributions, they also notify the PFA, who subsequently credits the RSA of such employee. The rates of contribution to the RSA by the employee and the employer are specified in section 4 (1) of the PRA 2014. However, these rates of contribution may upon agreement of the employer and the employee be revised from time to time and notice of such revision shall be given to PENCOM. Each organization with at least three employees is required to contribute a minimum of 18 percent of the monthly salary of each employee to be paid to a PFA of the employee’s choice. The employer contributes a minimum of 10 percent and the employee contributes 8 percent of the salary. The employer can choose to contribute the entire 18 percent of the employee’s salary. The employer shall deduct at source the monthly contribution of the employee and remit an amount comprising the employees’ and employers’ contribution to the custodian, appointed by the PFA, of the employee no later than seven working days from the day the employee is paid.

Pension management 253

Connecting principles to practice Box 14.1  Nigeria’s Pension Reform Acts The 2004 Pension Reform Act (PRA) repealed all existing pension schemes, replaced the Nigeria Social Insurance Trust Fund (NSITF) with a contributory pension scheme for any employment in Nigeria and introduced privately managed pension scheme. The PRA of 2004 transformed the pension industry in Nigeria from a largely voluntary, defined-benefits and unfunded pay-as-you-go system to a mandatory, defined-contribution and fully funded system. The PRA governs pension asset management in Nigeria. The act requires private and public sectors’ employers to make contributions towards the pension savings of all employees while establishing a scheme for the payment of retirement benefits. The PRA of 2004 established the National Pension Commission (PENCOM), with the overall supervisory and regulatory framework for pension in Nigeria. It was replaced with PRA 2014 which strengthened the powers of PENCOM and addressed issues of pensions of political office holders and professors. The new act provided incentives that allow individuals to make equity contribution towards owning a residential property from a portion of their retirement savings accounts (RSAs). To be licensed to carry on the business of a PFA in Nigeria, the organizations shall satisfy all requirements prescribed by the PRA 2014, other relevant laws or any such additional requirements or conditions as may be prescribed from time to time by PENCOM. The minimum paid-up capital requirement, at the inception of the scheme, was ₦150 million but was increased to ₦1 billion in 2011. PENCOM released its Regulations in 2010 and further revised in 2012, which govern the investment of pension fund assets in various asset classes. The key provisions of the Regulations cover the authorized markets, allowable instruments, quality of instruments, conflict of interest issues, investment limits, performance benchmark, violation of investment limits, closed pension funds and approved existing schemes. With the objectives of ensuring the safety of investment, PFAs are prohibited from borrowing or lending pension fund assets. In 2017, a new multi-fund investment structure, which is described in more detail in the following, was introduced by PENCOM. (PENCOM, 2018)

Major players under the new pension scheme

As of 2018, major players in the New Pension Reform Scheme include 21 PFAs, 4 pension fund custodians (PFCs), 7 closed PFAs and 19 approved

254  Managing capital in frontier markets Table 14.1 Number of pension operators in Nigeria Pension Operators

2011

2012

2013

2014

2015

2016

Pension Fund Administrators Pension Fund Custodians Closed Pension Fund Administrators Approved Existing Schemes Total

24 4 7 19 54

20 4 7 19 50

20 4 7 19 50

21 4 7 19 51

21 4 7 19 51

21 4 7 19 51

Source: PENCOM (2016).

existing schemes, respectively (Table 14.1). PFAs are limited liability companies duly licensed by PENCOM to carry out pension business only.The PFAs open RSAs account for employees, manage pension funds as the commission may from time to time prescribe and maintain books of accounts on all transactions relating to pension funds under their management. PFAs appoint PFCs to warehouse pension assets. Employers send contributions directly to the custodian, who notifies the PFA on receipt, and the PFA subsequently credits the RSA of the employee. The custodian would execute transactions and undertake activities relating to the administration of pension fund investments upon instructions by the PFA. The PRA 2014 has foreclosed new entrants as closed pension funds administrators (CPFAs) and no longer licenses CPFAs. Commencing 1 July 2014, all new employees of the sponsor companies are required to join the contributory pension scheme (CPS) and open RSAs with a PFA of their choice. Furthermore, an existing employee with CPFAs still reserves the right/option of pulling out of the CPFA to join the CPS. Pension fund RSAs and assets

The PRA of 2004 transformed the pension industry in Nigeria from a largely voluntary defined benefits and unfunded PAYG system to a mandatory, definedcontribution and fully funded system. The pension industry recorded a scheme membership of 8.2 million contributors as of August 2018. The private sector composes of more than half of RSAs membership, with a quarter from the federal public sector and a fifth from the state public sector (Table 14.2). The majority of RSA membership is concentrated among the 30–39 age group and the 40–49 age group; males account for more than two-thirds (71 percent) of the account owners, while female represent less than one-third of membership. Nigerian pension fund

The value of total pension funds under management increased from a deficit of ₦2.6 trillion ($16.3 billion) in 2004 to a surplus of ₦7.9 trillion ($22 billion) in 2017 (Figure 14.1). Between 2011 and 2017, AUM grew at a compound

Pension management 255 Table 14.2 RSA registrations by age and sector as of second quarter 2018 Age Range Public sector

Less than 30 yrs 30–39 yrs 40–49 yrs 50–59 yrs 60–65 yrs above 65 yrs Total

Private sector

Total

Grand total

Male

Female

Male

Female

Male

Female

Number

%

93,204

48,679

417,798

213,298

511,002

261,977

772,979

9.50

717,634 646,414 560,772 206,97 93,897

358,983 397,127 321,365 83,123 25,931

1,395,235 935,732 481,383 130,750 72,786

548,534 268,352 95,408 16,251 7,249

2,112,869 1,582,146 1,042,155 337,047 166,683

907,517 665,479 416,773 99,374 33,180

3,020,386 2,247,625 1,458,928 436,421 199,863

37.12 27.62 17.93 5.36 2.46

2,318,218 1,235,208 3,433,684 1,149,092 5,751,902 2,384,300 8,136,202 100

Source: NBS (2018).

8,000

7,515

7,000 6,165

6,000

5,303

5,000 4,058

4,000

3,152

3,000 1,990

2,000 1,000

4,611

2,030

7.0% 6.0% 5.0% 4.0% 3.0%

2,443 2.0%

1,530

815

1.0%

-

0.0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Total Asset (N'Billion)

Total Assets as a Percentage of GDP

Figure 14.1 Nigerian pension assets and ratio of GDP Source: NBS (2018).

annual growth rate of 20 percent. In spite of this recorded high growth rate, the ratio of pension assets to GDP is at 6 percent, much lower than the 16 percent in Kenya and the 52 percent in South Africa and considerably lower than the ratios recorded in Australia (160 percent), Switzerland (137 percent), the United States (136 percent) and the United Kingdom (117 percent), as shown in Figure 14.2.

256  Managing capital in frontier markets

Figure 14.2 Ratio of pension assets to GDP Source: Thinking Ahead Institute (2017).

Pension industry concentration

The pension industry structure in Nigeria is highly concentrated. In 2017, the top three pension fund managers, by RSA membership, were Stanbic IBTC Pension Managers, Premium Pensions and ARM Pension Managers, with 21 percent, 9.8 percent, and 8.5 percent of shares, respectively, of the total 7.9 million RSA holders. They accounted for nearly four out of 10 RSAs. The top three and five PFAs accounted for more than half the total and twothirds of RSA assets at 54 percent and 67 percent, respectively, at the end of the fourth quarter of 2017. The top 10 PFAs managed 88 percent of the total RSA assets at the end of the reporting period. Stanbic IBTC, which had a quarter of the RSA holders, accounted for more than one-third (37 percent) of the total pension AUM, nearly the same as the AUM of the next six PFAs. ARM Pensions Managers came second with 8.8 percent of the total AUM, with Premium Pensions ranking third with

Pension management 257

8.2 percent of the total AUM. Other pension managers are AIICO, AXA Mansard Pensions Ltd, Crusaders-Sterling Pensions Ltd, Leadway Pensure, Sigma and NPF Pension Managers. PFAs products include retirement savings account, voluntary contribution, defined benefit scheme management, benefits administrations and payment and retirement planning and advisory services. Pension funds investment

Pension regulations have prescribed restrictions for PFAs on the various asset classes that they may invest in. PFAs can invest in equity instruments through public offerings approved by the SEC and those trading on the floor of the NSE, with certain requirements. PFAs investments in State and corporate debt instruments must be through public offerings or private placements approved by the SEC. PFAs do not have restrictions in investing in bonds and debt instruments issued or fully guaranteed by the federal government, the CBN or eligible multilateral development finance organizations (MDFOs). Table 14.3 PFA concentration as of 31 December 2016 Name of PFA

1 2 3 4 5 6 7 8

AIICO Pension APT Pension ARM Pension AXA Mansard Pension Crusader Sterling Pension Fidelity Pension 1.99 First Guarantee Pension Future Unity Gianvills Pension IEI-Anchor Pension IGI Pension Investment One Pension Leadway Pensure Legacy Pension NLPC Pension NPF Pension Oak Pension Pension Alliance Premium Pension Sigma Pension Stanbic IBTC Pension Trust Fund Pension

9 10 11 12 13 14 15 16 17 18 19 20 21 Total Total (Numbers)

Source: PENCOM (2016).

RSA registration

Contribution

Assets

(%)

(%)

(%)

2.81 1.48 8.65 0.87 3.65 0.74 3.13 1.52

1.60 0.61 8.62 0.31 3.11 0.80 3.30 0.87

1.42 0.73 8.82 0.27 3.11 2.77 0.90

1.35 0.06 0.81 6.80 4.71 3.41 3.32 2.43 6.14 7.99 8.79 20.92 9.18 100 7,348,028

0.57 0.02 0.15 4.87 4.07 2.86 6.07 1.47 5.06 9.51 5.42 33.88 7.11 100 3,918,959.20

0.54 0.03 0.14 4.76 3.04 3.21 6.04 1.24 4.71 8.17 5.61 37.21 6.49 100 4,537,505.54

Table 14.4 Ranking of PFA by asset size as of Q1 2018 PFA Rank Q2 2017

Q3 2017

Q4 2017

Q1 2018

Amount % of Total Amount % of Total Amount % of Total Amount % of Total (₦ billion) RSA (₦ billion) RSA (₦ billion) RSA (₦ billion) RSA Assets Assets Assets Assets Top 3 2,767.3 54.3 Top 5 3,397.4 66.7 Top 10 4,486.1 88.1 Bottom 3 22.7 0.5 Bottom 5 90.3 1.8 Bottom 10 453.6 8.9

2,897.6 54.1 3,573.1 66.8 4,712.5 88.1 22.4 0.4 94.0 1.8 476.1 8.9

3,038.2 54.0 3,751.3 66.6 4,954.2 88.0 26.3 0.5 102.5 1.8 504.4 9.0

3,221.3 54.2 3,972 66.8 5,232.7 88 27.9 0.5 109.4 1.8 530.5 8.9

Source: NBS (2018).

Table 14.5 Pension funds investment allocation and performance Asset Class

Total pension fund assets 30-Jun-18 ₦ (billion)

Weight (%) ₦ Billion

Domestic 709.511 8.62 Ordinary Shares Foreign Ordinary 61.36 0.75 Shares FGN Securities: 5,823.97 70.75 FGN Bonds 4,040.31 49.08 Treasury Bills 1,709.20 20.76 8.35 Agency Bonds 0.10 (NMRC & FMBN) Sukuk Bonds 58.36 0.71 Green Bonds 7.75 0.09 State Govt. 151.95 1.85 Securities Corporate Debt 408.69 4.96 Securities Supranational 8.28 0.1 Bonds Local Money 736.55 8.95 Market Securities Foreign Money 0.22 0 Market Securities Mutual Funds: Open/Close-End Funds REITs

Total pension fund assets 31-Mar-18

Variance between March 2018 and June 2018

Weight (%) ₦ (billion) Weight (%)

734.51

9.25

(25.00)

(8.66)

60.81

0.77

0.55

0.19

5,591.66 3,861.08 1,661.19 5.8

70.39 48.61 20.91 0.07

232.31 179.23 48.01 2.55

80.45 62.07 16.63 0.88

55.57 8.02 161.43

0.70 0.10 2.03

2.79 (0.27) (9.48)

0.97 (0.09) (3.28)

390.84

4.92

17.85

6.18

7.37

0.09

0.91

0.32

651.82

8.21

84.73

29.34

0

0.22

0.08

0

19.91 10.39

0.24 0.13

19.22 9.45

0.24 0.12

0.69 0.94

0.24 0.33

9.52

0.12

9.77

0.12

−0.25

−0.09

Pension management 259 Asset Class

Total pension fund assets 30-Jun-18 ₦ (billion)

Real Estate Properties Private Equity Fund Infrastructure Fund Cash & Other Assets Net Assets Value

Total pension fund assets 31-Mar-18

Weight (%) ₦ Billion

Weight (%) ₦ (billion) Weight (%)

233.07

2.83

38.39

0.47

27.59

0.35

11.37

0.14

7.99

0.1

29

0.35

59.76

0.75

8,232.27

100

230.5

7,943.50

Variance between March 2018 and June 2018

2.9

100

2.57 10.8

0.89 3.74

3.38

1.17

−30.76

−10.65

288.771

100

Source: NBS (2018).

PFAs can invest in the units of open-ended, closed-ended, hybrid investment funds, ETFs, through public offerings or private arrangements. Trading of pension fund assets must be through a securities exchange recognized by the SEC or a trading facility recognized by the CBN. PFAs can also invest in SEC-approved eligible securities of Nigerian corporate bodies that are listed or quoted on an offshore securities exchange. They can also invest in Eurobonds and global depository receipts (GDRs) issued by listed Nigerian companies that are certified and approved by the SEC. PENCOM regulations for specialist and alternative investment classes are even more stringent. PFAs can invest in private equity (PE) funds, whose managers are licensed by the SEC. The PE funds must have well-defined and publicized investment objectives and strategies. The pricing of underlying assets of the PE funds must be disclosed. The manager can subscribe to a minimum of 1 percent of the fund MDFOs are co-investors or 3 percent otherwise. The PE fund must invest a minimum of 60 percent of its assets in companies or projects within Nigeria, with satisfactory predefined liquidity or exit routes. The investing requirements in infrastructure funds are broadly similar to those for PE funds. However, the infrastructure funds should have a minimum value of ₦5 billion and key principals must give a minimum of 90 days’ notice to PENCOM through the relevant PFAs before exiting the funds. In the case of REITs, the value should be a minimum of ₦1 billion, with a minimum of BBB rating. The promoters of a REIT should have at least 5 percent subscription to the REIT. Pension fund assets have typically been invested predominantly in federal government securities, which grew steadily from 52 percent in 2013 to 70.6 percent of total assets, and stood at ₦5.5 trillion as of December 2018. Quoted equity and money market securities accounted for 9.4 percent and 8.1 percent of the total investment instruments, respectively. FGN securities,

260  Managing capital in frontier markets

equity and money markets together made up 88 percent of the total investment of pension funds. Corporate debt made up only 4 percent of the investment instrument. Alternative investments including real estate, infrastructure and PE have been very insignificant in the portfolio of pension funds, having accounted for 2.7 percent, 0.1 percent and 0.4 percent, respectively. Investment in foreign equity and money market instrument accounted for 1.43 percent. Pension fund investment in infrastructure asset class more than tripled from ₦2 billion in 2015 to ₦8 billion in 2017, accounting for a mere 0.1 percent of total assets in spite of the huge infrastructure financing requirements in the country. Up to 15 percent of total assets or presently ₦2 trillion can be allocated to infrastructure assets class instruments. Multi-fund investment structure

In April 2017, PENCOM issued an amended Regulations, which replaced the 2012 Regulations. The new Regulations introduced a multi-fund investment structure (MFIS), which has the objectives of improving asset-liability risk management of pension funds, better aligning the risk and return profiles of contributors and enhancing the diversification of pension fund portfolios. The MFIS classifies different assets categories for the placement of RSA funds based on the age, work status and risk exposure of the contributors. The MFIS has four different categories: Fund 1, Fund 2, Fund 3 and Fund 4 (Table 14.6). Fund 1 is the most aggressive portfolio, targeted at people of 49 years and younger who willing to accept higher risks for higher returns and who, in the quest for higher returns, are willing to take more risks. Fund 2 also targets the same age bracket as in Fund 1, but with a moderate risk–return profile. Fund 3 targets people 50 years and older with very low risk appetite. Fund 4 is the most conservative portfolio aimed at retirees, with the lowest risk profile of all categories. The MFIS broadly classifies assets classes into variable income instruments and fixed income instruments. The variable income instruments are infrastructure Table 14.6 Multi-fund structure investment limits

Government Securities Money Market Corporate Debt Supranational/Sukuk Ordinary Shares Infrastructure Funds PE Funds Open/Closed Funds Source: PENCOM (2017).

Fund 1

Fund 2

Fund 3

Fund 4

RSA Retiree

RSA Active

60% 30% 35% 20% 30% 10% 10% 25%

70% 30% 40% 20% 25% 5% 5% 20%

80% 35% 45% 20% 10% 0% 0% 10%

80% 35% 45% 20% 5% 0% 0% 5%

80% 35% 35% 20% 10% 0% 0% 0%

80% 35% 35% 20% 25% 5% 5% 20%

Pension management 261

funds, PE funds and REITs, with higher risk–return profiles. The traditional fixed income instruments include TBs, government bonds and money markets. The maximum exposure to variable income instruments by funds is Fund 1 (75 percent), Fund 2 (55 percent), Fund 3 (20 percent) and Fund 4 (10 percent), while the minimum exposures to variable income instruments will be 20, 10, 5 and 0 percent, respectively. Future prospects

In spite of pension reforms and the growth of pension assets in the last decade and a half, the pensions industry in Nigeria is still in its infancy. As earlier observed, pension assets relative to GDP at 6 percent is one of the lowest in the world. There is a demographic and economic impetus for accelerating the growth of the pension industry, with a population expected to double by 2050. However, the high employment rate, especially among the youth, may constrain the growth of income and pension contributions. As Nigeria has a large informal sector, it is important to encourage voluntary contributions and selfdirected pension schemes among the self-employed.

Note 1 See Abdul Azeez (2014) for more detailed history of pension scheme in Nigeria.

Bibliography Abdul Azeez, N. (2014), Pension Scheme in Nigeria: History, Problems and Prospects, Arabian Journal of Business and Management Review, 5(2) Andrews, E. (2006), Pension Reform and the Development of Pension System: An Evaluation of World Bank’s Assistance Blinder, A. (1982), Private Pensions and Public Pensions: Theory and Fact. NBER Working Paper No.902, June 1982. www.nber.org/papers/w0902 Muller, K. (2003),The Making of Pension Privatization in Latin America and Eastern Europe, in Holzmann, R., M. Orenstein and M. Rutkowski (eds.), Pension Reforming Europe: Process and Progress, Washington DC: The World Bank NBS. (2018), Pension Asset and Membership Data Q2 2018 National Pension Commission (PENCOM). (2004), Pension Reform Act 2004 National Pension Commission (PENCOM). (2014), Pension Reform Act 2014 National Pension Commission (PENCOM). (2016), Annual Report National Pension Commission (PENCOM). (2017), Pension Reform Act 2017 Nwoji, E. (2018), Stanbic IBTC Pension Assets Hit N2.53tn. www.thisdaylive.com/index. php/2018/05/31/stanbic-ibtc-pension-assets-hit-n2-53tn/ [Accessed 31 May 2018] OECD. (2017), Pension Market in Focus. www.oecd.org/pensions/private-pensions/Pension-Markets-in-Focus-2017.pdf The Thinking Ahead Institute. (2018), Global Pension Asset Study – 2018. www. thinkingaheadinstitute.org/en/Library/Public/Research-and-Ideas/2018/02/ Global-Pension-Asset-Survey-2018

15 Securities brokerage

Principles Securities business comprises equity and fixed income brokering, sales of securities, equity and fixed income research. Investment banks have a brokering division which facilitates financial market trading of securities between buyers and sellers for a commission, as well as for its own proprietary account. Securities business engages in securities valuations and research to assist clients in making decisions about trading in securities. There is a synergy between securities business and investment banking. In underwriting issues in the primary market, the brokering division can provide a pool of potential investors that may be interested in the securities. The sales team can enhance the marketing of new issues. The research unit analyses the issue and makes necessary recommendations on its merits.

Securities valuation There are two basic approaches to security valuation: fundamental analysis and technical analysis. The technical and fundamental methods are not mutually exclusive.The fundamental analysis can be used to identify undervalued securities, while the technical analysis may assist in determining entry and exit point for the securities. Fundamental analysis

Fundamental analyses make use of the financial statements of a company to determine the fair value of the business while taking a long-term perspective to investing. Fundamental securities analysis includes the following; balancesheet asset-based methods, market-based analysis and DCF method (Pinto et al., 2015). In Chapter 10, these fundamental analyses have been discussed in the context of the valuation of companies for M&A. Some of the fundamental tools are relevant for valuing securities for stock trading.

Securities brokerage 263 Technical analysis

Technical analysts are interested in analysing the trends and movements of the price of a security based on the assumption that all publicly available information is already reflected in the price of a security (McMillan et al., 2011). Technical analysts believe that market sentiments influenced by demand and supply determine the price trend for a security, including stocks, fixed income, currencies, commodities and futures. Technical analysts use statistical techniques such as charts and indicators to analyse the historical price and volume data of a traded security and identify patterns for future investment decisions.1 Technical analysts believe the market already discounts all factors, which are reflected in the prices of securities. The analysis focuses on short-, medium-, and long-term trends in price movements. Market psychology based on fear or greed of investors tends to be repetitive leading to predictable historical trends in price movements.Technical analysis is often used for short- to medium-term trading of securities. Charts and trends

The most fundamental parts of technical analysis are charts, which are represented graphically by a series of prices over a set time frame. The period can be intraday, daily, weekly, monthly, quarterly and annually. The most common charts are line charts, bar charts, candlestick charts, point charts and figure charts. Chart patterns provide the big picture that can identify signals for future price movements in securities trading. In technical analysis, a line is added to charts in order to discern trends such as uptrends, downtrends and sideways trends. Channels are two parallel trendlines that act as strong areas of support and resistance over time. Support is the price level where a stock or market seldom falls, while resistance is the price level where a stock market seldom surpasses. Volume is the number of shares of contracts that trade over a given period, with higher volume representing more activity. Moving averages

Moving averages show the average of past price movement of a security over a given timeframe such as 200, 100, 50, 20, and 10 days. The 200-day moving average provides a good yardstick for measuring for price movements over a 1-year period, while the 50-day moving average covers a shorter timeframe. Technical traders analysing securities use moving averages to obtain a clearer picture of past trends by smoothing out the noise arising from day-to-day movements of prices. Moving averages can be used to identify trends, strength or resistance levels and specific trading signals for reversals or breakouts. Multiple moving averages

264  Managing capital in frontier markets

can be used to determine short-, medium- and long-term trends. A bullish signal is generally perceived when the long-term moving average is below a short-term moving average. The term death cross” is used for bearish signal to describe a situation when the short-trend measure by a stock’s 50-day moving average cross below the long-term trend 200-day moving average.

Practice Securities trading

The securities trading business, a low-margin business, is typically divided into three categories: institutional sales and trading, retail trading and fixed income trading. There is intense competition in the institutional sales trading with entrants of new foreign players such as Rand Merchant Bank (RMB), Barclays ABSA, EFG Homes, Pictet and a few others. In retail sales trading, improved financial literacy and awareness have increased the trading visibility of trading securities. Retail stockbroking is increasingly driven by improvements in technology, which is boosting online trading platforms (Box 15.1).

Connecting principles to practice Box 15.1  Meristem Stock Brokers Limited Meristem Stockbrokers Limited (MSBL) is a wholly owned subsidiary of Meristem Securities Limited (MSL). MSBL is a member of the Nigerian Stock Exchange (NSE) and is licensed by the Securities and Exchange Commission (SEC) in Nigeria. As a brokerage firm, MSBL provides holistic stockbroking and research services to a wide array of clients across the African continent, Europe and the United States. MSBL has consistently ranked amongst the top 10 leading brokerage firms in the Nigerian Capital Market since 2008. MSBL has successfully acted as the Stockbroker and Broker-Dealer to major primary and secondary markets transactions in the Nigeria Capital Market. MSBL received the Stockbroker of the Year award at the 2018 Business Day Banking and Financial Industry awards and the Digital Broker of the Year. Among its leading products are MeriTrade and Meriboss. MeriTrade is the first Nigerian online stock trading platform which allows users to buy and sell stocks on the NSE on the go from the comfort of their homes, offices and so on.The platform redefines the stockbroking experience in Nigeria and sub-Sahara Africa (excluding South Africa) in an entirely different language and creates a world-class experience. Meriboss is a robust capital market agency platform that enables brokers, sub-brokers, corporate and individual investment advisers, fund managers

Securities brokerage 265

and other registered capital market operators register to do capital market transactions and execute brokerage and client management activities, online and in real time from any internet-enabled device anywhere in the world. The platform allows brokers and other agents to place a mandate for clients to buy and sell shares, receive real-time updates and feedback on clients’ transactions to have a global status of clients’ portfolio position while updating clients’ account and contact information. Source: Meristem (2018).

Cross-border listing and trading service

Cross-border listing refers to the listing of securities issued by a foreign issuer on a domestic securities exchange. The foreign issue may be listed on its home exchange or on more than one exchange in several different countries. It may also take the form of a depository receipt to minimize transaction costs and increase settlement efficiency. Cross-border trading refers to the trading of securities in a foreign market. Investors can simply open an account with a foreign broker in a foreign country and place orders directly.They may also choose a local broker (Box 15.2).

Connecting principles to practice Box 15.2  Ecobank Securities Limited EDC Securities Limited (also known as Ecobank Securities Ltd or ESL) is a limited liability company with ownership spread across investors groups with a majority shareholding by Ecobank Transnational Incorporated (ETI) through its subsidiary – Ecobank Development Corporation (EDC) – and minority shareholdings by private and institutional entities. Established in June 1989 as Ecobank Securities Limited, it is a member of the Nigerian Stock Exchange (NSE) and licensed by the Securities and Exchange Commission (SEC) in Nigeria, NASD-OTC and FMDQ-OTC Securities Exchange. ESL has footprints across West Africa and is currently the only one-stop shop for easy access to all the major stock exchanges in the region. The company’s product offerings include equity and fixed income trade execution, corporate brokerage and financial advisory services. It also offers cross-border dealing services and online real-time direct

266  Managing capital in frontier markets

market access to customers in Nigeria, Ghana, Cote d’Ivoire and few other West African countries. Cross-Border Trading Services: ESL provides cross-border trading services through its membership in other foreign exchanges and acts as an agent for a foreign broker. Some shares currently listed on the NSE that can be traded cross-border are ETI, Oando PLC and Seplat PLC. Investors can buy these shares in one market and sell in another or vice versa. Cross-Border Listing Services: EDC Securities sponsored the first ever simultaneous listing of shares on three West African Exchanges including Ghana Stock Exchange (GSE), the NSE and BRVM (The Francophone Regional Securities Exchange) in 2006 when the shares of Ecobank Transnational Incorporated were listed. ESL has since become master of cross-border listing and trading of shares, offering a unique platform for securities arbitraging and fungibility. Ecobank Online Trading Platform: It is an easy-to-use technology that puts the ultimate power in the hands of users and allows them to enter and monitor trades without the need for a middleman or stockbroker. Investors can buy and sell shares from the comfort of their homes, offices, during vacation or while on the go. Source: EDC Securities (2018).

Market makers

Market makers contribute to the market quality on the secondary market of exchanges, where securities are traded as they provide improved liquidity and price efficiency, which enable investors to trade more efficiently and effectively in a timely manner. The NSE appoints some of its dealing members as market makers to enhance the market liquidity of a particular security in accordance with NSE rules. There are primary market makers and supplemental market makers. The NSE has also designated fixed income market makers, brokerdealers, DMO government brokers, and AMCON market makers. The market maker tries to maintain a fair and orderly market in its particular securities of responsibility and facilitate the buying and selling of the securities. Market making involves the act of entering bid and offer prices in the automated trading system for a specified security under the rules of NSE. Market makers profit by charging higher offer prices than bid prices. Over a period of 5 years, STANBIC, CSL, Chapel Hill, and FBN Quest have been consistently ranked among the top 10 brokers in Nigeria by volume and values. Other leading domestic brokers include Cardinal Stone, Cordros Securities and Meristem Securities Limited. Renaissance Capital

Securities brokerage 267 Table 15.1 Top 10 brokers by transaction values, 2012 Deali 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Total Top 10

ng members

Value market

Share (%)

Stanbic IBTC Stockbrokers Ltd Rencap Securities Ltd Vetiva Capital Management Ltd Chapel-Hill Denham Securities Ltd CSL Stockbrokers Ltd A.R.M Securities Ltd Meristem Stockbrokers Limited Cordros Securities Limited BGL Securities ltd GTB Securities Ltd

223,298,872,977 220,336,041,656 105,117,089,624 96,437,601,956

17.00 16.77 8.00 7.34

62,554,757,344 40,709,316,016 36,047,892,850 34,626,697,602 24,389,144,816 23,532,938,792 870,050,353,633

4.76 3.10 2.74 2.64 2.09 1.79 66.24

Source: NSE (2018).

Table 15.2 Top 10 brokers by transaction values, 2018 Dealing, embers

Value

Market Share (%)

1. Stanbic IBTC Stockbrokers Ltd 2. Rencap Securities Ltd 3. CSL Stockbrokers Ltd 4. EFCP Ltd 5. FBN Quest Securities Ltd 6. Cordros Securities Ltd 7. United Capital Securities Ltd 8. Chapel-Hill Denham Securities Ltd 9. Cardinal Stone Securities Ltd 10. Apel Asset Limited Total Top 10

324,938,692,027 203,085,059,354 171,861,121,068 140,623,901,351 71,084,910,842 46,637,728,006 40,095,371,379 37,699,168,191 37,191,822,561 26,690,637,852 .099.910.392.632

22.25 13.91 11.77 9.63 4.87 3.19 2.75 2.58 2.56 1.83 75.33

Source: NSE (2018).

(Rencap) and EFCP, two international investment banks, have also featured prominently among the top 10 brokers in recent years. Despite the large numbers of brokers, the top 10 brokerage firms accounted for two-thirds of the total value traded in 2012, which further increased to 75 percent in the first half of 2018. Foreign and domestic transactions

Over a period of 10 years, 2007 and 2017, foreign investors have become major players in the Nigerian capital markets. Foreign transactions driven by institutional foreign portfolio investors have accounted for half of the transactions trading on the stock exchange during this period. Over the same

268  Managing capital in frontier markets 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 -

2007

2008

2009

2010

2011 Domesc

2012

2013

2014

2015

2016

2017

Foreign

Figure 15.1 Foreign and domestic transactions trends, 2007–2017 (₦ billion) Source: NSE (2018).

period, domestic transactions have decreased by 63 percent from ₦3.556 trillion in 2007 to ₦1.335 trillion in 2017. Foreign transactions represented 44.5 percent in 2016, 47.6 percent in 2017 and 48.31 percent in the first half of 2018. The dampening in domestic participation has been due to the prohibition of margin trading and the inability of retail investors to recover for the 2008 burst. Largest stocks by market capitalization and volume traded

Dangote Cement Plc (DCP) is the most capitalized stock on the NSE, with a market capitalization of ₦3.5 trillion. DCP is Africa’s leading independent cement player with plant footprints in Nigeria, Ethiopia, Cameroun, Benin, Senegal and South Africa. It has grown rapidly with strategic acquisitions within Nigeria and Africa. It has more than 50 percent of Nigeria’s cement market share and owns the largest cement plant in sub-Saharan Africa. Guarantee Trust Bank (GTB) is the second-most capitalized stock on the NSE, with ₦1.1 trillion of market capitalization. GTB is one of the most respected banks in Nigeria, with the lowest-cost income ratio. It is a favoured stock among domestic and foreign investors. Four other banks – Zenith, First Bank Holding (FBNH), United Bank of Africa (UBA), and Access Bank – are among the top 10 league table both in terms of market capitalization and volume traded. Banks tend to dominate traded volume on the NSE. Three consumer stocks – Nestle, Nigerian Brewery, and Unilever – are also on the top 10 league table. Nestle has a market cap of ₦1.1 trillion. Seplat is the only stock in the oil and gas sector that features in the top 10 league table.

Securities brokerage 269 Table 15.3 Top 10 stocks by market capitalization and volume traded

Companies   1. Dangote Cement  2. GTB   3. Nigerian Brewery  4. Nestle  5. Zenith  6. SEPLAT  7. FBNH  8. Unilever  9. UBA 10. Access

Market Cap

Volume Traded

(₦ million)

(millions)

Q3 2018 3,493,304 1,075,710 731,717 967,128 734,768 370,720 319,468 287,951 287,275 235,763

Q3 2018 1,272 15,565 2,448 140 20,869 56 12,457 659 28,644 16,545

Source: NSE (2018).

Connecting principles to practice Box 15.3  CSCS: Securities Clearing and Settlement The Central Securities Clearing System (CSCS) PLC is the clearing and settlement house of the Nigerian Capital Market and the Nigerian Stock Exchange (NSE). The CSCS was incorporated on 29 July 1992 and commenced operations on 14 April, as financial market infrastructure (FMI) for the Nigerian Capital Market.The CSCS facilitates the delivery of securities transacted on the approved Nigerian exchanges. It enables securities to be processed in an electronic book–entry form thereby substantially reducing the period it takes a transaction to commence and end. The CSCS operates a computerized depository, clearing, settlement and delivery system for transactions in securities in the Nigerian Capital Market. The CSCS system operates a T + 3 settlement circle for transactions on the floors of the NSE in conformity with the practice in emerging markets.The T + 3 settlement circle is facilitated by the immobilization of share certificates in a central location, which, in turn, enables trades to be processed in an electronic book–entry form. In effect, physical delivery of share certificates to fulfil settlement obligations has been replaced by electronic credits and debits to shareholders stock position. CSCS also acts as sub-registry for Federal Government of Nigeria bonds and state and corporate debt instruments. It is equally a facilitator of the clearing and settlement of bonds and money market instruments traded on over-the-counter (OTC) markets (on NASD PLC and

270  Managing capital in frontier markets

FMDQ) and on the floor of NSE. In 2007 and 2009, the Central Bank of Nigeria (CBN) appointed CSCS as the clearing and settlement agent for OTC transactions in Nigerian treasury bills and commercial papers and of bankers’ acceptances, respectively. Source: CSCS (2018).

Research

Research is the backbone of the securities business. In Nigeria, research functional responsibilities tend to sit within the securities and brokerage subsidiary. The research function in investment bank covers global, regional and country macroeconomics. This also includes financial markets and financial instruments such as equity, debts, currency and commodities and sectors, industries and companies. Actionable research products often come with buy and sell ratings which assist traders with trading, clients with investment decision and investment banks in their capital raising and capital management activities. Economic research analysts provide macroeconomic, public policy, FX rate, commodities and interest rate forecasts. The products will include short-term daily, weekly, monthly, half-yearly and yearly commentaries. Economic research hardly covers long-term thematic ideas across developmental issues. First Securities Discount House Limited (FSDH) is reputable for its macroeconomic research. Macroeconomic research and strategy publication of Renaissance Capital is also highly recommended. Strategy research analysts provide market views, forecasts and recommendations covering areas such as asset allocation and investment strategies. Most investment banking houses undertake strategy research over a half-yearly and yearly period. In particular, in January and June of each year ARM Securities and Vetiva publish their individual strategy allocation and recommendations. Sector and industry research covers in-depth analysis of specific sectors and industries ranging from banking, insurance, oil and gas, manufacturing, cement, consumer goods and ICT. Except for the banking industry, publicly published, in-depth research and analysis of other industries by investment banks in Nigeria are generally lacking. The annual publication of Afrinvest on the banking industry in Nigeria is one of the flagship publications in the securities business on the banking sector. Equity research analysts analyse the stock markets to identify investment opportunities. The work of equity research analysts includes analysis of companies’ financial statements, updating financial models using DCF analysis, multiples and book-value approaches for generating financial ratios and stock recommendations. Most investment banks in Nigeria undertake equity research widely and make stock recommendations on a weekly basis, which are sent directly to their clients. Some investment banks publish their weekly stock recommendations online on

Securities brokerage 271

Proshare, a website dedicated to the financial and investment community. These investment banks include Cordros, Cardinal Stone, ARM,Vetiva and Afriinvest. Credit research analysts assess the DCM covering government debt and corporate fixed income. Fixed income research is not as prominent compared to equity research in Nigeria. DLM publishes weekly a short note on developments in the DCM. Besides the buy-side research which often targets securities traders, institutional investors and asset managers, sell-side research is also useful for the sell side of investment banking which deals with capital raising through equity and bond underwriting, PE and M&A financial advisory. Analysts may conduct internal, but not published, sector-, industry- and company-level research to support deal origination. They conduct due diligence analysis and financial modelling as well as valuation based on various techniques that will include discounting cash flows, book values, multiples and comparable analysis. They undertake market intelligence research for the purpose of preparing red herring prospectus, the roadshow pitch book and the marketing presentation. There are certain rules and regulations preventing conflicts of interest between the securities business and underwriting business. Future directions

There are expectations of renewed interest in Nigerian equities trading by foreign portfolio investors with attractive valuation and dividend yield. There is increased competition in the institutional sales trading with entrants of new foreign players such as Rand Merchant Bank (RMB), Barclays ABSA, EFG Homes, Pictet and a few others. In retail sales trading, improved financial literacy and awareness have increased trading securities trading visibility.Three factors should enhance retail securities business: first, improved real wage growth that will expand investors’ wallet to financial market investment; second, the growth of generation Y and millennials; and, third, the presence of technology and social media that are driving growth of online trading platforms and reduction in online trading costs. Market shares of securities brokerage firms will be driven by the ability to tap new markets, improve the speed of execution and enhance operational efficiency using skilled people and technology.

Note 1 Read more about technical analysis at Technical Analysis: Fundamental Vs.Technical Analysis, www.investopedia.com/university/technical/techanalysis2.asp#ixzz5W3ik1J3j.

Bibliography CSCS. (2018), Corporate website Fabozzi, F.J. and E. Pilarinu. (2002), Investing in Emerging Fixed Income Markets, edited. Hoboken, NJ: John Wiley & Sons

272  Managing capital in frontier markets Graham, B. and D.L. Dodd. (2009), Securities Analysis: Principles and Technique, 6th edition. New York: Tata McGraw-Hill McMillan, M., J. Pinto, W.L. Pirie, and G.Van der Venter. (2011), Investments: Principles of Portfolio and Equity Analysis. Hoboken, NJ: John Wiley & Sons NSE (2018), Database Palepu, K., V. Bernard and P. Healy. (2012), Business Analysis and Valuation, 5th international edition. Mason, OH: South-Western College Publishing and CFA Institute Penman, S. (2012), Financial Statement Analysis and Security Valuation, 5th edition. Boston, MA: Tata McGraw-Hill Petitt, B.S., J. Pinto and W.L. Pirie. (2015), Fixed Income Analysis, 3rd edition. Hoboken, NJ: John Wiley & Sons and CFA Institute Pinto, J., E. Henry, T. Robinson and J.D. Stowe. (2015), Equity Assets Valuation, 3rd edition. Hoboken, NJ: John Wiley & Sons and CFA Institute

Part VI

Future direction

16 Future trends and prospects

There is a confluence of global, regional and domestic national trends that would create opportunities for growth of capital market and investment banking activities in frontier economies such as Nigeria.

Economy Global institutions such as Goldman Sachs, McKinsey Global Institute (MGI), and PwC have projected that Nigeria would be among the top 15 to 20 countries in the world by 2050.These projections could be realized when key ingredients for development are in place. Economic theory and history have shown that long-term prosperity is driven mainly by the growth of the labour force and the growth of labour force productivity. Long-term output is determined by the size and quality of labour force, the stock of productive capital workers have at their disposal and the TFP, that is the efficiency with which that labour and capital produce goods and services. The size of the labour force is in turn determined by demography, while the stock of capital is driven by investment, and productivity is determined by incentives and innovation over time.

Demography and human capital Nigeria’s growing population of nearly 200 million is projected to be the third largest country by population at 440 million in 2050 behind China and India. This demographic advantage means that Nigeria, as an FM, has favourable long-term growth prospects, but it also implies putting in place policy measures to address growing inequality and poverty. The fast population and urbanization growth rates in Nigeria are creating opportunities as well as challenges for the residential real estate market in the country, especially in major cities. To meet the needs of a growing and rapidly urbanizing population, emerging and frontier countries are providing strong opportunities in real estate development, from residential developments through to business, retail and manufacturing. Real estate capital is being influenced by the interplay of both private capital, real estate funds and sovereign wealth funds (SWFs), and public–private partnership.

276  Future direction

In spite of pension reforms and growth of pension assets in the last decade and a half, the pensions industry in Nigeria is still in its infancy. As earlier observed, pension assets relative to GDP, at 6 percent, are one of the lowest in the world. There is a demographic and economic impetus for accelerating the growth of the pension industry, with a population expected to double by 2050. However, the high employment rate, especially among the youth, may constrain the growth of income and pension contributions. As Nigeria has a large informal sector, it is important to encourage voluntary contributions and self-directed pension schemes among the self-employed.

Infrastructure and physical capital Infrastructure is one of the largest drivers of trade and industrial development, but Nigeria’s infrastructure stock is about a third of GDP compared to over two-thirds in more advanced economies. The development, upgrading and maintenance of infrastructure is crucial to lowering the costs of doing business, facilitating access to markets for inputs and distributions of final products to consumers and businesses and reducing transit time for import and export and average waiting times of commodities at the ports as it affects the country attractiveness. Infrastructure enhances productivity through quality roads, telecom, energy generation and irrigation systems. An efficient road and railway network will result in faster transportation of goods and reduce transaction costs. Quality infrastructure creates a competitive environment for businesses to thrive in, attracts more foreign investment and aids the country’s goal of being competitive internationally. The government will be a major driver of investment in infrastructure. However, public-sector funds will remain inadequate in meeting huge infrastructure needs to support rapid economic development. While the government will provide key coordinating and financing roles for infrastructure development, it is essential to encourage private participation in infrastructure provision and financing. Attracting both domestic and foreign private investment through the facilitation of PPP will remain essential in addition to financial support from bilateral and development financing sources. Policies should be geared towards strengthening public–private partnerships in infrastructure financing and managing infrastructure projects. The recent encouragement provided for pension funds to invest in infrastructure is welcome.

Institutional capital Nigeria’s rankings on various measures of institutional governance, including Transparency’s Corruption Index, World Bank’s Doing Business Index and the World Economic Forum’s Competitiveness Index, are low compared to major emerging markets and some FMs.

Future trends and prospects 277

A capable and accountable state will ensure a sound public-sector management by strengthening public sector institutions, transparency and accountability. Efforts must be made to ensure adherence to the rule of law at all levels of the government and combatting corruption with enforcement and through improved information systems, which entails supplying quality and timely information to respective government bodies.

Domestic financial capital Nigeria’s economic fundamentals will be boosted by closing the savings– investment gap and enhancing financial deepening. Most economies that have achieved sustained rapid economic growth and development tend to have relatively high savings and investment rates. In Nigeria, savings and investment rates have been relatively low in the last few decades. Nigeria’s savings and investment rates are low even by African standards. Ethiopia, the fastest-growing economy in Africa in the last 10 years, has investment rates that are more than twice that of Nigeria. Financial intermediation and development can contribute to economic growth. Financial intermediation can help reduce the costs of acquiring information, monitoring and transactions costs; improve corporate governance; improve the evaluation of investment opportunities; mitigate risks through diversification and the allocation of resources to profitable projects; and transform short-term liquid saving into long-term illiquid capital investments.

Foreign capital flows During the period from 2011 to 2014, Nigeria benefitted from a surge in capital flows, especially FPI. There was a significant decline in FPI, as well as FDI, between 2015 and 2016 before recovering in 2017. Future capital flows will be driven largely by developments in oil prices, interest rate differentials, exchange rate expectations and the degree of risk aversion by foreign investors during electoral cycles. Foreign portfolio inflows are typically very volatile and associated more with consumption, while FDI is a more stable and impact investment in the real sectors of the economy. Nigeria is the largest recipient of remittances in sub-Saharan Africa and the sixth-largest globally with an estimated US$22 billion in remittances from abroad in 2017 (World Bank, 2018).

Single economic space in Africa Nigeria needs to embrace the opportunities provided by the single economic space being created through the African Continental Free Trade Area (AfCFTA). In March 2018, the landmark trade agreement was born when 44 of 55 African states initially signed it in Kigali, Rwanda. The AfCFTA will bring together 55 African countries with a combined population of more than one billion people and a combined GDP of more than US$3.4 trillion (Africa Union, 2018).

278  Future direction

The AfCFTA is the culmination of the fulfilment of the framework and roadmap for the creation of a continent-wide free-trade area endorsed by the 18th Ordinary Session of the Assembly of Heads of State and Governments of the African Union, held in January 2012.The AfCFTA is also a consolidation of the Tripartite Free Trade Area and other regional free-trade areas with a wideranging scope covering trade in goods, trade in services, investment, intellectual property rights, competition policy and rules and procedures on the settlement of disputes (Afriexim Bank, 2018). The UNECA (2018) estimates that the agreement will boost intra-African trade by half or 52 percent by 2022. At about 15 percent, intra-African trade compared unfavourably to Europe (68 percent), North America (37 percent) and Latin America (20 percent) (Afriexim Bank, 2018). Africa accounts for less than 3 percent of world trade, and participation in the global value chain has been limited as commodities and natural resources dominate exports from Africa. Progress has been made towards economic cooperation as well as accelerating the overall regional integration process, especially in functional sectoral cooperation. Free movements of persons include the abolition of visa and entry permit requirement and guaranteeing the right of residence and right of establishment. In the Economic Community of West African States (ECOWAS), no visa is required anywhere for nationals of member states who travel across the region. In the financial sector, Ecobank Transnational Incorporated (ETI) based in Lome, Togo, operates in more than 30 African countries. Standard Bank of South Africa is present in more than 15 countries. Nigerian banks, including UBA, Zenith, FBN and GTB, have a presence in several African countries. There are ongoing efforts to integrate capital markets in West Africa, which provides opportunities for cross-border securities trading, capital raising and financial advisory. Investment banking firms such as Chapel Hills have subsidiaries outside Nigeria. Chapel Hills has a subsidiary in Ghana.

Globalization The rapid globalization of trade and commerce, financial liberalization and integration of capital markets in the past three decades have contributed to boosting the activities of investment banks across the globe. As global trade blossomed, multinational companies require capital raising and global corporate finance and transactions services in different regions and countries of the world. Global investment banks follow the money and have operations in key capital markets in the United States, Europe and Asia, as well as in some African countries. Governments and companies from developing countries have also sought to tap capital from the global markets by raising bonds, especially Eurobonds and private placements opening opportunities for both local and global

Future trends and prospects 279

investment banks. Nigerian companies, in particular commercial banks, often resort to raising Tier 2 capital from corporate Eurobonds and private placement with the involvement of local and global investment banks. Non-banking institutions, such as the Dangote Conglomerate, has tapped into global markets. The FGN was very active in raising Eurobonds to the tune of $3.5 billion in 2017 as part of its strategy to reduce domestic debts servicing burden. In 2018, the FGN raised more than $5.3 billion in 2018.

Digitalization and Fintech Advances in technology, internet and digitization have helped in reshaping the ways investment banks manage their relationships with clients and their own risk management. Digitization has ensured broader participation of people in financial services, including online stock brokerage and accelerated flows of information with research products made available online. Advances in technology have improved financial knowledge diffusion and increased competition and greater financial innovation. Global securities trading, hedge funds, derivatives, ETFs and other complex financial instrument and securities have been made possible partly by advances in computer and mobile technology. Financial innovations, such as electronic funds transfers, mobile banking, online financial trading and cash and investment management, have been aided by advances in technology. Securities clearing and settlement cycle and process has been transformed and shorted to T + 1 trading days in advanced economies and T + 3 trading days in Nigeria’s FMs. Several initiatives in the FSS2020 have been implemented especially in respect of the national payments system. The cashless policy of the CBN has been implemented with the adoption of electronic payment channels. The implementation of the FSS2020, however, faces challenges including logistics and policy inconsistency to the realization of its overall objectives. The Nigerian capital market has recorded notable achievements with direct cash settlement, e-dividend, complaint management framework, risk-based supervision, commodity ecosystem and non-interest finance and derivatives, among others. Fintechs are companies that use new technology and innovation to compete with traditional financial institutions in delivering financial services. Specific to the capital market, fintech has been applied in the areas of core market infrastructure technology, post-trade digitization/regtech, artificial intelligence and analytics, investment technology digitization and alternative funding platforms. Digitalization and other emerging technologies are essential to reducing costs and inefficiencies while increasing alpha returns for investors in the capital market. A lot of opportunities exist in this area in Nigeria, and many capital market operators, as well as the regulators, are already embracing this new trend.

280  Future direction

Recruitment and retention of talent There is evidence of the high turnover of staff within the investment banking industry in Nigeria is due to several factors. There is a shortage of highly qualified investment bankers, especially those with professional certification such as Chartered Financial Analyst (CFA). The banking industry has typically hired finance specialists with an MBA and chartered accountants with professional certifications from the Institute of Chartered Accountants of Nigeria (ICAN) and Association of Chartered Certified Accountants (ACCA). In addition to chartered accountants, CFA holders have become the coveted standard of certification in the investment banking industry in Nigeria. In 2017, the CFA Institute approved the conduct of the CFA level examinations in Nigeria due to the high demand for the certification and the inconvenience of having to travel to Accra, Ghana to sit for the exams. The Nigerian branch of the CFA Institute is thriving and marketing the CFA widely. At the same time, well-qualified Nigerian finance professionals are seeking opportunities offshore, with Canada becoming an immigration destination for these professionals. The combination of these factors is creating shortages of qualified professionals and putting upward pressure on remuneration paid within the investment banking industry.

Risk management An investment bank is exposed to different types of risks such as strategic, market, liquidity, credit, operational, compliance, regulatory and reputational risks. It is essential to establish a robust risk management culture, framework, policies and processes for identifying, assessing, measuring and managing, such risks in line with regulatory requirements. The SEC in Nigeria requires each business entity in the capital market to appoint a compliance officer, distinct from risk officers and legal officers. However, the compliance culture starts with the tone set at the top from the board and executive management level and must be embraced by all employees and all departments.

Corporate governance The regulators have Code of Corporate Governance for their respective sectors. Corporate governance codes have been issued by several regulatory authorities, including the SEC and the NSE for capital market operators. The Code of Corporate Governance of the SEC further stipulates that all directors of companies should participate in periodic continuous education to update their knowledge and skills in their areas of business. The SEC’s Code of Corporate Governance stipulates that a director must abstain from discussion and voting on matters in which it has conflicts of interest.1 NAICOM and PENCOM have codes of corporate governance for the insurance industry and for the pension industry. The Financial Reporting Council

Future trends and prospects 281

of Nigeria (FRCN) for all public and private companies. In October 2018, the CBN issued new codes of corporate governance for DFIs, bureaux de change, microfinance, FCs, and mortgage refinance institutions. In 2016, the FRCN published the combined National Code of Corporate Governance (NCCG) for the private, public and non-profit sectors. The implementation of the NCCG was suspended by the FGN to allow for more consultation with various stakeholders. A technical committee was established in January 2018 to lead this consultation and review the NCCG. In June 2018, an exposure draft of the New Nigerian Code of Corporate Governance was published to serve as the template for the consultation with stakeholders.

Regulations The need for capital markets’ integrity through regulation and enforcement arises from three rationales: to improve public trust and reduce systemic risk, to minimize information asymmetry, and to promote market access and competition. Regulation ensures financial market integrity, which leads to investors’ confidence in the market and in turn enhances liquidity. Effective and efficient regulation is achieved by a combination of both primary and secondary market regulations. The SEC, the NSE and the FMDQ, as regulators, make and enforce rules relating to market conduct. They monitor, detect, investigate and sanction market abuse including insider trading. In both the primary and secondary markets, regulators encourage that corporate actions and information that are of interest to the investors are made available publicly in a timely fashion and in a non-discriminatory way as they are crucial for listing, trading and liquidity.

Note 1 SEC Code of Corporate Governance Article 16 (1)(b).

Bibliography Afrexim Bank. (2018), Africa Trade Report 2018: Boosting Intra-African Trade: Implications of the African Continental Free Trade Area Agreement, The African Export-Import Bank Africa Union. (2018), CFTA – Continental Free Trade Area. https://au.int/en/ti/cfta/about [Accessed September 2018]. UNECA. (2018), Leveraging the power of business to drive Africa’s integration, AfCFTA Business Summit. https://www.uneca.org/afcfta-business-summit-2018 [Accessed December 2018] World Bank. (2018), Database on Remittances

Appendix

Key regulators and agencies Central Bank of Nigeria Corporate Affairs Commission Debt Management Office Federal Ministry of Finance FMDQ OTC PLC National Bureau of Statistics NASD Nigeria National Insurance Commission National Pension Commission Nigerian Stock Exchange Securities and Exchange Commission

www.cbn.gov.ng www.cac.gov.ng www.dmo.gov.ng www.finance.gov.ng www.fmdqotc.com www.nigerianstat.gov.ng www.nasdng.com www.naicom.gov.ng www.pencom.gov.ng www.nse.com.ng www.sec.gov.ng

Key business and financial laws CAMA 1990 cacnigeria.org/downloads/CAC_1990_Decree_001.pdf BOFI 1991 www.cenbank.org/OUT/PUBLICATIONS/BSD/1991/ BOFIA.PDF CBN ACT www.cbn.gov.ng/OUT/PUBLICATIONS/BSD/1991/ CBNACT.PDF ISA SEC ACT sec.gov.ng/investment-and-securities-act/ SEC Rules and Codes sec.gov.ng/regulation/rules-codes/ NSE Rules and Codes www.nse.com.ng/regulation

Major investment banks Afrinvest (West Africa) Limited Asset and Resources Management Company (ARM) Chapel-Hill Denham Management Limited Cordros Capital Limited Cardinal Stone Coronation Merchant Bank FBN Quest First City Monument Bank (Holding Company)

www.afrinvest.com www.arm.com.ng www.chapelhilldenham.com www.cordros.com www.cardinalstone.com www.coronationmb.com www.fbnquest.com www.fcmb.com

Appendix 283 FSDH Merchant bank Limited Greenwich Trust Limited Investment One Financial Services Ltd Meristem Securities Limited Stanbic IBTC (Holding Company) SFS Financial Services Renaissance Capital United Capital PLC Vetiva Capital Management Zenith Capital Limited

www.fsdhgroup.com www.gtlgroup.com www.investment-one.com www.meristemng.com www.stanbicibtc.com www.sfsnigeria.com www.rencap.com www.unitedcapitalplcgroup.com www.vetiva.com www.zenithcapital.com.ng

Pension funds administrators AIICO Pension Managers Limited APT Pension Fund Managers Limited ARM Pension Managers Limited AXA Mansard Pension Limited Crusader Sterling Pensions Limited Fidelity Pension Managers First Guarantee Pension Limited IEI-Anchor Pension Managers Limited Investment One Pension Managers Ltd Leadway Pensure PFA Limited Legacy Pension Managers Limited NLPC Pension Fund Administrators Ltd NPF Pensions Limited OAK Pensions Limited Pensions Alliance Limited Premium Pension Limited Radix Pension Managers Limited Sigma Pensions Limited Stanbic IBTC Pension Managers Ltd Trust fund Pensions PLC Veritas Glanvills Pensions Limited

www.aiicopension.com www.aptpensions.com www.armpension.com www.axamansardpensions.com www.crusaderpensions.com www.fidelitypensionmanagers.com www.firstguaranteepension.com www.ieianchorpensions.com www.investment-onepensions.com www.pensure-nigeria.com www.legacypension.com www.nlpcpfa.com www.npfpensions.com www.oakpensions.com www.pensionsalliance.com www.premiumpension.com www.radixpension.com www.sigmapensions.com www.stanbicibtcpension.com www.trustfundpensions.com www.vgpensions.com

Selected private equity firms ACA Partners Actis Adlevo Capital AfricInvest Capital Partners Apis Partners Capital Alliance First Funds Helios Investment Partners Ventures  & Trusts

www.acagp.com www.act.is www.adlevocapital.com www.africinvest.com www.apis.pe www.aca-web.com www.firstfunds.com.ng www.heliosinvestment.com www.venturesandtrusts.com

Selected economic and financial web media Nairametrics Proshare Stears

www.nairametrics.com www.proshareng.com www.stearsng.com

Index

Note: Page numbers in italics indicate figures and in bold indicate tables on the corresponding pages. ABC private equity 160 Abdul Azeez, N. 252 Access Bank PLC 180 – 181 Acemoglu, D. 16 Adeniyi-Akintola, R. 100 adjusted dividend valuation method 174 AfDB 195 – 196, 209 – 210 AFEX Commodities Exchange Limited (AFEX), Nigeria 43 Africa: exit strategies for private equity in 160 – 161; future single economic space in 277; infrastructure and project finance in 203, 203; Nigeria as largest frontier market in 4 – 5; private equity market in 155 – 159, 158 Africa Finance Corporation (AFC) 195 – 196, 207 – 208 African Continental Free Trade Area (AfCFTA) 277 – 278 Afrinvest 72 agency bonds 136 analysts, investment banking 76, 77 anti-money laundering (AML) regulations 89, 102 asset and liability committees (ALCOs) 82 asset management: ETFs in 242 – 243; future directions in 247 – 248; global 234; institutional 234 – 235; mutual funds in 236 – 241, 237, 238 – 239; principles of 233 – 234, 234; PWM 235; regulation of collective investment schemes in 243 – 245; trusteeship in 245 – 247 Asset Management Corporation of Nigeria (AMCON) 27 Asset & Resource Management Company (ARM) Ltd 72; risk management structure at 86, 87 – 88

associates, investment banking 76, 77 Azura-Edo Independent Power Plant 205 – 206 balance-sheet asset-based methods in mergers and acquisitions (M&A) 173 Bank of America 92 Barclays’ investment bank 64 Benue Cement Company 184 – 185 Bloomberg 5, 108, 131 bonds: bidding procedure 139, 139 – 140; corporate market 140 – 142, 141, 142 – 143; FGN 134, 134 – 135, 137 – 138, 138; infrastructure project 196; regulations on 143; structure of auction of 138, 138 – 139; see also debt underwriting book value 173 bootstrapping 173 – 174 boutique investment banks 74 Brueggeman, W. B. 220 business environment in Nigeria 10 – 12, 11, 12 calculated intangible assets 173 CAMA, Nigeria 95 – 97 Capital Alliance Property Investment Company 223 – 224 capital commitments 151 capital flows, Nigerian 8 – 10, 9, 9 capital management 62; asset management (see asset management) capital market operators (CMO) 89 – 90 capital markets: global 39 – 41, 40; investment banking and primary 61; investment banking and secondary 62;

Index  285 real estate financing and 224; segments of 39; see also capital raising capital markets, Nigerian 28 – 29, 41 – 54; regulators in 93 – 95; size and efficiency of 45, 45 – 53, 46, 47, 48 Capital Markets Union 93 capital raising 61; capital commitments and 151; global equity underwriting market and 108 – 109; investment banking and equity underwriting in 113; IPO/offering 107 – 108, 109 – 111, 110; IPO process and timeline in Nigerian 113 – 128; by MTN Nigeria 125 – 126; Nigeria’s primary equity market and 109; practice of 108 – 128; principles of 107 – 108; private placement of equity in 112; rights issue in 107 – 108, 111 – 112; see also bonds; private equity (PE) career paths, investment banking 76 – 78, 77 Central Bank of Nigeria 24 – 25, 97 – 98 Central Securities Clearing System (CSCS) PLC 269 – 270 Chapel-Hill Denham 178 close of offer allotment phase in IPO process 120 – 121 combating the financing of terrorism (CFT) regulations 89 commercial banking: in Nigeria 25 – 27, 26; real estate finance and 222; see also investment banking Committee of Sponsoring Organizations of the Treadway Commission (COSO) 80 – 81 comparable company analysis 174 comparable transaction analysis 174 compliance risk 84, 85 concession deeds 197 conglomerate mergers 169, 170 Consolidated Breweries 183 – 184 construction contracts 197 contractors 192 corporate bonds market 140 – 142, 141, 142 – 143 corporate governance 100 – 101; future of 280 – 281 corporate trust services 247 counterparty risk 82 CPs (bonds) 142 credit risk 82, 85, 88 cross-border listing and trading service 265 – 266 cross-border mergers 176 Currency Transaction Report (CTR) 89

Dangote Cement PLC 184 – 185 DCF method 174 debt capital markets (DCMs): global 131; Nigeria’s 132, 132 – 134 Debt Management Office (DMO), Nigeria 28, 132 – 133; auction structure and 138 – 139; bidding procedure and 139, 139 – 140 debt securities, types of 134, 134 – 136 debt underwriting: FMDQ OTC securities exchange 144 – 146, 145; principles of 130 – 144; type of debt securities and 134, 134 – 136; see also bonds delisting 126 – 127, 127 democracy in Nigeria 6 demographics of Nigeria 7 – 8, 275 – 276 demutualization 53 DENHAM 72 deployment of capital 61 depository institutions 21 – 22 Deutsche Bank 63 – 64 development finance institutions (DFIs) 28 diaspora bonds 135 – 136 digitalization, future of 279 divested/affiliated investment banks 69, 69 Dodd-Frank Act 92 Doing Business Ranking of the World Bank 220 due diligence in mergers and acquisitions (M&A), Nigeria 186 – 187 Ecobank Securities Limited 265 – 266 Ecobank Transnational Incorporated (ETI) 278 Economic Community of West African States (ECOWAS) 278 economic indicators in Nigeria 7 Emerging Capital Partners (ECP) 159 enterprise value (EV) 173 ETFs 242 – 243; regulation of 245 Eurobonds 136 – 137 European Commission (EC) 93 executive directors, investment banking 77, 77 exit strategies, private equity fund 153 exposure at default (EAD) 83 FCF model 174 FCMB Group PLC 67 fees in private equity 151 – 152 FGN bonds 134, 134 – 135, 137 – 138, 138 finance, project see infrastructure and project finance financial institutions 21 – 22

286 Index financial instruments 20 – 21 Financial Market Dealers Quotation (FMDQ), Nigeria 42 financial markets 21, 22 financial regulators 20 financial risk management 81 – 84 financial sector assessment in Nigeria 29 – 34, 30, 32, 33 Financial Services Conduct Authority (FSCA), South Africa 93 financial services holding companies 74 – 75 financial system 20; financial institutions in 21 – 22; financial instruments in 20 – 21; financial markets in 21, 22; financial regulators and 20; overview of Nigerian 22 – 23, 23 financing and deal structures in mergers and acquisitions (M&A) 174 – 175 fintechs, future of 279 First Bank Nigeria (FBN): FBN Holdings PLC 67; Quest Mutual Funds 240 – 241 First Securities Discount House (FSDH) Limited 73 – 74 Fisher, J. D. 220 FMBN 222 – 223 FMDQ OTC securities exchange 144 – 146, 145 force majeure 197 Foreign Currency Transaction Report (FTR) 89 foreign domestic investment (FDI) in Nigeria 8 – 10, 9, 9 Freixas, X. 19 frontier capital markets see capital markets frontier markets (FMs): capital market (see capital markets); criteria for 5; financial development principles in 19 – 20; financial systems in 20; introduction to 3 – 5, 4; as “pre-emerging markets” 38 fundamental analyses in securities brokering 262 fund economics, private equity 151 – 153 future trends and prospects in Nigeria 15; corporate governance 280 – 281; demography and human capital 275 – 276; digitalization and fintech 279; domestic financial capital 277; economic theory and 275; foreign capital flows 277; globalization 278 – 279; infrastructure and physical capital 276; institutional capital 276 – 277; regulations 281; risk management 280; single economic space in Africa 277 – 278; talent recruitment and retention 280

global asset management 234 global bulge bracket 62 – 64 global capital markets 39 – 41, 40 global depository receipts (GDRs) 140 – 141 global equity underwriting market 108 – 109 globalization 278 – 279 global mergers and acquisitions (M&A) 175 – 177, 177 global pension assets 250 – 251 global project finance market 200 – 202, 201, 202 global real estate market 215 – 216 Goldman Sachs 63, 92, 177 Gordon dividends valuation model 174 Gramm–Leach–Bliley Act 92 green bonds 135 group chief executive officers, investment banking 77, 78 Guaranty Trust Bank PLC (GTB) 141 Haber, S. 19 Herfindahl–Hirschman Index (HHI) 30 high-net worth individuals (HNWIs) 62 Honohan, P. 19 horizontal mergers 169 host governments 192 HSBC 131 Hull, J. C. 81 independent full-service investment banks 71, 71 – 74 informational efficiency in Nigeria 52 – 53 information and community technology (ICT) in Nigeria 16 infrastructure and project finance: in Africa 203, 203; banks as lenders in 195; documentation of 199 – 200; financiers as parties to 194, 194 – 195; future of 276; global 200 – 202, 201, 202; investment banks as advisors to 193 – 194; market-based 196; multilateral development banks in 195 – 196; in Nigeria 10, 203 – 211, 210; parties in 192 – 193; practice of 200 – 211; principles of 191 – 200; risks and contractual structuring of 196 – 199, 198 initial public offerings (IPOs) 107 – 108, 109 – 111, 110; advisory, planning and preparation phase 113 – 114; close of offer allotment phase 120 – 121; marketing and roadshow phase 120; open offer and valuation and pricing economics phase 119 – 120; packaging phase 114 – 119;

Index  287 process and timeline of 113 – 128, 114; stock exchange listing process and requirements phase 121 – 128, 122 – 124, 127, 128 innovation in Nigeria 16, 279 institutional asset management 234 – 235 institutions, financial 21 – 22 instruments, financial 20 – 21 insurers and infrastructure and project finance 196 inter-creditor agreements 199 interest rate risk 81 – 82 international banks, investment banking by 74 – 78, 76, 77 International Finance Corporation (IFC) 5 International Monetary Fund (IMF) 3 International Property Rights Index 221 investment banking: boutique 74; career paths in 76 – 78, 77; client-facing activities in 59 – 60; divested/affiliated 69; equity underwriting and 113; global bulge bracket and 62 – 64; independent full-service 71, 71 – 74; international banks involved in 74 – 78, 76, 77; mergers and acquisitions (M&A) advisory and 171; Nigeria’s history of 64 – 65; practice of 62 – 71, 65, 66, 69; primary capital markets and 61; principles of 59 – 61, 61; project finance advisory and 193 – 194; regulation of (see regulatory framework and regulations); risks in 81; secondary capital markets and 62 Investment One 70 issuing houses 113 Johannesburg Stock Exchange (JSE) 41 J.P. Morgan 131, 176, 177 Kenya 158 King, R. 20 know your customer (KYC) regulations 89 Kohlhepp, D. B. 220 Lagos State government debt issuance programme 144 LBO analysis 174 lead arranging banks 195 legal risk 83 Lehman Brothers 92, 154 Levine, R. 20 liquidation value 173 liquidity risk 82, 85, 87 – 88 loan agreements 199 London Stock Exchange (LSE) 41 loss given default (LGD) 83

management of capital see capital management managing directors, investment banking 77, 77 market abuse and insider dealing, SEC regulations regarding 100 market-based analysis of mergers and acquisitions (M&A) 173 – 174 market-based financing of projects 196, 208 – 209 market integrity, SEC regulations regarding 101 – 102 market makers 266 – 267, 267 market risk 81, 85, 87 markets, financial 21, 22 McKinsey Global Institute (MGI) 15 merchant banking 27, 59, 73 mergers and acquisitions (M&A): balance-sheet asset-based methods in 173; comparable models in 174; DCF method in 174; defences against 170 – 171; financing and deal structuring in 174 – 175; global 175 – 177, 177; investment banking and 171; league table 177; life-cycle process of 171 – 172; market-based analysis of 173 – 174; motivations for 170; in Nigeria 177 – 189; practice of 175 – 189; principles of 169 – 175; types of 169 – 170; valuation in 172 – 173 mergers and acquisitions (M&A), Nigeria 177 – 183, 182; banking 179, 179 – 180; challenges of 188; documentation for 187 – 188; due diligence and legal process for 186 – 187; future directions for 188 – 189; regulations of 185 – 186 Meristem Stock Brokers Limited 264 – 265 MIGA 196 Mixta Real Estate PLC 218 – 219 money market, Nigeria 24 – 28, 26 Morgan Stanley 63, 92, 109 MSCI Frontier Markets Index 5 MTN Nigeria 125 – 126 MTNs (short-term bonds) 142 mutual funds 236 – 241, 237, 238 – 239 NASDAQ 40, 53 National Association of Securities Dealers (NASD) PLC, Nigeria 42 National Code of Corporate Governance (NCCG) 101 natural resources in Nigeria 6 – 7, 7 New York Stock Exchange (NYSE) 40 – 41, 53

288 Index Nigeria: AFEX Commodities Exchange Limited (AFEX) 43; as Africa’s largest frontier economy 4 – 5; Afrinvest in 72; Asset Management Corporation of Nigeria (AMCON) 27; asset management in 234 – 248; Asset & Resource Management Company (ARM) Ltd in 72; Banking and other Financial Institutions Act 97 – 98; bulge bracket in 65, 65; business environment in 10 – 12, 11, 12; capital flows in 8 – 10, 9, 9; capital market regulators in 93 – 95; capital markets and institutions in 28 – 29; capital market size and efficiency in 45, 45 – 53, 46, 47, 48; Central Bank of 24 – 25, 97 – 98; commercial banking in 25 – 27, 26; criteria for frontier markets and 5; debt capital markets (DCMs) 132, 132 – 134; Debt Management Office (DMO) 28, 132 – 133; democracy in 6; demographics of 7 – 8; DENHAM in 72; development finance institutions (DFIs) in 28; divested/affiliated investment banks in 69, 69; domestic savings and capital formation in 8, 8; economic indicators in 7; Economic Recovery and Growth Plan (ERGP) 14 – 15; effectiveness of regulations in 102; FBN Holdings PLC in 67; FCMB Group PLC in 67; financial depth and inclusion in 33, 33 – 34; financial holdings company (UB) structure in 66, 66 – 67; Financial Market Dealers Quotation (FMDQ) 42; financial sector assessment in 29 – 34, 30, 32, 33; financial soundness in 31 – 33, 32; financial system overview 22 – 23, 23; Financial System Strategy 2020 34 – 35; First Securities Discount House (FSDH) Limited in 73 – 74; future prospects for (see future trends and prospects in Nigeria); history of investment banking in 64 – 65; incentives for productivity in 16; inclusiveness in growth of 17; independent full-service investment banks in 71, 71 – 74; infrastructure and project financing in 10, 203 – 211, 210; innovation in 16, 279; institutional coordination and implementation in 15 – 16; insurance industry in 29; international banks in 74 – 78, 76, 77; Investment One in 70; Investments and Securities Act (ISA) 98; IPO/ Offer for subscription in 109 – 111, 110,

113 – 128; market-based project financing in 208 – 209; merchant banking in 27; mergers and acquisitions (M&A) in 177 – 189; money market and institutions in 24 – 28, 26; National Association of Securities Dealers (NASD) PLC 42; natural resources and oil dependency of 6 – 7, 7; Nigerian Commodity Exchange (NCX) 43; Nigerian Deposit Insurance Corporation (NDIC) 25; opportunities and challenges in 6 – 17; other capital market operators in 43 – 45; Pension Commission 29; pension management in 251 – 261; poverty in 17; primary equity market in 109; private equity market in 155 – 156; productivity in 12, 13, 16; public-private investment in 17; real estate sector in 216, 216 – 220, 217, 217; regulation of project finance in 210 – 211; SEC (Securities and Exchange Commission) (see Nigeria SEC (Securities and Exchange Commission)); securities-related laws in 95 – 102, 96; SFS Financial Services Group in 70; Stanbic IBTC Holdings in 68 – 69; Stock Exchange (NSE) 28, 41 – 53, 45, 46, 47, 48; United Capital PLC Group in 70 – 71; Vetiva Capital Management Limited (VCML) in 72 – 73;Vision 2020 plan 13 – 14; Zenith Capital in 71 Nigeria Infrastructure Debt Fund (NIDF) 209 Nigeria Infrastructure Fund (NIF) 209 Nigerian Breweries PLC 183 – 184 Nigerian Commodity Exchange (NCX), Nigeria 43 Nigerian Deposit Insurance Corporation (NDIC) 25 Nigerian Financial Intelligence Unit (NFIU) 89 Nigerian Mortgage Refinance Company (NMRC) 224 – 225 Nigerian Sovereign Wealth Fund 209 Nigeria SEC (Securities and Exchange Commission) 28, 53 – 54, 89 – 90, 93 – 95; corporate governance and 100 – 101; cost of public listing on 127, 128; market abuse and insider dealing 100; market integrity and 101 – 102; registration requirements 98 – 99, 98 – 99; transparency requirements of 99 – 100 Nigeria Stock Exchange (NSE) 28, 41 – 45; delisting 126 – 127, 127; largest stocks by

Index  289 market capitalization and volume traded on 268, 269; market size and efficiency and 45, 45 – 53, 46, 47, 48; recent developments on 50 – 51; Rules Book 121 – 125, 122 – 124; strategic execution in 2017 51 – 52 non-depository institutions 22

project sponsors 192 public-private participation (PPP): in global project finance market 200 – 201; in Nigeria 17 public trust 247 purchasers 193 PWM 235

off-takers 193, 197 oil dependency of Nigeria 6 – 7, 7 open offer and valuation and pricing economics in IPO process 119 – 120 operational risk 83, 85 operation and maintenance agreement (OMA) 197 Oshikoya, T. W. 4

raising of capital see capital raising real estate finance: capital market and 224; commercial bank lending in 222; development challenges and 220 – 221, 221; economic valuation of real estate and 214 – 215; FMBN 222 – 223; future prospects in 228 – 229; global 215 – 216; models of 221; Nigerian real estate sector and 216, 216 – 220, 217, 217; PMBs and 223; principles of 214 – 215; private equity 223; REITs and 225 – 227, 226; traditional 221 registration requirements, SEC 98 – 99, 98 – 99 regulators, financial 20; approval of IPO packaging 116 – 119; Nigerian capital market 93 – 95 regulatory framework and regulations: asset management 243 – 245; bonds 143; future of 281; global context for 92 – 93; mergers and acquisitions (M&A), Nigeria 185 – 186; in practice 92 – 102; principles of 91; private equity 161 – 162; project finance in Nigeria 210 – 211; REITs 228; risk management 89; securities-related laws in Nigeria 95 – 102, 96 REITs 225 – 227, 226; regulation of 228 reputational risk 85 rights issue 111 – 112 risk management: Committee of Sponsoring Organizations of the Treadway Commission (COSO) on 80 – 81; financial 81 – 84; future of 280; infrastructure and project finance 196 – 199, 198; operational 83; practice of 84, 85; principles of 80 – 81; regulations relating to 89; risks in investment banking and 81; SEC’s supervision framework for 89 – 90; strategic, legal and compliance 83 – 84; structure and government of 84, 86, 87 – 88; three lines of defence model of 88, 88 – 90 risk management committees (RISCO) 82 – 83 risks, classification of types of 84, 85 Robinson, J. 16

pension management: future prospects in 261; global 250 – 251; history of 251 – 252; major players under new scheme for 253 – 254, 254; multi-fund investment structure 260 – 261, 261; Nigerian pension fund value 254 – 255, 255 – 256; pension fund RSAs and assets in 254, 255; pension funds investment 257 – 259, 257 – 260; pension industry concentration and 256 – 257; practice of 250 – 261; principles of 249 – 250; reforms and regulation in 252 – 253 politically exposed persons (PEP) regulations 89 poverty in Nigeria 17 price/earnings (P/E) ratio 173 price/sales (P/S) ratio multiples 174 price setting 108 private equity (PE): current practices in 156 – 160, 157, 158; exit strategies for 160 – 161; fund economics and 151 – 153; future directions in 162 – 163, 163; global markets in 153 – 155, 154; Nigeria and Africa markets for 155 – 156; practices of 153 – 163; principles of 148 – 150, 149; real estate financing 223; regulation of, in Nigeria 161 – 162; structuring of 149, 149 – 150 Private Equity International (PEI) 154 private placement of equity 112 private trust services 245 probability of default (PD) 83 productivity 12, 13, 16 project finance see infrastructure and project finance project risk 85

290 Index Rochet, J. C. 19 Russell Investments and Financial Times (FTSE) 5 SANE (South Africa, Algeria, Nigeria, Egypt) group 4 – 5 São Paulo Stock Exchange 40 savings and investment in Nigeria 8, 8 Scope, Conditions & Minimum Standards for Merchant Banks Regulations 2010 73 securities brokering: charts and trends in 263; cross-border listing and trading service 265 – 266; foreign and domestic transactions 267 – 268, 268; future directions in 271; largest stocks by market capitalization and volume traded in 268, 269; market makers 266 – 267, 267; moving averages in 263 – 264; practice of 264 – 271, 267, 268, 269; principles of 262; research on 270 – 271; securities trading in 264 – 265; securities valuation in 262 – 264 SFS Financial Services Group 70 Shanghai Stock Exchange 41 shareholder agreements 197 shelf registration 143 – 144 Shittu, A. I. 20 Skye Shelter Fund 227 SPV 192 Stanbic IBTC Holdings 68 – 69 STL Trustees Limited 246 stock exchanges, global 39 – 41, 40 strategic risk 83, 85 subnational bonds 134, 136 Sukuk bonds 134, 135 suppliers 192 – 193, 197, 199 supply agreements 197, 199 supranational bonds 136 Suspicious Transaction Report (STR) 89 takeover defences 170 – 171 talent recruitment and retention in Nigeria, future of 280

TBs (bonds) 142 technical analysis in securities brokering 263 third-party equity investors 196 three lines of defence risk management model 88, 88 – 90 Tokyo Stock Exchange (TSE) 41 Toronto Stock Exchange 40 trading, capital 62 traditional real estate financing 221 transactional efficiency in Nigeria 49 – 50 transformational efficiency in Nigeria 48, 48 – 49 transparency requirements, SEC 99 – 100 tripartite deeds 199 trusteeship 245 – 247 UB system, Nigeria 66, 66 – 67 Union Homes Real Estate Investment Trust 227 United Capital PLC Group 70 – 71 valuation: in mergers and acquisitions (M&A) 172 – 173; of private equity funds 152 – 153; of real estate 214 – 215; securities 262 – 264 vertical mergers 169 Vetiva Capital Management Limited (VCML) 72 – 73, 244 Vetiva Sector Series Exchange Traded Funds 242 – 243 Wells Fargo 216 Why Nations Fail 16 World Bank 3, 17, 195 – 196, 217, 221 World Economic Forum Global Competitive Index 102 World Federation of Exchanges (WFE) 53 Zenith Capital 71