Author: Kihingu Inc

Africa badly needs long-term finance. But to properly develop, long-term finance markets need data and in-depth data analysis. For years, this sort of market intelligence barely existed. But the work of the Africa Long-Term Finance Initiative gives hope that things are changing.

Why is long-term finance important?

The simple answer: sustainable growth. Longer-term investments support growth and development by reducing costs. That increases productivity and competitiveness and creates jobs – particularly for the 12 million young Africans joining the workforce every year.

But there are significant long-term finance gaps across African economies, especially in the infrastructure, housing and enterprise sectors. These industries are crucial to the continent’s economic recovery from Covid, but businesses in these sectors often find they’re asked to repay loans before the investment has had a chance to yield a return.

Long-term finance is also necessary to accelerate Africa’s green transition, asies and governments seek to reconcile economic development with climate change mitigation and adaptation.

How can data help?

One of the main reasons for the dearth of long-term finance in Africa is a lack of investor confidence. Investors feel exposed to liquidity and interest rate risks, and thus lack the appetite to provide anything more than short-term money.

This is largely due to a lack of market intelligence. Historically, there have been few – if any – benchmarks or indicators to go on when it comes to the performance of long-term finance in Africa. Without this knowledge, investors are reluctant to provide the necessary finance, for the necessary length of time for many businesses and projects to grow.

The deepening of domestic financial markets, with increased provision of financial products and services for all levels of society, is crucial to increase the availability of finance and deploy it more efficiently, and also to reduce exposure to foreign exchange risk – and this process es accurate data, too.

What is the Africa Long-Term Finance Initiative?

In 2017, a number of institutions, including FSD Africa, came together to fix this lack of market intelligence by launching the Africa Long-Term Finance Initiative.

The initiative’s objective is to close the financing gaps in the infrastructure, housing and SME sectors. The ways it does this is by improving market intelligence through collecting data, operating a country-comparison LTF Scoreboard, summarizing the data in regular reports on key findings, and providing in-depth country diagnostics

These products enhance transparency and provide benchmarks to assess the comparative levels of long-term finance markets across the continent. The Africa Long-term Finance Initiative Scoreboard presents data using different benchmarking techniques, providing a more detailed picture than a simple comparison of country averages. The country diagnostics provide additional country-specific quantitative and qualitative analysis, complementing the data presented in the Scoreboard.

In turn, these outputs are helpful to inform policymakers, the private sector and donors about the availability of long-term finance, boosting investor knowledge and confidence – and thereby catalysing new partnerships that strengthen focus on what’s needed to increase the availability of long-term finance.

In addition, by enabling comparison between countries, the LTF scoreboard is creating positive competition among national stakeholders, and further driving the availability of long-term finance.

The green finance opportunity

Long-term finance is closely linked to the green transition in Africa. Countries like Kenya, Nigeria and South Africa have taken the leadcreating programmes for green bonds, which tap into domestic and international capital markets to finance green projects.

The success of these initiatives and the increasing global demand for green investments have led other countries – like Ghana – to follow suit in considering green instruments as a way of attracting long-term finance.

Driving recovery through data

The economic impact of Covid-19 means it’s more urgent than ever to respond to the investment needs of African businesses. The progress made on market intelligence by the Africa Long-Term Finance Initiative is therefore particularly timely. By equipping and emboldening investors, it’s hoped that the initiative’s work will be the first building block in the development of a strong long-term finance market to power sustainable growth

Climate change is increasing extreme weather events, and Africa is greatly exposed. Drought, flooding, extreme heat and tropical cyclones are all major risks with the consequence that 30 of the world’s 40 most climate-vulnerable countries are in sub-Saharan Africa¹. Given Africa’s high dependence on its natural resources, with agriculture contributing 16% of the continent’s GDP and employing roughly 60% of the population, these climate extremes pose a very high risk in the continents’ economies and household livelihoods. In Kenya, for example, in the three drought years in 2009, 2010 and 2011, the drought cost the country 11%, 7% and 9% of its entire GDP.

At the same time, only 3% of global climate finance² finds its way to Africa to drive mitigation and adaptation. There is also a large protection gap with a very low percentage of African weather-related losses currently being insured. A specific example is Cyclone Idai which in 2019 affected Mozambique, Malawi and Zimbabwe. Of t0bn losses, only 7% were covered by insurance³. As the frequency and severity of weather events increases, if more is not done to change this situation and increase resilience, then the cost of climate disasters will render sustainable development virtually impossible in Africa.

We thus face a major sustainable development crisis for which urgent action is required. The insurance industry has a vital role to play in responding to help drive both mitigation and adaptation.

Mitigation

Insurers are underwriters and asset managers of long-term capital and, in both capacities, can meaningfully contribute towards reaching net-zero carbon emissions.

As underwriters, insurers play an essential role in facilitating the flow of capital to mitigation projects through providing de-risking solutions to investors. For example, in the geothermal energy sector in East Africa, where capital intensive early-stage development drilling has a low probability/high severity risk profile, investors need risk transfer solutions to make the risk-return profile attractive. To address this barrier, FSD Africa is working on setting up a local underwiring pool that will provide de-risking solutions to enable the crowding-in of private capital to this important renewable energy source.

On the flip side, insurers can leverage their underwriting to reduce capital flows to the fossil fuel industry by making underwriting decisions using an ESG lens and not purely based on short-term commercial factors.

As managers of significant pools of long-term capital, insurers also have a critical role to play in the transition to a net-zero emissions economy through green investing.

The recently convened UN Net-Zero Insurance Alliance demonstrates the growing global momentum towards this.

Adaptation

The insurance industry is expert at managing complex long-term risks, and so when it comes to managing the unavoidable long-term consequences of a warming planet, the industry has much to contribute.

The starting point in managing risk is understanding it and having the right data and models to make informed decisions on how to respond. In simple terms, you need to know the likelihood of a hazard occurring, the direct financial losses it will cause and the indirect impacts (e.g. services disruption) that will result. Catastrophe models have been used for many years by insurers to model these types of impacts and price the risk. By incorporating climate risk modelling into these projections, insurers can help businesses and governments make informed decisions on what resilience initiatives to pursue.

Once risk is understood and evaluated, it needs to be managed. Investing in physical risk reduction measures (e.g. irrigation systems or flood defences) and pre-arranging risk finance are two important management options. The insurance industry is a key player in enabling both. For the necessary private finance to flow to resilient infrastructure, as with mitigation projects, risk transfer solutions underwritten by insurance companies are often required. And when it comes to pre-arranging risk finance, this is obviously the core of what the insurance industry offers. So, insurers making the necessary solutions available to individuals, businesses and governments is vital to ensuring climate resilience.

The way forward

One of the key global initiatives developed explicitly for the insurance industry is UNEP’s Principles for Sustainable Insurance (PSI). It focuses on sustainable insurance that reduces risk, develops innovative solutions, improves business performance, and contributes to environmental, social, and social-economic sustainability[1].

Given FSD Africa’s increasing focus on the role of finance in climate mitigation and adaptation, we have joined the UN Environment’s PSI initiative and will be directly supporting the implementation of the PSI global programme in Africa. FSD Africa was also a founding signatory to the recent Nairobi Declaration, which commits African insurance organisations to play the sustainability roles described in this article. We strongly appeal to all African insurance industry leaders is to also sign the Nairobi Declaration.  Let’s work together to leverage the collective financial might of the insurance industry towards a sustainable future.

<"#_ftnref1" name="_ftn1">[1] UNEP FI: PSI – Principles for Sustainable Insurance – a global sustainability framework and initiative of the UNEP Finance Initiative (2012)

¹ Notre Dame Research
² CPI, 2019
³ Swiss Re Institute,