Investment in Africa and the Bifurcation of Good and Bad Capital

Mark Taylor

Africa does not have a monopoly on corruption

Africa is not alone in struggling with corrupt and poorly behaved leadership in countries. However, countries with weaker democratic institutions and governance traditions are particularly susceptible, and it only takes a few financial institutions and professional advisors in otherwise respectable jursidictions to lose their moral compasses for corruption to flourish on an industrial scale. Fortunately, the majority of institutions and advisors play a straight bat (witness the EIB’s recent cancellation of loans to Africa). Nevertheless, referencing the scale of complicit corruption in other parts of the world does not help Africa – should we not aspire to a higher bar than that? Mo Ibrahim certainly thinks so.

The costs of corruption in Africa are astounding, and the knock-on effect to public service delivery affects everyone. Spare yourself a depressing day, and do not click on this link to the UN’s Economic Commission for Africa report.

Jon Foster-Pedley recently pointed out that, aside from the sheer cost, an insidious consequence is the normalisation of a culture of corruption and the numbing of our outrage.

“The costs of corruption in Africa are astounding.”

Time for a little optimism?

However, there are encouraging indications that this may be starting to change in Africa. This sentiment was echoed during the week by African Finance Corporation’s Sanjeev Gupta (no relation!) and Siemens‘ Sabine Dall’Omo at an Invest Africa lunch during the African Development Bank’s Africa Investment Forum 2019.

“There are encouraging indications that this may be starting to change.”

Good and bad capital

A notable contributor to this process has been the enforcement of anti-money laundering and anti-corruption legislation and regulations across the world, from FATCA in the US to the more recent CRS in Europe. This has forced the highly interconnected finance world to examine business more closely and to seek assurances from various participants in the chain of transactions which are involved in business deals. The consequence of this has been to bifurcate capital in Africa into pools of “good capital” and a “bad capital”. If good capital is polluted by bad capital it becomes bad capital whereas the reverse is not true. As they say, “you can’t put sh*t in the ice cream.” The problem is that it is easy to become bad capital but difficult to remain good capital. This bifurcation has important implications for, amongst others, family offices, impact investors, and regulated institutions, because there are clear criminal, civil and reputational risks.

Reputational risk in a social media-fuelled world

Investments involving families of unaccountable political leaders, unscrupulous business leaders and middlemen have turned sour. Examples abound: The collapse of Bell Pottinger, ruined reputations of a string of businesses and their advisors which sought to feed at the trough, and the wearying testimony at the Zondo Commisson. More recently, the Guptas and Salim Essa have been blackballed in 8 countries outside of South Africa and a litany of offences appear in the Telegraph’s article. Therefore, responsible advisors and investors who represent good capital are cautious about inadvertently becoming part of the pool of bad capital. Indeed, less responsible advisors and investors have ‘done the numbers’, cynical as they may be, partly because they know that social media is not easily managed.

“Responsible advisors and investors who represent good capital are cautious about inadvertently becoming part of the pool of bad capital.”

The cost of capital and a ‘bad capital premium’?

One of the difficulties with this bifurcation of capital is that the bad capital typically has a lower cost (and can invest at higher prices), certainly at the outset, and this is especially attractive if a vendor is exiting an investment. There is therefore great temptation to take bad capital at a higher valuation and turn a blind eye to the ethics of perpetuating underlying systemic incentives by enabling unscrupulous politicians and businessmen to continue to exploit Africa. Corporate financiers worry about country risk and liquidity premia in calculating cost of capital: Will we ever have enough publicly available data to calculate a ‘bad capital premium’?

“Will we ever have enough publicly available data to calculate a ‘bad capital premium’?”

Unexplained Wealth Orders

This bifurcation of good and bad capital creates an unfair market unless the subsequent costs from legal penalties, illiquidity (how much harder is it to IPO a polluted deal or sell it to a serious trade buyer?), and recruitment costs, are so significant that they negate the discount. The UK has introduced “Unexplained Wealth Orders” which allow investigating authorities to shift the onus of proof to individuals who have unexplainable wealth. This concept has been available to tax authorities in many jurisdictions but a broader application could add to the toolboxes of hard-pressed authorities dealing with corruption and money laundering.

Investigating corruption is not easy but, as investigators in criminal ‘cold cases’ know, digital fingerprints are hard to hide: they lie in wait for technology to improve and whistle-blowers to find their voices.