Conduits of Capital

2.2 Policy Issues Related to Onshoring
the PE Industry
The prospects for onshoring financial services need to
be assessed against the evolving development needs
of financial markets in Africa. With recent years’ growth
in their asset base institutional investors, predominantly
pension funds in countries such as Nigeria and Kenya, 8 are
increasingly constrained in their investment choices. They
are too heavily exposed to government securities, bank
deposits and real estate. Recently investment guidelines
have been modified so as to allow limited investment in PE
funds (e.g., in Nigeria and Kenya). 9
Two questions here are: (a) whether pension fund investors
are better serviced by locally-domiciled PE funds; and (b)
what efforts could be made to enhance the size of the PE
industry so as to satisfy increasing investor demand.
Important questions arise as to whether (and if so, how)
efforts should be made to encourage the development of
the local PE industry. Would local institutional investors be
better served, were PE funds to have an onshore rather
than an offshore domicile? In the country of domicile this
would make investment by local institutional (and indeed
retail) investors much simpler, since investment in PE
funds would become local and would not involve ‘roundtripping’
through an offshore centre that most likely will raise
concerns among regulators and trustees. Nonetheless, for
the foreseeable future local pension funds and their trustees
might not be comfortable buying locally-domiciled PE funds
—they realise that the reputation and efficiency of offshore
domiciled PE funds would serve them better.
The Nigerian authorities are trying to encourage the
establishment of a locally-domiciled PE industry by
mandating that eligible PE funds be domiciled locally and
that PE funds invest 75% of their funds locally. Given the
reputation of Nigerian market institutions and the costs of
doing business in Nigeria, there are considerable costs
associated with these efforts to ‘encourage’ the onshoring
of the PE industry, which will be borne by pension savers. 10
Another policy issue is whether expansion of the PE
industry in Africa detracts from the development of local
capital markets. Despite the increasing demand coming
from institutional investors there is a dearth of local
investment opportunities. In part this reflects the preference
of owners of medium- and larger-scale local enterprises
for investment by major international PE funds. Were such
enterprises to issue local IPOs, they would need to observe
transparency requirements associated with being listed,
such as disclosure of financial information and scrutiny by
the tax authorities.
Thus, in the case of such more established enterprises—
rather than expanding the frontier of available risk-capital
available to local entrepreneurs—funding provided through
PE funds often takes the form of ‘replacement financing’
and can be regarded as a substitute for local IPOs, and
thereby as a vehicle for facilitating transfer of potentially
sound investment returns from local to foreign investors. It
can be argued that the activities of PE funds actually inhibit
/ crowd out the development of local capital markets.
Even in more developed markets PE is often regarded as
“sucking life out” of issuance on the exchange. With the
extreme scarcity of new issuance and the limited supply of
viable and growing medium to large enterprises in Africa,
the likelihood is that the potential damage caused by the
PE industry could be serious. 11 Altogether, unless the
PE funds are addressing a particular gap in the funding
available to small enterprises, the question is whether
donor efforts could be better spent on facilitating IPOs and
thereby stimulating the development of the local capital
market. Only if PE funds do provide risk-capital to SMEs
that are too small to be listed would they appear to be
unequivocally beneficial.
8
Kenya and Nigeria are referenced here because they have undertaken significant pension reforms in recent years, whereby pension savings are
fully-funded and privately managed. For more discussion about PE fund investment by pension funds in Africa see “Pension Funds and Private Equity:
Unlocking Africa’s Potential,” EMPEA, Making Finance Work for Africa and Commonwealth Secretariat, 2014.
9
The regulations in Kenya and Nigeria stipulate that pension funds can invest 10% and 5% (respectively) of their assets in PE. The Nigerian regulations
require that pension assets are invested in locally domiciled PE funds that invest 75% of their assets in Nigeria. The Kenyan regulations also prohibit
investment by pension funds in offshore PE funds.
10
Indeed several larger Nigerian PE fund managers have established ‘mirror’ PE funds catering specifically to the needs of local pension fund administrators
(PFAs). These funds are registered locally, and – as one would expect – they face additional costs associated with operating in the local ‘ecosystem.’ These
relate to fund administration (e.g., fund registration with the SEC typically takes two years), legal uncertainty (e.g., law defining limited partners only being on
the statutes of the state of Lagos) as well as undue regulatory burdens and bureaucratic delays, see further discussion in Section 3.
11
Recent dialogue with the heads of the stock exchanges in East Africa confirms that this is indeed a major cause of concern.
Conduits of Capital – Onshore Financial Centres and Their Relevance to African Private Equity
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