Interview Isabelle Lessedjina: “Faced with currency risk, we must take concrete action and mobilize to build a more resilient and sustainable future”
Badly hit by the economic crisis caused by the COVID-19 pandemic, several African countries have seen their currencies depreciate which has automatically increased their financial commitments denominated in foreign currency. However, there are solutions, such as currency hedging that can optimize financing conditions. Isabelle Lessedjina, Senior Vice President of the TCX hedge fund, explains the concept and the benefits that Africa could gain from it.
Interview by Jacques Leroueil
When it comes to financing, many African countries or institutions borrow in a currency that is not their own, which brings us to the notion of currency risk. Could you explain this concept to us?
In many parts of the developing world, particularly in Africa, companies or governments that wish to borrow money on international markets can often only do it in foreign currencies (dollars, euros, etc.), even though their source of revenue to repay that debt is denominated in local currency. This is known in the economic literature as “original sin,” a term that refers to a situation in which some countries are unable to borrow abroad in their domestic currency, resulting in foreign exchange risk, i.e., uncertainty about the evolution of the exchange rate between currencies, which can quickly become problematic. In such a scenario, foreign currency borrowers in these countries can very quickly find themselves weakened by sudden exchange rate movements, which can impair their ability to repay. Funds specialized in currency hedging exist precisely to avoid this type of damaging situation.
How did the idea of these funds come about which, in a way, guarantee the absence of “bad surprises” in terms of financing conditions?
As is often the case, a solution is born out of a given need. As far as TCX is concerned, the need came from the development finance institutions (DFIs), which wished to hedge their commitments against the exchange rate risk of the countries in which they operated. From this possible hazard came the idea of launching a dedicated hedge fund; a solution that – until then – did not exist. Since most DFIs prefer not to carry out this type of transaction themselves, it was decided to launch an ad hoc financial vehicle, TCX, to share this risk globally. This is how our fund was created in 2007, in Amsterdam (Netherlands), supported by a group of development financial institutions, governments and investment companies specialized in microfinance. Since then, through futures contracts and currency swaps, we have hedged more than 3,500 transactions worldwide for a cumulative amount of over $8 billion.
Specifically for Africa, are there coverage solutions for the majority of the continent’s countries today?
Yes, almost all of Africa’s currencies can now be hedged and these arrangements primarily benefit the microfinance, energy and housing sectors, all generating their revenues in local currencies and for which the foreign exchange risk is lifted each time. It is also important to note that, as a general rule, there is no competition with local financial institutions, as the currencies and maturities processed are those for which domestic banks and capital markets do not offer coverage. But beyond this operational framework, what is important here is the underlying dynamic, The continent is increasingly the focus of hedging product offerings, with many more resources and dedicated “Africa” strategies.
If funds take on the currency risk of third parties, this means that they ultimately bear the risk themselves. How is this currency risk managed in practice?
Given the global exposure (Asia, Eastern Europe, Africa and America) and the wide range of hedging products offered by funds specialized in currency hedging, they operate on a model where diversification is, de facto, integrated into their portfolio. This acceptance of risk makes them more of an insurer than a traditional hedge fund: our role is to pay for losses that arise from time to time. The COVID-19 crisis, which occurred at the beginning of the year, is a perfect illustration of this and has only reinforced the relevance of having a good hedge against currency risk . “We are similar to an insurance company: it is when a house catches fire that the decision to have insurance pays off. In March, the house caught fire and we paid,” says our CEO Ruurd Brouwer.
The crisis arising from the Covid-19 pandemic is therefore a source of support for this type of solution.
Number of players active in the development sector (the European Commission, the German development bank KfW, the International Finance Corporation, Proparco…) have in any case renewed during this period their commitment to protect their borrowers – particularly Africans – against the exchange rate risk associated with international lending. Moreover, as the pandemic has shown more than ever the sensitivity of african economies to external shocks and the need to develop local currency capital markets, several of our government investors have specifically requested increased support for hedging products in Africa to strengthen its resilience over the long term. As such, among the transactions TCX has completed this year, we are particularly proud to have been behind a world first: the issuance on October 5 of the first synthetic bond in Congolese francs on the international markets for an amount equivalent to $20 million.
In terms of optimizing financing conditions, what are the remaining challenges in Africa?
Implementing these currency hedging solutions in a systemic way will be a long-term process and, given the huge needs of the continent, one of the main challenges to be met on a daily basis remains the need to build a lasting relationship of trust with local financial players. In addition, there is still a lot of upstream work to be done so that the major multilateral institutions change their old habits and offer solutions (loans in local currencies, hedging solutions, training in foreign exchange risk management, etc.) better suited to developing countries. In the end, I think that all the stakeholders are aware of the stakes (debate on the sustainability of the debt, study on the link between the debt and the exchange rate risk…). We must therefore move on to concrete actions and mobilize to build a more resilient and sustainable future.