Will the African Union’s Credit Rating Agency solve continental financing woes?

The issue of development financing is a sore thumb for Africa & it’s 54 states. According to the UN, Africa needs an additional financing of US$124 billion annually to achieve Sustainable Development Goals’ targets. This situation has motivated the African Union to consider creating its own African Credit Rating Agency (ACRA) set to launch in 2024 addressing “unfair” credit ratings given to African states.

Why is the African Union disgruntled by the status-quo?

The African Union outlined a number of shortcomings ratings from the ‘big 3’ (Moody’s, Fitch and S&P Global) CRA’s currently have that are affecting development financing efforts on the continent. The credit ratings from these and other firms have a big impact as they have the ability to increase cost of servicing debts – which is a big issue as African countries are then left to choose between repaying high interest debts or feeding citizens. At least that’s what the AU is arguing. A domino effect of this flawed rating system is that these credit ratings, which AU claims to be “non-objective”, also reduce the investment that African countries receive as these states are perceived as high-risk

ACRA will also look to address the lack of contextual understanding existing CRAs have displayed when it comes to operating on the continent. Recently, Kenya and Nigeria rejected their credit ratings citing a lack of understanding of the domestic environment by rating agencies. Nigeria’s argument was that it was “was already addressing the ratings agency’s concerns” and a further downgraded rating from Moody’s was testament to the fact that agencies don’t comprehend African environments. Nigeria also indicated that the CRAs projections regarding debt-to-GDP were wrong as tax-to-GDP actually rose. 

Similarly, the Kenyan government argued against Moody’s credit rating downgrade on the basis of liquidity risks was inaccurate. Kenya said their position was improving and pointed to the IMFs endorsement as a sign that it was on the right path.

Additionally, the AU alleges that the established CRAs continue to make huge errors in their ratings citing last year’s Silicon Valley Bank (SVB) scandal as yet another example. Before the crash SVB was rated highly by the agencies and there were no concerns raised regarding SVBs ability to meet obligations. As we all know now – there should have been serious concerns. This echoes the 2008 financial crisis and a research paper titled “Why Did Rating Agencies Do Such a Bad Job Rating Subprime Securities?“, by Clair Hill from the University of Minnesota acknowledges that the corners were cut:

…while it seems fair to say that some of what has happened could not have been predicted, there was clearly more readily available knowledge than was incorporated in rating agency models. Certainly, there is evidence that rating agencies were cutting comers.

Why Did Rating Agencies Do Such a Bad Job Rating Subprime Securities?

From the 2008 crisis – one of Moody’s errors was actually quite shocking. An erroneous AAA rating (“the closest you can get to risk-free”) was awarded to the Constant Proportion Debt Obligation (CPDO) financing instrument. It was later discovered that there was an error in the coding used by Moody’s to run its simulation of the CPDO and when this error was addressed the likelihood of default significantly increased.

More recently, the Silicon Valley Bank collapse echoed similar frustrating oversights. Rather than flagging the financial risks associated with the bank, the rating agencies maintained the bank’s A-rating until its collapse on 10 March 2023, despite signals showing a sharp increase in credit risk. 

Whilst these examples are not specific to Africa, they illustrate that the African Union’s disgruntlement towards these institutions are somewhat justifiable as the CRAs make costly mistakes from time to time.

What will ACRA actually look like then?

Given the problem areas we’ve explored it’s relatively predictable to see which areas the African Credit Rating Agency will look to prioritise solving for. AU documentation notes that ACRA will provide “balanced and comprehensive opinions on African credit instruments to support affordable access to capital and the development of domestic financial markets”.

Its safe to assume that if ACRA does materialise in 2024 it will look to address the following:

• Errors in publishing ratings and commentaries – For example, Fitch made an error7 in the application of the longterm foreign- and local-currency Issuer Default Ratings (IDRs) to the relevant issue ratings during its review of Tunisia in December 20228 , which was only corrected after three months. Fitch only issued corrections to comply with the European Securities Markets Authority (ESMA)’s regulatory requirements. Without European regulatory requirements, where the analysts responsible are based, it was unlikely that such corrections would have been publicly announced.
• Prioritising analysts on the continent – AU claims that leading CRAs have analysts who aren’t based in Africa and that this is done purposefully to “circumvent regulatory obligations as the analysts would not need to comply with the regulatory requirements of African Regulators as they are technically viewed as operating from outside the continent”. The AU is also arguing that the lack of a boots on the ground approach means analysts from the leading CRAs don’t understand or evaluate risk factors and end up relying on assumptions instead of obtaining critical data that is best obtained incountry in during credit reviews.
• The AU argues that CRAs random ratings’ announcements have left the continent prone to analysts abuse. AU notes that by contrast, European regulation mandates a ratings calendar. This calendar dictates that ratings for the following year should be published by December of each preceding year and that all announcements be made on Friday’s after close of business “to avoid market disruptions from kneejerk investor responses”.
• Threat of withdrawing credit ratings – AU believes that credit agencies use the threat of withdrawing their ratings, which would place Africa in serious trouble. To be honest this was pretty hard to verify or find supporting evidence for but it seems AU’s point here is with a localised rating agency this potential threat would cease to exist thus giving African regulators and entinties room to regulate and enforce measures that the established credit ratings firms need to follow.
• Herd mentality – The AU cites studies that claim that credit ratings agencies are eager to move first. If it ever manifests ACRA will seek to not fall into the same trap though one would imagine that there will be risks of overcorrection and the continental CRA becoming partial.
• Increased rating analysts’ workload – CRAs are overwhelmed and this compromises adherence to standard procedures. Whilst this was noted as being true the caveat to note was that this was cited as being a result of COVID-19 so it’s unclear if this problem was pre-existing or has become ongoing since the pandemic. 
• The AU also called on African governments to make accurate data more accessible as the credit rating process heavily relies on the availability of reliable data. This is a broader point that governments on the continent need to adhere to industry standards and practicies. If CRAs are to do a good job, then development finance institutions (DFIs) on the continent need to also meet them halfway by providing accurate data in a timely fashion – which they haven’t done consistently in the past.

What can African countries improve to make ACRA and pre-existing CRAs more effective?

All of this is not to say that African states are perfect and are only victims of unfair systems – there are things that have been noted as being worthy of improvement which would serve the countries well whether ACRA materialises or not. 

The United Nations called for better data which will have the impact reduce transaction costs, improve sustainability assessments and increase investor confidence. As of 2021 less than a third of African countries had a fully funded statistical plan, compared to almost half the countries in Latin America and the Caribbean (44%) and in developing Asia (47%). All this suggests that CRAs make poor ratings because they have poorer data sets regarding Africa’s situation and until that is addressed it’s unlikely that will change. Timely provision of that data has also been cited as being important.

One of the things the AU has been mulling over is a data policy framework which could also help in regards to credit ratings on the continent. If ACRA is to come into effect it will no doubt require a standardised set of data from all member states in order to ensure consistency of ratings and higher levels of investor protection. A model that has been suggested as worth following is that of South Africa’s Credit Services Act. The Credit Services Act requires local licensing for agencies and imposes disclosure requirements for ownership structures and methodologies. A combination of multiple credit ratings could also help inform

Improved macroeconomic data may help align risk perception with real risks. Partnerships with business associations or academic institutions can allow government agencies to share industry data that inform investors’ risk assessments at lower cost.

Africa’s Development Dynamics 2023: Investing in Sustainable Development

Regional integration of policies has also been cited as being potentially helpful. Cross-border initiatives like the Africa Continental Free Trade Agreement (AfCFTA) have been pinpointed as policy instruments that could help reduce trade frictions and market fragmentation – therefore increasing investor appetite on the continent.

Lastly, African governments have also been urged to do more in regards to tracking and communicating the impact of development financing. African governments have historically been bad at reporting and making information easily available in regards to financial flows. This will obviously have to change if the continent and its countries are truly invested in changing some of the biases they feel are affecting African states at the moment.

Current state of Development Finance in the SADC region?

The SADC’s annual report from 2022 gives some insights into how things are going in the region. In 2015, Development Finance Institutions (DFIs) in the SADC region adopted the Prudential Standards, Guidelines and Rating System (PSGRS). This set of procedures was established to enhance integration and standardisation across the region and does so by prescribing a guideline for financial reporting, regulation along with best practices for DFIs. This is all then followed up by a common methodology for assessing the performance and risk profile of DFIs. The SADC believes all this will facilitate cross-border supervision and cooperation among regulators. 

SADC’s Development Finance Resources Centre (DFRS) carries out an annual assessment along with a peer-review to determine if members are keeping up with standards prescribed in the PSGRS and at the end of 2021, 85% of the SADC countries were said to be participating in the PSGRS rating system. DFRS is a crucial body as it is jointly-owned by 40 development finance institutions in the region. This allows them to share information and strategies on what successful efforts at raising funds and cofinancing of projects looks like and allows DFIs within the region to follow best practices.

A separate peer review report by the Associate of African Development Finance Institutions (AADFI) in 2022 which included 5 DFIs from the SADC region which managed to rank impressively:

From the SADC DFRC 2022 report we also learn that at the end of 2021 there were 40 DFIs from the region currently working together to standardise processes and share information on best practices within the industry. Overall, whether or not ACRA materialises in 2024, African states still have some work to do to ensure that they become appealing in the eyes of creditors, and it appears there is considerable work being done across the continent in this regard.