More money, less problems: closing the climate finance gap in Africa

It is worth noting that the average expected loss on private debt in Africa is in line with global averages, but the high cost of debt is primarily due to higher initial default rates. Although higher default rates are offset by Africa’s post-default recovery rates, which are significantly higher than in other regions, lenders maintain risk premiums to account for high refinancing and collection frictions.

These high costs of capital mean that without properly structured and incentivized debt, take-up in green sectors will remain low.

In AVCA’s Limited Partner (LP) Survey in Africa (2021)

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AVCA: African Private Equity Industry Survey (2021)

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AVCA: African Private Equity Industry Survey (2021)

The top risks that discourage LPs from investing in private equity (PE) in Africa include the perception of a weak exit climate (62%), currency risk (56%), a less attractive risk/return profile than in other markets (35%). , political risk (35%) and unfavorable regulatory environment (32%). Investors recognize that they can obtain high returns by investing in safer markets and assets in Africa, such as sovereign Eurobonds, mining and real estate.

Solutions to unlock financing

To address the range of challenges facing private enterprises in green sectors, efforts are needed to improve macroeconomic conditions. This includes strengthening institutions, developing local talent and capabilities, and professionalizing sectors to ensure that investments can deliver capital returns and attract additional funds from international and local investors.

If sufficient resources and policies are developed in these areas, appropriately structured financial instruments can be scaled to increase capital availability and reduce costs. Private debt is particularly important for green sectors, which require more infrastructure and working capital.

Currently, higher levels of capital are looking to invest in climate assets both globally and in Africa. For example, the United Arab Emirates has launched Altérra, a new $30 billion catalytic climate investment fund, with core allocations to emerging markets. Such funds will only be successful if investors consider two main levers to reduce investment risk, especially in green sectors: portfolio value creation (PVC) and debt.

1. PVC investment gap in Africa

Globally, PVC – by providing in-depth technical and operational assistance to accelerate the growth and profitability of portfolio companies – plays an important role in achieving target returns for equity investors. However, in Africa, only about 5% of a typical PE firm’s investment team is involved in PVC, compared to the global median of 11%.

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LinkedIn Talent Insights (2024), BCG Analysis

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LinkedIn Talent Insights (2024), BCG Analysis

This is probably because funding volumes are smaller in Africa, making operating budgets tighter.

Development finance institutions (DFIs) – which are the main LP investors in these funds – could play a bigger role in PVCs, enabling PE firms to do the same. By developing much more ambitious technical assistance instruments to support the development of DFIs in Africa, it will be easier to achieve their impact goals.

2. An opportunity for debt to reduce capital risk in Africa

Various financial instruments can be used to reduce capital risk, ranging from traditional to more innovative mechanisms. If broader macroeconomic conditions in African markets improve, these tools could be effective in making capital more available and affordable for private enterprises.