The African Union (AU) is forging ahead with its plans to
establish a Pan-African rating agency, writes Misheck Mutize
The credit rating industry in Africa has been dominated by the three international Credit Rating Agencies (CRAs)—Moody’s, S&P, and Fitch—which controls an estimated 95% of the credit rating business globally. Credit ratings emerged in Africa in the early 1990s when South Africa was the first African country to receive a sovereign rating in 1994. To date, 32 countries have a sovereign rating from at least one of the ‘big three’ rating agencies. However, there is increasing dissatisfaction about their approach and methodology in assessing credit worthiness. Some of the factors being challenged are; the failure to accurately account for risk perception, inadequate consultations with stakeholders, lack of independence, and subjective basis for rating opinions. This has made conditions rife to advance the idea of establishing an African Credit Rating Agency (ACRA) as part of the medium to long-term solution to these challenges.
The idea of establishing an ACRA first emerged in March 2019 when African Union (AU) ministers of finance and economy officially adopted a declaration that such institution is needed. As part of process of establishing new institutions under the AU, the ministers requested a proposal on the legal, financial, and structure of the rating agency. Despite a common position that an ACRA is a necessity, there is still no consensus on how the key challenges of medium to long-term sustainability, credibility, and independence will be overcome.
The need for an ACRA has also been reiterated by the current Chair of the AU, President Macky Sall of Senegal, and the Champion of the AU Financial Institutions, President Nana Akufo-Addo of Ghana, during the 54th Session of the Conference of African Ministers of Finance, Planning and Economic Development (CoM2022) and 35th AU Summit, respectively. They highlighted a Pan-African rating agency as an important step towards complementing the AU financial institutions and accelerating continental integration, providing capabilities for AU Member States to access capital and integrating the continent with global financial markets, which makes tremendous reference to credit ratings.
There are two main institutional models that the AU follows in establishing new institutions, which were considered in the proposed ACRA, establishing it as an Organ of the AU funded by its member states contributions or establishing it as self-funded Autonomous Specialised Agency of the AU. Given the nature of the credit rating business, which requires credibility and independence, the option of a specialised agency was suggested to be viable. Similar institutions with autonomous nature, whose models will be replicated by the Pan-African rating agency are the African Export-Import Bank (Afreximbank) and Africa Risk Capacity (ARC) agency. Summary of the legal, structural, and financial model of the ACRA is as follows:
- The rating agency will be an independent specialised agency of the AU with shareholding of African governments through direct ownership or through their public institutions or their designated institutions, Pan-African multilateral finance institutions and African national financial institutions.
- On the financing structure, the agency will adopt the universally and scientifically established ‘issuer-pay’ business model, which is currently used credit rating industry. It will be fully funded by its shareholders through seed capital, loans from Pan-African financial institutions and then after, self-sustainable through revenue generated from its services.
- As is the process of establishing autonomous specialised agency in the AU, the Pan-African rating agency will be established through an agreement, signed by at least 10 member states.
This is proposed to ensure credibility of the services of the agency and that no further financial burden will be imposed on the AU.
The business case
Despite the dominance of the ‘big three’ rating agencies globally, there are still 22 African countries that have no credit ratings from any of the three dominant rating agencies and over 90% of corporates and municipalities remain unrated, although they have interests in having a credit rating. This will be a clear niche for the Pan-African rating agency, which is estimated over $46 billion, together with potential unrated market in the corporates and municipality space, which is growing exponentially. There is also tremendous value within the alternative rating sector which includes Small to Medium Enterprises (SMEs), initial bond offerings, initial public offerings, Environmental, Social, and Governance (ESG) scores, and foreign direct investment ratings, that the rating agency will service.
These rating services are urgently needed on the continent to complement governments’ efforts to support the development of domestic financial markets.
With the reputational leverage of affiliation to the AU, there is good potential that the ACRA will be able to secure substantial business in the ratings of domestic instruments that are aligned with Africa’s long-term strategy for promoting access to affordable capital and promoting the development of domestic financial markets.
Given the precedence of the few African-based rating agencies, which mainly assign ratings for domestic issuances, the ACRA could have a distinctive advantage of having an African-oriented rating scale, a unique understanding of the domestic context of Africa and issuing more informative and detailed ratings than international ratings issued by the ‘big three’.
The AU is forging ahead with its plans to establish a Pan-African rating agency, which will be an important complement to the rating activities of the three dominant international rating agencies to support the development of domestic financial markets in Africa.
Although there are many challenges that the ACRA will have to overcome in order have investors’ imprimatur, both domestic and international, with the huge appetite for an alternative and complementary credit rating institution in Africa, the ACRA has greater chances of success.
Misheck Mutize is the Lead Expert: Country Support on Rating Agencies for the African Union.