“Is Africa Cross-Border Lending Under Threat?” by Akosua Akowuah of AB & David Africa

The decision of the High Court in Uganda in the recent case of HAM ENTERPRISES V DIAMOND TRUST BANK (U) AND DIAMOND TRUST BANK (K) LTD has sent the financial sector reeling for cover. Incidentally, the controversial decision in Ham’s case was made at a time when an increase in potential cross-border lending in Africa was anticipated; and the continent was in transition buoyed by the African Continental Free Trade Agreement (AfCFTA). This article assesses the decision in relation to cross-border lending in Africa and its potential impact on the continent’s financial market.

Introduction

Other than direct government funding, many projects in Africa are financed by financial institutions resident outside Africa or who operate in multiple countries on the continent.

The key sources of funding for investment in Africa include:
(a) Development Finance Institutions (DFIs) (both within and outside Africa) who lend mainly to or through the public sector;
(b) Local banks and other financial institutions who lend mainly to SMEs and also co-lend to mega projects or perform representative banking services;
(c) Cross-border lending from offshore Africa or from DFIs located in Africa;
(d) Private equity and other miscellaneous financing sources operating on multiple countries on the continent.

Cross-border lending has increased significantly, cutting across many sectors including energy, infrastructure, oil and gas and agriculture. With constraints on public funds, many African countries and businesses will continue to source funds from international financial institutions and investors to finance transactions across Africa.

International financial institutions lend to many businesses and governments in Africa. Even where funding is to be provided by local entities, this is typically done on syndicated arrangements with foreign lenders primarily for projects that require huge amounts. There is, therefore, an appetite for foreign loans and syndicated lending, which also allows the lenders to share the risks of lending and also benefit from financial opportunities associated with such lending.

This trend is expected to increase because of several factors. These include the increasing expenditure on infrastructure on the continent and the growth of value addition options that will result from growth in intra-Africa trade. Pre-Covid19, intra-Africa trade had hit eighteen percent (18%) from a low of five percent (5%) some fifteen years earlier. Intra-Africa trade is expected to see a further boost from 2022 in the immediate post-Covid19 era with projected increase in lending to the private sector as a result of the free trade. At the same time, there appears to be an emergence of Africa-focused financial hubs. For example, Morocco, Mauritius and Rwanda are increasingly introducing legislation that position them as centres of finance for Africa; this is in addition to Johannesburg- Africa’s leading financial hub. In an era of heightened global awareness and legislation on anti-money laundering, the robustness required for these new financial centres will be top of the list of issues of concern.

It is in the context of the above trends that the case of Ham Enterprises vs Diamond Trust Bank (U) (“DTB (Uganda)”) and Diamond Trust Bank (K) Ltd (“DTB Kenya”) (the “Ham’s Case”) becomes a matter of concern.

The Ham’s Case

The High Court in Uganda in Ham’s Case has rendered a lending transaction between a foreign bank and a local borrower void. This recent decision of the High Court, raises a lot of questions and concerns around foreign lending in Uganda for both foreign lenders and local borrowers. The case has implications not only for financing in Uganda but in other jurisdictions in Africa with similar license arrangements/requirements as Uganda.

The Background

Ham Enterprises in Uganda (“Ham”) obtained a secured loan from DTB Kenya through DTB Uganda to fund projects in Uganda. Ham defaulted on its repayment obligations under the loan and DTB Kenya notified Ham of its intention to enforce the security for the loan. While the loan remained unpaid, Ham Kiggundu (“Kiggundu”), owner of Ham Enterprises, filed a case against DTB Uganda and DTB Kenya, seeking among others, a declaration from the court that the loan provided by DTB Kenya was illegal and unenforceable under the Financial Institutions Act of Uganda (FIA) on the basis that DTB Kenya was not licensed to undertake financial institution business in Uganda. Kiggundu also sought an order for an unconditional discharge of mortgages created over his properties as security for the loan.

The Outcome

The court ruled that the lending transaction between DTB Kenya and Ham was illegal and void ab initio since it was obtained without approval from the Bank of Uganda (BoU).

The decision is particularly important with Africa’s growing reliance on offshore lending and the emergence of financial markets. For the private sector in particular, the two (2) well known factors, “lack of access to capital” and “cost of capital” have often compelled businesses to look outside the continent for cheaper sources of lending. As the continent grows, so will the role of offshore lending, especially as many local banks are not well capitalized. For example, in recent years both Nigeria and Ghana experienced incidents of collapse of banks (as a result of financial sector reform) mainly due to inadequate capital adequacy ratio and high level non-performing assets.

Following the financial crisis in the last decade, new approaches to financing have emerged, creating robust checks for lenders. At the same time, cross border credit flows increased. This is evident particularly on the increased dollarization of loans attributed to the high incidence of offshore borrowing. Additionally, the amortization of these loans come with attendant FX challenges necessitated by the use of the dollar as the denominator.

The Impact of Local Law

Generally, the laws regulating financial institutions and lending in many African countries permit foreign lending without a requirement to obtain a licence or authorization except where specific conditions are provided. For instance, in many African countries, where the activities of a foreign bank (lender) are considered as conducting business within that country, there may be a requirement for such a bank to regularize its activities by obtaining the relevant authorization.

As a result, banks carry out risk assessment in all lending arrangements in order to be sure that, the agreements are valid under the applicable laws of the relevant jurisdictions. In other words, the offshore lender seeks assurance that its transaction is permitted under the local law. Where the offshore lender unlawfully engages in such transactions under local law, the transaction and any underlying agreement entered into to give effect to the transactions will be unlawful and unenforceable.

The Scare

The decision caused an uproar in financial circles. If not overturned on appeal, the direct impact is that a foreign bank cannot lend money to an entity in Uganda unless the foreign bank obtains a licence from the BoU pursuant to the FIA. Failure to obtain the license will render the transaction illegal and the underlying agreements unenforceable. Consequently, all foreign banks must obtain a licence from the BoU prior to lending to any local enterprise.

The concerns and fears of the decision stem from several factors. First, this will affect such lending transactions already concluded since this has hitherto not been the position. Secondly, it will affect transactions of many other African countries who have similar laws as the FIA, especially in Anglophone countries where precedents of decision of the courts of other jurisdictions are often used as reference points for persuasive effect. This is enough to discourage foreign lenders who hesitate to provide financing, for reasons brought about by the ruling.

The Amortization of Cross-border Loans

The component of offshore receivables in each of Africa’s fast developing countries is high. Accordingly, the consequential securitization of loans often requires the use of assets located in another country. Asset backed cross-border lending therefore depends on a high level of stability in the regulatory regime covering assets which are used as securities.

Naturally, the following are significant when it comes to the decision of lenders to advance money on projects in Africa:
i. The general legal regime or regulatory framework on loan transactions;
ii. The general risk profile of the country;
iii. The general legal framework on securitization of assets for offshore lending;
iv. In respect of the third factor (the general legal framework on securitization) lenders also consider the speed with which disputes relating to lending are adjudicated upon by the courts.

Further, they consider the extent to which commercial considerations are factored into the decision of the courts as against legalese.

The more commercial minded the courts are, the more likely investors and lenders feel confident in the judicial processes of the country in question.

This explains why there is high interest in the case.

The Response Of Regulators and Industry So Far

In Uganda, the BoU has sought to calm the fear of foreign lenders by issuing a clarification by which it has maintained that foreign banks are regulated and supervised by their home authorities. Consequently, the BoU does not regulate lending which involves “using funds obtained from foreign banks that do not take deposits from the public in Uganda”.

The Banking Association of Uganda has issued a response to the decision of the court, indicating that the ruling has huge implications on the Ugandan economy and puts various infrastructure projects funded by foreign lenders at risk. Banks in Uganda have called on the Ugandan government to reassure the financial sector, international lenders and the entire country of the government’s commitment to continue honouring all debt obligations of its funded projects in line with agreed protocols.

The decision has also been condemned by the legal fraternity and the banking and finance sector in several jurisdictions within Africa.

Is this the Norm or an Aberration?

It appears that the laws regulating financial institutions and lending in many African countries are generally territorial in nature and do not extend to foreign banks, or any other foreign lenders offering loans to local entities. Additionally, it has never been the practice of the Central Banks of these African countries to licence foreign banks or require foreign banks to obtain a licence in order to lend to a local entity.

Therefore, it is reassuring to note that the decision in Ham’s Case is a deviation from the law and practice with respect to foreign lending in Uganda and many African countries like Ghana, Nigeria, Zambia, Zimbabwe, Botswana and many others.

As an example, under existing Ghanaian law and practice, lending by foreign entities (including banks) is not a regulated activity and hence does not require a licence, permit or authorisation from the Bank of Ghana (BoG). There is also no indication or expectation that foreign lending may in future become a regulated activity by the BoG.

It is also not necessary under the laws of Ghana for a foreign bank to be licensed, registered or qualified in Ghana:
(a) In order to enable the lender enforce its rights under a loan agreement or
(b) By reason of the execution of a loan agreement or the performance of obligations under a loan agreement.

The Perception in Respect of Africa’s Risk Profile & Related Impact

The decision in Ham’s case is not helpful to proponents of offshore lending working to reassure the international business community of the clarity and predictability of business-related laws in Africa. Africa already struggles with the burden of being stereotyped as a continent for the actions or inactions of one or more countries on the continent. This may negatively impact the strategy of foreign lenders in relation to Africa.

Consequently, the impact of this ruling on the rest of Africa, from a perception standpoint, may include the following so far as cross-border lending is concerned:

(a) Extensive due diligence carried out prior to lending: the perception of a higher risk profile will lead to lenders resorting to more enhanced due diligence to uncover red flags that were not previously factored into the lending profile. This can make lending more frustrating, time consuming and costly.

(b) The range of asset backed securitization: lenders are likely to be more risk averse in respect of location of assets which are used as security by borrowers.

(c) The role of agency banks and collateral trustees: agency banks and trustees of securitized assets may have to assume a higher responsibility than previously envisaged before Ham’s Case and they in turn will have to conduct more detailed due diligence than before.

(d) Party autonomy in respect of choice of law: the use of laws of jurisdictions outside Africa (England, New York, Singapore, among others) is likely to continue into the foreseeable future as a result of the above factors. Where legislation compels local laws to be used, borrowers may end up being asked to assume new obligations.

(e) The location of the borrower: in order to enhance enforcement, lenders may impose a requirement that the borrower be an SPV separate from the beneficiary and dictate the country of residence of the borrower.

(f) It may also lead to further financial sector regulatory reform: this appears to have been signaled already by the decision of the regulator in Uganda’s central bank’s attempt to moderate the perception.

(g) Co-operation among regulators: on a positive note, it may also bring about the need for better co-operation among regulators across the borders of Africa’s fifty-five (55) countries. As an example, the case in point would be much easier to manage if regulators in Kenya and Uganda cooperate in this regard.

Issues Trending

Incidentally, this case makes the headlines at a time when a number of issues are trending in Africa’s financial landscape. There is increased talk about the need to end Africa’s risk premium; a call for further reform in the banking sector.

There is the imminent end to the use of LIBOR. An upward trend in digitization and fintech solutions among African banks. Obviously, the implications and repercussions of the case will extend beyond Uganda and Kenya. This is particularly so at a time when the AfCFTA is removing trade barriers, promoting free movement on the continent and when the African Union is pushing for greater integration. What happens in one country has a ripple effect in others.

There could not have been a more inappropriate time for the court to make such a decision.

As at the date of publication of this article, the decision of the High Court had not been enforced as a result of the appeal. Other bank executives on the continent are definitely watching and waiting for the outcome of the appeal as well as the response of regulators. Perhaps, this may be one of the issues that will be prime on the agenda of a future meeting of Africa central bank executives. For now, the jury is still out.

About Akosua Akowuah: Akosua Akowuah is an Associate Partner with the Banking & Finance Practice Group of AB & David Africa. She is based in the Accra office and works with the firm’s Africa Finance Team which looks at the finance sector across sub-Saharan Africa. She was assisted in this by Daniel Lubogo, AB & David Africa based in the Uganda office and Ferdinand Adadzi, AB & David Africa based in the Ghana office.

 

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