Don’t mention the “C” word
Roddy McKean, head of the Africa practice at Webber Wentzel, discusses how international investors are developing effective strategies for dealing with corruption issues in Africa.
Roddy McKean, head of the Africa practice at Webber Wentzel, discusses how international investors are developing effective strategies for dealing with corruption issues in Africa
Corruption is often mentioned as one of the reasons why international investors are wary of investing in Africa. But is this perception or reality and is the position changing?
Like many other risks for investors, the reality on the ground is different. Risks do exist but with a considered approach many of these risks can be minimised.
Is there corruption in Africa? Yes. Is there corruption in other parts of the world? Of course. Is the corruption in Africa worse than other emerging markets? Probably not. It is occasionally suggested by some commentators that corruption is just part of African culture and a way of doing business on the continent but this is based on a lack of understanding of such culture.
Indeed a number of studies have shown that this idea is completely misconceived. Many African communities have a culture of gift giving. So do many Asian cultures but that does not mean that this is the genesis of corruption. As in many emerging markets around the world, there are several catalysts for corruption in Africa; such as the fact that many economies are cash-based. There is often opaque legislation and business practice and endless bureaucracy, which slow down business dealings. In many countries, there is often a heavy state and political involvement in the economy and there is often a need for third party relationships. All of these combined with a difficult and challenging operating environment mean that corruption can be an issue in business in many African countries.
The discussion on corruption of course is a global one. It occurs across both public and private sectors and can take many forms from the abuse of public funds to undue enrichment. Anti-bribery and corruption legislation throughout the world has multiplied in recent years and there is a myriad of global conventions, legislation and guidelines which focus on tackling corruption.
We are seeing that this is slowly having an impact on the way business is done. The trends in such legislation include the fact that the legislation often has extraterritorial application, it includes widely diverging rules and enforcement practices, there are now more agencies with better resources taking tougher stances and there is more co-operation and information sharing between those agencies.
Perhaps the two pieces of legislation which have received the most attention are the Foreign Corrupt Practices Act of the US (FCPA) which has been in existence for some time and the recently enacted UK Bribery Act both of which have wide-ranging remits well beyond the boundaries of the enacting states. Many investors are blissfully unaware that these statutes can be relevant to many transactions in Africa where there is some “connection” (even tenuous) with either the US or the UK.
The FCPA addresses two general areas, the making of improper payments to foreign government officials and the concealing of “bribes” in the accounts of relevant companies. The UK Act goes much further than the FCPA in that it applies to bribery of both public and private citizens and uses a much more expansive definition of what constitutes a bribe. It adopts a zero tolerance approach to facilitation payments and, unlike the FCPA, there are no specific exemptions.
Whilst this global legislation receives the headlines in the fight against corruption, in fact a number of African countries including South Africa, Nigeria and Kenya have their own anti-corruption legislative frameworks in place. When investing in any country it is useful to understand how each of these regulatory frameworks overlay each other.
Turning to the private equity industry, the development finance institutions (DFIs) globally have driven an initiative to improve the standards of behaviour within the investment community in relation to environmental, social and governance (ESG) issues and many DFIs use the IFC’s Performance Standards as the reference benchmark for investments in emerging markets.
Given the impact of the global financial crisis on fundraising over the last few years, the vast majority of general partners (GPs) focusing on Africa have raised their funds and received support from the DFI community. One of the requirements of the DFIs for investing in those GPs is the adoption of those standards by the GPs on the closing of the fund and also when investing in portfolio companies going forward. Whilst those standards cover a wide range of issues regarding environment and social sustainability, there is also a focus on governance issues including corruption and other collusive behaviour.
This has had an impact on how the due diligence process is undertaken as well as the documentation used when making any investment. Specific undertakings and warranties focusing on corruption are now included in standard investment documentation as best practice reflecting appropriate standards of good corporate governance whether or not the relevant legislation is actually applicable to the investment in question.
The question is often raised as to whether this increasing mountain of rules and regulation is having a positive impact for investors. Does it just increase the costs of investment or does it even put companies who adhere to these principles at a disadvantage when operating in emerging markets?
There have certainly been studies by a number of consultancy firms which argue that investing in ESG programmes can generate significant financial returns and improve shareholder value. When investing in companies in Africa, imposing such guidelines will not change behaviour and practice overnight but it is making a difference over the medium term where GPs can add real value to portfolio companies by driving such change.
However the dangers of not focusing on corruption issues are illustrated by the fact that there have also been examples from around the world of companies who have acquired other companies without undertaking proper anti-corruption due diligence which has dramatically impacted on the value of the investment. There is a particular example where a US company purchased a company in Latin America where certain corrupt practices were not picked up during due diligence and indeed were carried on by senior management following the acquisition. When this activity was discovered, it was reported to the FCPA. The end result was that virtually the whole purchase price was wiped out through a combination of the cost of the FCPA investigation (which was borne by the company under investigation), the resulting fines and penalties, the termination of the senior management and of course the loss of business.
But is this making a difference to the investment environment in Africa? Our experience with our clients is that this is an issue which more and more international investors are taking extremely seriously and they are putting in place compliance systems for their employees to provide clear rules as to how to deal with corruption when it arises in their business dealings as well as avenues for confidential reporting of illegal activities by other employees.
But there are also many practical steps to take to minimise the risk when investing particularly in a new country. Understand the environment in which you are operating in. It is important to follow the rules rigorously – some investors take the view that when investing in a developing market they can cut corners which they wouldn’t consider doing in developed markets, often to their detriment. Know with whom you are doing business – use risk consultancy advisors if necessary to carry out background checks. The key is to do your homework before you start.
Internal compliance programmes should also be put in place for all employees. Appropriate values and behaviour need to be driven and lived by the senior management. Clear policies need to be communicated to those employees and training programmes devised. Prepare employees for bribe requests and run them through particular scenarios. Much of the corruption in practice is often petty requests for cash, but there are ways to deal with these situations effectively. It is also extremely important to document everything from policies, reporting procedures to specific requests for bribes – even if it is discovered that a bribe is paid. This could be an important part of a defence under anti-corruption legislation – under the UK Act the only defence that a company has is to be able to demonstrate that it has adequate procedures in place to prevent bribes being paid.
Our sense is that there is a growing move by international investors and multinational corporations to take on corruption issues head on when looking at investments in Africa, to adopt a zero tolerance policy to corruption and to only deal with other companies who adhere to similar principles. There may soon be a time when if an African company wishes to operate globally or interact with an international player on the continent, they will have to have developed their own anti-corruption policies otherwise they may find themselves at a competitive disadvantage. There is still a long way to go but we have certainly been seeing a shift in approach over the last few years.