Financing Impact in Nigeria - A Legal Roadmap

Nigeria is plagued with a myriad of environmental and social challenges. From desertification in the north to oil pollution in the south, the root causes of our environmental issues range from climate change to corruption and greed. In 2022, flooding across the country led to over 600 deaths and displaced more than 1,300,000 people. On the social end of the challenges spectrum, the list is endless and so palpable that it almost needs no explanation – real hunger, illiteracy, child mortality and many others. Currently, over half of the population live in poverty.

Against this backdrop and a 2.3 trillion dollar infrastructural deficit, it is clear that Nigeria requires not only sums of finance and capital but a different form of financing and capital investment. A new form of financing that seeks to meet its already chronic challenges with the urgency that such deserve. The model of raising purely commercial finance and capital, and utilizing the resulting tax earnings on social services has to be complemented with a strategy which ensures that from “the jump”, finance is not fixated on purely commercial, financial and economic returns.

Such a strategy must have its “eye” on the very present and visible social and environmental challenges facing the country. An intentionality to financing impact is critical to Nigeria’s development.?

For context, Impact Finance is the provision of debt finance to companies and projects, with an intention of generating positive, measurable, social and environmental impact alongside financial return. Similar concepts to impact finance are Impact Investment (which is the equity finance equivalent); and Sustainable Finance – which is the inclusion of environmental, social and governance considerations in investment decisions. In other words, impact finance is all about ensuring that the deployment of debt capital in companies or projects achieves a broader social or environmental purpose for the society beyond the specific company or project being financed.

Impact Finance is not new in Nigeria. An Impact Investors’ Foundation (IIF)? report stated that between 2019 and 2021, financial institutions deployed over 2.2 billion dollars’ worth of impact finance in the country. However, this volume of impact finance is grossly inadequate given the severity of Nigeria’s social and environmental challenges, and the wider financing trend. For example, despite contributing 48% to Nigeria’s Gross Domestic Product (“GDP”) and accounting for 84% of employment in Nigeria, only 4% of Nigeria’s Small and Medium Enterprises have access to debt finance. Relatedly, agriculture, which contributes 23% to GDP and employs millions of Nigerians, has a 91% financing gap.

Clearly, there isn’t enough being done to intentionally channel finance towards sectors, corporates and projects with the greatest impact potential in Nigeria.?

There are some possible explanations for the status quo – from a lack of awareness regarding impact finance and its overall importance for both providers of capital and the society at large; to a lack of incentives to pursue such “noble” ventures as impact or sustainable finance. However, one of the key factors inhibiting the growth of impact finance in Nigeria is the lack of an enabling and comprehensive legal framework.

Presently, impact finance transactions are governed by the legal framework for commercial finance transactions. This approach unduly increases transaction costs and disincentivizes providers of impact finance – who typically charge a “lower-than-market” interest rate and are amenable to relatively longer repayment periods.

For all its positives, justifying the economics of an impact finance transaction can get a bit tricky within the current legal and regulatory framework for commercial finance transactions in Nigeria.?

Therefore, increasing the flow of impact finance in Nigeria would require some changes in law and policy. As a first stab at this rather complex and nuanced subject, this article explores some “low-hanging” options that can be effected through an amendment of the Finance Act – Nigeria’s composite law on taxes and related matters. A roadmap for this amendment is set out below:?

• Definition of “impact” and “impact finance”

The most critical first step is to clearly provide a legal definition for “impact” and “impact finance” in Nigeria. These definitions will serve as a compass for identifying impact finance transactions. This identification is important for several reasons, including the determination of eligibility for the incentives proposed in subsequent paragraphs. In constructing a definition of impact, we must focus on our national priorities – as reflected in our National Development Plan.

For instance, does a project improve the quality of education for everyday Nigerians? Does it improve our infrastructure? Does it support our agricultural value chain? In layman terms – does it affect the price of “garri” in the market?

These definitions, which must emphasize clear and measurable impact, would serve as a frame of reference for all conversations around impact finance in Nigeria.?

• Exemption of impact finance agreements from ad-valorem stamp duties?

The legal documentation for an impact finance transaction in Nigeria typically comprises a finance agreement and a suite of security agreements (where the facility is secured). Under Nigerian law, contractual documents, like the finance and security agreements, are required to be stamped, for the agreement to be admissible in evidence. Whilst the finance agreement attracts an ad-valorem stamp duty of 0.125% of the loan amount; registrable security documents, like the All-Asset Debenture, attract an ad-valorem stamp duty of 0.375% of the loan amount. These fees, which at first glance might appear insignificant, would often run into substantial sums based on the value of a facility; and conversations about how to manage same would often arise in purely commercial financing transactions.

Needless to say that impact financiers generally find these costs to be prohibitive, especially when financing businesses or sectors which are not necessarily the most financially rewarding, due to the focus on impact.

Therefore, it would be beneficial to either exempt impact finance documentation from these duties or prescribe a reduced ad-valorem rate or nominal duty rate for such documentation.

• Reduction of registration fees payable on impact finance security documents?

The Companies and Allied Matters Act prescribes the registration of charges (security) over the assets of companies at the companies’ registry. Thus, in secured impact finance transactions, security agreements are registered at the companies’ registry. The applicable registration fee in this regard is 0.35% of the loan amount.

Also, where, in connection with a finance transaction, security is being taken over real property, a further registration of the security agreement is required at the land’s registry of the state where the real property is located – at a cost which may be up to 1% of the loan amount.?

These registration costs are also considered prohibitive by financial institutions, especially in the context of impact financing.

Thus, a 50% reduction in the registration costs is recommended.?

• Impact monitoring and reporting obligations?

To prevent non-impact finance transactions from benefiting from the incentives proposed above, financial institutions should be required to file annual impact reports in respect of the impact finance deals in their loan portfolio (if any) with their principal regulator – typically the Central Bank of Nigeria. In this regard, the Social Loan Principles, issued by LSTA and India’s Master Directions for priority-lending can provide helpful guidance.

Undoubtedly, some of these recommendations will lead to a reduction in Nigeria’s tax revenue - which some would argue is money the government could otherwise utilize to address some of the country’s environmental and social issues. However, mindful of how ineffective the tax for development model has been in Nigeria, I would argue that the environmental and social benefits from an increased flow of impact finance in Nigeria will outweigh any “potential” benefit from any consequential loss in tax revenue.

By unlocking the much-needed finance to finance real, clear and measurable impact in Nigeria – through SMEs, off-grid energy developments, key infrastructure projects, and agriculture enterprises amongst others, we would be unleashing a new phase in Nigeria’s developmental journey.