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Local currency debt: The color of money

Sep 1, 2013

Local markets continue growing as a funding source and investment opportunity, building on years of structural growth. The prospect of thinner global liquidity will offer the markets’ next big test. By Karen Schwartz

It’s a quirk of Latin America’s modern financial history that the devastation created elsewhere by the 2008 global crisis was, for the region, something of a blessing.

European banks, in particular, retrenched and then retrenched again as the crisis gained pace. But what was an ill wind for these institutions proved a boon to their LatAm counterparts.

The gap these departing banks left in international markets provided opportunities for local and regional players to prove themselves. Moreover, in a kind of virtuous circle, international investors attracted by Latin American interest rates had the opportunity to test the currency markets.

The two largest Latin economies – Brazil and Mexico – offered better yields than those in the US or Europe. Interest rates in Chile, Colombia and Peru were similarly attractive. And as political risk grew in Europe and the US, Latin financial markets in some ways came to be regarded as more predictable than their more established peers.

Though the local markets in many cases still suffer from limited liquidity and a picky investor base, they are growing. Importantly, Latin economies for the most part have continued stabilizing after signing the multi-billion dollar sovereign debt restructurings which ended the 'Lost Decade’ of the 1980s.

"If you look at the past, in the 1990s, we were going from one crisis to another," says Alexei Rezimov, head of capital markets, Brazil, at HSBC. "There is a very different perspective today – now it’s more economic policy fine-tuning."

Latin borrowers have taken advantage of increased political and economic stability to draw international investors to bonds denominated in local currency. Mexican export-import bank Bancomext sold the first peso bond tradable internationally in 2002. The $97.8 million-equivalent three-year euroclearable note yielded 11.175%. Despite the chunky yield, swap savings made the deal cheaper for Bancomext than a dollar issue would have been.

Brazil announced its first international market real-denominated bond in 2005. The 3.4 billion real ($1.5 billion) 10-year bond garnered global attention for its local currency and struck a tenor longer than those available in its home market.

Peru took the markets a step further in 2007, when it sold a $1.5 billion-equivalent 30-year bond through global depository notes, which are settled through US and European systems.

Still, a concentration of domestic investors and limited liquidity mean local markets have a long way to develop. In Brazil, the 10 largest traditional investors represent 80% of the buyer base, says Itaú BBA institutional sales officer Rogério Mansur. And a small volume of new issues – Brazilian corporates tapped local markets for 44.5 billion reais worth of debt in the first half of 2013 – also constrains depth in secondary trading.

"The market that hasn’t developed yet, that we would like to see happen, is a local capital market in reais," José Olympio Pereira, CEO of Credit Suisse in Brazil, says. "We still don’t have long-term funds in reais from sources other than BNDES."

Deeper debt

Across Latin America, regulators are examining how local markets can function better. Stability is crucial. That means long-term investment. A rush of outflows from global debt funds in the middle of 2013 shows how tough it can be to retain international accounts in for the long run.

Comments by Federal Reserve chairman Ben Bernanke in June, suggesting an early end to its program of quantitative easing, spooked investors and led to the biggest outflows in five years from Latin American funds. Bernanke indicated that the US central bank would taper its $85 billion monthly bond purchases by year-end.

Continued growth in the local markets will depend on the resilience of dedicated local currency investors and the growth of domestic sources of capital.

It is impossible to predict how local currency investors will react to higher US rates, says Diego Pace, former corporate finance director with Arcos Dorados, McDonald’s largest franchisee. The volatility could cut appetite for risks like carry trades.

"The main challenge will be if the US is going to do a soft QE tapering, or if rates go up quickly, since investors in these markets focus on yield spread differential and low FX volatility," he says.

But Carlos García Moreno, CFO of Mexican telecom América Móvil tells LatinFinance he expects more local issuance in the company’s home market.

"There will be windows in which you will not be able to issue, but things will reach a new normalcy and a new stability," he says. "These local markets are here to stay."

Reforming for liquidity

Chilean regulators have been working to make the local currency market more liquid. The Superintendencia de Valores y Seguros allowed foreign issuers to sell bonds in Chile in 2006. It took some time for offshore borrowers to take advantage.

Still, the huaso market – where foreign entities issue local Chilean peso-denominated bonds – has made some progress. América Móvil was first, selling a 4 million inflation-linked UF ($225 million) five-year note in April 2009.

In 2011, Chile instituted a broader framework for international issuance into local markets, opening the huaso market as a possibility for Latin American countries that had previously been excluded. The legislation allowed issuers based in countries with three sovereign ratings and which belong to the Financial Action Task Force, an anti-laundering standard setter, or an equivalent organization. Nevertheless, many international borrowers have yet to take advantage of the new terms, discouraged by an unpredictable swap market.

Pending reforms in Mexico could push trading in peso-denominated debt and attract further international investment. The market, meanwhile, has come a long way since the first Mbono in 2000, and offers both diverse investment options and a deep yield curve.

In Brazil, the government bond market is liquid, but corporate debt is less so, says HSBC’s Remizov. The country cut its 6% financial transactions tax (IOF) in June to attract more foreign flows.

More sellers needed

A crucial factor in the development of local currency markets for Latin borrowers has been the soaring rise of domestic savings, predominantly in pension and insurance funds.

From 2000 to 2012, Chilean institutional investors’ assets under management grew from $60 billion equivalent to $250 billion. That has been spurred by higher earnings, more people buying life insurance, and Chile’s overall economic development, says Juan Cristobal Peralta, syndication head at Banchile Citi. "We’ve seen assets under management grow five times and we’ve seen the money invested in bonds grow by 10 times," he says.

Still, liquidity remains hampered by investors’ reluctance to trade. "Everyone wants to buy, it’s hard to find people that want to sell," he says.

For their part, investors say a greater offering of debt would encourage liquidity. Peruvian pension funds must invest 64% of their funds domestically. Roberto Melzi, head of the fixed income portfolio for Peru-based pension fund manager AFP Integra, says he would like to see more corporates issuing bonds. Until that happens, liquidity will be poor. "So I hope to see more on the supply side," he says. "But that’s a wish, not a view." LF

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