Dark times drive EM sovereign bond issuers to innovate
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Dark times drive EM sovereign bond issuers to innovate

Kiev, Ukraine. 24th Feb, 2022. Ukrainian firefighters respond to the a rocket attack on a residential building attacked by Russian military forces during the invasion February 25, 2022 near Kiev, Ukraine. Credit: State Emergency Service of Ukraine/State E

New ideas in the capital markets this year have come from an unlikely source: emerging market governments

Pity the emerging market bond markets this year. They’ve had a shocker. The Federal Reserve busily jacking up interest rates, Russia invading Ukraine, food and energy prices surging and a discombobulated investor base not knowing quite where to turn has meant EM borrowers are longing to see the back of 2022.

Only $117bn of EM bonds were printed in 2022 through to mid-November, compared with $258bn for the full year 2021. By the end of November, EM bond returns for the year had been almost -10%.

But that doesn’t mean these last 12 months have been a complete write-off. Although the process of issuance has been much more difficult for all borrowers and dedicated EM investors at various times of the year — with long periods of no issues at all, such as after the Ukraine invasion in late February, as well as many consecutive weeks of investor outflows — there have been some sparkling innovations, notably by EM sovereigns.

In some cases, necessity has been the mother of invention.

Ukraine’s appalling predicament has forced the country’s sovereign debt management team to, at times, try anything and everything. Keeping Ukraine’s economy and financial needs at the top of the news agenda has itself been a central plank of the country’s overall strategy of building support from allies all over the world — support that has helped Ukraine not only resist Russia’s advance but knock it back in some parts of the country.

Officials, notably finance minister Serhiy Marchenko and head of debt management Yuriy Butsa, have spent much of the year on gruelling road trips to shore up diplomatic and financial support, lobby for debt moratoria and push for more cash, at times through innovative structures and diverse sources.

One option Ukraine was looking at, GlobalCapital understands, was issuing a bond in the North American markets that the Ukrainian diaspora there could invest in. Out of those discussions came the Ukraine Sovereignty Bond, a first-of-its-kind deal designed to allow Canadian retail investors to show their support in denominations of $100.

The deal, a C$500m ($372m) five year deal issued by the Canadian government, was in fact sold as a wholesale transaction, but with retail investors getting access to the bond via Canadian bank dealers and brokerages and their investment account platforms.

Some C$50m of the bond, which was fully backed by Canada’s AAA credit rating, was sold to individual citizens in one tranche, with the rest picked up in a second tranche by institutional investors, including bank treasuries, provincial central banks, pension funds and asset managers.

Some investors told GlobalCapital that they treated it like a use-of-proceeds labelled bond, since it had documentation language about how the cash could be used by Ukraine. The bond has a semi-annual interest payment of 3.245% and matures on August 24, 2027, Ukraine’s Independence Day. The Canadian Department of Finance will lend the proceeds to Ukraine through the International Monetary Fund Administered Account for Ukraine.

Bear market Panda

While not facing foreign aggression, Egypt has had its own economic crisis this year that culminated in the International Monetary Fund being called in to extend yet another emergency loan. The $3bn credit is due to be signed off on December 16.

However, this has not stopped the finance ministry from being creative. Indeed, ministry officials see the IMF’s new loan as a key to unlocking more finance from both the public and private sectors.

One possible source is the Panda bond market. Egypt says it is in discussions with the Asian Infrastructure Investment Bank and the African Development Bank about the two multilateral development banks guaranteeing an Egypt Panda issue, which would substantially lower the interest rate the single-B rated country previously had to pay.

While several EM sovereigns have used similar structures to raise funding in yen, via the Japan Bank for International Cooperation's Gate programme, GlobalCapital is unaware of it happening before in China’s Panda bond market. The World Bank has in the past guaranteed a Ghana bond and the US government has lent its support to various governments' issues.

It is not clear how far talks have advanced on Egypt's structure. However, if the deal comes to market, it could open up a useful way for emerging market governments, especially lower rated ones, to begin cultivating new investors, even at a time of high dollar interest rates and market volatility.

It might even deliver bond market access at a time when conventional routes are blocked due to high cost or shocks. 

SLB firsts

The climate crisis is also a driver of invention, something EM sovereigns have been quick to pick up on and even use to their advantage.

Of the first five sovereign green, social or sustainable bond issuers, four were emerging market countries — Poland (first), Fiji (third), Nigeria (fourth) and Mali (fifth). While developed market sovereigns fretted about whether green bonds would damage their perfect bond curves, EMs saw the opportunity for an extra marketing plus point.

Taking sustainable bond issuance to a new level this year have been Chile and Uruguay. The two Latin American sovereigns were the first to issue sustainability-linked bonds, Chile in March and then Uruguay in October.

Even though environmental, social and governance issues this year fell down the priority list of some investors, who found themselves with their backs against the wall amid the trickiest market conditions since the global financial crisis, the popularity of Chile and Uruguay's bonds underlined the fact that for other money managers there is real urgency in tackling the climate disaster, despite geopolitical tensions elsewhere.

Chile was one day into its investor roadshow in February when Russia invaded Ukraine, sending global financial markets into turmoil.

Undeterred, Latin America’s best rated sovereign attracted higher demand (over $8bn of orders), achieved greater tightening (35bp between initial price thoughts and launch), and a slimmer new issue concession — around 15bp — than almost all the LatAm deals priced before the invasion.

Although Chile was the first sovereign SLB issuer, Uruguay arguably moved the needle further, by incorporating a step-down coupon structure — a first for the mainstream public bond market — as well as the more familiar step-up documentation.

If Uruguay over-achieves on its two sustainability performance targets — related to greenhouse gas emissions and native forest area — by a certain margin by 2025, it will be granted a coupon step-down of 15bp per target.

If it meets the targets by that year without outperforming, the coupon will remain the same, while if it fails to meet the target the coupon will rise by 15bp per SPT.

While Uruguay’s symmetrical coupon outcome structure split market opinion, this did not stop it achieving apparently strong pricing.

So far, the structure has not been copied by other issuers, and it is too early to tell if it will catch on. Opinions are strong in both directions.

Nevertheless, the sovereign SLB genie is out of the bottle. Egypt is looking at the structure, having updated its green bond framework and turned it into a sustainable finance framework that will allow it to consider a rainbow of labelled bonds and sustainability-linked structures.

Even if the US interest rate curve is beginning to top out, there will be no shortage of funding stress for emerging market governments next year.

Ukraine, Egypt, Chile and Uruguay have shown, not only that EM state treasuries can come up with new ideas under pressure, but that they can find market partners — from other governments to MDBs to investors — willing to co-operate and engage with them. With this fertile spirit of creativity alive, the chances are the bond market will bear plenty more new fruit in 2023.

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