Latin America’s domestic bond markets have something of a reputation for breaching the definition of “market”. Trading can be minimal and consolidation among pension funds in several countries has left a handful of accounts dictating what happens when it comes to new issues.
With demand for local currency funding high and the market for global local currency deals sporadic at the best of times, Mexico decided to act.
The finance ministry, which has something of a trendsetting reputation in sovereign debt markets, set to work with clearing house Euroclear in an attempt to make domestic corporate bond markets more accessible for international investors.
Mexican finance minister Luis Videgaray Caso said that the agreement “should yield tangible benefits such as reducing the cost of borrowing for our local issuers, increasing the liquidity in our local markets and furthering investment in our economy”.
The agreement became active on January 31 and it took less than a week for state-owned oil company Pemex to issue the first Euroclearable Cebure (ECC), as the new instruments are called. International buyers can clear securities via Euroclear and local buyers can use the usual Mexican settlement system Indeval. The ECCs are completely fungible between both sets of investors.
Debt bankers say the trade was a roaring success. Pemex sold a triple-tranche deal that day but made only the largest tranche — a Mp17bn ($1.122bn) re-opening of its 7.47% 2026s — Euroclearable.
“Previously, Pemex would issue GDNs to get international investors to buy its peso paper, but under that structure there were effectively two markets,” says Gonzalo Mañón, head of debt capital markets Mexico at BBVA Bancomer, one of the bookrunners on the Pemex ECC. “Integrating local and international investors was very complicated.
“The Euroclearable Cebure will help international investors enter the local market in much greater volume and, above all, should make domestic paper much more liquid.”
International buyers took Mp9bn of the tap, a favourable proportion given recent history, whereas under the GDN format they had never taken more than around Mp3.5bn of one Pemex deal.
Expanding the Mexican market
Debt bankers in Mexico say that issuers rated AA (local) and higher generally enjoy a wide open local market. Even without international buyers, the market is growing; Mañón says that the assets under management of the local investor base have been growing at a faster pace than new supply.
But the ECCs arrive at a particularly great time for those who have saturated the investor base.
This was the case with Pemex, says Octavio Calvo, managing director and head of DCM for Mexico at Santander. “The way to develop the local market is bringing in more investors,” he says. “There has been a huge consolidation among Mexican afores (pension funds), meaning there are fewer and fewer investors. The new instrument marks a very important development.”
Local institutional buyers are buy and hold, he says, meaning there is no real market in Mexico. “It is illiquid, new issues are by appointment and there is little or no trading.”
International investors are already the largest holders of Mbonos — Mexican government bonds — so offer them a premium to the sovereign to buy quasi-sovereign paper, as was the case with Pemex, and they should be very interested, say bankers.
“Mexico is definitely an attractive market for foreign investors,” says Mañón. “Many of them find in pesos investments at attractive rates — higher than in the US.”
But both the Santander and Bancomer bankers say that for lower rated borrowers, access to domestic markets is much harder.
Mañón says he does not see this changing in the short term and says that initially the ECCs will be used by strong triple-A (local) companies. Another debt banker said he believes state utility CFE could be the next issuer.
High yield companies at the moment have to go to dollar markets or banks for funding. However, the new Euroclearable instrument could be the start of the road to domestic bond markets for different types of borrowers.
Calvo sees the ECC market evolving in several stages. After the quasi-sovereigns and investment grade corporates could come the investment grade ABS and project bonds, which he says are “highly dependent on the participation of afores and very difficult to execute”.
But ultimately he does believe high yield issuers will gain access to domestic markets via the ECCs. “If one afore is no longer representing 30% of a deal, its power over the borrower will be restricted,” says Calvo. “When these accounts see international investors playing in high yield deals, they will be encouraged to participate.”
Cheaper than global pesos
The ECCs are not the first attempt to enable Mexican and international bond buyers to buy the same peso-denominated instrument. With illiquidity in global local deals putting off many investors, América Móvil designed its títulos de crédito extranjero programme in 2012, registering the programme both with SEC and the Mexican regulator. It was aimed at increasing liquidity with regular issuance and seamless trading between local and international buyers.
Yet despite the hopes of copycat programmes from some New York-based DCM bankers, only Televisa has launched similar deals.
The ECCs effectively offer the same advantages as América Móvil’s programme but under Mexican rather than New York law. This makes the cost less prohibitive for borrowers that do not have the scale of América Móvil or Televisa.
“The trouble with global local bonds is the cost: paying the lawyers and registering with the SEC,” says Calvo. “For the likes of América Móvil it is fine, but others need more cost-effective instruments.”
Calvo expects some ECCs to be issued under 144A but that others will be Reg-S only, equating to substantial savings for the borrower.
Copycats
Rising dollar yields, volatile currencies, an increase in pension fund assets and huge infrastructure plans requiring local currency funding across the region are all legitimate reasons for other Latin American countries to be developing their domestic markets.
Cristina Schulman, who heads Santander’s DCM business in Brazil, says there is “talk” of Brazil trying to replicate Mexico’s move to pair domestic corporate bonds with Euroclear but that the country is “some way behind”.
Hugo Horta, director at Andean investment bank Credicorp Capital in Lima, says that there are some moves to make local markets easier for international buyers in the region, highlighting that some Peruvian securities have CUSIP numbers.
And in Chile, there is also a local effort to make the market more attractive for
international investors in order to increase its liquidity.
Gonzalo Álvarez-Cañedo, who heads DCM at Santander Chile, says the country could also look to replicate Mexico’s move, but that although it is “not a quick process”, he is expecting progress this year.
Domestic versus international
Unlike Mexico, where the alignment with US economic cycles means that any rate rise from the US Fed could be replicated by Banxico, in other Latin American countries domestic markets are gradually becoming more able to compete with international markets.
“We have seen changes in how Andean companies are approaching debt markets,” says Horta. “The devaluation of local currencies has hit companies that had issued in dollars. Many of them didn’t want to or were unable to hedge FX risk and in some cases the currencies are up to 20% weaker than when the bond was issued — which is having serious effects on balance sheets.
“These borrowers are now turning to local markets, especially in the case of Chile and Peru.”
Peruvian consumer goods company Alicorp sold $450m of 10 year bonds at 3.895% in March 2013, the lowest ever yield achieved by a Peruvian company. But just two years later, with the Nuevo sol nearly 20% weaker than at the time of the issue, Alicorp opted to switch some of its liabilities to local currency by launching a tender offer for up to $150m of the global bonds and paying for it with a Pen500m ($161m) domestic issue.
For Chilean borrowers, the local market offers not only less currency risk but better pricing.
“In general terms, the local market is becoming more attractive for Chilean issuers, and some investment grade borrowers can frequently achieve pricing that is 40bp-50bp better in the local market than in the dollar market,” says Álvarez-Cañedo.
This has led to financial institutions in particular prioritizing their home market for funding, he adds.
Where domestic markets cannot compete, however, is on size. In Mexico the maximum is usually around $500m-equivalent and in Brazil a typical deal is R$500m — which is only $150m, such has been the depreciation of the real. Colombia can usually manage up to $400m at a time for large borrowers while in Chile a normal deal comes in the $250m-$400m equivalent range.
Álvarez-Cañedo says that appetite in the Chilean market is growing, which could lead to larger deals becoming possible, but that it will not be a major shift.
There are signs of deal size increases in Peru, as Horta says that when he began working in Lima three years ago the maximum you could issue was just $50m. But restrictions abound.
“Unlike 144A issues, local bonds tend to have to be in tranches,” says Horta. “So if you need say $200m, you’ll probably have to do $50m as a five year, $100m in a 10 year and then $50m in a 20 year.”
For now, says Horta, international investment in domestic markets in the Andean region tends to be limited to sovereign curves.
Brazil seeking infrastructure funding
Brazil’s debenture market is easily the largest in Latin America but the government is still looking to bring in more investors. In 2012, the government created tax-free infrastructure debentures to incentivise investment in the sector.
The initiative got off to a slow start but Vale’s R$1bn issue under the format in February 2014 gave added impetus to the programme. As well as financing badly needed infrastructure works, the programme is broadening the investor base.
“There has been an increase in interest from private individuals in fixed income,” thanks to these tax-free bonds, says Cristina Schulman, head of DCM at Santander in São Paulo. The market for these instruments “is now functioning and more deals are in the pipeline”.
The debentures market keeps chugging along, despite Brazilians being shut out of international bond markets as a result of the bribery scandal at state oil giant Petrobras. Investors are just a little more selective.
“Some have suffered hits from recent defaults or other situations,” says Schulman. “But this just means they really favour the highly rated companies and it is more difficult for new names to issue. We see a market that is functioning and liquid.”
There are some typical international bond issuers from the country who are looking at the local market as an alternative — particularly those with revenues mainly in reals as the currency depreciates. But the size and maturity limitations — with three to five years the maximum maturities, according to Schulman — mean local markets “will not completely offset the need to go to international markets”.
With external conditions looking more challenging, Latin American companies will be happy for all the funding tools they can get. - OW