Why do it? The five reasons for local issuance
Issuers look at local currency issuance for a variety of reasons, whether it be a manufacturer financing a foreign operation or a development bank looking to promote growth. One way or another, all are looking to take advantage of opportunities not available elsewhere, writes Philip Moore.
There are five principal reasons for issuers to tap into local currency bond markets. The first, and perhaps the purest, is to raise local currency to finance operations outside a borrower’s home market. One of the most regular exponents of local currency issuance in order to raise funding to support local operations is the US heavy machinery manufacturer, Caterpillar, which has issued recently in currencies ranging from Argentine and Mexican pesos to Russian roubles and Chinese renminbi.
While corporate borrowers like Caterpillar raise local currencies directly, many others do so through development banks or export credit agencies, which has also bolstered liquidity in a number of markets. One example is Sweden’s SEK. Petra Mellor, a director in the funding department at its Stockholm headquarters, says that raising local currency funding for on-lending is becoming increasingly important for SEK.
“Our strategy is to match-fund our borrowing and lending in terms of maturities, and we think we will do so more and more in local currencies as well, as regulation makes currency swaps more expensive,” she says.
At the same time, says Mellor, demand for lending is rising as alternative sources of funding for exporters have become more scarce or more costly. As SEK explains, “demand has been affected by some banks being less willing than before to provide long term lending and many purchasers of Swedish exports requiring long term financing.”
This was a contributing factor to overall lending at SEK reaching Skr56.2bn in 2012, the second highest annual total the group’s history, of which Skr38.6bn — in 262 deals — was accounted for by end-customer finance. According to SEK, “there has been significant demand within direct finance for lending in local currencies, and we conducted around 120 different deals in local currency [in 2012], with a total lending volume of approximately Skr3bn.”
A clear example of companies’ funding requirements feeding through into local capital market activity has been SEK’s issuance in the offshore renminbi (RMB) market. Its debut transaction was an Rmb200m three year bond led in January 2012 by Citic Securities, with the proceeds on-lent to Volvo, which has ambitious plans for its operation in China.
SEK returned to the RMB market in May 2012, raising Rmb500m in a three year transaction arranged by HSBC and TD Securities, priced at a coupon of 2.375%.
“These issues are another step for SEK in establishing itself on the Chinese market so that it has the capacity to meet the financing needs of a number of Swedish exporters in local Chinese currency,” says Mellor at SEK. “Previously, Swedish companies operating in China were only able to access local currency financing from banks in China, but this was expensive and, in particular, was over much shorter maturities than SEK was able to offer.”
This suggests that SEK may be a regular borrower in the RMB market in the future, but Mellor says that the potential of a number of Latin American local currency markets is also being scrutinised by SEK. This is because a notable component of its increased lending last year was what SEK describes as “significant interest in financing for Swedish exports to Latin America”, which accounted for Skr5.7bn of total lending in 2012.
“The more we can match-fund, the better, which is why we may also look at funding in local currencies such as Brazilian reais, as well as Chilean, Mexican and Argentine pesos,” Mellor says.
There are regulatory as well as commercial reasons why borrowers’ requirement for local currency funding is rising. Chris Jones, managing director and head of local currency syndicate at HSBC in London, points out that banks, for example, are under increasing regulatory pressure to ring-fence their balance sheets across geographical borders, which is leading to more issuance from multinational banks’ local units rather than via the holding company.
Mellor says that issuing local currency funding to on-lend is part of SEK’s two-pronged policy in non-core markets. The other part, which makes up the second and third reasons most regular borrowers have for funding in a range of currencies, is the dual objective of capitalising on arbitrage opportunities and diversifying the investor base.
The two often go hand in hand, because by accessing a completely new group of investors borrowers can reduce their overall funding costs by leveraging their scarcity value in a given currency and relieving pressure on their core funding currencies.
That is the principal reason why SSA borrowers with large funding requirements routinely explore a wide range of funding options outside their core markets.
Take the example of one of the biggest of them all, Germany’s KfW, which has recently revised its funding requirement for 2013 down to between €65bn and €70bn, compared with an annual total over the last five years in the €74bn-€79bn range.
Petra Wehlert, head of new issues for public markets, says that as a rule of thumb KfW aims to complete around 80% of its annual funding in its two core markets, which are dollars and euros. In the dollar market, she says, Basel III liquidity requirements have meant that KfW has been a notable beneficiary of demand from bank treasuries. “In euros, bank treasuries have always played an important role in KfW’s benchmark transactions,” says Wehlert.
That still leaves about €10bn-€15bn to find in a range of other markets, which explains why, at the last count, KfW had borrowed in 13 different currencies in 2013. That compares with 15 in 2012, although Wehlert says that in previous years it has tapped as many as 20 different currencies. The non-core share has been lower in 2013 than in 2012, she adds.
Much of KfW’s requirement outside the US dollar and euro markets has been met in recent years by issuance in what may be termed semi-core markets, where KfW has been able to respond to growing demand from central banks, as it has in the market for core currencies.
“Our most prominent investor base is central banks, which have been diversifying out of core currencies in recent years,” says Wehlert. “Demand for Australian dollars has been particularly strong, and has in previous years been driven both by domestic demand and international investors. In 2013, this has shifted, with about 75% accounted for by international demand, much of it from central banks.”
This combination of international and domestic demand has made the Australian dollar market very fertile ground for global local issuance by a number of frequent borrowers. Jens Hellerup, head of funding and investor relations at Nordic Investment Bank (NIB) in Helsinki, for example, says that the Australian dollar has accounted for about 18% of NIB’s funding this year, after contributing over 20% in 2012.
Wehlert says that while KfW has a strategic approach to the Australian dollar market, which involves a commitment to maintaining a yield curve, funding outside the home market still needs to be competitive on an after-swap basis. “We have a natural need for euros, and the euro market has provided very good funding opportunities this year. Other currencies need to compete with KfW’s euro funding conditions, which is why our activity there is largely dependent on the basis swap,” she says.
Another market that has resurfaced as an attractive funding source outside KfW’s core currencies is the Canadian dollar market. KfW returned to the market for the first time for just over a year in early June, launching a C$1bn five year global issue via HSBC and RBC Capital Markets that was the largest Canadian dollar bond ever from a non-domestic SSA borrower. Shortage of supply in Canadian dollars underpinned strong demand, notably from central banks, which accounted for 78% of distribution.
Robust demand for Canadian dollars allowed KfW to follow this transaction with a C$750m three year global issue via RBC Capital Markets and TD Securities in July. Increased from an originally planned minimum of C$500m, this was priced at the tight end of guidance, or 3bp over mid-swaps, with 34% of the bonds taken up by central banks.
The strength of demand from official institutions for non-core currencies is clear from data collated by the IMF. According to its most recent numbers, the dollar’s share of central banks’ reserves, which was 71.5% in 2000, had fallen to 62.2% by the end of the first quarter. Much of that slack has been taken up by the euro, but central banks’ holdings of so-called “other currencies” — which include Australian, Canadian and New Zealand dollars — has new passed 6%, compared with 1.8% at the end of 2007.
In other currencies, says Wehlert, KfW pursues the same issuance policy as it does in semi-core strategic currencies. “At the end of the day our issuance reflects global investor demand,” she says. “If that demand is sufficiently strong and if there is a liquid swap market allowing us to issue at a reasonable cost we will consider doing so.”
Those are big ifs. Consider, for example, KfW’s experience in the fashionable offshore RMB market, where it launched a debut offshore Rmb1bn two year bond via HSBC in May 2012 at a 2% coupon, the proceeds of which were swapped into euros.
KfW said at the time that it had no intention of making its RMB issue a one-off, but returning to the market on a cost-effective basis has been easier said than done.
“The biggest bottleneck we have encountered in the offshore RMB market in Hong Kong has been finding swap counterparties,” says Alexander Liebethal, head of new issues private placements at KfW in Frankfurt. “We’d love to do more in the RMB market but funding costs and the availability of swap opportunities are limiting factors. We’re monitoring the market and are confident about its future growth, however, given the long term potential for wealth creation in China.”
Beyond the proceeds-driven and price-driven motives for accessing new, often non-core markets, for some borrowers there are also reasons for accessing local currency markets that are not directly of commercial benefit.
One of these — and fourth reason borrowers may have for accessing local currency bonds — is that it can help to enhance an issuer’s profile in a given country or region. As Jones at HSBC says, issuing in an emerging currency such as RMB can be a very constructive way of doing this, especially for borrowers that achieve the kudos of being first-time issuers from their country or sector. For many, that can be a more powerful influence on the decision to issue in a local currency than size or pricing.
“In some local currency markets, borrowers will often be prepared to pay a wider spread to where they would price in benchmark currencies if it ensures they’re the first or the biggest issuer in the market,” says Jones.
For example, the Canadian province of British Columbia has been eyeing up the potential of becoming the first government or sub-national issuer to access the RMB market. Jim Hopkins, assistant deputy minister in the provincial treasury of BC’s Ministry of Finance, says that the province announced its interest in issuing in the dim sum market in December 2012, and has since followed up with meetings with government officials in Beijing and with investors in Hong Kong and Singapore.
BC is interested in the CNH market as a way of further diversifying its investor base and to access new sources of liquidity. A new issue is likely to be modestly sized, but would cement trans-Pacific relations between BC and China.
“Further, the province values the global emergence of China as a trading partner and the internationalisation of the RMB because these developments play to the province’s strengths as a North American gateway to the Asia Pacific with significant cultural and family ties with China and Asia more broadly,” says Hopkins.
“The CNH market in 2013-to-date has not yet offered a cost-effective borrowing opportunity for highly-rated, international public sector issuers,” Hopkins adds. “The province plans to build on the strong reception it received from CNH investors last year and continues to monitor the CNH market for a benchmark-sized opportunity.”
The fifth reason some borrowers have for accessing local markets is linked to their mandates to promote regional growth and development, principally in emerging markets. Development banks such as the World Bank, International Finance Corp, European Investment Bank, European Bank for Reconstruction and Development, African Development Bank and others have all played an essential role in helping to create and promote capital markets across the world — be they in Eurobond or local currency format.
The motives these borrowers have to access local currency bond markets are an amalgamation of some or all of the five reasons issuers have for exploring opportunities outside their core currencies. The IFC, for example, borrows in local currencies and on-lends the proceeds in those currencies to local private sector borrowers (see profile article on page 17).
The World Bank, by contrast, has only on-lent local currency bond proceeds in back-to-back transactions once, which was in Uruguayan pesos. Heike Reichelt, head of investor relations and new products at the World Bank in Washington, says that at the last count, it had issued in 56 local currencies to raise financing for on-lending to governments — which is the Bank’s mandate — rather than to the private sector. In almost all cases, says Reichelt, the proceeds of the World Bank’s local currency bond issuance are swapped into dollars.
In common with other supranational borrowers, the World Bank’s developmental role in local currency markets does not mean that it is insensitive to price. Quite the opposite. “We have a fiduciary duty to borrow at the most competitive rates we can, because our borrowing rates determine our lending rates, and the markets of those countries we are aiming to develop are also the beneficiaries of our loans,” says Andrea Dore, lead financial officer at the World Bank.
At the same time, the Bank is also committed to supporting the evolution of local markets’ capital market infrastructure and encouraging the development and expansion of its institutional investor base.
“We have other, more strategic reasons for issuance in addition to funding at competitive levels,” says Reichelt. “In markets where we are among the first or earliest issuers we invest a lot of time and effort in areas that will benefit the development of the market over the medium term, such as documentation and clearing systems.”
Tangentially, the World Bank’s support for the nurturing of local currency markets also means exploring ways of developing very illiquid swap markets. “Finding the currency swap is of course one of the challenges of local currency issuance, because obviously the cash markets develop much more quickly than derivatives markets,” says Dore.
While much of the World Bank’s local currency issuance has been in the form of Eurobonds rather than under local law, Dore insists that this is not inconsistent with the Bank’s developmental role, for two reasons. First, she says that for many investors, buying triple-A supranational bonds is a helpful way of gaining familiarity with a new market. “We find that many investors initially welcome the opportunity to separate credit risk from currency risk,” she says. “This gives them the comfort they need to take both risks at the same time in later issues.”
Second, Dore says that triple-A issuance in Eurobond format can have an important role to play in helping to build and extend local yield curves. “We issued the first Turkish lira bond immediately after the redenomination of the currency at the end of 2004 and a few years later we did a 10 year lira issue,” she says. “At the time, the government curve was only up to five years, and by issuing 10 year debt in lira we were able to establish a longer benchmark which the government was able to follow later on.”