By Nina Shapiro
Crises in emerging markets over the last decade have made it increasingly clear that corporate borrowers need to be able to access term funding in their domestic currencies. Too many high-quality private-sector companies have failed simply because they had currency mismatches between their liabilities and their assets or revenue streams.
Providing precisely such innovative financial solutions has been a key challenge facing multilateral development banks in recent years in emerging and transition economies. The IFC, the World Bank’s private-sector arm, is one institution that has pioneered techniques to help develop local capital markets in emerging markets. Through its Treasury department, it has focused on financial innovation that integrates structured finance and derivative-based products into its operations, while also making local currency lending more prevalent in emerging markets.
Prior to the Asian economic crisis, the development of emerging bond markets focused primarily on making bonds available to international investors through offshore issues in the Euromarkets (e.g. Spanish pesetas, South African rand, and former eastern European currencies). Since then, however, the focus has shifted more towards deepening and strengthening domestic markets through bond issues that build on existing bond market infrastructure and extend it in new directions.
Depending on the market, this can be done by introducing a new class of top-rated issuers that provide investors with new benchmarks and investment opportunities, by lengthening bond market maturities, or, in some cases, by introducing offshore investors to domestic capital market instruments. In all cases, domestic capital markets have benefited from exposure to international best practice for bond markets. Non-resident firsts
The IFC, for instance, has borrowed in 33 currencies; it is also the first non-resident to issue in many currencies including Peruvian soles, Colombian pesos, Singapore dollars, Moroccan dirham, and Malaysian ringgit in the domestic markets. Establishing the institution’s credit in those domestic markets, while not a prerequisite, nevertheless helps the issuance of structured finance products that involve partial credit guarantees. Such guarantees allow selected domestic borrowers to achieve threshold investment-grade rating and gain access to the domestic capital markets, or to borrow in maturities that would otherwise not have been available to them.
Because of their developmental nature, such borrowings now entail a disproportionate share of the work programme for the IFC’s funding team. They are also highly collaborative efforts, involving member government authorities and market counterparts. The institution nevertheless still expects to meet certain minimum funding cost levels through such deals. So it will never issue if all preparatory work has been completed but funding costs are considered too expensive. In such situations (e.g. in India, where it has been ready to issue for some three years), the organization chooses to wait until it can achieve acceptable costs. Similarly, the IFC takes great care to ensure that the first issue is a complete success, as it sets the tone for future issuance by supranationals. Accordingly, the IFC pursues a transparent book-building process with its underwriters, helping ensure a broadly distributed transaction.
The first local currency borrowing after the east Asia crisis was the IFC’s Singapore dollar issue in October 1998. The issue was a resounding success, so much so that subsequent opportunities for supranationals in Singapore’s market have been limited to the relatively few instances when a top-rated issuer is needed. Domestic firsts
The domestic markets in which the IFC has been most active recently are in Latin America. In 2002, the IFC was the first non-resident issuer to access the domestic Colombian peso market; this was also the first time any supranational had done a domestic bond issue in any Latin American market. Since then, the IFC has returned to the Colombian market twice. In 2004, the institution issued the first domestic public bond offering by a multilateral in Peru, opening the domestic bond market for foreign entities, and in April this year, it returned to the domestic Peruvian bond market.The IFC has also been active in other areas of the world. In December 2004, it launched the first-ever domestic currency Islamic bond by a supranational – in the Malaysian domestic capital markets – and in January 2005, it launched the first-ever issue of bonds by a non-resident issuer in Morocco’s domestic capital markets. The introduction of a new top-rated issue helped broaden those markets and diversify investor choice.
Criteria for issuance
Not every market is a good candidate for a domestic bond issue, however. Local markets must have achieved certain threshold levels of development to reap the benefits. An established government bond market helps, as this will already have led to a certain level of development in the fixed-income investment industry. In this case, issues by supranationals can help the market to diversify credit and extend yield curves.
An established fixed-income investment industry is also useful, since such investors are typically looking for greater diversification benefits at low credit risk. For instance, bond issuance in Colombia and Peru has benefited from the existence of mandatory private pension plans that create a demand for longer-dated bonds issued by strong credits. The ability to hedge domestic currency exposure into US dollars in a given market is often also important.
While some issuers have opted to use the proceeds of domestic bond issues to fund local currency loans, other products can also be used for this purpose: in particular, swaps and partial credit guarantees. These products allow the maturity, interest rate basis, and other modalities of such loans to be matched perfectly to the needs of the client rather than trying to match them to the desires of investors. The IFC is currently able to offer local currency loan products through swaps in some 20 currencies, and to date the corporation has undertaken 22 partial credit guarantees in local markets.
The IFC is working towards issuance in a number of additional markets. Given the many variables involved, however, it is difficult to predict if and when a specific initiative will come to fruition. For instance, the institution received approval to issue in the Brazilian capital markets several years ago and continues to work on pulling together all aspects of such a transaction. So it has not yet chosen to issue in reais (or via reais-linked deals) in the Euromarkets. The IFC, like the Asian Development Bank, is also working towards issuance in the Chinese domestic market. Ultimately, the funding activities of the IFC, as with the major multilateral development banks, will continue to help accelerate the development of the emerging capital markets. Promoting these local markets is an essential component of the mandate of multilateral development banks to support a thriving and sustainable private sector in developing countries.
Nina Shapiro is vice-president of finance and treasurer, IFC