Thursday, 20 September 2018

From Single A to Triple A

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The World Bank has been at the forefront of innovation in the capital markets, enabling it to pass on the benefits of its relative scarcity to its end clients. The credit credentials of the Washington-based borrower have seen it at the forefront of capital market innovation, as it continues to work in parallel with the International Monetary Fund, reports Mike Winfield.

The World Bank stands at the top of the credit pyramid. Like others in a similar position, it has been able to continue with 'business as usual' in going about funding its annual needs, almost immune from the happenings lower down the credit spectrum during the last year. In the fiscal year commencing July 1 2008, the IBRD is expected to fund towards the lower end of its US$15bn–$20bn projected range, compared to the 2008 fiscal year in which US$19bn was borrowed. The institution has more recently re-focussed on the socially responsible nature of investment and continued to develop the role it has in helping to develop local currency bond markets.

While the IMF focuses mainly on macroeconomic and financial sector issues, the World Bank is concerned mainly with longer-term development and poverty reduction. Its loans finance infrastructure projects, the reform of particular sectors of the economy and broader structural reforms. There are 185 IMF member countries which are automatically eligible for World Bank membership. From a capital market perspective, the difference is that the IBRD has been at the forefront of funding innovation, while the IMF is an organisation that is funded directly by its member states.

The World Bank consists of two development institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). Both play different but supportive roles in [their] mission of global poverty reduction and the improvement of living standards. The IBRD focuses on middle income and creditworthy poor countries, while the IDA focuses on the poorest countries in the world.

The IBRD raises most of its funds through the world's capital markets using its Triple A credit rating. It borrows at the lowest cost possible rate and passes on this advantage to its client base. It is a far cry from the days when both institutions were established after the Second World War: when the IBRD first accessed funds to finance reconstruction in Europe, a lack of familiarity saw it afforded a single A rating. Subsequently, its borrowing requirement has grown; its likely peak occurred 10 years ago at the time of the Asian financial crisis, when US$28bn was needed – although this has subsequently fallen to nearer US$15bn per year.

"Much of the IBRD's funding was historically carried out in global format in [US dollars], although it has used an increased array of funding options in recent years to fund its annual needs,” said Doris Herrera-Pol, head of capital markets operations. “In particular, the Uridashi market became a key part of the overall funding program since it started burgeoning around 2002."

With a borrowing programme of around US$15bn–$20bn for 2009, the IBRD is a regular borrower in the non-core markets. Although highly diversified in terms of currency mix, it also maintains a dependency on the core bond markets. The World Bank only launched its inaugural euro-denominated trade in 2007 – at 18bp through mid-swaps – and has not raised US dollar funding in benchmark Global format for several years. This, however, confers the cost benefit of having a scarcity premium, which is something the IBRD shares with the IDB (which needs around US$9bn per annum) and the IFC (around US$8bn per annum). This is reflected in its lower cost of funding.

The Global Emerging Markets Local Currency Bond (Gemloc) program was launched by the World Bank Group in October 2007. The goal was to help emerging market countries develop their local currency bond markets and attract more investment.

“Gemloc will help boost growth and overcome poverty by increasing investment in emerging markets and improving access to long-term local currency finance,” said World Bank group president Robert B. Zoellick. “With its link between policy reform and investment, this innovative program could help create new emerging market asset classes for investors worldwide.” As part of the program the World Bank has selected PIMCO to develop and manage investment strategies that will promote institutional investment in the local currency bonds of emerging market countries.

In a companion move and as the second pillar of the Gemloc program, IFC, a member of the World Bank Group, entered an agreement for the data and index provider Markit to develop a transparent index of emerging market local currency bonds. Markit has created an index, called GEMX, which will serve as a benchmark for the program and for the wider investor community. The new index and the underlying criteria set out transparent guidelines that countries can use to implement reforms, with the aim of improving their index weight and attracting additional investment.

As the third pillar of the program, the World Bank will provide advisory services to help emerging market countries implement policy reforms and improve their market infrastructure. The Gemloc program thus combines the comparative advantages of the World Bank Group and the private sector under three separate but complementary pillars.

The World Bank continues to expand its efforts to provide investment products that combine financial and social returns aimed at investors with ethical or social investment strategies, with its first certified CO2 emission reduction Uridashi bond launched in June 2008. Most recently it launched a domestic New Zealand dollar deal aimed at retail investors, which was accompanied by a communication campaign highlighting the sustainable and socially responsible aspects of the use of the funds by the World Bank.

A key goal in the years ahead is "to be the world's foremost issuer of socially responsible investment products, working with intermediaries in their local and regional markets to offer high-value investment opportunities to retail and ethical investors," said Herrera-Pol.

The IBRD did not always find funding in the post-war years this easy, despite its strong sponsorship and solid credit backing. The US represented the best source of funding, although some pension funds and insurance companies were prohibited by various state laws from investing in the securities it issued. These barriers had been lifted by the 1950s, following the first bond market transaction in 1947 – a US$250m two-tranche offering. The syndicate for the single A rated Bank consisted of 1,725 dealers and the issue was over six times oversubscribed.

The second bond market offering was denominated in Swiss francs. It was followed by others denominated in sterling, Canadian dollars and Dutch guilders. By 1959 the rating agencies had decided that, based on the composition of its equity shareholders, the World Bank was a Triple A rated entity which actively borrowed in a number of currency sectors. The 1970s saw a rapid growth in its annual borrowing volumes, which rose from US$5.3bn in fiscal 1980 to over US$10bn five years later.

A decade on, as US interest rates rose, the IBRD concentrated on issuance in currencies with low nominal interest rates such as Swiss francs, Deutsche marks and Japanese yen. The 1980s also saw the bank's pioneering role in the use of cross currency swaps, as a means of benefitting from exchanging another issuer's liability stream with its own.

In the late 1980s it was decided to pursue structuring a global bond product, to be sold to investors both in the US and elsewhere, to address the anomalies in the trading levels of comparable IBRD paper. The US$1.5bn ten-year issue has become the blueprint for US dollar issuers in the years that followed for other Washington-based issuers – the International Finance Corporation (IFC) and the Inter-American Development Bank (IDB) – and many other supranational and agency borrowers based elsewhere. A similar route was pursued in the Japanese yen market, leading to the first global securities in that currency. This again provided a role model for other borrowers.

In a speech in 1995, Kenneth Lay, its chairman, noted that "the genius of the IBRD's financial structure… lay in the way in which it applied the sovereign credit of its rich shareholders and leveraged it, so that a modest cash outlay by stockholders to purchase equity in the IBRD has generated dramatic volumes of developmental finance from private sources."

The World Bank led in the process of evolution in terms of capital markets financing, and has continued to extract cost effective solutions from the evolving landscape in the more recent past – notably through the diversification it has been involved with into other currency markets. The opening up of the 'niche' markets has continued to allow the World Bank to move away from reliance on the core markets, usually regarded as US dollars, euros and sterling. As of mid-2008, funding had been completed in 47 different currencies including the constituents of the euro, as well as its predecessor, the ecu.

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