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Sunday, 17 December 2017

Self sufficiency

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A number of countries have tried to position themselves as regional hubs for Latin America, allowing corporates from across the continent to borrow in local currencies, insulating them from market disturbances in Europe and the US. But various factors – not least illiquidity – have prevented the idea from getting off the ground. Savita Iyer-Ahrestani reports.

To view the digital version of this report, please click here.

Peru and Chile have long harboured ambitions to serve as regional financing hubs for Latin American issuers. Many have looked to them in the hope they could evolve into centres that would ensure issuers can continue issuing debt and circumvent any troubles that arise in the international capital markets. Telefonica del Peru, Repsol, America Movil and Southern Copper have all recently taken advantage of the bond markets in those two countries.

But the development of independent capital markets in Latin America, at both the local and regional levels, has been a slow process. Some experts even suggest this vision is theoretical in nature, and are unconvinced it can be achieved in practise.

Governments across Latin America have been working to deepen local markets in individual countries. Some have also tried to foster regional financing hubs, such as an Inca bond market in Peru or a Huaso bond market in Chile. These markets were designed to allow issuers from across the continent to borrow in the local currencies of those countries. But while the idea makes sense for both practicality and cost reasons, regional markets have not gained much traction. Experts do not expect this to change anytime soon.

According to Richard Francis, sovereign analyst covering Peru for Standard and Poor’s, the greatest impediment to the growth of both local and regional bond markets in Latin America is the limited number of companies in a position to issue bonds.

“In the case of Peru, there really are only a few names that can issue bonds, whether locally, regionally or internationally, and this is why we have not had so many issues,” he said. “You mainly see the local subsidiaries of international companies that tap the markets, because the bulk of the private sector in Peru and in other countries, too, is made up of small- and medium-sized industries for which the cost of issuing debt is prohibitively high.”

It is a similar picture for regional stock markets, which are also dominated by a small number of names – even in Brazil, which has the broadest and most liquid equity market.

“Companies that can issue bonds in Latin America need to be large firms with high standards of financial transparency and financial reporting, and they need to be large enough to overcome the fixed cost of issuing that bond,” said Eduardo Borensztein, Regional Economic Advisor at the Southern Cone Department of the Inter-American Development Bank (IDB) in Washington, D.C. “In Latin America, you do have a number of large and well-known names, but given the size of most of the business sector, the bond market is really not an option, and this is why the bank market dominates.”

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Bank lending remains the dominant form of funding for corporate borrowers across Latin America. While governments take advantage of local currency markets to issue bonds for their own funding needs, the bank loan market is still the lender of choice for corporates. This trend became even more pronounced in the aftermath of the financial crisis, when banks across Latin America were lending to companies at very cheap rates.

Now rates have risen and there is a chance for capital market financing to become attractive again to some companies, said a banker at Spanish bank BBVA in Lima, Peru.

To date only a few big-name companies have had – and taken – the opportunity to sell regional Huaso or Inca bonds. But where they have occurred these issues have been attractive to local investors, providing access to the debt of recognised, international companies that they would otherwise be unable to access.

The S150m, five-year bond issued last year by beer brewing company SABMiller is a case in point, eliciting a great deal of interest from local investors.  “This kind of issue allows a company to take advantage of a growing local investor base and it also gives more people a chance to participate in a different type of financing,” the banker said.

Besides their stable economies, one reason Peru and Chile are often cited as potential regional capital market hubs is their sizeable pension fund industries. This domestic institutional investor base ensures there is always good demand for bonds. “Pension funds are the major players in the debt markets of these countries and the governments are keen that they have a greater range of instruments to invest in,” the banker said.

But pension funds are also restricted in what they can invest in. While governments have been working to ease restrictions and allow pension funds to invest in different kinds of instruments, the process takes time. Chilean pension funds could only invest in Huaso bonds – which are considered foreign securities – after the government increased the limit for investing in foreign securities from 30% to 45%.

This change allowed issuers like Mexican telecommunications giant America Movil to raise US$200m equivalent in the Chilean market last year. The bond was denominated in inflation-indexed currency, or UF, and came with a 25-year maturity. It was a cheaper financing alternative than the US or European bond markets.

Lacking liquidity

But relying on institutional investors – and pension funds in particular – to buy locally issued bonds also has costs. Pension funds and insurance companies are typically buy-and-hold investors, meaning liquidity in the secondary market is a real issue. Many issuers would find contending with the lack of liquidity a costly undertaking, said Borensztein. Most of the region’s bond issues have also been private placements, limiting liquidity even more.

“Pension funds don’t want to be stuck with just government paper, they like to have something to diversify into and to take different kinds of risks,” said Borensztein. “But from the point of view of market development, they are not the ideal bondholder because they just don’t give enough liquidity to the market.” This illiquidity deters foreign investors from participating in regional Latin American issues, he said.

While it would help both regional and local markets if the investor base broadened out to include funds from overseas, investors like Howard Booth, director and co-head of international fixed income at MacKay Shields in New York, believes illiquidity is the greatest impediment to investing in local currency corporate debt in Latin America.

Regional and local fixed income markets in Latin America will continue to develop, said Booth, but for now there are too few investors in them for MacKay Shields to take on the double risks of currency and credit that are embodied in local currency corporate bonds. Instead, MacKay Shields buys local currency government debt issued by some Latin American countries.

“We as investors prefer to take currency and credit risk separately,” Booth said. “I’d be concerned about the liquidity of local corporate bonds during volatile markets.”

And even as pension funds in places like Peru and Chile are given the freedom to invest in a greater range of instruments, they are also less restricted from investing outside their home country, said S&P’s Francis. Peruvian pension funds can now invest up to 50% of their holdings overseas and are looking increasingly at opportunities outside the country.

Nevertheless, efforts to “regionalise” markets in Latin America continue, both on the bond and the equity side. Chile, Colombia and Peru intend to merge their stock market operations, thereby creating the second largest exchange in Latin America (see separate feature on ECM). Colombia has also been touted as another potential regional hub for bond issuance by some Latin American corporates.

It makes sense for Latin America to ensure its markets are structured the same way and function with the same regulations and rules of disclosure said Borensztein. It makes life easier for both issuers and investors.

But moving in this direction is not easy. In Asia, there has been talk of an integrated, regional bond market for a long time, but nothing significant has materialised. It will not be any easier to achieve in Latin America, which is in a much earlier stage of the process. That dialog has a long way to go.

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