IFR IMF/World Bank 2011

To view the digital version of this report, please click here. The structural weakening of the dollar and the strengthening of emerging market currencies have set the stage for strong performance by local currency bond funds. Indeed, a look at recent reports from data analysis group EPFR show that in the past twelve months inflows into EM local currency bond funds have far outpaced the amount moved into hard currency and blended funds. The downgrade of the US to AA+ by S&P and the continuing problems of the eurozone have accelerated the shift. What is more interesting is the asset class held up even amid the intense volatility of August. When equity funds lost US$26bn in the week ended August 10 – with EM stock funds accounting for US$7bn of that – US bond funds saw US$1.5bn go out the door and high-yield bond funds lost US$6.2bn. Meanwhile, EM local currency funds saw inflows of US$108m. The week ending August 17 repeated the pattern as local currency EM bond funds took in a net US$273.1m even as hard currency EM bond funds and blended currency bond funds lost US$562.3m and US$83.8m, respectively. “In the current environment, investors have realised they want to invest in the creditors rather than in the debtors,” which includes being exposed to their currency, said Brad Durham, managing director at EPFR. “Most emerging market countries run current account surpluses and exhibit more healthy macroeconomic fundamentals than developed economies.”Setting the stage Robert O. Abad, senior emerging markets analyst at Western Asset Management Company, furthered Durham’s theory. He said the extreme volatility had prompted a flight from risky equity markets into developed world bonds which has pushed yields even lower and made EM local currency bonds more attractive. He added that institutional investors were thinking: “Wait, I need to pare down my traditional holdings in favour of asset classes such as emerging markets, reaffirming the stronger credit metrics and growth prospects of those countries.” Furthermore, the structural weakening of the dollar, and the strengthening of emerging market currencies have set the stage for strong performance by local currency bond funds. “If you feel the dollar or euro will weaken, you know there has to be an appreciation side of the equation, and that side is emerging market [currencies],” said Abad. Most of the money being parked in these funds is being invested directly into the local markets. For instance, at the end of August foreigners held 40% of all Mbonos issued by Mexico, the highest level ever. But there is increased demand for Reg S/144a local currency instruments. “Most emerging market countries run current account surpluses and exhibit more healthy macroeconomic fundamentals than developed economies” So much so that bankers have been building up a significant pipeline of local currency deals in Latin America. They recently reported several mandates for global bonds denominated in Brazilian Reais. Colombian companies have also been interested in issuing and Chilean corporates may return with more peso inflation-linked transactions. Not to mention sovereigns as Peru and Uruguay which have stated their plans of issuing more debt in local currency. There should be no shortage of interest, not only because the pocketbooks of local currency funds are bulging but because these bonds provide such an attractive investment now. “This is not just an FX play, but a rates play,” explained Abad. “You look at the yield curve in the US and Europe and it is very flat and low based on historicals. Then you look at Brazilian local markets and see you can get 5% or 7% [real return].” As for the risk of a reversal, Abad notes that: “If global growth slows, as many expect, the cycle will just keep perpetuating itself because you are getting compensated not only from the currency side, but from the carry and yield compression on the rates side.” Indeed, some investors have been talking about a secular c

To view the digital version of this report, please click here. Despite its rapid economic growth, Turkey’s capital markets are struggling to draw foreign inflows. International investors have been deterred by questionable macroeconomic decisions and IPO pricings are perhaps unrealistically high amid the current global volatility. Moves to tackle the nation’s burgeoning deficit and stabilise its currency, as well as a substantial privatisation programme should go a long way towards providing a more attractive environment for foreign investors. The country’s capital markets are hard to love at the moment. Despite having the fastest growing economy in the world in the first quarter of 2011, the performance of its international financial markets has been anaemic. By early August the stock market had fallen by 14% from its highs in mid-May, although it has recovered 6% by the end of the month. The Turkish lira is the worst performing of any major emerging market, down by 10.8% against the dollar and 15.6% against the euro year to date. Even yields on government bonds are widening as are spreads on Turkish sovereign eurobonds. This disconnect has many causes: much can be attributed to the global market downturns. But there is also some inverse alpha at work: Turkey has actually made life more difficult for itself. As a result there are a number of chasms that Turkey needs to bridge if its markets are to regain their standing in the international financial markets. These lacunae cover many parts of the business: the valuation gap between domestic sellers and foreign buyers is too wide; the country sits awkwardly between a sub-investment grade rating and investment-grade pricing; and macroeconomic policies are proving a deterrent to international investors. This last point centres around the Central Bank’s controversial decision to cut interest rates while forcing the banks – through the banking regulator – to hike their reserve rate requirements. While this is meant to stave off hot money and a rapid rise in the value of the lira, it has had the effect of blowing out the current account deficit (CAD) by rapidly diminishing the value of the currency. The CAD was only US$13.8bn at the end of 2009, but it rose rapidly to US$42bn by the end of 2010 and now is up to US$68bn in the first half of 2011. This ballooning CAD is causing many international observers to worry that Turkey could be heading to another of its self-inflicted crises. “Under stable global growth and financial market conditions, this [CAD] is manageable,” wrote RBC emerging markets research analyst Nick Chamie in August. “But given the scale of the recent widening in the CA deficit, if there is a sustained deep flight from risk assets and/or tightening in global credit conditions, Turkey is highly exposed as it could have a much harder time financing its CA deficit, potentially triggering a disorderly balance of payments adjustment.” Macroeconomics have a deep influence in Turkish capital markets. In particular all three ratings agencies use the CAD as a reason not to upgrade Turkey to investment grade. The sovereign nestles one notch below investment grade at Ba2 by Moody’s, BB+ by Standard & Poor’s and BB+ by Fitch. “If they upgrade Turkey to investment grade, then there will be many more opportunities for foreign finance to come here,” says Birgul Denli, executive vice-president of Vakif Bank in Istanbul.Stuck in no-man’s land Turkey’s international bond market is now in a no-man’s land: stuck between non-investment grade rating and investment-grade pricing, Turkish issuers don’t offer enough yield to attract emerging market bond investors, nor do they offer the credit rating necessary to bring in the developed market investors. As a result, the sovereign and Turkey’s leading companies have visited the international bond markets only rarely this year. Turkey’s banks have, however, been active. And yet again it is those banks that are doing the hard work of interna

To view the digital version of this report, please click here. This year has been a bleak period for Russian firms hoping to access equity capital markets. Half of the companies attempting to list have failed. Although firms have looked for a more welcoming listing venue, for most London remains the only option and deep discounts will have to be accepted. A senior banker tells the story of travelling in the Russian wilderness, through a place he had never heard of and stumbling across an unknown company large enough to be in the FTSE 100. Such is the appeal of the largest country in the world – a behemoth that could churn out new issue after issue for investors around the world to feast on as it makes its transition into a developed, capitalist economy. Yet, somewhere things have gone a bit awry, and Russian firms stepping into the international arena (primarily through London listings) are struggling to garner the sort of appeal they should. One Russian banker working in equity capital markets claimed London has a “prejudice” against Russian issuers. While this is hyperbole, others agreed that investors are displaying an increased degree of hostility towards Russian firms. A lengthy list of failed London deals has led bankers and issuers to reconsider the best venues for listings, yet the UK remains favourite. “London remains the most attractive destination for Russian companies, though there may be a few cases where New York may be more suitable,” said Marina Kraschenko, head of Russian ECM for Deutsche Bank. In some transactions, emerging market funds in the UK can be very demanding on the discount, she said, but Hong Kong and New York are only suitable for specific firms. In the year to date, a dozen Russian IPOs have launched London IPOs, and only half have priced. The argument that macroeconomic conditions were to blame is not entirely true as three of those failures came in the first quarter of the year, when there were as yet no signs of the eurozone turmoil that has subsequently frozen markets across the continent. The six that priced have fared indifferently, with container terminals operator Global Ports the only one trading above list price in late August. Market conditions have played a part, but HMS Hydraulic Machines and Systems and Rusagro both dipped in value well before broader markets slumped. “It is true that investors have shown a high degree of discipline, but this does not mean London does not work as an IPO venue for Russian companies,” said Richard Cormack, head of ECM for the emerging EMEA region at Goldman Sachs. “If you look at the last two deals, Global Ports and Phosagro, they priced above the bottom of the range.” As with any IPO, you need to bring the right offer at the right price, he added. Unfortunately, that has been part of the problem.The key reason why there was a high percentage of failures was the disconnect between issuer valuations and investor expectations on price.Discounts required “Some management teams and owners retain a mental image of a period of time that no longer applies, when valuations were substantially higher than today,” said Daniel Jacobowitz, co-head of investment banking for Deutsche Bank in Russia. Controlling shareholders in Russian companies have been tough salesmen since the UK IPO market opened up for them in 2005, but with stock prices depressed they have become even less keen on accepting discounts. “In their defence, they have to set themselves against a Russian peer group that is already trading at a 10%–15% discount to Asian peers, for example, and have to offer a hefty discount to those already discounted stocks,” an analyst at a Russian bank said. The IPO of Russian Helicopters collapsed earlier this year when investors demanded a 40% discount to some Western European peers. Asset fund managers in the UK, ever wary of the Yukos precedent – the company taken over by the government in controversial circumstances in 2003 following the arrest of billionaire

To view the digital version of this report, please click here. The IMF’s role and the financing arrangements enabling it to fulfil that role were expanded at the London Summit in 2009 to meet the increased demands that were being placed on it amid the financial chaos. It was agreed the Fund’s resources should be trebled, from US$250bn to about US$750bn. The representation of dynamic, emerging market economies on the board was also increased. The full package of changes has been phased in over a number of years, constituting significant reform of the IMF’s structure. Part of the increase came in the expansion of the New Arrangements to Borrow facility. According to the IMF: “NAB is the facility of first and principal recourse in circumstances in which the IMF needs to supplement its quota resources.” It allows the Fund to receive voluntary, bilateral loans, traditionally from rich countries, but recently from some emerging markets too. If the Fund’s financing requirements were to suddenly expand significantly, NAB could be expanded to include more emerging markets, said Peter Chowla, programme manager at The Bretton Woods Project, a group working as a watchdog focusing on the IMF and the World Bank. He believes that would allow resources to be expanded with only a limited concession of control to those countries making the loans. “…Questions are again being asked about the role the IMF will play if the worst-case scenario unfolds…” The real influence comes via quota subscriptions which constitute the bulk of the IMF’s financing. The US, for example, pays 17.7% of the IMF’s total subscriptions, with Japan paying just under 6.6%. For that, the US receives just over 16.7% of the voting rights, making it the only country able to block an IMF decision on its own. Japan has voting rights worth more than 6.2%. The subscriptions were also doubled in early 2011. According to the IMF, the subscription amount is determined as a weighted average of GDP (50%), openness (30%), economic variability (15%), and international reserves (5%). With greater subscriptions come more voting rights for the larger, developed economies. Few at the time could have envisaged its newly bountiful coffers would be put under pressure. But few at the time could ever have envisaged a sovereign debt crisis would have been ignited in Europe, or that the contagion between European markets would be so swift or devastating. The sums the IMF needs to lend are therefore not as huge as the overall liabilities of the European sovereigns involved, but they are still quite considerable. Its exposure to Greece is only US$43bn, compared with its US$77bn exposure to Mexico and US$31bn exposure to Poland. “Lending at the scale that is now required in Europe was never considered,” said Jens Larsen, chief European economist at Royal Bank of Canada. With Greece, Ireland and Portugal ablaze and all eyes on Spain, Italy and even France, questions are again being asked about the role the IMF will play if the worst-case scenario unfolds, and whether it will have the resources to make a meaningful difference. If Italy, for example, were to be dragged fully into the crisis, the problem would dwarf anything seen so far, even going back to former crises in Argentina or Asia, said Gabriel Sterne, economist at Exotix, the frontier market investment banking group. The IMF is a small organisation by historical standards, relative to the size of the global trade flows it was originally conceived to help manage. Its war chest once represented about 10% of those flows, compared with a mere fraction of a percent now. Over time its function has also evolved, so that where it once helped with balance of payment problems, it now has to contend with capital movements, in which context its resources look even more meagre. There is little doubt the IMF has access to further financing if it sought it. The real question is where it would look for the capital that would be needed if it were to find its cu

To view the digital version of this report, please click here. Total ECM volume in Latin America amounted to US$29.9bn for the year to August 5 with a total of 91 deals, according to Thomson Reuters. Brazil made up 54.3% of the total with 44 transactions. It was followed by Mexico, which accounted for 14.6% of the volume with 10 deals, by Argentina with 14.2% (with eight deals) and Chile with 12.6% (16 deals). However, previously Brazil has accounted for about 80% of the ECM activity in the region. Last year, there were a total of 173 transactions in Latin America adding up to US$71.79bn and Brazil made up 78.6% of the volume (or US$56.4bn) with 94 issues. Chile accounted for 7.8% of the volume last year with 28 deals and Colombia 7.2% with four deals. Brazil peaked in 2008 when it made up 86.7% of all issuance from Latin America. “The Andean region – especially Chile and Colombia – is becoming much more active,” says Juan Carlos George, managing director and head of equities market for Latin America at Citi. “Brazil remains the number one market but other countries are now becoming more important than before.“ He adds that the Andean region’s allure is highlighted by the fact that it has seen a number of transactions around the US$1bn level this year. “Brazil will pick up again significantly and Chile and Colombia are expected to continue to raise capital to fuel attractive equity stories,“ he adds. “Chile has been considered a safe haven for a long time and its companies have had the highest valuations on a multiple basis in the region for many years. However, it has strong domestic pension funds and these are able to absorb most of the local issuance.“Scaling the heights of the Andes George thinks that the creation of the new Latin American Integrated Market (Mercado Integrado Latinoamericano/Mila) – which is composed of the main stocks from Chile, Colombia and Peru – should help to make the Andean region’s markets – especially the secondary ones – even more dynamic. Alex Lehmann, head of equity capital markets for Brazil at Deutsche Bank, says: “We are starting to see a significant rise in transactions coming out of other parts of Latin America – especially Colombia, Peru and Argentina. We are also witnessing more internationally distributed deals from Chile. Global market conditions mean that this is a tough time to undertake an equity capital raising, but looking over a three to five-year period, the total size of the Latin American pie is clearly going to expand. “The region is attracting substantial interest from sovereign wealth funds, private equity groups, hedge funds and family offices from around the world. Traditionally, Brazil has made up about 70%–80% of ECM activity in Latin America; that could slip to about 50%–60% in coming years, as other countries become more significant.¨ Analysts say that overall IPO activity has been disappointing this year and a large number of deals have been shelved or postponed, mostly because of volatility in the international market. At the start of the year, bankers were expecting about 60 IPOs from the region including 40 from Brazil, according to Deutsche Bank. For the year to August 5, only 19 IPOs have taken place, including 11 from Brazil, according to Thomson Reuters. Lehmann estimates that for the remainder of the year the region is likely to see around an additional seven IPOs including five from Brazil but only if market conditions normalise. “The Andean region – especially Chile and Colombia – is becoming much more active” Last year’s ECM market in the region was skewed heavily by just one transaction: the follow-on by Petrobras, the semi-public Brazilian oil major, in September which raised a total US$67bn, the biggest share issue in corporate history (this deal is not included in the Thomson Reuters totals). In comparison, the biggest deals out of Brazil this year are the March follow-on by Eletrobras, the power utility company, and the April follow-on by Gerdau, the

To view the digital version of this report, please click here. Lenders’ strategies for the Central and Eastern Europe, the Middle East and Africa syndicated loan markets have been cautiously adjusted amid renewed concerns on the economy, fuelled by the US and European debt crisis. Many, however, plan to take advantage of the relative stability in Eastern Europe – notably Russia. Economic balance and commodity strength means Russia is increasingly viewed by international lenders as a safe haven, separated from the economic volatility of the US and Europe. A string of record loans for the country’s banks, together with a number of deals for blue-chip commodity borrowers have consolidated Russia’s position as the CEEMEA hotspot. Amid the financial turmoil, “Russia is a quiet little world by comparison,” a senior banker said. Russia accounts for 29% of all loan volume in CEEMEA so far in 2011, with US$22.7bn of the US$77.8bn CEEMEA total. Volume generated in Central and Eastern Europe is US$46bn, or 59% of the CEEMEA total. Refinancings continue to dominate deal flow, as in the rest of Europe and total US$48.4bn, or 62% of total CEEMEA volume so far in 2011. In Russia, refinancings total US$15bn, or two-thirds of the country’s year-to-date loan volume. “Companies are trying to refinance earlier, from approximately two years of their maturities to avoid a refinancing wave and to reduce the borrowers’ refinancing risk,” considering the European liquidity concerns, a European banker said. “One of the biggest constraints for the emerging market is not related to Russian borrowers. The risk is that you won’t raise money because some European banks have problems lending” State-owned banks and large commodity companies have driven Russian deal volume. VTB’s US$3.13bn, three-year, three-day loan – the biggest loan for a Central and Eastern European bank – closed in July, shortly after state development bank VEB secured a US$2.45bn, three-year deal. Meanwhile, oil firm TNK-BP secured a US$1.5bn, four-year club loan with 10 banks. Growing liquidity concerns across the European banking sector threaten to curtail activity, though appetite for Russia should remain steady. Lower pricing on several deals has caused additional challenges for lenders. VTB, VEB and TNK-BP all carry a margin of 130bp, establishing a lower benchmark for both financial institutions and corporate deals. VEB and TNK-BP’s last deals closed at 190bp in November 2010 and 175bp October 2010, respectively. Nevertheless, an incentive to continue lending relationships with Russian companies for “as long as possible” means the loan market has a larger buffer against the current economic difficulties than other debt capital markets, a banker said.Corporate preference Appetite for financial institutions’ borrowing in Russia has been largely satisfied by a handful of sizeable deals. Aside from VTB and VEB, Gazprombank and ZAO UniCredit signed three-year deals in August worth US$1.2bn and US$300m, respectively. Many lenders are hoping for more lending opportunities from Russia and Eastern Europe’s corporate sector, which is being fuelled by growing internal demand. “There is a willingness to put a lot of money into corporate loans,” a banker said, which is being encouraged by pricing haircuts. “Russia has cash, but they are going to take cheap money when they can.” Rusal, the world’s largest aluminium producer, agreed a US$4.75bn, five-year, pre-export loan in August, with an initial margin of 235bp over Libor. Aggressive pricing means that deals are taking longer to conclude, bankers said, but the deal size demonstrates the amount of capacity that exists for Russian paper. Other Russian commodity borrowers that have tapped the loan market this year include oil firm Tatneft, which signed a US$550m, three-year unsecured deal in June, and steel producer NLMK, a subsidiary of NLMK Europe, which completed a €400m, four-year syndicated borrowing base facility in August that was increas

To view the digital version of this report, please click here. Telecoms projects in Iraq, local currency bond deals in Latin America, or funding education projects in the Mekong delta are images that come to mind when people think about the World Bank Group or the IFC, its private sector development arm. The Group’s activities in the international financial markets, while noteworthy, are relatively minor. There is, however, one corner of the market where IFC dominates: the fast-growing emerging markets’ private equity sector. Since 2000, IFC has built up a portfolio of limited partner positions in many of the world’s leading emerging market private equity funds. It now has US$3bn of commitments to the funds, of which US$1.5bn has been disbursed. It is invested in 180 funds, representing about 10% of all private equity funds operating in the emerging markets. In the past few years, it has been increasing its commitment to the business: in the years 2000–06 it was looking to allocate about US$200m a year in eight to 10 funds. By 2006, its returns were coming through strongly and so it was decided to ramp up to about US$400m in 20 funds. By 2009 and 2010, with returns holding up well despite the crisis, it expanded once again, aiming to allocate up to US$900m a year in about 30 funds. “It would be very difficult to overstate the importance of the role played by IFC in seeding the private equity industry in emerging markets” Over the years it has backed leading funds from local markets that have gone on to deliver stellar returns, such as Baring Vostok in Central and Eastern Europe, Pan-African Investment Partners II Limited (PAIP) in Sub-Saharan Africa, GP Capital in Latin America, CDH in China and Turkven in Turkey. It is also the only limited partner among the development finance institutions that is truly global: CDC in the UK is now limited to investments in India and Africa, while EBRD, EIB and the European national development agencies are limited to Europe. It is more relevant to compare it with private sector fund of funds such as Siguler Guff and HarbourVest. “It would be very difficult to overstate the importance of the role played by IFC in seeding the private equity industry in emerging markets, not only as a provider of capital, but also as a leader in instituting best-practices and cultivating manager talent,” says Jen Choi, head of research at the Emerging Markets Private Equity Association, a trade body, in Washington DC. Behind this commitment to the business is a strong IRR performance. Since 2000, the private equity portfolio has generated 18%–19% returns on average a year. The total portfolio including debt funds and real estate funds is around 15.5% per year. Pre-crisis the IRR was up to around 23%, and then during the crisis it dropped to about 15%.Swimming against the stream According to David Wilton, CIO of Global Private Equity Funds at IFC in Washington, one of the reasons why the portfolio is performing so strongly is that it does not follow the usual benchmarks, which are heavily skewed towards Asia. Cambridge Associates for instance has a 70% weighting to Asia while IFC’s portfolio is only 35% invested there. Moreover, IFC is 16% invested in African funds, while the benchmark only allocates 2% to that continent. “Our job is to go out and take on things that the commercial sector thinks are a bit risky,” says Wilton. “So we are really at the frontier, proving that private sector investment in these places can be commercially viable and profitable. More than 50% of IFC’s investments are in the poorest countries, where we are often the first private equity investor. This focus helps us reach smaller companies and frontier countries such as Sierra Leone and Liberia – countries underserved by the existing financial systems and where impact can be greater. And when the commercial money comes in, we move on.” Wilton himself is an emerging markets veteran. Originally from New Zealand, he has been with the Wo

To view the digital version of this report, please click here. Watching African capital markets mature is a pastime that requires considerable patience. However, while change may not be as rapid as some would like, there are signs of improvement. “Corporate governance is improving, and the difference is quite striking if you compare it with 10 years ago,” said Clifford Sacks, Africa CEO at Renaissance Capital. “Countries such as Zimbabwe have progressed to the point that Essar had the confidence to make an offer for Zisco – one of the the biggest deals the country has seen since independence.” That the flows are relatively meagre relative to some previous expectations probably demonstrates the unrealistic nature of those expectations. Neither did the financial crisis help frontier markets, which have not benefited from the structural shift towards emerging markets and away from the West in recent years. Many hedge funds and other investors that would be the natural leaders of the move into frontier markets made significant losses on their illiquid investments in 2008 and are still nervous about any investment that might be hard to exit if the market turns. Often precarious political situations are a particular hazard in Africa, while rapid urbanisation is putting a strain on already threadbare infrastructure systems, creating the most significant constraint on growth in the region. Governments are keen to address the situation. Traditionally infrastructure investment has been supported by aid but the capital required outstrips supply. Chinese investment in infrastructure is increasingly important, though the importance of this funding avenue is often overestimated, according to Stephen Bailey-Smith, head of African research at Standard Bank, with some headline-grabbing deals failing to materialise. Neither is China the only source of finance outside the West: both India and the Middle East have made significant investments in African infrastructure projects. Cheap European assets divert attention For many investors, however, attention has been diverted from Africa by a glut of underpriced assets in Europe. Some investment grade assets have traded at a discount to African equivalents. And while many thought 2010 would be the year the continent’s fortunes picked up again, the depth and severity of the crisis means risk sentiment has taken longer than expected to normalise. However, with Africa on average now trading inside PIG levels, global market flows look to have entered a new, healthier paradigm, said Bailey-Smith. Africa is dominated by South Africa, Nigeria and Egypt, with Kenya and Ghana comprising a second, considerably smaller tier. This concentration is mirrored within African counties, where the markets tend to be dominated by a small number of very big firms – which are often listed outside Africa. Very few African corporates are big enough to issue paper, while only around 10 to 20 of the biggest corporates from each country – usually mining companies or financial groups – are big enough to tap the syndicated loan market. Although Africa is often viewed as an extension of the commodities story, and many of the most well-known African companies are resources concerns, there is little correlation between the sophistication of African markets and mineral wealth. Two of the most sophisticated African markets are found in Kenya and Cote d’Ivoire – two countries with little commodity wealth. Mauritius, another small country that relies heavily on imports to make up for its lack of natural resources, also boasts a strong and diverse economy. Conversely, resource-rich countries such as Congo, Liberia and Sierra Leone have often been hostage to civil war and corruption, while even Nigeria’s financial sophistication is not matched by its commodity reserves. In the north of the continent, the revolutionary developments of the “Arab Spring” have been bittersweet for the region’s capital markets. While the insurrections have gi

To view the digital version of this report, please click here. Dubai became the latest example with a toll road fee-backed deal, and while there is potential for further issuance from the Middle East, hurdles still remain. European issuers have been able to rely on RMBS and auto loan ABS, confident of well-worn paths and proven track records in each specific line, but for the atypical countries of issuance, the situation has proved far more troublesome. But off-the-run secured transactions such as the US$800m Salik toll road receivables deals on behalf of the Road Traffic Authority (RTA) to fund future infrastructure projects in Dubai prove there is life in the market yet. The six-year issue closed in July through Citigroup, Commercial Bank of Dubai, Dubai Islamic Bank and Emirates NBD. Commenting in a press release at the time of closing, Matthew Job, capital markets partner at Herbert Smith said: “The transaction is notable because although it is a bank-funded structure it incorporates some receivables-based technology usually found in securitisation deals, and because it contains both conventional and Islamic tranches.” Essentially, this project started out in the banking market but adopted an ABS strategy. “In borrowing the funds RTA needed to provide some security, this ultimately was the future flow of toll road revenues,” explained Debashis Dey, partner at Clifford Chance. The Salik toll road system, named after the Arabic word meaning “open” or “clear”, launched in July 2007 as an automated tolling system charging road users Dh4 per gate they pass through. Despite the relatively low charge per toll gate (a little more than one US dollar equivalent), it has sufficient use for the cashflow to be considered strong enough to secure this transaction. It could, therefore, set the tone for receivables-backed funding projects in the future. Outlining some of the reasons why, one lawyer said: “Taking into account the heat, everyone uses cars. There is an utterly robust traffic forecast, based on steady and persistent traffic”, which provides exactly the kind of stability of cashflow that a secured issue requires in order to under-pin investor confidence. This is in contrast to Europe where deals have not performed in line with expectations, he said. From the value point of view, the asset “has to be an issuer pay arrangement raising money from the population and not the state. Any issuer pay arrangement with genuine robustness to cashflow would fit the bill”, he added.Potential grows As far as issuance growth is concerned, secured financing strategies could be employed using a variety of assets. Salim Nathoo, partner at Allen & Overy, referred to real estate lease receivables and possibly more auto deals, although a steady supply of auto loans receivables in Dubai is hindered given the limited population of the emirate at around two million. Dey listed a number of potential future flow revenue suppliers including the use of infrastructure elements such as oil and gas costs, airport and transport usage fees as well as real estate leases in Dubai. And for other countries, such as Qatar, gas revenues were also a consideration to harness a technique such as Salik, he said. Despite the potential elsewhere, Dubai may actually remain the biggest advocate of securitisation technology in the Gulf Cooperation Council region simply due to its lack of access to a major asset – oil. “Other GCC sovereigns don’t necessarily need the money as much as Dubai does because of the availability of oil revenues,” said Nathoo. He added that other countries considering external borrowing could benefit from monetising assets. But while the potential for secured financing is clear, it is likely that such decisions will vary between GCC countries. “Each country has its own future infrastructure needs but will not want to commit large amounts from their oil reserves to exclusively fund this development,” Dey explained. There are other issues that n

To view the digital version of this report, please click here. John Borthwick, IFC deputy treasurer and head of funding at the IFC, says that after four years of programme increases, the issuer now does the majority of its funding in the handful of markets able to provide cost-efficient volume and duration. ““The funding program has grown from USD2bn to USD10bn and we see it remaining at around that level over the next few years. As a dollar-based institution swapping from Euros doesn’t work for us, so it’s fallen to the dollar global and Kangaroo market to do most of the work,” he says. During the last fiscal year, US dollar investors supplied some 59% of the IFC’s funding requirement, with Australian dollar buyers the second most active investor base providing 20%, according to data supplied by the IFC. The borrowers’ fiscal year runs from July 1 to June 30. Overall, the borrower tapped 13 currency markets in the full year of 2011 according to IFC data, with notable supply in local currency markets with attractive cross currency basis swap dynamics for dollar funders such as Turkish lira (5.1% of total issuance), South African rand (4.6%), and Brazilian Real (4.2%). Further diversification came via sterling, Mexican peso, New Zealand dollar, Russian rouble, Chinese renminbi, South Korean won and Japanese yen. Euro issuance accounted for just 0.2% of the borrowers annual haul. Increased issuance, and therefore greater liquidity, brings with it significant strategic advantages among domestic US institutions, which have historically viewed the IFC as relatively illiquid compared with the International Bank for Reconstruction and Development and the European Investment Bank. Borthwick notes that the borrower’s credit quality and the eligibility of its debt as a liquidity instrument for regulatory capital purposes is driving increased traction with a variety of US accounts at a time when they are seeking alternatives to US agencies. “The US is a new market that has opened up for us. The fact that we are a high-grade US-based supranational issuer with a global shareholder base has allowed us to develop a niche based on our strong credit, and we continue recruit new investors among cash rich corporates and bank treasuries,” he explains. US investors have responded well to the addition of a second dollar global to the borrower’s benchmark calendar, dealers say. Before the 2011 fiscal year, the IFC would typically bring a single benchmark in the US$1bn–$2bn range. Last fiscal year it printed two, including a US$2bn seven-year in November 2010 and a US$2bn five-year in April 2011. Priced at mid-swaps minus 2bp, the seven-year was the first supranational five-year benchmark to achieve sub-Libor funding since the third quarter of 2008. Raymond Seager, director and co-head of public sector debt capital markets at Bank of America Merrill Lynch in London says that strong demand for the credit has allowed the IFC to maintain price tension relative to its peers amid growing supply. “In the past when the IFC had a smaller funding programme, they could only do one USD1bn benchmark a year and a limited variety of other transactions. Now with the increased needs they’ve been able to target a wider variety currencies like AUD, as well as retail and structured trades that has not only achieved about a good cost of funds, but has actually brought new investors into their benchmark programme. The US is a good example of this,” he says. Propelled by a combination of attractive cross currency basis swap pricing and investor preference for US-based supranational credits over their European peers, Australian dollar accounts have become a key strategic investor base for most Washington supranationals. With one of its first major transactions of FY2012, the IFC distinguished itself as a leading credit in the Kangaroo sector with a A$1.5bn two-tranche five-year deal, the largest by any SSA borrower in the sector so far this year. “When the European and Asi

To view the digital version of this report, please click here. Malaysia accounts for about 65% of all sukuk issues, a market which has grown by leaps and bounds in the past decade with an average annual growth of 15%. Yet, despite these statistics the country suffers from an image of being an insular market with issuance mainly confined to local borrowers and investors. This is expected to change as the government is now actively encouraging foreign issuers to consider selling in sukuk format when they tap the ringgit bond market. A report from the Kuwait Finance House estimated that some US$47bn worth of global and domestic sukuk were issued in the first half of this year, exceeding the whole of last year’s US$45bn, which was itself a record high. That phenomenal growth is likely to be reflected in Malaysia this year. Thomson Reuters data showed that the total volume of Islamic bonds issued in the country reached US$28bn in the period of January 1 to August 15, almost double the US$15.2bn issued over the corresponding period last year. In stark contrast, Indonesia trailed a distant second, at only US$2.5bn over the same period this year, with Bahrain at US$1bn and Saudi Arabia at a mere US$480m. It is a step in the right direction but is unlikely to bear fruit as swiftly as it did about four years ago when the government embarked on a series of overseas roadshows to internationalise the country’s reputation as an alternative bond hub. That paid off handsomely when the global financial crisis broke in 2007 and borrowers from South Korea, India and the Gulf region – shut out of the global market – came to the conventional ringgit bond market in droves. Largely as a result of that, Malaysia’s bond market deepened and broadened and now boasts a well-diversified base. In fact, it has become a viable alternative funding market for overseas borrowers. Getting foreign borrowers to sell utilising Islamic structures, however, presents more challenges. An unwritten government directive to push all foreign issuers to offer sukuk rather than conventional bonds in the domestic market filtered out last year and was thought to be part of the second stage of the government’s plan to promote the ringgit bond market as the Asian centre for the asset class. “This is part and parcel of the government’s aim to promote the country’s debt markets as a hub for sukuk issuance,” said a Malaysian banker. “The first step to draw in foreign issuers to sell conventional bonds in ringgit was a success, so it is only natural that the government is now taking that to the next level – to get the foreign borrowers to sell Islamic bonds.” Nevertheless, the government is also aware that commercial banks will have great difficulty in meeting Sharia compliance, given that interest-bearing loans account for a large portion of their business. Most of the South Korean borrowers that came to Malaysia were financial institutions. But there are also South Korean corporates keen to tap the sukuk market, using the developed Malaysian bond market to tap the Middle East investor base. One such borrower is GS Caltex, which has been eyeing an Islamic bond since 2009. It was eager to proceed with a sukuk deal despite the lack of tax breaks, but is thought to have held back after the South Korean government indicated it wanted to sell a benchmark sukuk issue should the new laws get passed in parliament. Egged on by these potential borrowers and the great potential of the Islamic financing markets, the South Korea government has for the past couple of years attempted to introduce tax breaks for sukuk issuance. But the attempts have failed so far, hobbled by strong opposition in that country to Islamic finance, with a powerful lobby of staunch Christian groups resisting the bill.Gulf optimism While Islamic financing hopes languish in South Korea, sukuk from the Gulf region have shown far more promise. In late July, Gulf Investment Corp privately placed M$750m (US$252m) of five-yea