Multi-lateral Sponsored Regional Swap Facility
Outline of Proposed Concept:
Apart from convertibility and transfer risk, one of the major issues facing
emerging market issuers is currency exchange rate volatility and depreciation.
Due to limitations imposed by the ability to raise capital in the local markets,
lack of liquidity, size of the market, availability of long term capital, etc.
issuers frequently need to rely on the international capital markets and foreign
currency denominated debt. As the projects and/or companies typically
generate local currency revenues they have inherent asset/liability mismatches
which they need to resolve. However, in the majority of cases, derivative
markets are not developed sufficiently to allow the issuers of foreign currency
denominated debt to hedge their exposures via the local markets. In addition,
the international providers of hedging mechanisms (major financial
institutions such as Citibank, JP Morgan Chase, Deutsche Bank, etc.) are often
unwilling to enter into transactions due to country risk limits, credit
restrictions, political/currency risk, size and tenor of the transactions, counter
party risks, etc.
To address these and other issues this proposal calls for the establishment of a
Special Purpose Vehicle (“SPV”), or Multi-lateral Sponsored Regional Swap
Facility (“MSRSF”) analogous to the SPV’s created by Investment Banks
such as Goldman Sachs Financial Products, Lehman Brother Financial
Products, Salomon Swapco, and others. These SPV’s were established for the
sole purpose of intermediating a wide variety of derivative products such as
interest rate and currency swaps and options.
The proposed MSRSF would be established as a Special Purpose Vehicle
sponsored and “owned” by the Multi-lateral community such as the World
Bank (or IFC), Inter American Development Bank, European Bank for
Reconstruction and Development (“EBRD”).
In addition, regional
development banks would be the key sponsors and “owners”, such as CAF,
Bladex, and CABEI in the case of a Latin American sponsored Swap Facility.
Similar regional SPV’s could be established in Asia, Middle East and Africa,
as well as Eastern Europe.
Proposed Key considerations for the MSRSF are:
Legal Risks: The SPV should be established as a separate legal entity,
bankruptcy remote and subject to preferably UK or US law.
Financial Risks: Capital for the SPV would come from equity injections by
the sponsors (owners) and contingent capital and access to liquidity lines from
the parents. In addition, the SPV will need to monitor closely its leverage of
existing capital and its credit exposure to maintain a high investment grade
rating. Agreements with the owners to enter into offsetting transactions to
mitigate the risks should be considered and analyzed. To what degree existing
preferential creditor status of the sponsors could be transferred upon the
facility would need to be explored, however, if applicable would serve to
enhance the functionality of the facility and reduce financial risk.
Operating Risks: To ensure that the operating risks are minimized, a strong
management board will need to be created and clear operational guidelines
will need to be established. Through a transfer of existing experienced
personnel from the sponsors these risks can be controlled and mitigated.
Product Lines: The facility should focus on a narrow product array which
addresses the key hurdles faced in the region to attract foreign capital and
risks associate therewith for the local market participants. It is the author’s
recommendation that products offered by the MSRSF be interest and currency
swaps and related derivates. The purpose of the facility is to provide for risk
mitigation in asset/liability mismatches arising from local vs. foreign currency
issues.
Counterparty Risks: In order to minimize the counterparty risks and to build
on the experience of the owners/operators of the facility, it is proposed that the
MSRSF would act as a counterparty to regional sovereigns, local
Governments, and local/regional financial institutions. The local financial
institutions are best equipped and have the credit experience and knowledge to
intermediate for the local and or regional corporations. The facility would
provide those financial institutions with the ability to lay of the interest and
currency risk, but not the credit risks of the financial institutions’
counterparties. In turn, the MSRSF would look to enter into offsetting
currency and interest rate as well as credit derivative transactions with the
owner institutions, international financial institutions or regional sovereigns.
Benefits:
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Ability to hedge cross currency and interest rate exposures which are a
key deterrent for foreign capital to enter the local markets.
Potential to address tenor extensions by providing local financial
institutions with the ability to hedge assets and liabilities.
Potential for intermediating between generators of hard currency
revenues (with local currency liabilities) and local currency generators
(with foreign currency liabilities).
A pooling of resources and a coordinated approach by the Multilaterals for the region.
Channeling of technical assistance to further the development of the
local capital markets.
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Attract additional sources of funding from the international financial
community which might otherwise be restricted due to country risk
exposures (i.e. currency risk due to perceived government risks).
Obstacles:
Clearly there are a large number of obstacles to overcome, not withstanding
the “competitive nature” of the Multi-lateral community itself. Questions that
come to mind are (and these are by no means all inclusive):
 How to enlist a Regional Multi-lateral as the champion of the Facility?
 How to coordinate and meet the individual Multi-lateral objectives as
well their charter mandates within the context of the facility?
 How to staff the facility with experienced people from the region or
with Multi-lateral personnel?
 Should a Regional Multi-lateral, in the case of a Latin American
Facility, such as CAF be the main partner which would coordinate the
involvement and resources of the facility? Would they be prepared to
assume this role and provide the necessary resources and
management?
 Would Governmental agencies need to be involved, such as the US
treasury, to provide the impetus needed?
 Would the IMF support and endorse this type of facility? Especially if
Sovereigns use the facility to manage their debt, and or support the
facility’s activities by acting as counterparties to currency swap
transactions?
 What role can and should domestic financial institutions play in the
initial phase of the facility and should they be allowed to take equity
stakes in the facility?
 Can undeveloped local markets and lack of appropriate local hedging
instruments and government debt markets/instruments and yield
curves be overcome?
Next Steps for implementation:
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Discussion with Multi-laterals on a coordinated approach to creating a
Special Purpose Vehicle channeling their combined efforts for a region
Lobbying Multi-laterals as well as IMF (and possible US Treasury) to
provide support for the concept and refine and define proposed
structure as well as strategy
Stress developmental impact of facility on local/regional capital
markets and how existing Multi-lateral sponsored technical assistance
projects targeted to capital market developments can be tied to the
facility
Stress the potential for attracting foreign direct investments by
providing infrastructure as well as project capital raising activities
ability to hedge currency-asset/liability mismatches
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Develop clear understanding of scope of the products and services the
proposed facility can deliver (should the facility only provide political
risk guarantees for swap transactions, or should it intermediate
between International Financial Institutions and the end users of
Swaps –both pure interest rate as well as cross currency swaps?)
Provide the regional/local financial market participants (banks,
investment banks, etc.) ability to assume greater responsibility and
ownership of the facility over time (exit strategy for Multi-laterals?)
Discuss and develop structure to meet rating agency criteria for
investment grade ratings.
Additional Steps to be explored and addressed:
Feasibility to replicate ADB transaction on a larger scale and or in more
countries, i.e. Multilateral Swap with host Governments to raise local
currency for domestic on-lending (Local Currency swap mechanism)
Domestic regulatory environment and issues which will need to be addressed
to encourage and foster longer term domestic capital markets
Are domestic resources within the investment community able to invest in
project risk, ie. Pension plans, mutual funds, retirement funds, insurance
companies?
Encourage and assist local financial institutions to actively intermediate swap
transactions between domestic companies which complement each other
through their generation of foreign currency receivables with those of foreign
currency liabilities. How could multilateral or international financial
institutions aid in the further development of this market?
Odo Habeck
OGH Advisors
October 2004