Market Insights en-gb Mon, 22 Oct 2018 22:58:18 GMT 1973 Rising Rates, Volatility Force Latin American Banks, Borrowers to Adapt to “New Normal” Latin American economies are facing a range of complex challenges, both internal and external, as they power through the current election super-cycle – arguably the most significant in the region’s history. Bonds & Loans spoke to a number of Latin America-focussed debt capital markets bankers, rating agencies and law firms in the Americas to get a sense of the major themes and concerns that will dominate the agenda in coming months. "Off record" insights from the region 22 Oct 2018 Americas Market Insights 45 Mon, 22 Oct 2018 14:38:11 GMT The conversations confirmed one trend prevalent in responses to the Bonds & Loans CFO surveys in the region: that political – and broader market volatility – is still the biggest source of anxiety in the region. Latin America is currently half-way through its present election cycle, with key votes still to come in Brazil, and then Argentina, Uruguay and others in 2019, causing further policy uncertainty.

On top of that, broader EM risks are still felt in the region, mostly stemming from geopolitical tension points around the world: the NAFTA negotiations (which appear to have been tentatively finalized), trade wars, and the resulting emergence of new alliances between countries, with many crossing the boundaries of existing “blocks”.

In terms of market trends, the commodities rally has been a blessing and a curse – depending on whether you are a net exporter or importer; the rising oil price, meanwhile, is generating a lot of interest and appetite for oil & gas related assets (and oil field auctions) in places like Mexico and Argentina.

Another global trend, increasingly prevalent in Latin America, is a rise in M&A activity and broader corporate consolidation, particularly in the face of rising interest rates and cost of borrowing. The same factors are driving growing concerns over the region’s corporates’ ability to maintain access to long-term financing – and the resultant push to introduce innovative financing structures that could mitigate country risk for foreign investors while leaving funding channels open for companies across the Americas.

Renewables, ESG and “green finance” are increasingly top of mind for Americas-focused bankers and investors, as has been the trend each year in the past decade. Finding eco-friendly solutions to reducing the carbon footprint and infrastructure gap is no longer a niche topic, but rather a consistent mindset across much of the industry.

Likewise, fintech – another subject that was once so niche it was almost completely absent from discussions among the Americas funding community – is becoming less divisive and much more widespread, with many of the most conservative-minded players embracing the advantages new technologies, such as blockchain, could offer to the financial markets.

Politics, Corruption Scandals and Trade Wars

In Brazil and elsewhere, upcoming elections are high on the agenda, with multiple sources expressing concern that the outcome has the potential to have a negative impact on the whole region and set the political vector for neighbouring countries (including Argentina). The original business-friendly candidate, Ackman, is not expected to even pass the first round, let alone win.

As a result, many businesses are pivoting towards support for the current favourite – the right-wing populist candidate Jair Bolsonaro. The country’s populace is extremely polarized, and many of the voters make their choice not on the preferred candidates’ policies (which, in Bolsonaro’s case, many see as dangerous), but rather as a way of choosing “the lesser evil”, namely when compared to the PT candidate (a proxy for Lula da Silva).

Notably, the risk with Bolsonaro’s candidacy lies not just in the radical and potentially damaging nature of his proposed policies, but also in his “no-name cabinet”, which carries the risk of yet more surprises. As a result, many of the international banks with a foothold in the country are remaining in “wait and see” mode, although, as one banker noted, Brazil remains one of the biggest markets and the largest economy in the region, has a number of large companies with strong credit quality, and has plenty of potential for growth regardless of the election results; as such, it is bound to remain a big focus for a number of international lenders.

Similarly, Argentina’s travails are weighing on market sentiment, although, in terms of policy and openness, its government has been favourably contrasted with other struggling EM peers – namely Turkey, even as capital inflows are drying up. There is less consensus over the impending rescue package from the IMF: most observers admitted that it doesn’t bode well for the country’s brand as an attractive investment destination in the short-term, and that the Argentinians’ almost genetic loathing of “The Fund”, instilled by the pain of past recessions, is bound to take a toll on Macri’s political capital going into the next election. That said, most admitted turning to the IMF was the best of bad options, and broadly approved of Macri’s market-friendly initiatives, such as the oil and gas sector development.

Corruption scandals like Argentina’s “Notebook” debacle, have been different from past and similar events in neighbouring states – such as Lava Jato in Brazil, which saw graft and kick-backs by state corporates – in that it implicated government officials in extortion. While a few correspondents admitted that their expectations of cross-border debt and equity capital markets activity are low, there are still opportunities in the country for some sectors and industries, not least in the distressed debt space. But with more investigations pending, the peso in a downward spiral and several years of austerity anticipated before any significant improvement in the macro situation can be realised, optimism is waning – in stark contrast to sentiment in 2016 and 2017.

Mexico: CerPis and Decades

When questioned on Mexico, bankers and investors were significantly more upbeat, and highlighted the macro strength and growth prospects of the region’s leading economy in spite of their reservations about the new administration’s plans. More clarity on future policy is unlikely until AMLO and his cabinet are sworn in this December, but most observers are confident that the system of checks and balances will help subdue the incumbent’s more unorthodox policy positions. Mexican assets are still seen by many as undervalued, which leads to expectations of more debt refinancing by local corporates as well as a rise in M&A.

There is also renewed hope that more project concessions will be awarded, particularly in the oil and gas sector, which according to multiple sources is likely to remain one of the strongest for this economy. The fact that so far there has been no interference in the financing of the new Mexico City airport is a positive factor, and more developments in the infrastructure and renewables space are also anticipated. AMLO’s market-friendly rhetoric has definitely helped subside some investor fears; that said, the amount of foreign investment needed to support the pipeline of projects in the energy sector is vast, so maintaining an enabling environment for international capital to come in will be critical. On the supply side, the volume of financing through CerPis and decades is expected to remain buoyant, helping to source foreign and local funding into the aforementioned sectors.

Venezuela remains a huge drag on the economic stability of the region, and few have ventured to predict the scale of the disaster that the current political course could lead to – or assess the possible damage to its neighbouring economies. Some have expressed fears that, were its economy to implode, there is a chance that either the US, or members of UNASUR, could decide to intervene, with consequences of such a move nearly impossible to predict. In the meantime, Venezuelan refugees in their millions continue to stream across the border to neighbouring states, in what is becoming the biggest humanitarian crisis in South America’s recent history.

Commodities, Project Finance, and Regulation

The recent rally in commodity prices, particularly in crude oil, has had an uneven impact on the region, according to bankers and experts who spoke to Bonds & Loans. Mining – one of the largest industries in the Americas – benefited from a rally in metals prices in 2017 and Q1 2018, though valuations have started to creep down. This could create complications for exporters, as the rally has led to increased dividend demand from shareholders which may now prove hard to sustain, noted one banker specializing in the natural resource sector.

Oil and gas, particularly on the back of an unexpected rally in crude prices, remains one of the most durable sectors regionally, creating opportunities even in places where the broader outlook is quite bleak. One source noted that while the pipeline of deals in these sectors is still looking healthy, particularly on the project finance side, there are some questions regarding the level of involvement of IFIs and ECAs in supporting these developments, which is likely to create opportunities for commercial banks. Much of that potential rests on the quality and success of the project concessions and field auctions in countries like Mexico and Argentina.

Project finance more broadly was a recurring theme in conversations with bankers and law firms alike, although the sector’s potential is currently stifled by the reverberations from past corruption scandals, from Lava Jato to Notebook to Odebrecht, and the resultant scepticism among local populations towards public-private partnerships and private-sector led infrastructure initiatives.

Notably, deals in the project finance space are taking longer to mature and several sources admitted that the bottleneck in some countries (particularly in Peru and Argentina) means demand is vastly outstripping supply. Furthermore, some concessions have been terminated by the governments, which is creating additional legal issues for sponsors and investors willing to participate in state-led initiatives.

While CFOs surveyed by Bonds & Loans in the first quarter of 2017 overwhelmingly listed unattractive pricing as the biggest reason behind deals being scrapped, sponsors and lawyers involved, tellingly, pointed to the uncertain (and rapidly changing) regulatory environment. Several sources lamented a lack of unity among regional jurisdictions, suggesting that financial authorities (including stock exchanges) could do more to push for harmonization of frameworks.

M&As and Consolidation

On the corporate side, US Fed tightening is propelling South American central banks into action, and rising rates are a growing concern for local borrowers, particularly those hoping to secure long-term funding in dollarized sectors like construction and mining. In Brazil, for example, the problem is becoming quite acute as local banks’ funding abilities will become more constrained amid the implementation of Basil III rules, which imply a need for higher level of reserves and regulatory capital.

As a result of rising borrowing costs, there is a growing trend towards consolidation and mergers across a number of sectors which, some say, is signalling a crossroads ahead for the region: will this consolidation lead to monopolization or privatization? Much of the answer rests on the political and economic inclinations of the incoming administrations, experts admit. Either way, this trend is likely to create opportunities for banks and law firms operating in the region, particularly as the lack of legal frameworks and poor arbitration mechanisms are still major issues in many jurisdictions.

With many projects and companies still distressed following the recent scandals in the sector, construction firms in Latin America are focussed on freeing up their balance sheets, which could provide new opportunities for other developers (notably from Europe and Canada) to take on concessions.

The increasing cost of borrowing and consolidation is likely to make South American companies and assets even more attractive to existing and new liquidity pools, particularly capital from Asia – which has already been pouring into the region.

The strict demands for due diligence and quality put certain constraints on European and US-based investors when it comes to investing in high-yielding assets, investors based in China are less inclined to focus on transparency issues with a view to satisfying broader policy-driven objectives. The influx of Chinese corporates in particular – and major Chinese lenders that follow them – is a hot topic among bankers operating in Latin America, and is likely to become even more relevant if credit quality were to decline further.

Macro Policy Americas Andes Latin America
1972 Will Weaker Currencies Help or Hinder EMs? It Depends With an increasing number of column inches being devoted to the currency rout wreaking havoc on emerging markets, economists and investors suggest looking more closely at the interplay between bond yields, inflation dynamics and real effective exchange rates (REER) provide a better gage of which economies will struggle – and which might thrive – in the current environment. What's behind EM currency weakness? 19 Oct 2018 Macro Global Market Insights 98 Fri, 19 Oct 2018 13:14:52 GMT Emerging market currencies have suffered in recent months on the back of a strengthening US dollar and rising yields in developed market assets, driven in part to the unwind of quantitative easing in some of the world’s largest economies and rising global trade tensions.

Among other things – namely, its conspicuous impact on emerging market equities – the trend has reaffirmed the challenge of high external debt and fiscal pressure faced by many emerging market economies, concerns that have found their way into EM bond yields in nearly every major region (Turkey and Argentina in particular).

But is what we’re seeing in EM currencies truly a reflection of underlying weakness of emerging market fundamentals? How does the currency rout affect the competitiveness of these markets?

Economists and a growing chorus of investors have increasingly argued against our collective general fixation on nominal exchange rates as a determinant of external competitiveness. If you look at EM balance sheets over the past five years, they have largely improved – meaning macroeconomic strains resulting from the recent currency rout are likely to be contained largely to Turkey and Argentina in the medium term.

But while a currency’s fall should generally be considered a net positive for economic growth, there are a number of additional factors to consider, according to William Jackson, Chief Emerging Markets Economist at Capital Economics.

“We should focus on changes in real rather than nominal exchange rates. These take account of inflation differentials between countries and are better measures of competitiveness. They have depreciated by less than nominal exchange rates,” he explained.


If the nominal exchange rate tells you how much of one country’s currency you can buy with another country’s, REER essentially tells you how much of one country’s goods you could buy with the goods of the countries it trades with at the current nominal exchange rate. There are a number of determinants of REER: level of productivity; external debt-to-GDP; degrees of development and fiscal policies; and quite importantly, the terms of trade.

“Changes in the terms of trade appear as an important determinant of the REER in most countries—but the terms of trade move in completely opposite directions depending on whether a country is primarily a commodity exporter or a commodity importer,” explained Rob Drijkoningen, Co-Head of Global EM Debt at Neuberger Berman in a recent white paper.

EM real effective exchange rates (REER) have depreciated by about 10% since the US began its quantitative easing programme, according to data from the Bank of International Settlements, far less than the EM nominal rate over the same period. US REER, by contrast, appreciated 25% during the same period. But an important caveat to bear in mind is that inflation also tends to be higher in emerging markets than those found in their trading partners, especially when those partners are developed market economies.

REER, in conjunction with changes in local currency bond yields, can help give observers a sense of whether currency falls tend to be headwinds or tailwinds for growth, which – once the headline risk dissipates – should feed back into bond yields in theory.

As we’ve seen recently, a combination of weakening REER and lower yields have been a growth-positive combination, while rising yields and flat or negative REER movement have tended to present headwinds for growth.

It also depends on the extent to which domestic financial conditions tighten, and whether there is capacity to take advantage of improved competitiveness – so for instance, whether an economy is running at full employment; whether there is additional demand generated for goods either domestically or abroad; or whether productivity has fallen or increased.

“There’s a trade-off in that higher bond yields are likely to tighten financial conditions and cause domestic demand to weaken, while a weaker real exchange rate should boost export competitiveness. So those countries that have had a relatively large currency fall and relatively small rise or even a fall in bond yields may enjoy a boost to growth. Those who have suffered a large rise in bond yields, but a relatively small depreciation in the real exchange rate may suffer from weaker growth,” Jackson said.

“Turkey and Argentina were overheating before their recent crises, so there is probably limited scope to immediately raise output, at least in the near term. Similarly, in parts of Central Europe and India, capacity constraints are starting to bite. In contrast, in parts of East Asia, most of Latin America, Russia and South Africa, there still seems to be some slack, which could allow output to be raised.”

Keeping the Equilibrium

While REER does provide a better gauge of external competitiveness, it has some pitfalls. For one, it can’t provide an absolute value.

“One has to gauge ‘fair value’ by comparing the REER with its long-run average while taking account of other factors that might affect fair value, such as differentials in productivity growth and moves in a country’s terms of trade. Just as importantly, nominal exchange rates can deviate from their fair value for some time,” Jackson explained.

But investors maintain that keeping REER close to equilibrium is a fundamental cornerstone of good macroeconomic policy, and leads to longer-term gains on competitiveness.

“Equilibrium REER is the price level and foreign exchange rate consistent with a financeable current account and full employment,” explains Jan Dehn, Head of Research at Ashmore Group in London. Keeping REER close to equilibrium “is what good macro is all about.”

“There is a huge competitive edge in EM now, due both to lower inflation and cheaper FX,” Dehn concluded.

Currencies Policy
1971 SWOT Analysis of Colombia’s Credit Markets Bonds & Loans team spent some time on the ground in Colombia to meet with a broad range of local finance leaders in order to get a sense of the risks and opportunities on the horizon in the Andean country. The country's 4G program is in full swing 18 Oct 2018 Colombia Market Insights 72 Thu, 18 Oct 2018 14:51:33 GMT Strengths

-        Markets have recovered in 2018 as political volatility dissipated. Colombia is in better positioned to deal with corruption issues and infrastructure plans.

-        Colombia’s FDN has been successful in pooling a variety of sources of finance for its 4G projects, and introducing innovative structures. The first deal between the FDN and a Chinese sponsor passed, and hybrid structures have begun paying contractors on milestones, rather than final construction. 

-        Green bonds from Colombian FIs in 2017 have been followed by the first green bond issuance by a Colombian energy company. The government supported this by offering tax incentives for investors.


-        The Andean markets are not standardised, making it difficult for issuers in one market to tap liquidity in another.

-        There is currently a lack of visibility on the new government’s plans, concerning the continuation of 4G projects and tax reform. The latter issue is leading corporates to hold off on financing.

-        Investors continue to avoid any companies rated below AA+ locally.

-        Local banks have been curbing over-exposure in the 4G projects; international banks have filled in funding gaps, but there is a limit to what they can provide in pesos (which the majority of projects require funding in).

-        In spite of legislation introduced in 2017, financers and contractors remain unsatisfied with payment in cases of project termination.


-        A slow-down in 4G projects has been matched by growing interest in social infrastructure, as parties develop structures appropriate to finance schools and hospitals.

-        Non-conventional renewables have been building traction. The key challenge remains in coming up with financing structures to mitigate the risk, which is different relative to conventional renewables that have a guaranteed output. 

-        The government and Bolsa de Valores are rolling out initiatives to make tapping the bond market easier. While there are cases of bond defaults in the infrastructure segment, they hope to see repeats of the positive experience of the Pacifico 3 package.

-        17 of the 30 contracts in the 4G initiative have received financial close, and the FDN hopes to close another 4-5 by next June.

-        Panama has a big project pipeline and is looking for Colombian developers and investors to fund it.

-        The market is gradually moving on from the corruption scandals and there are new opportunities for those not being investigated to get involved in projects.


-        The recent difficulties of EPM’s Ituango dam present a challenge not only for the company, but the power sector as a whole which is already set to reach capacity in the next three years.

-        Ituango is not the only project to have encountered difficulties. A large part of 4G is yet to come online as hoped.

-        Funding the remaining 13 contracts from the 4G programme will be challenging given the loss of appetite from local banks.

-        Interest rates set to rise in the US and Europe, posing a threat to corporates’ financing strategies. These concerns are worsened by global trade wars and geo-political risk.

-        Globally, rising rates, trade wars and geo-political risk present a challenge for Emerging Markets. Within Latin America, politically volatility in Brazil and on-going challenges in Argentina have an effect on the region as whole.

Projects Americas Andes Latin America
1970 ESG Integration and Engagement: South Africa Sovereign Credit Environmental, social and governance (ESG) indicators are integral to PIMCO’s sovereign credit assessments, which inform our investment decisions. But how exactly do we incorporate ESG considerations into our decisions? PIMCO's Lupin Rahman explains 17 Oct 2018 Africa Market Insights 44 Wed, 17 Oct 2018 14:34:16 GMT In addition to rigorous analysis of ESG and other risk factors, in-country engagement is key for us to gain a holistic sense of broader developments, pinpoint country-specific risks, share in active dialogue with public officials and business leaders, and assess governments’ track records in meeting ESG objectives. We detail our approach in our recent Viewpoint, “Applying ESG Analysis to Sovereign Bonds,” and our experience in assessing South Africa’s sovereign credit, in particular, offers a concrete case study of how active engagement and thorough ESG analysis helps shape portfolio strategy.

ESG sovereign risk case study: South Africa

Political developments in South Africa in 2015–2017 highlight how integrating ESG factors into traditional sovereign credit analysis as well as timely engagement can potentially improve risk assessments and shield portfolios from large downside risks.

In July 2015, allegations of corruption emerged with regard to former South African President Jacob Zuma. Criticism focused on a nuclear energy agreement between South Africa and Russia, which was believed to be engineered for President Zuma’s personal gain to the detriment of a South African public utility. President Zuma was also accused of having a corrupt relationship with the Guptas, a prominent South African business family. A power struggle within the African National Congress (ANC) followed, resulting in a weakening of South Africa’s institutional framework, with frequent changes of finance ministers, fiscal slippage and political turbulence.

When the allegations first surfaced, we initiated a reassessment of South Africa’s political and governance risks, and a senior PIMCO team made a due diligence trip to the country. The objective was to understand the economic and institutional impact as well as the social consequences of the diversion of fiscal resources away from health and education.

PIMCO’s assessment prompts internal downgrade

Following in-depth discussions with the government and a detailed analysis, we downgraded our internal credit rating for South Africa several quarters before the major rating agencies did (see chart). The weight of the governance indicators within our sovereign ratings, our assessment of the impact of weaker institutions on economic growth and on the country’s debt burden, and our engagement with senior government officials all drove our decision to downgrade.

Our downgrade in turn led us to re-evaluate our portfolio exposure to South African sovereign and quasi-sovereign risk, and led us to make a call to reduce exposure across PIMCO accounts. Due to the integration of ESG factors in our standard sovereign risk framework, we were able to identify problems early and reduce exposure when the markets were still pricing in a favourable scenario for South Africa. Over time, as the extent of the corruption became known, the markets and the rating agencies caught up with our assessment.

Continuous analysis and engagement

From 2015–2017, we remained engaged with the government and key stakeholders in South Africa. This enabled us to better understand the political dynamics and relay investors’ concerns directly to decision makers.

As global macroeconomic conditions improved, the markets started to reprice South Africa positively, but our negative view on governance and transparency led us to remain cautious, particularly as there was a good chance that President Zuma’s policies would continue if his ex-wife, Nkosazana Dlamini-Zuma, won the leadership of the ANC.

With the election of President Cyril Ramaphosa as leader of the ANC in December 2017 and the exit of President Zuma from politics in February 2018, we are monitoring the new government’s progress in correcting management gaps in the state-owned enterprise sector and advancing reforms to improve governance and transparency. The procedures being put in place to reduce corruption are promising signs that South Africa is finally on the long road to recovery.


Ratings Africa Sustainable Finance
1969 Dufil Prima Foods COO on Financial Strategy, Expansion into Agricultural Segment Madhukar Khetan, Chief Operating Officer at Dufil Prima Foods, spoke to Bonds & Loans about the Nigerian company’s expansion plans, cost-revenue balance, and the role of the issuance house for the local debt capital market. Instant noodles manufacturer sees 20% growth 16 Oct 2018 CEO CFO Insights Africa Market Insights 78 Tue, 16 Oct 2018 13:20:00 GMT Bonds & Loans: Can you give us a sense of the company’s key strategic focus areas over the next 6-12 months?

Madhukar Khetan: We are expecting growth from 15-20% from where we were last year. Despite the current economic hurdles, we are still successfully driving our three-fold strategy. Firstly, we are looking to organically grow our business. Nigeria is the land of opportunity and we want to expand our capacity in the market here.

The second part of our growth strategy is to expand into the agricultural market. Thirdly, the cost of business is rising in Nigeria so it is important to bring efficiency to both our processes and costs. It is important that we focus on enhancing our core competencies whilst remaining efficient.

Bonds & Loans: What would you say is the biggest constraint or challenge facing the Treasury department at the moment?

MK: There are no major challenges right now because the economic situation in Nigeria is much better following the liquidity crunch. We do have an internal challenge but it is probably better viewed as an opportunity; the costs of capital are coming down, so how do we, as a business benefit from this?

Bonds & Loans: Between the cost side and revenue side of the business, what is the Treasury more focused on at the moment and why?

MK: We are a market driven company and we have a revenue focus right now. We always want to be increasing in revenue and it is therefore important that we don’t compromise on this. The cost component of the business is equally important and we look for ways to bring down cost whilst still maintaining revenue.

Bonds & Loans: How does a successful bond programme tie into the broader diversification agenda in Nigeria?

MK: We are very passionate about our successful bond programme: it is a win-win option for both local and international investors, as it allows them to diversify their portfolio. We are continually involved with local investors and keep foreign investors posted on developments.

Bonds & Loans: How do you view the role of an issuance house? What should issuers expect from them?

MK: There are a very important player because they are a link between the investors and the borrower.

Bonds & Loans: In light of the current economic and political environment in Nigeria, how do you see this impacting investor appetite in the country?

MK: I think local and foreign investment prospects are still good. As long as the corporate governance is up to standard and the business models of the corporations are correct then there will be continued desire for investment.

Bio: Mr.  Madhukar Khetan (Chief Operating Officer)

Mr. Madhukar joined Dufil Prima Foods Plc. (Dufil) as Finance Controller in Oct 2005. He held various positions in Dufil and later promoted as Chief Operating Officer (COO). He is one of the instrumental team member to bring transformation in Dufil. Before joining the Company in Nigeria, Mr. Madhukar worked in India with leading Software Company HCL Technologies Ltd (2003 – 2005) as Deputy Finance Manager and in Voltas Ltd, part of Tata Group (2000 – 2003). He has over 17 years of professional experience in Finance and Operations. He is a 1997 graduate of the St. Xavier’s College, Calcutta University, India. He is qualified Chartered Accountant of India and also an Associate Member of the Institute of Company Secretaries of India.