November 9, 2010 / 11:06 AM / 10 years ago

Analysis: Emerging currency global bonds: shelter from FX curbs

LONDON (Reuters) - Investors hungry for emerging markets exposure but fearful of getting slammed by capital controls are finding an attractive new option — global bonds that developing nations are issuing in their own currencies.

Listed on overseas exchanges and subject to international law, these bonds give investors exposure to emerging currencies, yet skirt the exchange curbs that more and more countries are mulling to stem the steady appreciation of their currencies.

The capital controls hubbub looks set to grow after the U.S. Federal Reserve last week effectively unleashed more cash onto world markets, with Latin American and Asian policymakers vowing more steps against the capital flooding their countries.

For a U.S. fund manager, it may seem sensible to trade in his rapidly-depreciating dollars for a Philippine peso bond that is free of future exchange curbs and is payable in dollars.

Buying a local bond in Manila necessitates opening a local custody account there, but a global bond is easier to access — the fund manager pays dollars to the exchange bank which does a spot FX transaction on his behalf. On coupon dates, he gets dollars, with the bank again doing the peso conversion.

“The advantage for investors is first, that these bonds are easy to clear, and second, they are not subject to capital controls as they are offshore deals,” said Kieran Curtis, who helps manage $1.4 billion in emerging debt at Aviva Investors.

The threat of capital controls looks very real. While Brazil’s 6 percent tax on flows to local debt securities is by far the most draconian, there are fears others may emulate it as record flows into emerging markets — over $80 billion this year, according to EPFR Global — show no sign of abating. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

“(With global bonds), investors are protected from future policy changes,” Curtis said. “They trade expensive (to local debt) for the convenience, and also because investors are worried there may be more capital controls coming in.”

Volumes are still small — $4.3 billion of global bonds have been sold in 2010, by sovereigns including Colombia, Chile, Brazil, Philippines and Croatia. That’s just 1.5 percent of the issuance projected for 2010 in the emerging hard currency space.

But the number is up from zero in 2009 and volumes could top $10 billion if planned sales go ahead from Russia, Belarus and a host of corporates. That would be the most since the 2007 peak when $15.9 billion was issued, according to ING Bank data.

“Appetite for emerging markets paper is generally very high but the format is important. To get a bond with U.S. dollar settlement is very attractive. Investors will pay a premium to get bonds in a DTCC dollar-settleable format,” said Spencer Lake, head of debt capital markets and acquisition finance at HSBC, which arranged bonds for Philippines and Chile.

The U.S. Depositary Trust and Clearing Corporation clears and settles transactions between securities’ buyers and sellers.


For borrowers, too, such issuance makes sense. First, currency risk is held by investors and second, a wider investor pool means yields are usually lower than on home bond markets.

“Emerging countries don’t want more offshore capital in their local jurisdiction but they do want to keep their liabilities in local currency,” said Jose Wynne, emerging debt strategist at Barclays Capital in New York.

Unlike traditional Eurobonds, which have restrictions on selling to U.S. investors, global bonds can be sold anywhere. They also appeal to more risk-shy investors.

Chile for instance said its July global bond saved it $24 million in debt servicing. It placed the 10-year peso bond at a 5.5 percent yield, versus 5.7 percent for local five-year debt.

Brazil’s recent reais deal was 350 basis points tighter to the local curve, and buyers of Philippines’ debut peso bond were happy to take 100 bps below domestic 10-year debt.

And capital controls may also boost global issuance. That’s because taxing debt inflows leads to a jump in risk premia, affecting the ability to raise longer-term funding at home.

“You increase the barriers to entry to deter foreign investors and then you don’t have sufficient investors to buy long-dated funding,” RBS analyst Siobhan Morden said of Brazil’s decision last month to tap a global reais bond issued in 2007.

“To bypass this and to still continue to get investors for long-dated funding they had to reopen the reais global market.”


Obviously not all global issues will find ready buyers.

For one, investing locally is usually more lucrative — despite Brazil’s 6 percent tax, holding 10-year local debt to maturity yields better returns than similar-tenor global paper.

And with demand for such debt rooted in currency appreciation hopes [ID:nLDE6971DG], only issues denominated in strengthening currencies are likely to do really well — hence the success for Chile or Colombia.

That means weakness in Russia’s weak rouble, despite high oil prices, could make it tough for Moscow to place its upcoming $3 billion issue at a significant discount to local bonds.

Subsequent corporate issues may face more problems.

“The rouble has not been the best currency in emerging markets,” one fund manager said, explaining why he had not touched recent corporate rouble bonds. “You are doubling up on your risk with a rouble bond — corporate and currency.” (Additional reporting by Alex Chambers and Carolyn Cohn; Editing by Catherine Evans))

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