TRADE WARS AND SANCTIONS America’s growing use of soft power poses new challenges

THE LIFE OF AMLO Is Mexico’s new prez a Tropical Messiah – or just a very naughty boy?

ESKOM’S WOES Time is running out for South Africa’s troubled SOE

GOVERNANCE IN MENA Will Abraaj’s fall from grace catalyse an ESG revolution?

RUSSIAN DE-DOLLARIZATION Risks of economic isolation mount

INDIA’S BORROWERS Stuck between a rock and a hard place THE LARGEST EVENT THAT CELEBRATES THE LATIN AMERICAN FINANCE INDUSTRY AND CONGREGATES MORE THAN 1,600 BANKERS FROM AROUND THE WORLD, WILL BE HELD IN DOMINICAN REPUBLIC.

November 11-14, 2018 Punta Cana International Convention Center, Hard Rock Hotel

www.asambleafelaban2018.com.do From The Editor

Dear Reader,

What was supposed to be a quiet, restful Summer turned out to be anything but, with the consistent escalation in global trade war rhetoric, capricious currency volatility, and rising concerns over structural deficiencies in emerging economies sending markets wobbling in the best of moments and crashing in the worst. Chief Executive Officer and Publisher Alex Johnson Against that backdrop, what was perhaps most surprising T: +44 (0)20 7045 0922 was the volume of economic and political discord E: [email protected] surrounding not just Turkey and Argentina – once Managing Editor emerging market darlings, now faced with amongst Jonathan Brandon the worst crises they’ve confronted in years – but others T: +44 (0) 20 7045 0937 like Italy, the United Kingdom, the United States, and E: [email protected] Germany, among others. Deputy Editor However, looking at the macro and sectorial challenges Yevgeny Kuklychev facing EMs from Brazil to Bali and many in between in T: +44 (0) 20 7045 0904 any considerable depth gives one the sense that there E: [email protected] need not be such a stark trade-off bet ween institutional Advertising strength or sophistication, and the willingness of leadership Aveen Prasad to take bold and often politically or economically risky T: +44 (0) 20 7045 0928 measures to stave off crisis and return to growth. E: [email protected]

For reprints please contact: In other words, there may be a flipside to all of this – a silver Marcia Ardila lining that brings new opportunities and new challenges. T: +44(0) 20 7045 0900 Here, I’m thinking of the acute reprioritisation of ESG in E: [email protected] investment and organisational ethos; the rising use of soft over hard power – fighting wars with g-spreads, not © GFC Media Group THE LARGEST EVENT THAT CELEBRATES THE LATIN AMERICAN FINANCE www.bondsloans.com guns – on the global stage; and the growing acceptance INDUSTRY AND CONGREGATES MORE THAN 1,600 BANKERS FROM www.gfcmediagroup.com that countries must live within their means to ensure Unauthorised photocopying is illegal. The contents stability (or in some cases, survive in their present form). AROUND THE WORLD, WILL BE HELD IN DOMINICAN REPUBLIC. of this publication, either in whole or part, may not Whether market participants and lawmakers alike are be reproduced, stored in a data retrieval system or up to the challenge is, as ever, another story. transmitted in any form by any means, electronic, mechanical, photocopying, recording or otherwise November 11-14, 2018 without written permission of the publishers. Action These are some of the issues we explore in the latest will be taken against companies or individuals who issue of Bonds & Loans. Punta Cana International Convention Center, Hard Rock Hotel ignore this warning. The information set forth herein has been obtained from sources which we believe to Kind regards, be reliable, but is not guaranteed. www.asambleafelaban2018.com.do

Jonathan Brandon Managing Editor CONTENTS Issue 15 - July / August

GLOBAL THEMES THE AMERICAS AFRICA

6 18 26 A LIBORious Transition The Rise of AMLO East African Credit Exploring the challenges of Some call Mexico’s new president the In-depth look at the idiosyncratic gradually weaning the world off the “Tropical Messiah”, while others balk at challenges still weighing on the region’s most popular credit benchmark his “naughty” fiscal policies local debt markets 10 23 31 ESG: Standards on Standards Case Study: Atlas Prints Green Power Outage Project Bonds Will ESG standards and ratings Exploring the factors behind Eskom’s heterogeneity kill the sustainable The unique A/B private placement failings and scandals – and what it finance market? structure with both senior and means for South Africa’s economy subordinated traches is a first for 13 Uruguay 34 The Flipside of Turkey Kenya Pooled Water Fund While the US doubles down on 24 The Loan Syndicator The fund’s CEO on green bond sanctions as key foreign policy opportunities in the water and tool, is the impact of “soft power” Monica Macia on how the loan market sanitation sectors waning? is evolving in line with the shifting dynamics on the ground in the Americas

4 www.BondsLoans.com MIDDLE EAST & TURKEY RUSSIA, CIS & EUROPE ASIA

36 46 54 Governance in MENA Reserve Reservations Corporate Borrowers in India Abraaj's spectacular collapse is a Russia seeks to mobilize internal Facing the challenge of a thin bond cautionary tale on governance too reserves amid sanctions and dollar market on one side, and increased big for MENA to ignore liquidity shortages tightening by banks on the other 40 52 57 Fiscal Woes A Serbian Miracle Green Sukuk Concerns have risen over Bahrain’s Branco Drcelic, the director of As Indonesia finds itself in the finances, but are things better than Public Debt, elaborates on the nexus of ESG and Islamic finance, they seem? Anita Yadav has the country’s transition from chronic we interview Luky Affirman, answer deficits to a healthy surplus the Director General of Budget Financing and Risk Management 42 Turkey: Call & Response Richard Segal’s take on the monetary policy measures, discussions with the Central Bank and the country’s economic outlook 44 Looking for Windows Turkey’s healthcare industry still has access to the markets, but smart balance sheet management and timing is key, says CFO of MLP Care

JULY / AUGUST 2018 5 Global Themes A LIBORious Transition

Weaning the World off the Most Popular Credit Benchmark

ore than a year has passed since the UK FCA’s Chief Executive Andrew Bailey set the deadline for the financial markets’ transition Maway from LIBOR, upon which roughly USD350tn in securities, loans and derivatives across five major currencies is contracted. Finding an alternative that can satisfy the diversity of markets that rest upon this crucial benchmark is proving to be more elusive than anticipated, beckoning questions about the pace and scale of transition.

The saying “vision is always 20/20 in stop compelling banks to publish data decade. And because it remains a critical hindsight” is fairly apt for LIBOR, whose used for rate setting, but despite the global benchmark, we’re continuing demise largely comes as a result of the high probability that transactions in to invest in strengthening LIBOR such acute realisation that a key financial the near term will continue to be based that investors have confidence in benchmark likely shouldn’t be decided on it, its future is anything but certain. the benchmark.” through a survey of select banks A big part of ensuring its integrity going drawing on their ‘expert judgement’; forward, especially during the transition “What we want to avoid is a vacuum - an this, coupled with the fact that the period, will involve shifting the market’s uncontrolled process in which LIBOR underlying market which LIBOR seeks perception of the benchmark. ceases to exist but markets have not to measure – the market for unsecured yet fully adopted new rates,” he added. wholesale interbank lending – is no “Given how important LIBOR is in the longer sufficiently active. pricing of the extension of credit, we Investors believe it is likely that, given believe the banking industry and their the extensive use of LIBOR globally, Had the height of the LIBOR-rigging clients will be willing to work with us to the banking community will continue scandal, in which bankers at some of find a path for LIBOR to continue to be to voluntarily support and publish the the world’s largest lenders colluded to published. We have received significant rate for many years, despite several fix the rate, not coincided with one of positive feedback from banks and banks having previously requested to the worst market crashes in history, one their clients on LIBOR’s utility and its withdraw as contributors due to the wonders whether we would have indeed strengthened framework,” explained costs maintenance incurs and rising come to that realisation. Following the Tim Bowler, IBA’s President. “However, revelations, significant reforms were we can’t make any promises and there Global Themes implemented in multiple jurisdictions to is no guarantee that the banking help address moral hazard – including industry will remain committed to LIBOR 6 requirements for panel banks to use beyond 2021.” Libor: Weaning the World off the Most actual trades and keep records of Popular Credit Benchmark large submissions. “LIBOR in 2018 is not the same as LIBOR 10 in 2008. People often see the name London Remains Top Spot for International ICE Benchmark Administration (IBA) – LIBOR and think of all the connotations Debt Listing Despite Brexit Noise the organisation that has maintained that come with that, but much has LIBOR since 2014 – has agreed to changed. The benchmark is now well 13 America's Growing Use of Soft Power continue publishing (and improve) the regulated and managed in a thoroughly Poses New Challenges rate beyond 2021, the year the FCA will different manner than it was in the last

6 www.BondsLoans.com Global Themes

In the UK, Japan, Europe and Switzerland, more consideration is being given to reference rates based on unsecured overnight repo rates. In the UK and Japan, the chosen replacements (Sterling Overnight Index Average, SONIA, and the Tokyo Overnight Average, TONAR, respectively) are already commonly used reference rates for swaps and collateral. European regulators have set themselves a deadline of 2020 to develop a euro unsecured rate, one that may or may not be largely based on existing benchmarks – the Euro Overnight Index Average (EONIA) and the Euro Interbank Offered Rate (EURIBOR).

Pioneering floating rate note issuers are already trying to set the pace for other borrowers. In late June the European Investment Bank placed what we understand to be the first bond linked to SONIA since 2010. The GBP1bn 5-year notes pay a coupon of SONIA+35bp, a move the EIB hopes will instil confidence in alternative reference rates among other borrowers.

But effectively replacing LIBOR while at regulatory risk, and despite only a that reduce as much as possible any the same time continuing to sustain it quarter of the rate being based on subjective judgement in their constitution. also brings with it additional challenges, actual transactions. largely in the form of how risk is valued Simultaneous Replacement and priced fairly. Indeed, one of the Banks and authorities are already shifting and Continuation is Risky reasons banks are moving away their focus towards developing more Much of that work is only just starting from using the wholesale interbank regionally-specific benchmarks that to bear fruit. In the US, the Alternative borrowing market as a measure more accurately reflect the underlying Reference Rates Committee (ARRC) was of the base interest rate charged markets they intend to. Martin Egan, convened in late 2014 to identify a set on credit transactions is because Vice Chairman of Global Markets at BNP of alternative USD reference rate more their reliance on overnight lending Paribas says there’s no clear answer firmly based on transactions from a has in many instances diminished; on what those will look like in terms of robust underlying market which comply many lenders – particularly since the their practical application. with the International Organization onset of Basel II and III regulatory of Securities Commissions’ (IOSCO) frameworks – have sought out Tier “ What we do expec t is less of a specific Principles for Financial Benchmarks. 1 and 2 capital issues as a way of global standard, but more specific The group has recently chosen the boosting regulatory capital, rather standards in each relevant jurisdiction Securities Overnight Financing Rate than go directly to their relevant with some consistency across the board. (SOFR), a secured overnight Treasury Central Bank, which raises questions The most important thing is that it’s repo rate, which is published daily by about any of these new benchmarks’ fair and transparent and that all the the New York Fed. adequacy as a credit interest rate market counterparts can understand floor for future transactions. how a particular rate is set, but also The SOFR is calculated as a volume- who actually inputs the data into the weighted median of transaction-level The potential cost implications for particular rate – and that’s it’s seen to tri-party repo data collected from the borrowers (and investors) of maintaining be appropriate.” Bank of New York Mellon as well as GCF a dual benchmark market, and the threat Repo transaction data and data on to generating liquidity in new reference Authorities in most major financial bilateral Treasury repo transactions rates – arguably the most important jurisdictions have over the past couple cleared through FICC's DVP service; precondition for any new benchmark’s of years set to work on helping the it’s a broad measure of the cost of adoption – could force regulators to industry seek out and develop new borrowing cash overnight collateralized move beyond just encouraging the risk-free reference rate benchmarks by Treasury securities. market to shift to new ones.

JULY / AUGUST 2018 7 Global Themes

“If existing trades continue to reference reference rates included.” The same There could be a number of ways to the old LIBOR, there is a risk that a conspicuous absence of fall-back address this according to Serge Gwynne, bifurcated market will develop which provisions applies to much of the loan a corporate and institutional banking may severely affect end-users and result market, too. Upgrading these contracts specialist at Oliver Wyman. One would in punitive impacts to valuations,” argue will be costly and time consuming to be to use an arrears-based compounded William De Leon and Courtney Walker say the least. version of an overnight rate, but it would of PIMCO in a recent note. be backwards looking, and wouldn't give Understanding the impact that the a borrower the visibilit y of cashflows they “Because such a transition would be variety of benchmarks condoned would require. Another option would so complex and potentially involve by authorities will have on liquidity – be to develop a term structure for SOFR significant participation within the and market friction – is another story and SONIA and other benchmarks, but financial industry to implement, the altogether. The elegance of using one kind as of today, authorities have yet to find transition may require regulatory mandate of reference rate for derivatives, futures a way of assessing or establishing the to ensure a coordinated and smooth and other frequently traded products is term value of these reference rates move away from LIBOR and to the new that it can be well-understood by global that is anchored in actual transactions. benchmark… Our greatest concern is investors of varying sophistication. Using Borrowers and banks could create a that a transition is not well-scripted and myriad reference rates appears likely term-based rate linked tothe futures fails to consider the potential impacts to cause unnecessary confusion and markets or overnight index swaps, which on all securities types [which] threatens potentially lead to a market slowdown. by definition would combine a daily to favour certain market participants rate compounded up and a fixed rate over others.” Loan Markets Could Become on the other side; the fixed rate would Moan Markets essentially provide stakeholders with Derivatives and forwards – which account The challenges most banks and borrowers an expectation on the compounded for nearly 95% of all contracts linked face in adjusting to the new reference interest over the next three months. to LIBOR – that aren’t transitioned to a rate environment will be difficult to CME Group has for instance created one new benchmark may become less liquid overcome, in part because most of the and three-month SOFR futures based as we move towards 2021, especially if benchmarks currently being mulled on the compounded daily SOFR rate. their contracts don’t have suitable fall- by authorities are overnight rates – back benchmark mechanisms in place. whereas LIBOR is a forward-looking “If there is sufficient liquidit y in the OIS According to one legal professional rate and calculated on a term basis (1 market, you could then use pricing in focused on derivatives and futures month, 3 months, 6 months, and so that market to form a term-based three- contracts, the number of contracts forth). Term-based rate provide loan month benchmark,” he explains. “But that make reference to LIBOR without borrowers and lenders with more with all of these alternative rates, the suitable fall-back language “vastly and certainty over their funding costs and question is whether there is sufficient overwhelmingly exceed those with asset value, respectively. liquidity in the underlying market to

The Legacy of Libor It’s still used to benchmark over USD370tn of financial products in five currencies

160 140 120 100 80 60 40 20 0 U.S Euribor British Japanese Swiss *Tibor Euro Dollar (Euro) Pound en Franc (en) Source: ISDA Note: Figures reflect face value of contracts benchmarked as of 2014 Euribor is the Euro Interbank Offered Rate and is distinct from euro-denominated Libor. Tibor, the Tokyo Interbank Offered Rate, also differs from from yen-denominated Libor

8 www.BondsLoans.com Global Themes make it happen. It’s a classic chicken Estimated USD LIBOR Market Footprint by Asset Class and egg problem: no borrower would use a reference rate that doesn’t have sufficient underlying liquidity, but without olume sufficient liquidity these reference rates Trillions End End After After would not be viable in the first place. USD It’s still an open question.” OvertheCounter Interest rate swaps 81 66% 66% 7% 5% Derivates Reference rate heterogeneity could also Forward rate agreements 34 100% 100% 0% 0% be problematic due to their differing Interest rate options 12 65% 68% 5% 5% constructions. While many banks have Cross currency swaps 18 88% 93% 2% 0% been updating their loan documentation to allow for additional reference rates, some are still uncertain about how SOFR Echange Traded Interest rate options 34 99% 100% 0% 0% Derivates in particular will operate in practice Interest rate futures 11 99% 100% 0% 0% because it is secured with US Treasuries, in contrast to other mostly unsecured Business Loans Syndicated loans 1.5 83% 100% 0% 0% rates being proposed in the UK, Europe, Nonsyndicated business loans 0.8 86% 97% 1% 0% Japan, and Switzerland. Nonsyndicated CRE/Commercial 1.1 83% 94% 4% 2% mortgages According to one banker, this could mean, hypothetically, that US dollar loan rates Consumer Loans Retal mortgages3 1.2 57% 82% 7% 1% linked to SOFR could actually decline in Bonds Other Consumer loans 0.1 the event of market stress, since many 1.8 84% 93% 6% 3% investors typically pile into shorter-dated Floating/Variable Rate Notes US Treasuries whenever global markets panic – reducing their yield. Securitizations Mortgage -backet Securites 1.0 57% 81% 7% 1% (inci. CMOs) “As banks have increasingly turned to the Collateralized loan obligations 0.4 26% 72% 5% 0% traditional bond and loan markets for additional capital, particularly those that Asset-backed securities 0.2 55% 78% 10% 2% are fairly well-capitalised already, their cost of capital is no longer as dependent Collateralized debt obligations 0.2 48% 73% 10% 2% on interbank liquidity as it was in previous years, and increasingly dependent on Total USD LIBOR Eposure: market rates… [this] could create a double-whammy for banks – where Source: US Federal Reserve the cost of our bonds or capital could rise in the event of some geopolitical or market event, while those borrowers we “It would have been simpler if all the is a significant risk in waiting. But it’s extend loans to could benefit through different currencies adopted a similar not just borrowers that are exposed a compressed reference rate,” said one definition and approach, and while most to the risks prevalent throughout the bank treasurer based in Dubai, where market participants are sophisticated transition. the US dollar tends to be the currency of enough to differentiate between secured choice for larger loan transactions. The and unsecured benchmarks, the bigger “Not knowing how much you have to next twelve months, which is forecast to issue is that as we transition, if there are pay in the future is a ver y real cashflow see the highest US Treasury bill issuance different timings on different currencies, management problem that simply isn’t volumes since 2010 to finance a yawning there could be a huge impact on multi- on the radar of many corporates. But deficit, could be crucial for the SOFR – currency swaps and multi-currency one concern we have for banks is particularly as the yield curve continues loans,” Gwynne adds. “If you have a potential conduct risks that they are to flatten and interest rates rise. term structure in US dollars and an facing. If they are originating lots of overnight struc ture in Sterling or Yen, new business beyond 2021 based One of the challenges of using a secured as a borrower you will not only have on LIBOR, there simply isn’t sufficient rate over an unsecured one is that its to factor in different currencies but clarity for corporates around the fact viability doesn’t just depend on the also the timing effect of one leg looking that LIBOR may not be available after ability or willingness to lend but the forward three months and the other that point in time. There is a risk that availability of the underlying collateral. looking back three months.” [banks] may have either mis-sold or at If collateral is scarce, it could drive the very least not communicated those additional volatility in pricing – which The level of awareness of these issues risks clearly enough to corporates,” could feed through to the repo market. among borrowers is minimal, which Gwynne concludes.

JULY / AUGUST 2018 9 Global Themes Standards on Standards Will ESG Standards and Ratings Heterogeneity Kill the Sustainable Finance Market?

s the world continues to embrace ESG-led investing, a dizzying array of standards and ratings tools has emerged to help clarify Athe underlying non-economic impact of an investment and help investors make sense of ESG-linked assets. This explosion in ratings, criteria and standards, however, could sow more confusion than they aim to resolve.

Measuring a borrower’s ESG – shorthand universe. BNY Mellon for instance has for environmental, social and governance partnered with Sustainalytics to provide – posture has in recent years become environmental, social and governance more important for investors looking to data on and to global issuers. BlackRock gain deeper insight into an organisation’s uses a combination of ESG data provided ethical and sustainability practices, often by MSCI along with its own data for in the hopes of using this information to its own ESG-focused ETF products. help avoid reputational or idiosyncratic JP Morgan, which has partnered with weights in the index, and issuers with risk events. It is particularly essential for BlackRock on its recently launched better ESG scores will have their weights those on the hunt for green bonds and ESG index (JESG) specifically aimed increased relative to their baseline other securities that claim to generate at emerging markets, claims to soak index weights. The JESG suite will also similar non-economic returns. up data from Sustainalytics, RepRisk, overweight Green Bond issuances.” and the Climate Bonds Initiative (CBI) ESG rating services are used by many of as inputs. A standardised approach to what the world’s largest investment funds and constitutes a return in ESG terms are growing more numerous; Bloomberg, It also applies another ethical screening is, however, sorely lacking, despite Dow Jones, Institutional Shareholder on top of that, excluding sectors like the flurry of activity around properly Services, MSCI, RepRisk, Sustainalytics, Thermal Coal or ‘Clean Coal’, Tobacco, pinning down their measurement, SigmaRatings, and Thomson Reuters Weapons, or any violator of the United making it more difficult for investors are just a handful of the dozens of Nations Global Compact (UNGC) to compare securities’ and companies’ specialist providers catering to rising principles. The JESG is available for ESG practices in an unbiased way. Core demand for ESG analysis and rating. the EMBI Global Diversified, GBI-EM ESG metrics considered by some of Traditional credit rating agencies like Global Diversified and CEMBI Broad the largest rating houses can vary Moody’s, which recently launched a Diversified to begin with. from anywhere between 12 to more green bond-specific rating system than 1,000. aimed at measuring the management, According to JP Morgan: “There are five administration, and allocation of use of components in the JESG methodology “Individual agencies’ ESG ratings proceeds on ESG-linked instruments, once the baseline index is selected: can vary dramatically. An individual are also throwing their collective hat define the data inputs; establish company can carry vastly divergent into the ring. JESG index scores; apply integration ratings from different agencies mechanics; consider ethical factors simultaneously, due to differences in Lack of Standards and exclusion, and calculate new ESG methodology, subjective interpretation, This veritable pick & mix in ESG weights. These newly calculated JESG or an individual agency’s agenda,” rating and scoring has naturally led index scores will be systematically explains Timothy Doyle, Vice President to varied adoption within the investing applied to determine the new ESG of Policy & General Council at the

10 www.BondsLoans.com Global Themes

obligations (like Europe, which requires Our portfolio is roughly 50% investment companies with 500 employees or more grade and the average rating across to publish non-financial statements the portfolio is BB or BB-.” and provide additional disclosures around diversity and sustainability) ESG profiling has been a big focus for are likely to be home to entities that PineBridge in recent years. The EM bond carry a stronger ESG rating than their team relies exclusively on its own data, peers based in regions where such and uses 9 ESG factors against which reporting is optional, like the US or each of the 400 entities his team covers Indonesia. are matched, ranging from binary box- tickable metrics like ‘is the company Both of these factors skew the ESG operating in the alcohol or firearms rating scale in certain countries and produc t segment s? ’ to others that are industries in a way that disadvantages much more difficult to quantify, like some – usually smaller – entities. ‘is the company ethical?’ or ‘how does management treat human capital?’. Doyle contends that because there are no standardised rules for “It can be tricky, especially when you environmental or social disclosures are trying to compensate for natural for ESG-linked instruments, nor any discrepancies that emerge in certain mandated disclosure auditing process sectors and in certain countries, or in to verify reported data, agencies have countries that are handicapped by a to rely on assumptions about the legacy of poor investment,” he added. efficacy and tangibility of ESG-related impacts in their assessments. Measuring the Unmeasurable It is indeed quite difficult to take “That lack of disclosure distorts the something qualitative like ethics and information available to both rating place it in a quantitative framework, agencies and investors.” Bates explains, but one of the ways this can be done is by separating out EM Bias entities into respective peer groups Then there is the general emerging aligned by sector, geography, size, and American Council for Capital Formation market bias present in ESG scoring, rank them relative to one another on (ACCF) in a recently published report, partly a function of the above, and partly an empirical basis. which analyses and compares different the result of a broader psychological ESG rating providers. divide between developed and This also helps contextualise borrowers emerging markets that influences against a myriad of factors that some Understanding, Overcoming fuzzier qualitative factors like ethical external ESG score providers either Bias posture or perceptions of corruption to don’t adjust for, or do adjust in peculiar There are also inherent biases – more fundamental underlying factors or opaque ways. from market cap size, to location, like credit ratings. to industry or sector – many if not all “For instance, from an ESG perspective, of them rooted in a lack of uniform “There are companies in Mexico and according to MSCI scoring, Petrobras disclosure, Doyle says. Argentina that are every bit as savvy would be excluded, but PEMEX wouldn’t. when it comes to embracing ESG in But if you look at RepRisk, the opposite These biases seem inherently difficult practice and internal policy as their is the case. So, there is definitely a to address through quantitative counterparts in Europe and the US, difference depending on the provider modelling, and some experts are but many ESG rating agencies still treat and it isn’t always clear which of the sceptical about how one would quantify emerging markets a bit homogenously, variables either entity falls down on,” certain factors. For instance, it is particularly when it comes to perceptions explains Claudia Calich, who manages reasonable to expect that larger of governance,” explains John Bates, M&G’s emerging market bond fund. companies are better positioned to an emerging market corporate analyst “It’s easier to normalise something like allocate resources into non-financial at PineBridge in London. carbon emissions or green investment disclosure than smaller, leaner entities, because you can compare to regional thus increasingly the likelihood that “Whether on ESG or credit rating, one peers rather than global average and larger companies will score higher of the biggest anomalies is that most localise them to some extent. It’s much in ESG terms. of the corporates in our universe, if harder to do this from a governance they were literally lifted out of Brazil, or perspective, or with perceptions of Additionally, jurisdictions with more Colombia, or Russia, and implanted in the corruption, in a quantifiable way, and stringent non-financial reporting US, they would be A-rated companies. in a way that doesn’t lean on biases.”

JULY / AUGUST 2018 11 Global Themes

“For example, many people have a but they aren’t necessarily precise, to measure the non-financial benefits sense of which countries may have either.” they aim to foster. But investors also more endemic corruption, as lofty as need to be aware that going into the that may be… but look at something For ESG-centric investors, the variety murky world of ESG scoring without like the Freedom House Index – it’s in approaches aimed at assessing an eyes wide open could lead to unmet an entirely different thing than saying entities approach to the environment, expectations on the very non-economic country ‘x’ is 23% more corrupt than sustainability and governance isn’t benefits they aim to measure at best, country ‘y’”, she says. “At the end of necessarily a bad thing. For the savvier, or a misinterpretation of risk that could the day, there are so many indicators more switched-on pockets of investors, lead to a blow-out down the road at and components of scoring, and the it’s that variety which gives them the its worst. results are not necessarily irrational… ability to choose exactly how they want

ESG Agency Rating Scale Key Metrics

37 key ESG issues across ten themes: climate change, natural resources, pollution & waste, environmental MSCI AAA (highest) to CCC (lowest) opportunities, human capital, product liability, stakeholder opposition, social opportunities, corporate governance, and corporate behaviour

70 indicators in each industry. It also 100 (highest) to 0 (lowest) using sector breaks down ESG indicators into three Sustainalytics and industry-based comparisons distinct dimensions: preparedness, disclosure, and performance

28 ESG issues connected to the Ten Principles of the UN Global Compact. It divides these into environmental, community relations, employee RepRisk AAA (highest) to D (lowest) relations, and corporate governance issues. It also includes ESG risk exposure for both a two-year and a ten-year timeframe using a scope of 28 ESG issues and 45 “hot topics”

380 factors (at least 240 for each industry group) divided into environmental and social factors. Areas of focus include management of 10 (highest) to 0 (lowest) for environmental risks and opportunities, ISS E&S Quality Score environmental and social overall human rights, waste and toxicity, and product safety, quality, and brand. The offering is touted as being very similar to the company’s well-known governance score.

Source: Davis Polk

12 www.BondsLoans.com Global Themes The Flipside of Turkey

America’s Growing Use of Soft Power Poses new Challenges Jan Dehn, Head of Research, Ashmore Group

nited States sanctions against two Turkish government ministers triggered the recent bout of volatility in the Turkish currency market. While Turkey was fundamentally vulnerable to begin with, Udue to a lengthy period of bad economic policies, the fact that volatility was so severe and spread far beyond Turkey indicates that this was not just about Turkey. It is also about the major shift in America’s use of soft power on the global stage.

US President Donald Trump favours America’s allies react and how quickly The imposition of sanctions on Russia discretion over rules and increasingly China overcomes its credibility deficit for alleged involvement in a recent UK uses American soft power in a coercive to emerge as the new global hegemon. poisoning incident similarly precipitated way in pursuit of narrow short-term material Rouble volatility. Even the objectives rather than using it to reassure Emerging Markets, mighty Renminbi has weakened under and support the global governance Submerging Currencies the onslaught of US trade tariffs this infrastructure. This particular use of Apart from the times when the United year, although this weakness is largely US soft power confers clear benefits States (US) is physically dropping bombs mechanical. onto Trump, who appears strong and on other countries, American power is felt potent, but at the same time erodes most keenly when the US imposes legal, The term used to describe America’s America’s stock of soft power at the financial, trade and other sanctions on ability to effect massive pressure on other fastest rate in the modern era. other countries. The imposition of sanctions countries with mere words or tweets on two Turkish ministers a fortnight ago is ‘soft power’. America established The erosion of US soft power will immediately led to significant pressure on its stock of soft power during World render the world more uncertain in the Lira, which in turn triggered a broader War II, when the US successfully used the foreseeable future, but exactly how global repricing of assets including US its massive military might, aka hard long the uncertainty persists and how stocks, EURUSD, VIX, US Treasuries and, power, to bring about a morally good bad it gets depends on the US itself, how of course, non-Turkey EM. outcome to the conflict.

JULY / AUGUST 2018 13 Global Themes

Top countries that hold the most soft power Ranking based on global factors, 2017

France 75.75 United Kingdom 75.72 United States 75.02 Germany 73.67 Canada 72.90 Japan 71.66 Switzerland 70.45 Australia 70.15 Sweden 69.32 Netherlands 67.98

Source: Portland

In subsequent decades, the US broadly recent US presidents have. Ironically, had told blatant lies on the floor of the preserved this original stock of soft the greater use of soft power may simply United Nations. Close allies, UK and power through the exercise of global reflect the fact that the US has become US, thus found it impossible to mount economic and political leadership in more constrained in terms of its ability military incursions against President the Cold War and by sponsoring the to exercise hard power. Bashar al-Assad after his use of chemical establishment of global institutions weapons against his own people in for conflict resolution. For example, every Republican president 2013, 2014, 2015 and again in 2017. since Ronald Reagan has gone to war in American soft power remains formidable. his first term. Trump may yet become the In short, Trump is turning to the use It rests with the size and openness first Republican president not do so. Why of sof t power because it is so difficult of the American economy, the global has the US become more constrained in to mount global coalitions in support reach of the US banking sector, control its ability to go to war? US military might of the application of hard power. Of of important benchmark indices by US is as formidable as ever, perhaps even course, the world may ultimately be banks, the widespread use across the more so, but America’s ability to form safer in an era of soft power compared world of the Dollar in transactions and broad alliances in support of military to an era of hard power in the sense the high levels of trust vested in American action has received significant setbacks that there are fewer US-instigated wars. legal and regulatory institutions. over the last couple of decades. Uses and Abuses Soft power manifests itself in a willingness For instance, despite the outrage of Soft power, like hard power, can be of other countries to comply with US rules 9/11, former President George W Bush used or abused. How soft power is even when they do not agree them, at was unable to establish a Europe-wide utilised determines whether its stock least up to a point. They comply because coalition against Iraq after declaring increases or decreases. When American business ties with the US institutions that, “either you are with us or you are soft power has been employed in pursuit are so deep and wide that those ties with the terrorists”. Iraq had nothing of objectives with broad global backing, ultimately matter more than relations to do with 9/11, so Bush’s categorical US leadership credentials have tended with most third parties. statement alienated many European to improve and the stock of soft power countries for whom frivolous application has grown. Many also comply because they recognise of military power is still a sensitive issue the value of a predictable and stable (this sensitivity is rooted in Europe’s The US victory in the Cold War, the collapse system of rules, even if those rules are memory of the horrors of two world of the Soviet Union, the establishment not always very fair. wars on its own soil). of NATO, the rise in living standards in the post-World War II era, free trade and Growing Reliance on Soft Power European scepticism about US military globalisation, America’s technological It has not escaped anyone’s attention action deepened further when it became advances and the Brady Plan, which that President Donald Trump has made clear that Iraq had no weapons of mass laid the foundations for the integration greater use of American soft power than destruction and that General Colin Powell of Emerging Markets (EM) into global

14 www.BondsLoans.com Global Themes financial markets, all contributed to Europeans are sceptical of Trump’s the US legal framework and banking American soft power. North Korean adventure, but Iran is institutions. The likelihood that the EU a far more divisive issue. The Trump conforms with US sanctions in the future On the other hand, the use of soft power Administration’s withdrawal from the is also lower. in pursuit of goals defined from the Iran nuclear deal and the imposition of perspective of narrow US self-interest, or sanctions against companies in third Global Governance Framework in pursuit of objectives seen as contrary countries doing business with Iran has Under Threat to values of the majority of the world, has pushed Europe into a direct challenge The third and largest threat posed been negative for American soft power. to US law. to American soft power comes from the recent withdrawal and/or outright The loss of macroeconomic control in the For the EU, the disagreement over Iran is attacks by the Trump Administration on 1970s with resulting high inflation and not solely about European self-interest. the institutions, which form the pillars a halving of the value of the Dollar, the EU nations strongly believe, with good of the system of global governance. flawed ‘Domino Theor y ’ that ultimately led reason, that the Iran nuclear deal was These institutions, which include NATO, to military defeat in Vietnam, America’s working as intended and that it made WTO, UN, the Human Rights Council, support for South Africa’s Apartheid the world a safer place. The EU believes TPP, NAFTA and the Paris Agreement Regime, CIA sponsorship of coups as Iran is less of a threat to world peace if on climate change, have widespread well as recurring financial bubbles its economy can be integrated into the global support and there are no obvious (Savings & Loans, telecoms, DotCom global economy and views US withdrawal replacements. Across the world, their and Subprime) depleted American from the nuclear agreement as reckless, decline is seen as posing a direct threat soft power. self-serving and counter-productive. to global stability.

Diminishing Returns to Soft In the EU’s eyes, the threat against In addition, there are growing doubts Power European companies doing business with about America’s commitment to sound Today, even as Trump steps up his Iran is therefore particularly offensive, so macroeconomic policy following a reliance on soft power, America’s stock offensive, in fac t, that the EU has issued massive fiscal stimulus at the precise of it is eroding away at the fastest rate a ‘blocking statute’ to shield European point the US achieved full employment. since World War II. Depletion is coming companies involved in legitimate Iranian The unilateral imposition of tariffs on from three specific direc tions. First, the business from US sanctions. Under key US trading partners has upended Trump Administration is applying soft the statute, EU companies can take the decades’ long equilibrium in trade power to targets, where soft power has US banks and businesses to court to policy. These changes may boost US sharply diminished effectiveness, much recover damages arising from adherence economic performance in the short like trying to get blood from a stone. to Trump’s sanctions. term, but they are unambiguously inconsistent with a stable Dollar, thus The recent US sanctions on Iran are In other words, the EU is threatening to threatening the global reserve currency not going to have much of an effect, do to US businesses exactly what the US over the medium to long term. because the more divorced a country is is threatening to do to EU businesses. from US systems, the less effective the The result will be a drop in direct EU-US Despite global concerns about American application of s ystem levers. In the final business and less reliance in Europe on attacks on the global governance equation, countries become practically immune to soft power, when they no longer have any ties with the US at all.

Iran is extremely removed from US system levers after thirty-nine years of US sanctions, including a ban on using US dollars for international transactions. Iran is still alive and kicking. North Korea and Cuba are other examples of countries, whose regimes are still in place despite decades of US sanctions, blockades, interventions and other US measures designed to destabilise them. Where to Apply Soft Power? The second reason why US soft power is waning is that the US government is now applying soft power in areas where America’s long-standing allies clearly believe it is unwelcome. Many

JULY / AUGUST 2018 15 Global Themes

infrastructure, which America itself was so instrumental in establishing, such concerns appear to have little effect on the Trump Administration. Moreover, since the Administration appears to be responding to political considerations emanating entirely from within the US itself, there is very little reason to expect major changes in the near term.

Widespread domestic discontent with the conventional political establishment in the US due to stagnating living standards and rising inequality continues to nurture a political environment in which it is politically expedient to attack establishment institutions in all their manifestations. Trump is responding to this discontent and likely to continue to do so. Short-term Trumps Long-term America now employs soft power in a coercive way in pursuit of narrow short- term national objectives rather than to reassure the likeminded and support the global governance infrastructure. This is a deliberate choice based on a simple political calculation, which says that it is no longer efficient for the US to incur the upfront costs of global leadership.

Rather, by actively divesting the US from its global leadership obligations Trump gives the impression of wielding great power. He sells himself to voters as a man of action, someone who is taking back control, someone with great virility. communism took root in Europe and The risk of war ultimately rises. The Unfortunately, the actions are mainly ultimately led to World War II. Even if list goes on. destructive in nature. He is tearing things such extreme outcomes do not occur, down rather than building anything it seems reasonable to expect less Rivals Appear (apart from the wall with Mexico). predictable international relations, When then French finance minister which will be bad for businesses. Valery Giscard d’Estaing coined the The dismantling of institutions built term ‘exorbitant privilege’ in the 1960s, painstakingly over decades is populism Economic nationalism and growing he undoubtedly did so with a twinge in the classic sense of the word. The discretion in policymaking increases of envy. Other countries have long private short-term benefits, which the risk associated with engaging in wished they could avoid the risk of accrue to Trump, vastly exceed any business with the US. Gains from trade currency crisis by issuing the global short-term costs, but the longer-term evaporate. Global financial flows shrink. reserve currency of choice. implications, which are only negative, The Dollar ultimately becomes less widely only accrue over time and affec t America used and America’s ability to finance China, in particular, is not oblivious to as a whole, not just Trump. its deficit is gradually undermined. the benefits of global hegemon status. China will exploit any vacuum created Costs Harmonisation of legal and regulatory by America’s shrinking leadership role. What are those long-term costs? The systems falls apart. The environment China’s greatest obstacle to assuming list is long and some of the risks are suffers. Rogue states exploit the greater global leadership is lack of credibility. Not impossible to predict. The last time room afforded by divisions among the big only is China a relatively new entrant on America turned in on itself, fascism and powers. Geopolitical tensions increase. the global stage, the country also has a

16 www.BondsLoans.com Global Themes

massive opportunity – European leaders the UK went from the world’s largest have repeatedly failed to act in unison. empire to IMF patient in just 30 years; when a hegemon loses the will to lead, The resulting ‘U’-curve in global leadership things can change very quickly indeed. means that the world is heading into a period, which could last for years, Final Thoughts in which aggregate global leadership America’s shift away from rules towards goes into decline. This period is likely discretion and her willingness to abandon to be characterised by growing rivalry the pillars of global stability is rooted in between the leadership contenders domestic political developments. These until the baton has decisively changed developments demand that America hands. If, as appears to be the case, looks inwards, but introspection is the US leans more on direct attacks inconsistent with global leadership. on individual countries in a bid to US hard power is already constrained demonstrate soft power, such as the and soft power is now depleting rapidly recent attack on Turkey, then noise as well, aided by Trump’s abuse of levels will spike periodically. soft power.

Europe may not be able to lead, but The US withdrawal from global leadership European countries are very open, vastly increases global instability and introduces experienced in the realm of geopolitics hitherto unfamiliar risks associated with and have populations, which broadly direct dealings with the US. Protectionism support global governance institutions. and fiscal irresponsibility pose clear As such, Europe can generally be relied risks to the Dollar’s standing as global upon to exercise boring and slow, but reserve currency over the medium term. sensible leadership and to support Rational countries must therefore constructive global initiatives. now begin to face reality and adjust. Change is scary, but ultimately good, It is in the interest of the world as a because global leadership belongs whole that global leadership changes to countries, which are willing to hands as quickly as possible. Europe set aside their narrow self-interest will undoubtedly play an important part in order to protect the pillars of the in this process as will Japan and the big global governance structure. EM economies. EM central banks will be important supporting actors in a Today, the vast majority of countries in transition, because they are the stewards the world do not share Trump’s vision of of USD8.5trn of FX reserves, which are introversion, populism, protectionism mainly invested in USD denominated and irresponsible fiscal policies. Instead, US Treasury bonds. they strongly favour a continuation of nasty legacy of Maoism, the most militant a rule-based global system, which has version of Communism ever known. The quicker Europe, Japan and large delivered sustainable gains in living EM countries move, the sooner the standards for many decades. Today, China is working to overcome these new geopolitical reality comes about. China, rather than the US, looks the most handicaps by acting in an especially Remember that change can be rapid: likely country to deliver this outcome. mature and rational manner in the face of US aggression, including explicitly supporting the very global institutions from which the US is currently seeking to divest itself. It serves China’s purposes America now employs soft power in a coercive that Trump’s America is doing all it can way in pursuit of narrow short-term national to not lead. objectives rather than to reassure the like-minded and support the global governance infrastructure. The Soft Power ‘U’ Curve This is a deliberate choice based on a simple Due to the rapid pace of erosion of political calculation, which says that it is no longer US soft power and the still formidable efficient for the US to incur the upfront costs of challenges faced by China in gaining credibility as a global leader, it seems global leadership. rational to expect the global stock of soft power to decline for a time. While Europe ought to pick up the slack – a

JULY / AUGUST 2018 17 The Americas AMLO Rising

Markets Cautiously Optimistic after “Tropical Messiah” AMLO’s Mexico Election Landslide

onths of uncertainty finally ended in July as Mexico decisively voted in its new president, Andres Manuel Lopez Obrador M(better known as AMLO), an ageing left-wing icon with populist appeal. With almost four months until the official inauguration, he is trying to woo the markets with a more conciliatory tone. If the currency and bond yields are anything to go by, it appears to have worked, but will it manifest in policy?

Lopez Obrador’s victory in Mexico’s 250 mayoral elections and four out of reassure them that he will maintain presidential election – emphatic as it eight gubernatorial positions, as well regulatory continuity and not introduce was, with the widest margin in decades as achieving a majority in Congress – any drastic measures. – has polarized popular opinion, with no mean feat. widespread disdain for mainstream “The market environment is good, politicians turning him in a sort of “In the past the incoming administrations especially after a year of pain for “tropical messiah” on the one hand, struggled to pass new legislation and Mexican assets,” noted Octavio Calvo, and the fear that his “naughty” public implement reforms,” said Enrique Managing Director, Debt Capital Markets spending and social policies could topple Covarrubias, Director of Economic at Santander. “AMLO is get ting the benefit the economy on the other. Strategy at Actinver. “The PRI lost, but of the doubt, and his popularity gives are recognizing AMLO’s mandate and him a strong mandate.” Two months on from the election, the reacting constructively.” former far outnumber the latter: it is Mexico’s new leader has significantly more vocal, positive and, crucially, The strong mandate and party support toned down the radical rhetoric from politically active. could prove to be game-changing. Some, his pre-election rallies and has made however, are wondering whether this is “With presidential, congressional and too much power for the “radical leftist.” state elections all bundled together, Americas this is the most significant voting period Tightening Belts in Mexico’s history,” a CFO of a large- His party, Morena, has a majority, so passing 18 Markets Cautiously Optimistic after cap Mexican company told Bonds & legislation should be easier, admitted "Tropical Messiah" AMLO's Mexico Loans a few days before the vote. And Alejandro Padilla, Head Strategist for Election Landslide while AMLO’s victory did not come as Fixed income and FX at Banorte. a big surprise, few had anticipated the 23 landslide and, even more impressively, “But he has also been very consolatory, Case Study: Atlas Renewables Prints one of Latin America's First Green the mandate his party – Morena – would and emphasized his commitment to Project Bonds achieve in congress and across the states. fiscal responsibility, which investors are taking to,” the expert noted. 24 Lopez-Obrador garnered 53% of the HSBC's Monica Macia Talks Loan vote, the highest proportion among Indeed, market observers on the ground Market Dynamics in the Americas any of the four most recent presidents. are encouraged by early signs, praising At the federal level, Morena won over AMLO’s phone call with investors to

18 www.BondsLoans.com The Americas

far. “Lower salaries tend to lead to a talent drain,” Calvo admitted. Even AMLO himself conceded that he would bring the base salary even lower, raising concerns around the attractiveness of the public sector. An Eclectic Cabinet While his official inauguration is still months away, Lopez-Obrador is hoping to get a head start, getting involved in and acquainted with government affairs; the threat of wage cuts has not prevented AMLO from informally bringing in a formidable transition team, most of whom are expected to take up senior positions once in office. A few observers pointed out that the incoming president tends to announce the new cabinet a week or two before coming into office, so AMLO is four months ahead of schedule.

According to a senior banker who spoke with Bonds & Loans, the likeliest candidate to take the role of Minister of Finance and Public Credit is Carlos Urzua, a respected career academic with a doctorate in economics. a point of emphasizing commitment in the public sec tor by forcing officials to to fiscal discipline. That included a disclose their assets (Mexico currently He, like many of the picks, can be traced somewhat populist, but nevertheless ranks 135 out of 180 countries in the back to AMLO’s time as governor of praiseworthy decision to take a 60% Corruption Perception Index published Mexico City, where Urzua was the pay-cut for himself and lower salaries for by Transparency International). finance chief. During his time in the government officials across the board. role, Urzua reigned in the spending The proposed measures, predictably, and brought the level of indebtedness This ties in with his broader austerity have been welcomed by the general in real terms from 19% to just 3.3% - a plans, taking away other “perks” from state public, although some have raised feat he would certainly be welcome to officials and fighting to stem corruption concerns about pushing this plan too repeat on the federal level.

AMLO - in His Own Words He also vowed to maintain fiscal discipline, respect the Central Bank’s autonomy and keep the floating exchange rate. What we want is for the budget to reach everybody With current CBM governor Alejandro Díaz de León set to remain in his role until December 2021, the signs are that the fiscal and monetary policies should at the very least remain independent We must make the US see that the most important thing and consistent. is justice and universal fraternity where we can live without walls, poverty, fear, discrimination and racism. “Mexico’s Central Bank remains one of the most stable institutions in the country. They are nonetheless facing a broader global trend of greater mandate More than the use of force, we will deal with the causes for central banks,” noted Covarrubias. from which insecurity and violence originate. ¡am conviced that the most effective and humane way of Finally, Lopez-Obrador’s preferences fighting these ills involves combating inequality and for ex-Mexico mayor Marcelo Ebrard as poverty. Peace and tranquillity are fruits of the justice. new foreign minister, ex-Supreme court judge Olga Sanchez Cordero as new

JULY / AUGUST 2018 19 The Americas

head of Ministry of the Interior, and Rocio EET THE TEA Nahle, a 53-year-old congresswoman ROLE AMLOS CANDIDATE and former chemical engineer, as the new Energy Minister, received for the Graciela Mrquez Coín - academic most part a welcoming reception from Economy Secretary and author with a history pHD investors and observers. from Harvard

Controversial Appointments Carlos Manuel Urza Macías - Others, however, raised some eyebrows Finance Minister ex - finance minister for Mexico City – in particular, those picked to run the government state-owned giants, Pemex and CFE. The former is expected to be run by Norma Rocío Nahle García - a Octavio Romero Oropeza, an agronomist Energy Minister federal deputy for Morena and a and relatively obscure figure with no professional petrochemical engineer background in the energy sector – but a close ally of the president-elect. For Víctor Villalobos - director of the the latter, AMLO has reportedly picked Minister of Agriculture Inter-American Institute for Manuel Bartlett, an 82-year old career Cooperation on Agriculture politician, who in the past espoused views opposing private investment in Esteban Moctezuma Barragn - the electricity sector. former member of the Institutional Revolutionary Party (PRI), served as “As for the Pemex and CFE appointments secretary of the interior and Education Secretary – markets weren’t very happy with them,” secretary of social development; has admitted Yamur Muňoz, Head DCM MA from Cambridge & ECM Origination, Global Banking, HSBC Mexico. “But, whatever happens, Javier Jiménez Espri - ex - Pemex the people below [the ministry heads] Transport & Communications deputy director and a former are technocrats and should maintain Minister university professor stability.”

The worry is that the appointments “When AMLO was mayor of Mexico, he and gas rather than selling crude – but come at a crucial time for the oil and made partnerships with the private how will it be financed?” asked Adrian gas sector, in particular, as Mexico sector, and eventually he will discover Garza, Vice President, Senior Analyst, prepares to auction off a total of 45 he needs to do the same in the new Global Project Finance and Infrastructure onshore conventional and shale block. role,” echoed Muňoz. Group, Moody’s ratings agency. The auction, originally scheduled for September 27, with tenders to pick Respect the Contracts “CFE, the national utility – how will its the partners for Pemex in seven other While for now the future of those projects financial profile evolve? And another areas to be awarded a month later, on is not in doubt – AMLO reaffirmed his key question is about tariffs – in one of October 31. commitment to respect the existing his statements AMLO said “electricity contracts – prospective investors and should be accessible for everyone”. This process has now been postponed partners are getting nervous. In particular, This means subsidies, it seems. The until the incoming administration can one concern is that the new administration mismatch of cost and revenues could review the projects and contracts, though could simply stall the review process either hit companies, like the CFE, or more than 100 contracts have been on deals that are expected to attract weigh on the federal budget. They awarded to private and foreign firms since over USD160bn worth of investment might also charge industrial consumers 2013, when the industry overhaul was in the coming decade. and higher-income homes more – it first initiated by the current president remains to be seen what their plan will Pena Nieto. And with ambitious plans on energy be,” Garza mused. laid out by Lopez-Obrador after the “I get the sense that the new government election, which include state investments Step-in Rights and Regulatory is facing a trade-off: on the one hand, equivalent to USD16.5bn to boost Obstacles they need to have the public finances, so exploration and modernize six existing With significant infrastructure and energy they need investors and foreign capital refineries, along with building t wo new projects in the works, ensuring a sound inflows. But the oil sec tor in Mexico is ver y ones, it is not clear where that money legal environment is key to ensuring unique: Mexicans feel very nationalistic will come from. a continued inflow of capital. While about it. Perhaps it will push Pemex to the Mexican jurisdiction (especially become more efficient and streamlined,” “On energy, they announced two new in terms of banking regulations) is commented Covarrubias. refineries, which will help to process oil seen by many as exemplary, there

20 www.BondsLoans.com The Americas remain some blind spots, particularly Thus, foreclosure over other contractual on the project. Maybe by February 2019 in energy and infrastructure sectors, rights, such as typical step-in rights, we will know its fate,” Garza said. and project finance. is generally disallowed.” NAFTAlk, More Action According to one oil executive who spoke In the context of AMLO’s grandiose Finally, the re-negotiation of the North to Bonds & Loans, there is willingness infrastructure development plans American Free Trade Agreement (NAFTA) in the sector to tap the debt capital – including a much-touted rail link between Mexico, Canada and the markets for exploration projects, but across the Isthmus of Tehuantepec, US is in full swing, and its outcome there are obstacles. the country’s skinniest strip of land, would dictate the international trade where the Atlantic and Pacific are just and foreign relations landscape the “There is currently no market for funding 200km apart – ironing out these issues incoming administration will have to “reserves” – that is, greenfield projects or letting them linger could have crucial navigate for years to come. With that where there is no existing infrastructure. ramifications on the government’s ability in mind, Lopez-Obrador is taking a Regulatory constraints are preventing to fund these initiatives. hands-on approach and has already banks from lending to such ventures sent his own envoy - Jesus Seade – to – even as some are more than willing The future of existing projects could accompany Pena Nieto’s team. to do so,” the source lamented. also hang in doubt. GACM, the group behind Mexico City’s new airport, has Experts who spoke to Bonds & Loans The main roadblock is the absence of been criticized by Lopez-Obrador in expect AMLO and his team to continue the step-in rights in cases where operators are the past for mismanaging the project’s negotiations in line with his predecessor. not delivering on the contracts. According finances. The vehicle has been a prolific to a publication by the Dentons López issuer of debt and various types of “The transition team from AMLO is getting Velarde law firm, generally Mexican law securities, including green bonds; at involved in the tri-lateral negotiations, allows the creation of security interests least according to sources close to so most of the uncertainty actually over almost all kinds of assets and rights these deals, the new administration comes from the US side. There is broad held by project companies, such as would struggle to scrap the project, consensus among the different political contractual rights or concessions. which is already 29% completed and sides in Mexico on the terms the country has many foreigners invested in it. needs to achieve in the negotiations, There are exceptions to this general rule, Other observers are less optimistic. and AMLO’s party has a majority in however. “Contractual rights stemming Congress, so they’ll likely find it fairly from contracts governed by Mexico’s “The airport was a key campaign topic easy to garner its support,” noted Garza. government procurement laws – most for AMLO – he went from promising contracts with government entities to scrap it altogether, to considering Up to 60% of the deal is already secured, and agencies, other than Pemex and concessions on the project. Now they according to Calvo. But some key sticking CFE, are limited on the type of security are talking about a public consultation, points remain – including the sunset interests that may be granted, as only so the people can make the final call. And clause, rules of origin and supply account receivables may be assigned. they’ve hired some technical advisors chain issues (mostly concerning the

Meican pesoUS dollar echange rate MN per USD 18

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'18 Feb. Mar. Apr. May. Jun. Jul. Aug. Source: XE.COM JULY / AUGUST 2018 21 The Americas

car manufacturing sector), as well as Muňoz speculated that both of increasing welfare and improving discussions over the US-Mexico border. administrations will be keen to to close wealth distribution in one of the most the deal sooner rather than later. unequal economies in the world. The big Ironically, by being a political polar question is how to fund those initiatives: opposite of Trump, AMLO may actually “Trump needs to have a big “win” ahead through the private sector (if he can become an ally on the border wall issue. of the midterms; besides, farmers in convince investors) or with more debt In the run-up to the election he often the Midwest have been suffering due issuance (if conditions remain stable), bemoaned the continued outflow to slowdown in expor t flows. Mexico, or maybe a mixture of both. of human capital from Mexico via its meanwhile, has become more flexible on northern border. the rules of origin issue, as a compromise.” But, more importantly, his strong mandate represents something that As Covarrubias noted, making concessions Looking beyond NAFTA and oil field has perhaps been missing from Mexican would still be better than scrapping auctions, Lopez-Obrador will be politics for a while – an inspirational NAFTA altogether. And a “worse” deal inheriting a country that, despite figurehead whose transformative vision could put further pressure on Mexico’s all the obstacles and downfalls, has could really help push the country’s productivity, so it will be up to the new made a lot of progress over the past development to a new level. Perhaps government to tackle that through decade, achieving unprecedented that, above all else, should encourage improving education, professional macroeconomic stability, with falling Mexico’s citizens to “look on the bright training and infrastructure development. inflation and interest rates at record side of life.” lows, and rising per capita income. “Maybe he will help Trump build a symbolic “Border Wall” – by creating As the majority of analysts and better conditions for Mexican workers economists who spoke to Bonds & Loans back home, disincentivizing emigration,” agreed, there is nothing intrinsically he mused. dangerous about AMLO’s social ideas

22 www.BondsLoans.com The Americas Case Study: Atlas Renewables Prints One of Latin America’s First Green Project Bonds The unique A/B private placement structure was a rarity in the capital markets in light of its inclusion of both senior and subordinated tranches. It’s also the third green project bond issued out of Latin America.

Background Deal At A Glance

Atlas Renewable Energy is a Latin American renewable Deal Type: Private Placement Green Project energy generation company founded in 2017 and owned by Bond/Loan Actis LLP, a UK private equity fund manager. The company is one of the first platforms in Actis Energy 4 fund and Deal Structure: Senior and Subordinated B has a current portfolio of renewable energy projects Bond with A Loan (A/B Structure) producing 800MW of power. Borrower: Atlas Renewables

El Naranjal (58.8MWp) and Del Litoral (17.0MWp) are two Offtaker:The National Administration of solar energy Projects that have been operational since Power Plants and Electrical Transmissions September and June 2017, respectively. The company (UTE) sought fresh funding to repay outstanding loans linked Deal Size: USD108.4mn to their construction. Signing Date: 20 June 2018 Transaction Breakdown The deal was arranged as an A/B structure and is unique Tenor: Senior A Loan: 2042; Subordinated for its inclusion of a senior and a subordinated note. A Loan: 2033; Senior B Bond: June 2042; Subordinated B Bond: June 2033; IDB-Invest was the lender of record, with its preferred Coupon: Senior Tranche: high 500s; creditor statues benefitting investors with privileges and Subordinated Tranche: undisclosed immunities, including protection against convertibility and/or transferability restrictions. The structure also Issue Rating: Senior Tranche: Baa3/Stable allowed IDB Invest to ringfence the deal with its strong (Investment Grade); credit rating. Subordinated Tranche: Ba2/Stable (Moody’s) The underlying assets enjoy rich and stable cashflows under a 30-year fixed power purchasing agreement (indexed Green Bond Rating: GB1 (Moody’s) to US PPI) with Uruguay’s National Administration of Power Plants and Electrical Transmissions (UTE), which Governing Law: New York Law has approximately 25.5 years remaining. Location: Uruguay

Total financing across the A/B transaction is USD114.4mn, Organizers/ Bookrunners: DNB Markets, split between a USD6mn A tranche – which itself was equally Inc. Inter-American Investment Corporation split between senior and subordinated tranches – and (IDB-Invest) a USD108.4mn B tranche, split between a USD97.5mn senior B bond and a USD10.9mn subordinated B bond. Placement Agent: DNB Markets The B bond amortises semi-annually to zero. Legal Adviser to Bookrunners: Allen & Overy Total tenor and average life for the senior tranche was 24 years and 15.3 years, respectively, and for the subordinated Legal Adviser to Issuer: White & Case tranche, 15 years and 9.4 years, respectively. Use of Proceeds: Refinance construction of El Naranjal (58.8MWp) and Del Litoral (17.0MWp) solar plants

JULY / AUGUST 2018 23 The Americas The Loan Syndicator

HSBC’s Monica Macia Talks Loan Market Dynamics in the Americas With an election almost every couple of months in the Americas, it seems 2018 is shaping up to be one of the most politically volatile periods the region has seen in over a decade. Coupled with the increasing de-synchronisation of regional growth and rising prevalence of macroeconomic and political factors globally, how borrowers satisfy their funding requirements through the remainder of the year is coming sharply into focus. We speak with Monica Macia, Head of Loan Syndications, Americas at HSBC about how the loan market is evolving in line with the shifting dynamics on the ground in the Americas.

Q Bonds & Loans: The macro key clients with outstanding dollar debt general, we have seen more syndications environment we found ourselves in and revenues denominated in pesos this year. through much of the first half of this took the opportunity to borrow in pesos year seems quite different from what in order to repay that hard currency Regarding the flattening of the yield we saw during the same period in debt; others sought funding for CAPEX curve, the loan market tenors are typically 2017. How have the loan volumes in expansion. shorter than what you would find in the Americas performed against that the bond market, so we haven’t seen a changing backdrop? In some countries, particularly those significant material impac t in the loan prioritising large infrastructure projects, market. One of the main exceptions A Monica Macia: If we compare the we haven’t seen the volumes we had is for investment-grade borrowers or first half of the year to the same period expected – places like Mexico, Peru, infrastructure-related borrowing. The last year, syndicated loan volumes haves Argentina, and Colombia for instance. sweet spot for banks is three to five already outpaced those seen during But we suspect that this has more to do years, and in the infrastructure space 2017 and we are on track to see greater with election uncertainty. That said, we we are seeing dedicated players going full-year volumes in 2018. These are think the passage of key elections in these longer, but there hasn’t really been some of the highest loan volumes since countries should begin to reactivate much feedback of the flattening yield 2007. One of the standout transactions the project-centred lending pipeline. curve into loan pricing. of the year – the credit facility used by pulp and paper leader Suzano to Q Bonds & Loans: Are we just seeing Q Bonds & Loans: To what extent are partially finance its acquisition of Fibria – a rise in bilateral / club deals or have we seeing new stakeholders enter certainly helped push this year’s volumes we seen more true syndications? syndications on loans originating higher. But even excluding the Suzano And related to that, are we seeing a from the Americas? And if there are, transaction, we have seen substantial flattening US treasury curve creating what do you see as the main drivers loan volumes. opportunities for longer-term finance bringing new lenders into the region? in the loan markets? One of the key drivers is the prevalence A Monica Macia: The stakeholders of elections in several Latin American A Monica Macia: True syndication are largely the same, though we have countries. Mexico’s July elections clearly activity has definitely increased – we’ve seen more appetite from Asian and had an impact on first-half volumes. seen more syndications than club European lenders, many of which may Many of our clients in Mexico, which deals, either because of the size of have previously existed the market for accounts for a substantial share of the the transactions or because clients’ one reason or another and are coming region’s volumes, were preparing to preference leans towards dealing with back in a strong way. We have seen a prefund 2019 and 2020 maturities one or two institutions rather than number of banks opening offices in and looking to get ahead of potential five or six. That’s not to say we aren’t Colombia and Peru that haven’t been volatility, while also taking advantage of seeing any club deals – this format active in the market for many years, the relatively abundant bank liquidity remains attractive, particularly for but they aren’t new in a true sense, and attractive terms. A number of our investment-grade clients – but in they are simply becoming more active.

24 www.BondsLoans.com The Americas

There are some exceptions. In Mexico, we have seen Politics has weighed on the region but in different ways. new players enter the local currency bank funding space, In Mexico, for instance, we saw issuers take advantage particularly from Asia and Canada; they are looking to expand of liquidity in the bank market as we discussed earlier. In their local currency funding capacity to take advantage of Colombia, it was a more of a wait-and-see mode; similarly rising demand. We have also seen growing participation with Brazil, as we approach the October elections. I think from insurers, which – due to recent regulatory changes banks and companies are used to the volatility in the region – are now able to facilitate more primary market activity. in general – we know what to look out for, and they know That’s an interesting trend to look out for in Mexico and what to look out for. But as long as the structure is robust, we perhaps elsewhere: Insurers have for years minimised their will always find ways of remaining ac tive in these countries participation in the loan markets on the perception that and supporting our clients on the ground. pricing levels and relative liquidity were unattractive. But that’s changing, and it’s encouraging to see more insurers Q Bonds & Loans: In the bond world, rising interest rates coming to the table. and a strengthening dollar have caused EM investors lots of headaches in recent months – and some have Q Bonds & Loans: We have seen a rise in A/B structures suggested that volatility may lead to increased borrower in recent years, which have helped new borrowers gain preference for the loan markets. To what extent is the traction with new pools of lenders. Are these likely to loan market a way for borrowers to insulate themselves remain attractive for new borrowers – and lenders? Are from that kind of volatility? there other structures becoming more prominent which you believe might benefit certain borrowers in specific A Monica Macia: It’s a good question. In the bond world, sectors in much the same way? markets open and close in the blink of an eye and you have this rapid oscillation in pricing, which is also influenced by A Monica Macia: We will definitely keep seeing A/B broader sentiment around emerging markets. The loan structures, particularly in countries that don’t have the markets are obviously less reactive to what’s going on in same depth of banking liquidity seen in some of the region’s other parts of the emerging market landscape, and have largest countries – so you may not see them in places like slightly different pricing drivers. And as I mentioned, bank s Mexico and Colombia, but you will definitely see them that are present and active in these countries will likely becoming more prominent in non-IG countries and/or remain so. some of the Central American countries. In some cases, you have seen that volatility in rates feed The benefit of A/B structures of course is that the borrower back into pricing, which is interesting. On the other hand, secures the advantage of multilateral participation with I do expect that some borrowers – particularly those that the A portion, while the lenders benefit from the credit want to wait for better rates in the bond markets – may look rating halo and preferential treatment. We have seen a to access to loan markets for three- to five-year money. number of interesting structures based loosely on the A/B I think we will see some shifts, but the scale will largely format that rejig the nature of preferential treatment and depend on how extensive and prolonged the current guarantees in a such a way that bring in new institutional volatility weighing on emerging markets will be. investors and lenders alongside multilaterals in addition to combining loans and bonds, which I suspect will play a growing role in some of the countries mentioned earlier.

Q Bonds & Loans: That brings us to the elephant in the room – politics. It seems 2018 is shaping up to be one of the most politically volatile periods in the Americas in many years, made more challenging because certain economies are on unsteady economic footing. How do you see these trends affecting borrowers in the markets you cover? Is it a tougher market for borrowers?

A Monica Macia: Indeed, it is shaping up to be a very interesting year. Last year, many borrowers would have found that most of the markets were open for them, but right now that’s simply not the case. It’s important to draw the distinction between the capital markets and the loan markets. While some borrowers may struggle to tap into slightly choppier or relatively more expensive global capital markets, local and international banks are active and present in these markets – and that isn’t going to change. Bank liquidity is still healthy and we are still seeing strong competition for transactions in the region.

JULY / AUGUST 2018 25 Africa East African Credit Idiosyncratic Challenges Weighing on East Africa’s Local Bond Markets Growth

ince the turn of the century, two trends have notoriously characterised African economies: world-beating rates of growth and mounting Sforeign debt. East Africa has been at the forefront of this growth spurt, much of which came from the vast volumes of cheap dollar funding streaming to EMs from the low-yield environment in Western economies post-2008.

But as the global EM sentiment turns that has reached USD170bn annually out investor appetite from the corporate sour and investors abandon riskier according to the AfDB, African countries space. Among the challenges facing the regions, those high levels of dollar are now coming under pressure to region’s companies looking to come to credit are becoming unsustainable, and seek alternative sources of funding, market are the strict requirements on fostering growth of local debt markets with the domestic bond markets collateral and data reporting, which some is becoming increasingly urgent. looking a likely candidate for the most of the SMEs simply don’t have the resource buoyant economies, such as Kenya, and to comply with. These, incidentally, are As a recent report by Renaissance (admittedly to a lesser extent) Tanzania, also issues facing the buyside. Capital indicates, 2018 saw a significant Uganda and Ethiopia. repricing of African Eurobonds despite “For lenders, legacy challenges for due the fundamentals remaining largely Similarities and Differences diligence and KYC, together with tough unchanged – sometime even improving Looking at the local issuance in the unit economics to get adequate ROI in incrementally – for many of these countries. region, the bond market is heavily low income regions have seen services dominated by the sovereign – around concentrate in lower risk segments of “The 2018 re-pricing has occurred despite 90% of all local issues come from the market,” noted Wayne Hennessy- 14 of the 20 African Eurobond issuers government entities. Barrett, CEO of 4G Capital. being forecast (by the IMF) to grow faster in 2018 than the previous year (when “The governments either issue a new Eurobond spreads tightened). 13 issuers bond or re-opens an already issued one Africa are expected to see their current account every month,” commented Edwin Chui, balance improve, and 17 are forecast Senior Fixed Income Analyst at Dyer & 26 to have single-digit inflation in 2018.” Blair. “These bonds are generally either Idiosyncratic Challenges Weighing for general budgetary support or for on East Africa's Local Currency Bond This, along with a mixed performance specific infrastructure projects, in which Markets Growth on keeping a lid on fiscal deficits, has case they are both amortized and tax 31 put further pressure on debt ratios, exempt. These two features make them Eskom is running out of options - and so according to the researchers, and is quite attractive to foreign investors.” is the government bringing back simmering concerns about debt sustainability. This dominance of the sovereign is to 34 some extent “a little unhealthy”, noted Kenya Pooled Water Fund CEO: The With a wall of maturities coming up in John Lentaigne, Chief Underwriting Water, Sanitation Sector is Ready for Green Bonds 2022-2025, and an infrastructure gap Officer at the ATI Agency, as it crowds

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Aside from concerns about liquidity, foreign and more risk-amenable investors struggle to find sufficient yields. The Kenyan Central Bank’s interest rate cap on commercial bank lending, introduced in 2016, is partially to blame, and it also exacerbates the crowding out of the private sector players in domestic debt.

“With the exception of the infrastructure bond, a Kenyan bond becomes compelling at yields north of 16%, both on short and long ends; at that stage the curve flattens and finally inverts because the long end gets swallowed up by the pension funds.” From Uganda to Ethiopia Uganda, another “up-and-coming” market, has recently made some initial moves to open up the government securities market: the Ugandan Central Bank ruled to open the primary markets for all commercial banks, meaning that there will be more scope for small and large investors to participate; previously, only a select few “Primary Dealers” were licenced. This will also help stoke secondary market activity, With lack of investor appetite for corporate given the pace of reform at the moment. regulators hope. paper, companies have to look for other Tanzania – which should naturally be funding sources, such as term loans, one of the largest regional markets – Other obstacles remain. As in Kenya, which tend to be benchmarked off the has proven to be a tougher market to most of the longer-dated paper is traded sovereign yield curve. crack for foreign lenders and this may in almost exclusively by local pension turn restrict liquidity to some degree.” funds, allowing little room for carry- But while there are some qualities that trade investors. East African capital markets have in Dissecting East African Credits common – such as the heavy presence Looking more closely at the region, the “That’s one policy the government will of government issuers, lack of regulatory differences that emerge are both “legacies” need to rethink. They need to deepen frameworks and little access to long-term of the countries’ respective development capital markets and the best way to financing – it is increasingly important trajec tories and of the different stages do it is to enable investors to make for investors to differentiate between of development they find themselves in. t wo-way bet s in fixed-income market s,” various regional credits, and to address Based on the sheer size of the economy, Qureishi suggested. some of the idiosyncratic challenges Kenya is the most prominent market facing these markets. in the region, agreed Jibran Qureishi, He also pointed to the “perennial Regional Economist for East Africa at bug” of the 20% withholding tax on “We think it’s important to distinguish Stanbic Bank, albeit not necessarily the the bonds in Uganda, which means between the different countries rather most attractive one – depending on the anyone willing to buy them has to pay a than treating the region as homogenous,” type of investor one asks. premium, which, along with the 14.5% explained Lentaigne. The Kenyan market short end of the curve and a volatile FX for example is deeper and more liquid “Kenya has some limitations: following rate, erodes much of the carry. than most other East African regional the currency drops in 2011-12 the Central markets, although the interest rate cap is Bank came up with a policy that meant By contrast to Kenya and Uganda, Tanzania a challenge, which naturally encourages foreigners cannot hold bonds for less than is yet to liberalize its fixed-income market a flight to quality. 1 year, meaning that foreign capital couldn’t fully: along with Ethiopia, that is to an really be directed to short-term T-bills,” extent the legacy of their socialist-leaning “Ethiopia could be a significant market he noted. “In both Kenya and Uganda, roots. The market is largely closed to should banking reform come into play, longer-duration securities (above 10 years) foreign investors and even though regional which – although historically not on are mostly traded by pension funds, and investors are allowed to buy their bonds, the agenda – shouldn’t be ruled out, most are actually held to maturity.” there are restrictions.

JULY / AUGUST 2018 27 Africa

“EAC members cannot buy anything Group’s Mauritius subsidiary. And the Some of this distrust stems from recent less than 1-year long, and a certain Tanzania Mortgage Refinance Company challenges. A number of commentators jurisdiction cannot hold more than last month placed a TZS12.5bn bond have pointed to the cases of two Kenyan 40% of certain type of paper. These on the stock exchange, the first tranche banks, Chase Bank and Imperial Bank, limitations prevent the opening of a 5-year TZS120bn corporate bond which for different reasons were placed and growth of these markets,” the programme by the TMRC. under receivership of the Central Bank, economist said. in addition to a missed corporate bond “Tanzania and Ethiopia still tend to have payment by ARM Cement. Overall, around While it is still very much a nascent these socialist leanings, which stifle the KES12bn worth of bonds issued by the market, Ethiopia has seen some development of capital markets. I have aforementioned banks, and the privately progress in this space recently. An my reservations about being excited placed commercial paper of another apparent détente with Eritrea after about Tanzania for now. But the latter bank, Nakumatt, have been written years of simmering border conflict is is now turning into a positive story, off. These cases left a bit of a scar on a huge step for the country and ought with some reforms and liberalization, the market, conceded Qureishi. to help it attract new capital. There on the economic and political side, are already reports that Safaricom’s which will hopefully trickle down into Notably, Imperial bank’s KES2bn 5-year M-pesa microfinancing initiative the financial markets and help open notes were offering a lucrative yield of could hop across the border from up the banking sector. That could lead 15% to investors, for example, many of the neighbouring Kenya, where it to deeper capital markets reforms in whom were local insurance and pension has been wildly successful. the long run,” commented Qureishi. funds. Some were able to rescue their capital, thanks to a partial Central Bank Ethiopia’s local market activity is Matter of Trust guarantee, but the bulk of the debt was encouraging. The sovereign sold writ ten off and remains a bone of contention USD56mn worth of so-called diaspora Many of the difficulties that East African between various bondholders. bonds to finance a 6,450 megawatts economies are encountering can be dam being built on the Nile, the latest bundled under the umbrella of country One of the major causes of uncertainty in a series of issuances bought by the risk – the lack of confidence and trust is the fact that unlike in most markets, country’s population. The finance needs among investors, who are becoming Kenya’s domestic bonds are not for the dam, named Grand Ethiopian more bearish on high-yield instruments protected, with only partial coverage Renaissance Dam (GERD), are estimated as EM assets come under pressure. from the Investor Compensation Fund, to reach USD4.7bn and will be sourced This has intensified the flight to quality. resulting in low uptake. entirely from the domestic market. “While there is a fairly robust local debt “Indeed, we have seen cases of investors Meanwhile, there is also some activity market in commercial paper and local showing reluctance to move forward on on Tanzania’s local markets. Earlier this bonds where locally originated capital debt instruments without some form of month Swala Oil and Gas applied to can be put to use effectively, it remains guarantee or insurance wrapper, which list a USD50mn corporate bond (with hampered by perceptions of ‘African can make debt a lot more expensive, Greenshoe rights) on the Dar es Salaam risk’ and volatility arising from political and consequently places greater stress Stock Exchange, with funds to be used instability or growing national debt,” on the enterprise investee trying to on acquiring 40% of Orca Exploration admitted Hennessy-Barrett. service that same debt,” Hennessy- Barrett recalled.

He stopped short of calling for the government to provide guarantees, however, pointing out that underwriting or guaranteeing private investments can be complex and could potentially lead to risk appetite imbalance “if people feel they'll get paid whatever the outcome”.

Qureishi also believes government guarantees are a dangerous path: “There’s only so much they can vouch for – it then becomes a moral hazard, and a tax payer issue.” Instead, as both commentators agreed, the industry will be better served if the state created an enabling environment and oversaw fair enforcement of existing regulations and frameworks.

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Going forward, certain tweaks could Regional economic growth in Africa improve the sentiment around the local instruments. The Capital Markets al DP o Authority in Kenya is reportedly looking 2016 2017 (estimated) 2018 (projected) 2019 (projected) at ways to amend the bankruptcy laws to exempt the settlement of 7 securities from the provision of the 6 Insolvency Act, for instance, thus ensuring settlement conclusiveness. 5 4 With the government retrenching from the issuance pipeline, East African local 3 bond market participants will have 2 to seek private sector alternatives – from investment insurance and 1 instruments that entitle tax breaks, 0 to DFIs, multilaterals and microfinance. Central Africa East Africa North Africa Southem Africa West Africa Africa

Investment insurance is increasingly becoming a major way in which lenders Source: AFDB statistics. mitigate credit risk. Under the Basel regulations lenders can substitute the Nigeria, for example, has sought to use “The major foreign investors that we rating of the insurer for the counterparty international debt capital markets for see are regional and international and this provides both counterparty some of its infrastructure funding needs. banks, with regional African banks relief and improved capital metrics. It issued a NGN100bn sukuk in 2017 increasingly active, and some EM funds,” that was specifically tied to a number of noted Lentaigne. “There’s definitely “This lowers the bank’s capital charges projects. The government also refinanced scope for innovative ways to try and and can therefore lower the cost of some of its domestic debt with a new crowd in the big pools of capital that debt and related investments for infrastructure-linked Eurobond. wouldn’t otherwise consider sub- regional counterparts, or simply investment grade risk, for example allow the lender to lend when they Tanzania’s government, in turn, is the provision of explicit credit wraps. otherwise couldn’t,” Lentaigne said, implementing a series of large-scale An interesting and potentially healthy adding that the credit default swap infrastructure projects, including development is the increasing talk market, which previously played a key a 2,500km standard gauge railway of PPP, possibly driven by sovereign role, has shrunk in recent years and network stretching from the Dar Es borrowing constraints; we think that lacks significant depth and liquidity Salaam port in the East to the Stiegler’s a significant amount of infrastructure in East Africa. Gorge hydropower plant in the West, all could be funded in this way.” of which could cost the country as much A deeper engagement with the private as USD14bn over a five-year period. Senegal has moved down this path sector is already beginning to take quite successfully. The West African shape on a policy level in Kenya. Earlier With bank credit running thin due to nation worked to restructure its this summer, the Treasury met with high levels of NPLs in recent years, the commercial laws and implement a PPP insurers and fund managers after it government looks to tap large multilateral clause that ensured the transparency signalled plans to issue debt through banks and DFIs, like AfDB. The AfDB of tenders and contracts in the oil private placement. The policymakers recently launched a new investment and gas sector, with an allocated hope the move will help to diversify initiative to help foster financial markets department created in the government their portfolios and improve the and institutions in Africa; it has set up a to maintain investor relations. risk-return trade-off by providing local currency bond fund (the African additional yield. Local Currency Bond Fund) that seeks Kenya, too, is taking steps to encourage to raise USD100mn in the first closing more private participation, with a Infrastructure Boost and PPPs and USD200mn in the second. number of local pension managers One of the big drivers for developing putting together a fund that would pool innovative capital markets solutions Sovereigns in the region already borrow resources and allow joint investment in East Africa is likely to be the need from multilaterals and DFIs, but the in capital-intensive infrastructure to fill the region’s infrastructure gap. same funding pools for corporates are projects. According to Bloomberg, the Kenya, Tanzania and the rest could look still limited by risk-averse investors, consortium is about to close a non- to their Western and South African who lament the lack of transparency, binding agreement with a number of neighbours for some ideas about how especially among East African companies. US pension funds who are “very keen” to alleviate some of the problems For corporates, PPP projects could offer to invest jointly with the Kenyan funds. associated with debt financing. another solution.

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Regional economic growth in East Africa

al DP o 2016 2017 (estimated) 2018 (projected) 2019 (projected) 10

5

0

-5

-10

-15 East Africa Burundi Comoros Djibouti Eritrea Ethiopia Kenya Rwanda Seychelles Sudan South Sudan Tanzania Uganda Somalia

Source: AFDB statistics.

Fintech and disruptive financial expanding into others, the prospects empowering commercial banks to price innovations could provide solutions for microfinance in the local debt space risk again, portfolio investors worry on a continent unburdened by “legacy” are looking bright. that banks lending will go to credit risk banking systems and with vast chunks and less towards sovereign debt. But of unbanked populations. Regulatory Steps I expect there to be a bit of a lag, the To ensure that local issuers have access to taps won’t open immediately. And if “Recently the market has seen a number the market – and cross-border investors the government follows through with of unsecured fintech lenders at tempt to show interest – these economies still its fiscal consolidation promise, which deliver scalable consumer credit through need to show improvements on the includes a lower domestic borrowing smartphone apps, but often with alarmingly regulatory and policy side. target, then of course that could soften low collec tions rates for first time loans, the impact of rising yields.” and a lot of re-financing of customers in One obvious case is for Kenya to allow arrears,” Hennessy-Barrett noted. “This Over The Counter (OTC) trading for local According to the economist, the key landscape needs to be set against a bonds, which ought to make the market driver for interest rates in Kenya is the huge and growing informal market more fluid and encourage secondary FX rate, so, given the currency remains and an almost limitless demand for trade. Another is the scrapping of the stable, interest rates to are unlikely to working capital credit, but a limited interest rate cap in Kenya – something shoot up when the cap is repealed. set of options to deliver that credit the IMF has long insisted on, and, judging sustainably to the benefit of all par ties.” by reports in the local press, is not “If anything, it will be gradual and will too far off. depend on two factors: how quickly Hennessy-Barrett’s organization, 4G banks start lending and the FX rate Capital, operates in this space by delivering “The interest rate capping law and dynamic.” working capital to MSMEs blended with high twin deficits have in a sense led bespoke business skills training. to a crowding out effect of private Chui, in turn, sees the regulatory sector players by the government in landscape as “a matter of philosophy”, “The approach has seen average the domestic debt market. One has to but indicates that some rules, such as collections rates of 94% with no client hope that once the caps are repealed the tenor of state debt that qualifies refinancing , 82% repeat business and and if fiscal consolidation will materialize for liquidity assessment, need to be a net promoter score of 72, according then corporate issuance can grow,” reviewed in order to facilitate the uptake to customer surveys. Clients grow Chui summarized. of long-term capital by private entities their revenues by an average 82% by from banks. partnering with 4G Capital,” he added. Qureishi, however, warned that it is not a be-all end-all solution, and the “As for the pension funds investment With the likes of 4G Capital, MyBucks effec t s of this reform would be gradual. activity, it is more a behavioural or and Safaricom’s M-Pesa – which has tactical issue than regulatory in that I around 20 million active users – “Once a repeal comes through, which would want to see local pension funds gaining influence in this market and will be positive for the banking sector, become less of market followers.”

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Power Outage Eskom is Running Out of Options – and so is the Government

skom, South Africa’s scandal-plagued state-owned The most recent financial results from February this year power utility, has embarked on an ambitious overhaul paint a bleak picture of a cash-strapped, inefficient power Eof its balance sheet, governance structure and utility that could slip further into the red. Sales revenue approach to the markets as it looks to overcome allegations declined 2% to ZAR95.5bn, while net cash generated from of corruption and mismanagement. Analysts are split on operations declined by 30% to ZAR22bn. Net financing whether it will be enough. costs increased by a whopping 53% to ZAR10bn, and net profit af ter tax declined 34% to Z AR6.3tn. Allegations against the company, ranging from the former CEO’s and CFO’s close financial links to the notoriously The firm, which is by its own admission not financially shady Gupta brothers, purported receipt of kickbacks for sustainable, has struggled to bolster the revenue side hiring Chinese contractors in exchange for cheap loans, to of its balance sheet. Delayed revenue clawbacks via the accusations of inflated office chair procurement contracts, regulatory clearing account (RCA), a mechanism designed to have mired Eskom in scandal since 2015. Combined with reconcile projected and actual costs, lower than expected its weak financial position and declining revenues, the electricity pricing, and rising municipal government debt outlook is not particularly positive, prompting Finance – with key cities increasingly unable to pick up the tab for Minister Malusi Gigaba to brand the firm the “big gest risk ” their power consumption – have all conspired to harm the to South Africa’s economy. company’s balance sheet.

It is also suffering from a liquidity crunch, with the company unable to raise more than a quarter of its budgeted borrowing over the past year – due primarily to governance issues. The There would be no currency, and no liquidity shortage and deteriorating financials prompted economy for the country if Eskom went Moody’s to downgrade the company’s long-term corporate belly up,” Gigaba said earlier this year. family rating from B1 to B2 at the end of March, take negative action on its GMTN programme and unsecured bonds, and raise its default probability to B3-PD, from B1-PD.

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Between a Rock and a Hard Place levels and will, in any event, continue to weigh on its very The impending crisis was neither lost on the government weak financial metrics.” nor Eskom, which generates 95% of the electricity used in South Africa and is the country’s single largest employer. In Nersa has since given its permission for Eskom to raise January this year the government oversaw the beginning of a prices by 5.2% in April, about a quarter of the increase top-down strategic turnaround at the utility, which included the utility was looking for – and once adjusted for inflation the appointment of Phakamani Hadebe as CEO and Jabu (4.5% in April) is essentially flat in real terms. Mabuza as Chairman, in addition to a range of new board members, and led to the exit of embattled CEO Matshela To say the situation is delicate would be an understatement, Koko and CFO Anoj Singh among other top executives. but it is by no means unnavigable. Eskom has financing requirements of roughly ZAR70bn for the 2018/19 financial Moody’s looked positively on the company’s bid to improve year, including a ZAR20bn short-term club loan with a syndicate governance and trust – but it also conceded that more of lenders that analysts suggests will likely need to be rolled needs to be done to stave off a full-blown crisis. over when it comes due later this year. It faces about ZAR62bn in principal repayments over the next five years. “Conditions at the company nonetheless remain challenging. In the State Budget, the government noted that, despite About ZAR200bn of its overall debt comes with state addressing the immediate concerns highlighted above, the guarantees, which is a significant risk for the sovereign, while financial position of Eskom posed a risk to the economy ZAR80bn of that same stock is owned by Public Investment and the fiscus. This reflected the lack of tariff increases Corporation, the state-owned asset manager and pension in the face of flat demand and the need for a reduc tion in fund investor, a significant risk for the countr y ’s citizens. operating costs and a change in the company's business model, potentially involving private sector participation. Making matters more challenging, as this issue goes to press, However, the Budget did not provide for any tangible financial Eskom was locked in a battle with the National Union of support, as the government has demonstrated on prior Mineworkers (NUM) and the National Union of Metalworkers occasions when the company has been under stress,” the of South Africa (Numsa) over wage increases, which the rating agency said in a report earlier this year. utility – given its balance-sheet position – is reluctant to give. Analysts believe the utility and the unions are likely to “Eskom's challenges are complex and not easy to resolve. arrive at some sort of agreement that includes some wage They include stagnant demand, potentially driving declining increases, possibly as high as 6.25-7% per year over the output from its coal, fired generation plants as renewables next three years according to recent proposals, but at a output increases and a large committed investment cost. It recently offered union members a one-off payment programme. The regulator, [National Energy Regulator of ZAR10,000 each in a bid to stem demands for greater of South Africa (Nersa)], have announced that they will bonus contributions. A senior manager at the firm recently consider Eskom's ZAR66bn application for under-recoveries conceded that it plans to shed around 7,000 jobs over the and overspending relating to the three prior years, which next five years, further straining an already tense negotiation. would benefit the company. However, absent significant tariff increases, or reductions in costs and investment, “It has done the ‘governance’ thing, now it needs to address Eskom's large debt burden, amounting to ZAR367bn as of costs and signal a return to financial sustainabilit y. And the 30 September 2017, could grow to potentially unsustainable seemingly unavoidable scenario is that wage increases will

32 www.BondsLoans.com Africa be coupled with job losses,” says Jones Gondo, a senior credit analyst at Nedbank. “The fact is, if you can’t really control the revenue side of your business – because tariffs are flat or municipalities are refusing to pay – then what are you lef t with? ”

How the company could shoulder wage increases against mostly flat electricity sales and an already weakened balance sheet position is anyone’s guess, but rumours are swirling that it could look to shed up to 15,000 of its nearly 48,000 employees over the next four years to help return it to financial sustainability. Precarious Way Forward How the government deals with Eskom is important in part because it will give us a sense of how it plans to deal with other state-owned enterprises. One of its main considerations will be whether it steps up support for the embattled utility, either in the form of additional debt guarantees or direct capital injection (bailout). up crucial revenues (that said, so would reforming the municipal budgeting process). Forcing Eskom to overhaul The National Treasury is reluctant to pursue the latter, in its credit risk control mechanisms will also be crucial in par t due to its own delicate fiscal situation. While its new helping it become a more sustainable utility. strategy sees it unwilling to provide any new state guarantees on SOE debt that isn’t directly linked to new projects or These are long-term solutions to longstanding issues, CAPEX, it could make an exception for a brief ‘transition but where does that leave Eskom’s funding strategy in period’ to help insulate the utility from investors – who have the near-term? The utility recently inked a USD2.5bn loan grown weary over mounting emerging market paper losses with the China Development Bank and is in the market in recent months. This would still weigh on the Treasury’s for USD1.5bn dual-tranche bond. The company has been contingent liabilities, which it needs to closely monitor as trying to rally international investors for the better part it looks to keep its investment-grade rating intact. of the past eight months and lay the foundation for a new transaction, with mixed success. While it has refuted reports The government could help set Eskom up for success in of a large-scale restructuring in the offing, some have the longer term by, among other things, helping it expedite suggested that without significant changes to expenditure, the transition away from horrendously inefficient coal it may have little choice but to go down that route in the production in favour of supporting privately-owned IPPs next few years. through scaled-up transmission plans, a move viciously opposed by at least one of the key unions pitted against the “I suspect they will try to hit the market before the September utilit y and one that would be likely to come at a significant rate hike in the US – that will be the target to beat,” Gondo political cost given the potential implications for headcount explains. “If they don’t manage to hit the market by then, reductions at the company. that will raise serious questions about its short-term liquidity position.” Still, it would unlock a sizeable portion of the public purse, which could then be deployed to more productive ends. The mood is unlikely to change until the company’s turnaround It could also help ease some of the company’s funding plan is finalised, which was originally scheduled for release challenges in the long term. Apart from the domestic and September this year but was recently pushed back to the international bond markets, Eskom relies (increasingly) end of the year, according to one investor. Others have heavily on DFI funding for cheaper loans, a constituency suggested the full scope of any plan could be shelved of the funding universe increasingly reticent to lend to until after the 2019 general election, which would likely ‘dirty’ power producers. Redoubling its commitment to see the company’s balance sheet eroding further, making ‘green’ technologies – which have become much more price- its situation even more precarious. competitive since the utility originally embraced them in the 2010 Integrated Resource Plan for electricity – would help “I don’t think it’s likely the government will make a move reduce the country’s carbon footprint and create a viable until Eskom’s new executive leadership and board approve long-term alternative to the recently-halted and exorbitantly some kind of turnaround plan. Only then, assuming the expensive Nuclear Energy New Build Programme. environment broadly surrounding Eskom doesn’t suddenly erode, will there be some kind of light at the end of the Strengthening Eskom’s hand in being able to recoup tunnel,” an investor said. “They need to move quickly. We overdue debt from municipalities – which stood at more are optimistic, but we don’t foresee this being particularly than ZAR9.73bn in May – would also help the utility shore easy. Something has to give.”

JULY / AUGUST 2018 33 Africa Kenya Pooled Water Fund CEO: The Water, Sanitation Sector is Ready for Green Bonds

A core part of Kenya’s Vision 2030 plan, the water and sanitation sector is driving significant improvements in the quality of life of the country’s citizens, and after years of regulatory review it is only just beginning to open up to private sector funding. Robert Bunyi, CEO of the Kenya Pooled Water Fund talks to Bonds & Loans about why green bonds could help funnel billions of shillings to the sector, and discusses the company’s own issuance plans.

Q KPWF is planning a 1.5 billion This is critical because Kenya has green, their governance standards will shilling ($15 million) bond this year progressed to become a middle- also be raised – not just with respect to fund Kenyan water utilities. What income country, and therefore – in to their environmental impact. This are some of the things driving you to donor circles – is no longer eligible to should reflect well on these entities in issue a green bond over a conventional secure grants and other lower-cost the eyes of investors. Finally, it’s simply instrument? funding lines previously open to it. So the case that in the long term, everyone there are very few options other than has to think about sustainability, so A This is a crucial moment for the to access commercial funding in order there’s no better time like the present water sector in Kenya. What we are now to expand services. to get in front of this. witnessing is the first foray of the public water and sanitation infrastructure into At the same time, we are on the tail end Q The issuance, as we understand private sector funding. Previously, these of about two decades of regulatory it, is three years in the making. What sectors have been developed either reform – and some of that reform has were some of the key elements that through government grants, donor resulted in a conducive environment for needed to be in place before you hit grants, or development finance banks which private institutional lenders can the market? lending through the national sovereign assess new investment opportunities which then on-lend to the sector. in this sector. A There are a number of challenges split into two broad streams: the challenge The funding challenges being faced by On the green element specifically: water related to the capital markets, and the sector currently are significant. The is a natural resource, and is green by the challenges related to borrowers funding gap in the water and sanitation its very nature, and these companies specifically. We are lucky in Kenya sector currently stands at KES1.1tn, need to employ sustainable strategies in that the capital markets is well- which will be required to meet the for managing their resources, and to developed, well-structured, and government’s Vision 2030 objectives ensure those strategies are climate well-regulated. However, the water related specifically to providing water resilient in order to ensure the long- sector is undergoing significant and sanitation services for all. Those term viability of their operations. It is change. Water sector regulators estimates have already taken into account our hope that by deciding to issue green in the country have been in place available resources from the public bonds, other companies will start to since 1992, and they ringfenced sector. To fill that gap, new funding think a bit deeper when designing and water utilities to be separate from solutions for the water sector must identifying projects and activities to their local governments. In 2002, be identified, and the capital markets expand operations, and think about a new period of regulatory reform is seen as one of the means by which sustainability in the long term. We also began, which culminated in the financial viable entities can access the hope that by putting forward green constitutional overhaul of 2010 and long-term funding they require. projects, and companies that are thinking placed the function of water services

34 www.BondsLoans.com Africa to local governments as part of a wider disseminate any information if there improving people’s wellbeing. That’s the devolution of powers. are any outcomes that stray from profile of the ser vices we offer – we have that. We also have certain reporting a direct impact on the ability to minimise Early on, when the Kenya Pooled Water requirements related to ESG as part of disease through better sanitation and Fund started, the key issue was to review the donor community’s participation greater access to water. So, whenever the regulatory environment and legal with the KPFW, and we will collate and we sit down with trustees and pension regime in place to determine if water disseminate these as well. funds, they get it; but the challenge is companies can borrow from private getting them to understand the risks lenders; whether the government itself We don’t have specific green reporting inherent to the sector and how they are was open to the idea of allowing water requirements related to the capital managed, given the fact that the sector companies to petition private investors markets. This initiative is being led by the in Kenya has never really been accessible for funding; to see whether the regulatory Central Bank and the Ministry of Finance. from a private investment perspective. environment surrounding the capital At the moment, the government is simply markets specifically would allow for looking to encourage more supply, but Q Do you see the market for ESG- pooled bonds – essentially asset backed the reporting framework on the green linked instruments growing in Kenya? securities; and to analyse default scenarios aspect has yet to be designed. I suspect And if so, what do you think will be and what their implications would be. that will come through in due course. the main drivers for local issuers?

Then we had to estimate the potential Q What is the government doing to A The biggest driver of debt issuance market size of the water sector. We try and encourage issuers – beyond over the past 20 years has been think the market is roughly KES5bn simply visibility-raising? government, whether directly or through per year, possibly higher in five years state-owned enterprises. The country onward. We also evaluated different A Kenya’s capital markets in general is rich in natural resources – particularly paths of market entry for water utilities. is suffering from a lack of supply, but of the non-mining variety – and these not a lack of investors. At the moment, include water, renewable energy, and All of this took about 18 months to investors will buy anything that gives wildlife-related sectors among others. complete. We were very fortunate them a decent return for reasonable that the Dutch government, through risk. Our issue here is that we have When you look at those sectors, it’s easy its development aid budget, agreed to potential issuers that are concerned to see potential for greater issuance. take this on as one of its initiatives; it was about the borrowing costs of a green The government, which will probably quite an undertaking from a cost point bond, and the ongoing reporting costs. be the main catalyst in the short term, of view, but the Dutch government was The government’s position is that there is in the process of looking at issuing crucial in helping us ensure all of the is an inherent advantage to issuing green bonds; it’s early days, but they key elements are in place to facilitate green – that it improves the liquidity are warming to the idea. KenGen has this issue. of an entity’s issuance going forward, by been looking at issuing green bonds appealing a to wider range of specialist to finance geothermal power projects Q What kinds of reporting has the funds. The government could introduce among others. These kinds of projects KPWF committed to in relation to some kinds of tax incentives, but I think have a huge impact on the environment the green bond? it’s more likely the government would and are appealing to investors. The target all types of capital market credit other thing to keep in mind is that A Today, water companies – being instruments because it is fairly keen even if borrowers like these were regulated entities – have continuous to grow generic and green supply at to go to the banking market to fund reporting obligations under their the same time. these projects, they would still need established provision licenses, and that to go through much of the same due reporting, which is then correlated by the Q What is your perception of the diligence and environmental impact water sector regulator and disseminated extent to which local investors assessment that they would otherwise publicly through its website, include value ESG-linked capital markets do to issue a green bond. That being governance and financial metrics. The instruments? said, as the impetus for diversification capital markets also has continuous grows, so too will the willingness to go reporting requirements on bonds and A I think it’s still early days. I don’t think to the green bond market to finance any similar liquid instruments, to which many local investors are that nuanced these kinds of projects. This will boost we must comply. Use of proceeds is at this point. However, it’s important local liquidity in the medium term, and of course set out in the information to point out that there are differences help incentivise other borrowers to memorandum at the time of issuance, between long-term institutional tap the market. and we will report performance on use investors, or fund trustees, and asset of proceeds regularly. managers. The largest pool of capital markets investors in Kenya are pension The impact of the underlying projects funds, and we tend to find they are more will be described and explained in the sensitive – or more willing to – invest information memorandum, and we will in initiatives that have a direct link to

JULY / AUGUST 2018 35 Middle East & Turkey Governance in MENA Abraaj Collapse Reverberates Through GCC Markets, but will Lessons Really be Learned?

s recently as 2016 the Abraaj Group was flying high. With around USD13.6bn of assets under management globally, the investment firm was one of the largest in the region and blazed the trail for GCC private equity investors to expand into growth markets. TwoA years on, abandoned by its founder Arif Naqvi, it is facing USD1.2bn in debt, multiple lawsuits and an unprecedented level of attention and scrutiny from authorities, threatening to send shockwaves through Middle East’s financial markets. What went wrong, and what crucial lessons can the market draw from the saga?

In 2002, when Pakistani businessman corporate governance – exacerbated Arif Naqvi launched his new USD3mn by dubious personnel choices, such as fund, few could have anticipated its the appointment of Waqar Siddique, stellar rise – and the spectacular fall – of Naqvi’s brother-in-law, as Abraaj’s one of Middle East’s most extravagant managing partner and head of risk business ventures. Over the decade and compliance – led to a group of following its launch, the Abraaj Group foreign investors commissioning an had expanded into most of the world’s audit of the healthcare fund. growth markets, including Asia, Latin America, Turkey and Africa. The latter The inquest, made by the Bill & Melinda appeared as a particularly bold move Gates Foundation, questioned the use with the closing of a USD990mn Sub- of the cash it had allocated to Abraaj, Saharan Africa fund in April 2015, and and expressed concerns about the another USD375mn committed to North deployment of proceeds. Despite Africa months later. Abraaj’s deployment of an independent auditor – KPMG, which cleared the Finally, in 2016 Abraaj announced company of any wrongdoing at the another milestone – the launch of time – to verify the fund’s transactions, its USD1bnn Abraaj Growth Markets it soon became clear that the firm was Middle East & Turkey Health Fund (AGHF ) to build affordable sourcing millions of dollars from its and accessible health eco-systems for multiple funds, including the flagship 36 middle and low-income communities Abraaj Private Equity Fund IV. Abraaj Collapse Reverberates Through GCC in Sub Saharan Africa and South Asia. Markets, but will Lessons Really be Learned? With investments spanning multiple A series of resignations of senior 40 segments, from private equity and management followed towards the We Need to Talk About Bahrain credit to real estate, ESG and impact end of 2017, and, with the failed fire- 42 investing, the company’s ascent seemed sales of various assets, Abraaj’s liquidity Turkey: Call and Response unstoppable. crunch intensified, leading Naqvi to seek last-resort short-term loans, one 44 MLP Care CFO: Smart Balance-Sheet Fast forward to September 2017, when of which came from investors and local Management Key to Finding Borrowing growing concerns about tightening businesses. After one of the personal Windows in Turkey liquidity, fund mismanagement and checks, issued as a security on a loan,

36 www.BondsLoans.com Middle East & Turkey

& Loans about the factors that lead up to Abraaj’s demise.

“Ultimately this story is one of poor corporate governance," which is a broader issue in the region, said Khalid Howladar, founder of Acreditus, an advisory firm. “Lack of transparency, audit quality and independence, independent board members coupled with conflic ts of interest and related-party lending are often an ‘acceptable’ part of doing business in the region.”

But while commonplace in the Middle East, such practices are not acceptable at the higher levels of international finance and investment.

“As Abraaj crossed over into the international institutional space they did not evolve to the tighter, more disciplined operating standards of those investors who do not accept these weak governance practices and sought to investigate.”

While Abraaj’s overall growth model raised some questions and concerns, observers point to a number of key deals and developments that in retrospect are clear “red flags” signalling future troubles. Among them are their decisions to expand to the African market, questionable asset purchases, and a growing trend towards nepotism.

“Abraaj until 2012 was a much smaller entity, but when they took over the Africa operations of another smaller entity, they moved beyond private equity to taking on a lot of regional market risk,” the bank source explained. “And to sustain the intense dividend flows and rates of new capital injections, they needed to expand faster and faster, trying to replicate their growth model bounced – a criminal offence in the put the figure at USD2.5bn; it owes over across multiple markets.” Emirate of Sharjah – the full depth of USD1.5bn to its creditors. the crisis came into full view. The Group invested in K-Electric, “Abraaj was the biggest private equity Pakistan’s largest integrated power utility, By February, Naqvi was forced to cede fund in the region and nobody expected taking a major stake in 2009 and aiming control of the collapsing firm, and it to blow up like this, and in such a quick to benefit from burgeoning grow th of liquidation proceedings began after a way,” said a banker affiliated with one the power sector in the country. The court-appointed restructuring of one of of Abraaj’s creditors. gamble did not pay off, and since 2017 its operational jurisdictions, the Cayman Abraaj has been looking to offload the Islands. As of March, Abraaj’s assets Where Did It Go Wrong? USD331mn stake. The process is being stood at USD1.1bn, according to the Barring a few minor details, there is stalled by the Paksitani government, liquidator’s report, cited by Bloomberg fairly broad consensus among industry with time running out until the new – far below its official statement which players and experts who spoke to Bonds administration comes into office. That

JULY / AUGUST 2018 37 Middle East & Turkey

has added more pressure on Abraaj to The source noted that they see the issue will probably spin-off on their own. Of divest from other ventures and assets. as two sides of the same coin. On the course, selling as a whole will bring greater one hand, foreign investors traditionally value than if they were to offload it in “The K-Electric deal was the first warning have very low exposure to GCC; and, parts, but they’ll have trouble finding sign,” noted Sabah al-Binali, a UAE based given the shortage of options, they a purely commercial buyer.” investor and CEO of Universal Strategy. were willing to give Abraaj, a GCC fund “The natural question was – do they with a compelling diversification story, The fate of Abraaj’s managers, though, actually know how to run an operating the benefit of the doubt. Meanwhile, is harder to predict. Its founder, Naqvi, business? And the appointment of Naqvi’s the company was riding high on its recently reached an interim settlement brother-in-law as head of compliance initial success, and made some smart with a creditor on a USD300mn loan was another ‘red flag’: it was a clear investments, but the new markets failed and narrowly avoided prosecution for conflict of interest and was publicly to provide the same kind of returns a bounced cheque. Whether he will known. Some of their staff were moving that regional investments did before. end up in more legal jeopardy remains back and forth between Abraaj and to be seen. KPMG, too – how were these things “So to some extent there was just greed allowed to continue?” on both sides,” they concluded. According to Howladar, the challenges come on two levels – the corporate and Who is to Blame? Assessing the Damage the personal – and those are heavily Part of the blame lies with the board, as While the prospects for Abraaj itself are commingled. well as regulators, which many market now very gloomy, getting an accurate observers blame for allowing to create a read of the damage to its founder, its “A distressed corporate restructuring “cult of personality” in the company, with creditors and auditors, and to the financial is not an unusual event although one little pushback even to Naqvi’s wildest markets in the region, is not easy. needs a strong legal and regulatory initiatives. KPMG itself has come under environment to ensure efficient and scrutiny because of its failure to pick At the start of August, a group of investors fair conduct,” he explained. “However, up the warning signs and report the with stakes in Abraaj Private Equity the weak governance that has been inconsistencies. It recently launched an Fund IV hired an advisory firm to help reported may expose the firm and internal review into the Abraaj audits, with recovering their capital, around its officers to much more qualitative and international watchdogs are also USD100mn, from the ailing firm. Overall, and legal issues. The impact of such looking to investigate the case. the liquidators – Deloitte and PwC are issues is difficult to quantify in advance working over the settlement of more and makes the restructuring far more On the other hand, the rampant lack of than USD1bn of debt, with Mashreqbank, complex than normal.” transparency and accountability should CBD, Noor Bank, Air Arabia and Auctus also have been noticed and looked into Fund among the creditors lining up to Market Fallout by investors – by more of them, and get back their share. Perhaps the biggest question concerns certainly much sooner. The current the damage dealt by this scandal to the investigation was initiated by the Bill To source the funds for the potential region’s financial markets. Here, opinions & Melinda Gates Foundation, but other pay-offs to creditors, the liquidators are more diverse. Al-Binali pointed major stakeholders had been silent until are looking to offload a range of assets out that the size of the exposure and then, despite clear gaps in reporting. under Abraaj’s management, including restructuring is actually fairly small, so a USD22mn stake in the Entertainer, the damage is mostly reputational. But “It has been reported that PWC [one a local discount publisher, as well as even that could end up shifting investor of the liquidators] could not locate K-Electric, Tunisian convenience store sentiment further into bearish territory. ‘standalone annual financial statements or chain Aziza Commerce de Détail, and management accounts’,” noted Howladar. various private equity funds. “We all thought the private equity “If this is true, then any accurate due industry is here to stay, as a favourable diligence would be extraordinarily difficult. Its USD375mn North Africa fund is alternative to the banks, with the There should be regulatory enforcement looking to split from the parent, which equity banks sector growing rapidly,” of basic governance practices related could complicate attempts to sell the noted the bank contact. “But now, to audit independence and conflicts entire asset management unit. Abraaj after this case, there are some of interest to promote confidence in is currently considering bids for its concerns; since 2017, the fallout the local market.” fund-management unit from US hedge has been painful – so it’s a bit of fund York Capital Management and reality-check. It will take some time Public governance was never a preferred investment firm Abu Dhabi Financial to recover, and every dollar is going topic to discuss openly in the region, Group. As for the holding company, to be closely scrutinized for now.” agreed the banker from an Abraaj creditor. we are unlikely to see a restructuring, While people in the know suspected that indicated al-Binali. For Sergey Dergachev, Senior Portfolio there were loopholes in the framework Manager and Lead Manager for to support strong governance, they did “It will either be broken up and sold, or Union Investment Privatfonds, the nothing to challenge the status quo. collapse entirely,” he noted. “The funds firm’s collapse is unlikely to affect

38 www.BondsLoans.com Middle East & Turkey

Abraajs Biggest Creditors millions USD

Public Institution for Social Security 205.3 Auctus Fund/Hamid Jafar 200.0 Mashreqbank 177.5 Commercial Bank of Dubai 166.3 Noor Bank 100.0 Societe Generate 100.0 Air Arabia 75.0 First Gulf Bank 28.6 Arab National Bank 21.1

Source: Bloomberg their assessment of MENA, which is has become more challenging on the by the US Fed is now driving far more supported by other drivers that are equities market – the same way Dana investment discrimination globally – likely to persist – at least on the fixed- impacted Islamic Finance markets. weaker and riskier markets will face income side. Regulators are not replacements for rising spreads and funding costs.” due diligence, it’s up to the investor “As ironic as it sounds, it remains to carry it out.” Ultimately, private equity markets – like one of the EM regions currently well any – demand trust and transparency, isolated from whole trade war noise; Notably, on August 16 the DFSA came especially when investors are becoming it was less impacted by the tensions out from its shell to announce it is cagey about pumping money into we are seeing between US and China, imposing a ban on new client transactions risky funds and assets. That should where Asia and Eastern Europe have for Abraaj. The ban prevents ACL, the encourage players in the region to been hit more.” holding company, from moving money tighten their ships – and do so in the to Abraaj Investment Management most public way possible. “The issue is clearly that the EMBIG (AIML). DFSA also warned AIML not to inclusion expectation story is driving undertake any unauthorised financial “The best thing that could happen is strong investment appetite for sovereign services activities in or from the DIFC for private equit y firms to individually and corporates in the region. It will since it is not licenced by the agency. reassess their growth models and be a very positive step if JP Morgan governance practices, and find a includes Saudi and Qatari sovereign The capital markets authority appears common voice to regulate and manage debt to its widely followed EMBI index to have gotten a handle on the situation the market,” said the source. family, and this will be a long-term and, considering the aversion of Middle positive anchor for region´s bonds,” Eastern government agencies to The contact pointed out that there the portfolio manager concluded. negative press and noise, it is likely are 15-20 regional players in GCC who that any internal investigations will have quite varied business models Regulatory Reforms be limited in scope and conducted and approaches. They ought to come Al-Binali likens the case – and its impact in behind closed doors. together, either as an association or on the relevant industry – to the infamous in some other form, and formulate Dana Gas sukuk debacle, and its impact “Clearly events like this and Dana Gas a common policy framework, and on the Islamic finance market. remind investors that despite high commitment to more transparent credit ratings – these are still Emerging and effective corporate governance. “The regulations in UAE are actually and Frontier markets with additional top notch, the issue was with risks that need to be considered “That will go a long way to restoring implementation,” he said. “The when investing,” Howladar noted. some of the GCC market’s credibility,” investment climate is still strong, but it “The quantitative tightening driven they concluded.

JULY / AUGUST 2018 39 Middle East & Turkey Fiscal Woes We Need to Talk About Bahrain Anita Yadav, Head of Fixed Income Research, Emirates NBD Questions have swirled in recent months over Bahrain’s strained finances, but there is good reason to believe the country is in much better shape than sensational headlines suggest. This bodes well not just for the country, but fort the region as a whole.

Questions have swirled in recent months Bahrain mainly raises debt via public been increasing by circa 10% every year over Bahrain’s strained finances, but market issues. It’s current debt since 2014. In addition, expectations there is good reason to believe the obligation of USD USD37bn is made of frequent new supply from Bahrain country is in much better shape than of a) bonds (including TBs) of USD27bn has dampened investors’ enthusiasm sensational headlines suggest. This and b) committed interest expense of and, consequently, investors’ demand bodes well not just for the country, USD10bn. The debt is denominated in for high return is making it increasingly but fort the region as a whole. USD (56%) and BHD (44%), with 84% of expensive for Bahrain to raise new debt. it is at fixed interest rate and remainder The Kingdom of Bahrain has been at zero coupon (mainly T-bills). 100% In Q1 this year, the government shelved one of the most prolific issuers of the debt is in bullet form with no plans to raise debt via longer dated of sovereign debt in the GCC. The amortization requirements. bond issues, mainly due to high pricing Bahrain government increased social demanded by investors. However, with spending earlier in this decade to Unlike Saudi Arabian and Omani over USD3.5bn in projected budget promote peace and prosperity, and governments that engage in borrowings deficit and several upcoming bond as a result has been recording budget in the loan market, Bahrain’s debt is maturities this year, we think that new deficits since 2009 – much before mostly in domestic and international debt offerings will have to surface up the low oil prices exacerbated the capital markets. International investors again soon. deficit situations. Currently it has are reasonably familiar with the name about USD35.9bn of debt including and therefore access to funding has Bahrain’s five-year credit default swaps USD11.3bn in dollar-denominated not been an issue in the past. touched 609bps in June this year, the bonds and USD3.6bn in dollar- highest level since the financial crisis. denominated sukuk. Bahrain is However, lately the Gulf state's credit Though 5yr CDS spreads have now fallen rated B+/Stable, B2/Negative and rating has been falling, from A/A2 in to around 357bps, it remains one of BB-/Stable by S&P, Moody’s and 2007 to B+/B2 now by S&P and Moody’s the most stressed sovereigns in the Fitch respectively. respectively, whereas Debt/GDP has emerging markets universe.

Bahrain: Sovereign Debt Maturities Moody’s recently downgraded Bahrain’s 8000 rating from B1 to B2 while maintaining 7000 a ‘negative’ outlook, citing concerns 6000 with the kingdom’s heavy reliance on external funding and lack of urgency in 5000 implementing reforms. IMF had earlier urged Bahrain to consolidate its finances

USD mm 4000 via implementing a comprehensive 3000 package of reforms, including direct 2000 taxation, spending cuts and subsidy restructure. 1000 0 Though oil prices are significantly higher than the assumption of USD55 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 2043 2044 2045 2046 2047 2048 + per barrel, which Bahrain used for its Bond Principal Interest 2018 budget, government financials Source: Bloomberg, Emirates NBD Research continue to be fragile in the face of 40 www.BondsLoans.com Middle East & Turkey ongoing budget deficits and the government’s Given the on-going fiscal and current account high reliance on external funding. Bahrain is the deficits, immediate aid is necessary to maintain only Gulf oil producer that needs prices to climb the Bahraini dinar’s peg to the dollar. Its GCC beyond USD100 a barrel in order to balance its neighbours are unlikely to risk Bahraini’s dinar budget in 2018. peg to fall as it would raise questions about the sustainability of their own currency policies. Excluding the ongoing fiscal budget deficits, Bahrain will need circa USD10bn over the next Although no formal support has yet been two years for debt servicing and repayment alone provided there may be some indirect support (USD1.8bn in interest expense and USD8bn in already filtering into the Bahrain system. principal repayment). Its current debt to GDP According to data from the Central Bank of is close to 90% and continues to rise by circa Bahrain, foreign exchange reserves jumped 10% every year. to USD2.17bn in June, a 22% increase over the previous month and its highest level this year. The refinance risk is high in the current environment The increase in reserves appears to have from of investor skepticism, thereby causing its credit higher deposits being placed with the central cur ve to inver t somewhat. Yield on BHR AIN 4 4s is bank which in turn may have come from banks currently lower at 7.80% vs over 8.10% on BHRAIN that are regionally owned. 28s. Investors are justifiably cautious on the credit. Z-spread on BHRAIN 20s has increased We note that although as a percentage of 124bps to 316bps and that on BHRAIN 24s sukuk GDP, Bahrain’s budget deficits appear high increased 90bps to 349bps in the last quarter. (between 11% - 15% of GDP), in absolute terms, its only circa USD3-4bn p/a, which is not a large Too Small to Fail amount for its rich neighbours to consider. In Bahrain is one of the six nations that make up the this regard, we think Bahrain is too small to Gulf Cooperation Council beside Saudi Arabia, fail. Given Bahrain’s relatively low financing Qatar, UAE, Kuwait and Oman. Though substantial needs, it would cost its neighbours less to differences exist between the wealth and economies bailout Bahrain now, than to pay higher yields of these six nations, international investor base on their own new issues when tapping the tend to treat GCC as one block and view the risk international markets in the future. as one. Therefore any problems at Bahrain are likely to taint the overall risk perception of the On its own part, Bahrain is believed to have GCC nations as a whole. hired investment bank Lazard Ltd. to advise on how to repair its strained public finances. Given this predicament, Bahrain’s GCC neighbours Its parliament is also believed to have vetoed have vested interest in supporting Bahrain. Though any increase in expenses requested by the Saudi Arabia, UAE and Kuwait announced in June government and has set up a committee to that they were working with Bahrain on a support work on finding ways to balance the budget package, details of this are yet to emerge. With over the coming three years. The possibility of ongoing budget deficits, Bahrain will need a implementing VAT next year, as well as increasing multi-year support package, not just a one-off oil prices, are other factors that would provide aid, and this is what may be causing the delays some respite to the battered sovereign. In the in finalizing the details of the aid package. interim, cautiousness is more than warranted.

Bahrain: Forecast at a Glance F Nominal GDP (USD bn) 32.2 35.3 37.7 Real GDP qrowth (% y/y) 3.2 3.9 2.9

Revenue (USD bn) 5.1 5.8 7.0 Expenditure (USD bn) 9.4 9.8 10.3

Fiscal balance % of GDP -13.5 -11.4 -8.6 Curr A/c Balance % of GDP -4.6 -3.9 -2.3

2018 forecast assumes oil priecs at 69 /b JULY / AUGUST 2018 41 Middle East & Turkey Turkey Call and Response Richard Segal, Emerging Market Credit Analyst, Manulife Asset Management (Europe) Limited

ith Turkey seemingly approaching a critical junction in its economic trajectory, a call with the country’s Minister of Finance sheds light on how the country looks to Wtackle the rising challenges confronting it.

The Turkish lira has added to earlier gains minimums will be surpassed. Rollover The Q&A with Finance Minister subsequent to the finance minister’s rates are still at manageable levels both Albayrak landmark presentation to investors in for banks and corporates, which in turn mid-August, so it seems likely therefore have a debt repayment buffer. There On capital controls that the objectives in scheduling this are no major deposit outflows and the We have no plans call have been achieved. He declined BRSA is watching the system closely. to comment directly on monetary Corporate loan restructurings will limit IMF policy, though did suggest that fiscal losses, but banks will be required to No engagements aside from ‘routine and monetary policy coordination are set aside more reserves. If necessary, discussions’ that are planned; for necessary to achieve single digit inflation, the government will not hesitate to put now, long term flows such as FDI will which will be a top objective. He also capital into banks, and other action be important indicated that while he doesn’t expect plans are in place. Turkey’s government any fine to be imposed on Halkbank by and household sector is not leveraged, Fiscal policy US authorities (this is difficult to predict, 28% and 17% of GDP, respectively. given the recent surprise doubling of Fiscal discipline is crucial, Turkey cut tariffs on steel and aluminum exports), The top priority is to reduce inflation public debt from 60% to 28% of GDP but reasserted that the government will as soon as possible and the MOF will and there will be ‘no deviation’ from stand behind Halkbank and all other work closely with the central bank to target, the 2018 deficit target is 2% of state-owned banks. In the Eurobond achieve this. There will be no lack of fiscal GDP, spending cuts are underway: a market, for the time being, the banks discipline, which will be strengthened. comprehensive fiscal transformation look likely to continue their recovery ‘Low value’ public investment projects has begun, with the assistance of from very oversold positions and will be suspended or cancelled. ‘We international consultants especially the Tier 2 debt, but among will increase’ the primary surplus and more stable credits a company such this target will become more ambitious Monetary policy as Koc is still attractive. next year. The Ministry of Finance is It is not enough to fight inflation working on a fiscal rule and quar terly with monetary policy alone, but a ‘How we see things’: A reports will be produced. These will coordinated approach is necessary, Summary of the Presentation be significant, because the new polic y with other institutions – not exclusively There has been ‘resilience to shocks’ in objectives will be achieved through the central bank recent years thanks to a strong banking longer term measures. He emphasized sector and ‘fiscal space,’ but strong crisis intentions to cut public spending sharply, Corporate sector management and demographics and but as expenditures climbed during Market estimates of the international being part of a ‘good energy corridor’ the pre-election period, there is plenty liquidity buffer are understated. have also helped. of low hanging fruit. Halkbank ‘We understand all challenges’ and will Structural reforms will also be a priority, Not expecting any fines from the US but seek to achieve a healthy rebalancing as they are ‘key’ to rebalancing and the MoF will stand by it and other state- amid market turbulence, but there are securing sustainable growth, with labour owned banks if necessary. Relations some ‘false impressions’ about banking market flexibility ‘top of the list.’ Turkey with US Treasury Mnuchin are good and system health: The CAR is 16.3% and NPLs has never introduced ‘non-market Albayrak hopes rationality will prevail. are stable at 3%. Stress tests under a measures,’ such as capital controls, worst-case scenario suggest prudential even during 2008/09, and ‘never will.’

42 www.BondsLoans.com Middle East & Turkey

Economic prospects and additional ministers. Moreover, it will acknowledged that while the cabinet has forecasts drive Ankara closer to Berlin and Moscow, had in its hands a worthwhile structural The priority is to rebalance the economy, and let’s not forget how frosty contacts reform program for a long time, it has never rather than to achieve strong growth. with these bilateral pairs were until been implemented. On the other hand, The current account is structurally weak recently. President Erdogan is good at while gross external financing needs may because of a perpetual energ y deficit. making enemies and rivals, but he is appear insurmountable in a vacuum, they Rebalancing and more modest growth also good at burying the hatchet when are less pressing when disaggregated. have ‘already started.’ the economic need arises. If we consider four major components The Qatar deal The Relative Importance of – the current account deficit, and public Strong bilateral relations are longstanding, Bilateral Relationships sector, commercial bank and corporate and there are many components to For economic and financial purposes, rollovers – we find that the current the USD15bn package announced relations with Germany and Russia are account is likely to disappear, public yesterday, including swap lines and far more important than with the US, sector rollovers are immaterial and FDI. More details will follow soon. unless one assumes Turkey will have to the other two sectors have rarely had run to the IMF, where Washington holds difficulty in refinancing, for relationship US sanctions and tariffs an effec tive veto. However, if the new reasons; the question has always been Turkey will navigate through with Germany, Turkish finance minister believes the the cost and the available tenors. Some China and Russia. Many other countries solution to the currency crisis should point out that, along with Argentina, are facing a trade war with the US. be orthodox, then he could merely Turkey’s official reserve assets are impose those kinds of policies with the among the lowest in the non-hard Rollover risk Fund watching with approval from the currency universe, when scaled by short Banks are mostly deposit funded and sidelines, but if the unorthodox brands term external debt. This, though, is an have excess swap lines. FX liquidity of policies that the president and his imperfect indicator, because the other coverage is 194% and the minimum advisors have publicly espoused win members of the bot tom five are Malaysia, is 70%. the day, then if he runs to the IMF he South Africa and the Czech Republic. will not find any open doors and such Central banks that don’t intervene don’t Banking system policies will not be effective. require as many official reserves, as long The loan to deposit ratio is only 90% as the Ministry of Finance has a fiscal for FX, and this can act as a buffer; FX Addressing the Policy Vacuum commitment – which will be tested next movements will cause the overall LDR Until the investor presentation, the month when the fiscal rule is launched. to drop (due to FX deposits exceeding post-election policy vacuum had FX liabilities, though it is unclear which been worrying – this was addressed, Building Credibility are higher quality). Contingent liabilities but aside from the central bank and Nevertheless, the Turkish economy of the government and banks are banking regulators, not much has faces structural and geographical overstated due to double counting. been implemented and the real test disadvantages, including demographic will occur with market conditions call factors which make consumption The Aftermath: Implications for orthodoxy; but the tendency for suppression when necessary difficult and Ways Forward the executive to prefer the unorthodox and perennially low savings propensities. The Turkish lira rallied down to TRY5.75/ raises its head, particularly with local USD the morning after, but subsequently elections scheduled for a little more In addition, in spite of consistent slumped on misgivings about the US than six months from now. Moreover, a assertions from various finance ministers bilateral relationship, in part because compelling backstop plan for the banking and central bankers that the tools were Finance Minister Albayrak insisted during system isn’t very relevant without macro available to achieve moderate and his presentation that his rapport with stability. However, currency stability stable inflation, if they existed they US Treasury Secretary was ‘good,’ only will probably be a better campaign have always remained in the tool bag. for the latter to mention the possibility backdrop than speeches pointing In global comparison it is remarkable of further tariffs or other sanctions fingers at the ‘interest rate lobby,’ so that since the middle of 1970, Turkish being introduced if Pastor Brunson there may be slightly less reason to inflation has pierced the 5% level during and others were not released soon. worry than normal, on this particular only four months, a consecutive period score. That said, we do take note that at the start of 2011, with a low of 4%. This also led some to question Albayrak’s the political opposition – which might Crude oil prices bottomed out in Q1 assertion that Halkbank might escape be successfully lobbying the public ’16, at USD 26.11 on WTI for example, without a fine from US authorities, for the conventional, given the crisis but Turkish inflation bot tomed out at although this is difficult to predict in created by taking the unconventional only 6.6%. The majority of participants either direction. However, the US bilateral road – has more or less disappeared in August’s arena-style conference call question is largely symbolic, because since the elections. may have been willing to grant Finance raising tariffs further will not have a Minister Albayrak the benefit of the material net economic impact on the Considering Refinancing Needs doubt, but there is a lot of room for Turkish economy, nor will sanctioning Along a related line, Albayrak building policy credibility.

JULY / AUGUST 2018 43 Middle East & Turkey MLP Care CFO: Smart Balance Sheet Management Key to Finding Borrowing Windows in Turkey Turkey’s healthcare industry has moved forward leaps and bounds since the government overhauled the sector in 2003, and the present currency dynamics coupled with high external savings rates and a huge concentration of domestic medical expertise has translated more recently into a health tourism boom – a bright beacon floating in troubled waters. Bonds & Loans speaks with Burcu Öztürk, CFO of MLP Care, a hospital operator, about how the current economic conditions in Turkey have influenced the company’s approach to the markets and its balance sheet.

Q Bonds & Loans: Can you give us a Q Bonds & Loans: Between the cost sense of the company’s key strategic side and revenue side of the business, focus areas over the next 6-12 months? what is the Treasury more focused on at the moment and why? A Burcu Öztürk: We are operating in the healthcare sector, which perhaps A Burcu Öztürk: On the revenue side, distinguishes us from other companies we have seen a bit of an increase given and sectors in Turkey – we are more the government’s recent mandate for defensive by nature. Healthcare tends to higher fees on more recent projects, continue performing well, even during which has been helpful. The next six times of economic downturn. That months will see us focus on the cost- said, we haven’t been as negatively side of our balance sheet, which means impacted from an operations and smart cost management. Ensuring our revenue perspective as others. hospitals are running as cost-effectively as possible and making sure they are doing Over the past four years, we have opened better from an EBITDA and productivity between two and three new hospitals perspective. We will continue to focus annually. Our strategy for the next 6-12 on sustainable growth, but our focus months will see us continue to open on operations will be central to this. up greenfield hospitals, but since the election and the ensuing volatility in Part of this means focusing more closely the market, we have held back plans on the collections side, so making sure to open up any new hospitals. and with that we have increased our our billing and collections are matched overall open position, and our leverage with supplier payments. But our overall Q Bonds & Loans: What are the dramatically decreased. focus will be on the working capital side Treasury’s key priorities over the and working capital improvement, next 6-12 months? Maintaining a healthy balance sheet especially on EBITDA. has helped us weather the turbulent A Burcu Öztürk: We secured a euro- market in Turkey. We have targeted a Investments are also key. We want to denominated loan earlier this year, in few hedging transactions and are still make sure we don’t deploy any new part because of the high cost of funding looking for alternatives to further protect CAPEX this year and focus on effective in local currency, and the devaluation has our balance sheet. Turkish banks are in a management of existing assets. made servicing this more challenging; difficult position as well, tr ying to price TRY- we’ve had another syndicated loan in denominated loans fairly while targeting Q Bonds & Loans: What is the biggest place since 2015, which includes some the right sectors. Over the past 4-5 months, constraint or challenge facing the of the largest lenders in Turkey. About the banking sector has been struggling, Treasury department at the moment? 40% of our debt costs are fixed-rate. and we are trying to manage that. But our advantageous net leverage position A Burcu Öztürk: Interest rates are We also executed a large capital injection means we aren’t as heavily impacted by our biggest constraint. Currently, we are into the company earlier this year, some of these pressures. looking at borrowing rates of roughly

44 www.BondsLoans.com Middle East & Turkey

26-27% for TRY-denominated long-term funding. That the local bond market, which we tapped earlier this year. said, any kind of investment needs to take into account Over the next couple of months, we may look to issue in the exorbitant cost of long-term borrowing in Turkey, the local market again. If we were to look at other lenders, which was already challenging before inflation and there are a range of government-backed banks that offer interest rates rose to new heights. very favourable interest rates, and we would also consider participation loans or sukuk, again due to favourable pricing. Overall, if you look at the companies in Turkey, those with But we aren’t near our syndicated loan limit, so will continue export revenues are in an advantageous position. We to use that as a source of funding when needed. have some revenues denominated in hard currencies, and cashflows generated in US dollars and euros are fully Q Bonds & Loans: What advice would you give to sufficient to cover our interest and principal payments. borrowers looking to come to market for the first time? Generally, banks seem to be more comfortable with companies that are generating hard currency revenues; it A Burcu Öztürk: Working capital management is creates a natural hedge that is attractive in this environment. essential. If you are good at managing that and you can demonstrate this to lenders and investors, it’s easier Q Bonds & Loans: Given the environment in Turkey to secure cost-competitive funding. The other factor to and the particular constraints on banks in the country, look out for is leverage ratios. Staying below a net debt do you see more urgency around engaging with new to EBITDA multiple of 6X, for instance, will also help you pockets of investors? demonstrate a healthy balance sheet, and would be advantageous as well. Having export revenues is also A Burcu Öztürk: If you look at our current financing a huge advantage at the moment, so any borrower that source, we continue to draw down from our existing falls into that category will likely find the windows for syndicated loan. The only other source we look at is borrowing more open to them.

JULY / AUGUST 2018 45 Russia, CIS & Europe Reserve Reservations Russia Seeks to Mobilize Internal Reserves Amid Dollar Liquidity Shortage he Russian Central Bank tentatively confirmed that the banking sector is experiencing a dollar liquidity deficit. In an apparent Tpush to de-dollarize the economy, it may for now resist from intervening, hoping to encourage more local currency borrowing. But inaction could pile additional pressure on the rouble in coming months. Despite numerous overt advances made by Donald Trump to mend the fractured relationship between Washington and Moscow, Russia continues to feel the heat from the Western sanctions, with additional measures introduced by the EU in July, and a double blow from the US.

the USD went into purchasing Euros, First, the State Department announced little regard to market sentiment or as well as IMF bonds and the yuan. The a new set of sanctions (mostly on bilateral tensions. official statement by the CBR chief Elvira chemical and military tech sectors) Nabiullina (citing generic global risks following the Skripals nerve agent The sell off of 84% of USTs held by the and the need to diversify portfolios) attack in the UK, while a new bill in MinFin, going from USD96.1bn start of did little to quash the rumours. But the Senate has threatened to ban new May to a mere USD14.9bn by mid-July, while the above motives likely played a Russian sovereign debt trades and, according to the US Treasury report, was part, most observers agree that threat potentially, close the US markets off by far the biggest percentage sell-off of of further sanctions also influenced for key Russian state-linked lenders, the US notes in history, and led to the the decision. like VTB and Sberbank. country plummeting out of the list of top-30 UST sovereign holders (China, “With regards to Russia’s sale of US On top of that, is now forced to face the Japan and the KSA remain atop that list). Treasury bonds, it is likely caused by very immediate threat of global trade fear of sanctions and asset freezes, wars and waning investor sentiment Diversification Game similar to those that happened with towards emerging markets. Some of the cash sourced from the Iran’s UST holdings,” said Denis Poryvay, sell-off went into other safe asset s, such a Raiffeisen Bank analyst. “That’s why Confronted with multiple internal threats as gold, with Moscow swiftly breaking and uncertainties in global markets, into the top-5 sovereign gold holders Russia, CIS & Europe Moscow is retrenching, mobilizing its following a five-year monthly buying internal resources both in terms of spree. In June, Russia added a further 46 production (the much touted “import- 500,000 ounces of the precious metal Russia Seeks to Mobilize Internal substitution” initiatives) and funding (15.55174 tons) to reserves and bought Reserves Amid Dollar Liquidity – by means of reducing the economy’s some 106 tons of gold since the start Shortage dependence on the dollar. of the year, with total reserves now 52 approaching 2,000 metric tons, a record How Serbia Improved its Fiscal Some of the measures have been more for the post-Stalin period. Position and Catalysed Local Capital direct, and nothing short of extraordinary. Markets The Finance Ministry has sold off the These drastic moves by the Central vast majority of its US Treasury holdings Bank and the MinFin have, naturally, in a mere two months, following years aroused speculation about motives. of ploughing billions into them – with According to the official line, much of

46 www.BondsLoans.com Russia, CIS & Europe

“In addition, there is a seasonal summer impact related with vacation season that increases demand for hard currency from the population,” she pointed out.

Aleksashenko, meanwhile, disagrees with the CBR assessment, claiming that the MinFin FX purchases and the OFZ redemptions would have been offset by the rise in oil price during May and June.

“And I disagree with the CBR view on seasonal decline in export proceeds – this factor starts being visible in August,” he noted, adding that out flows by non- residents have indeed been significant and the FX purchases by the Ministry, perhaps, excessive. Capital Outflows According to the Central Bank figures, direct foreign investment to Russia fell 2.5 times to USD7.6bn – USD5.6bn in Q1, 10% higher year-on-year, but only USD1.7bn in Q2. Overall the real sector saw USD23.2bn of foreign investments in 2017, dropping by a quarter compared to 2016. Private they are pulling out of the US jurisdiction Notably, as Bloomberg reported, citing sector outflows reached USD17.3bn and investing into Euros, yen and, of central bank data, its deposits in other in January-June 2018, compared to course, gold.” central banks, international institutions USD14.4bn a year earlier. and foreign lenders jumped by the “The latter has long been a favourite equivalent of USD47bn in April and Russian government bonds also came commodity of the CBR. Either way, May, indirectly supporting the idea of under pressure in recent months, with owning large amounts of an albeit asset diversification. the sell-off accelerating and new auctions volatile commodity is a better option seeing demand wane. Foreigners’ share than having your assets frozen,” In a July report the Central Bank in Russian OFZ bonds was at 34.5%, he added. indicated that the structural liquidity or RUB2.35tn (USD3bn), as of April 1, surplus dropped in June due to some days before the fresh U.S. sanctions. Sanctions risk and possible asset of the major lenders reducing the That share fell to 27.6% as of June 29, freezes are also the reasons cited by amount of assets in their deposits while according to the Central Bank data Sergey Aleksashenko, an economist at simultaneously increasing their cash cited by Reuters. the Brookings Institute and a former deposits at the Central Bank – as well as deputy finance minister, who added he other factors. Some observers highlighted Yields on Russian bonds jumped in doesn’t see much impact of these moves the significance of this admission by April after a round sanctions, and on the banking and financial markets. the CBR, which, as a regulator, tends again in August, as fresh sanctions were to soften the rhetoric and smooth out announced. Following the US Treasury’s Dollar’s What I Need the rough edges. announcement, Russia’s 2043 issue fell Other analysts, however, have speculated 1.7 cents to 105.25 cents in the dollar that the move could be linked to the “Indeed, we have recently observed according to Tradeweb, the lowest levels longer-term goal of de-dollarizing the significant tightening of foreign currency seen since June 22. The 2029 Eurobond economy, a notion supported by recent liquidity in the Russian banking sector,” fell 1.15 cents to 93.14 cents. The average interviews with the Finance Minister said Natalia Yalovskaya, Direc tor at S&P bond yield spread of Russian sovereign Anton Siluanov. He recently conceded Global Ratings in a note. “There are bonds over safe haven U.S. Treasuries that the US currency was “becoming several likely reasons for that, such as on the JPMorgan EMBI Global Diversified a risky instrument in international capital outflow, following a new round index rose by 6bp. settlements” – which is still heavily of sanctions in April this year, as well dependent on the USD and has been as sizeable volumes of external debt The slowdown of late spring and early hit by capital outflows, leading to hard repayment made in 1Q-2Q2018 by banks summer was somewhat offset in a recent currency shortages. and non-bank borrowers.” debt sale on July 24, when the MinFin sold

JULY / AUGUST 2018 47 Russia, CIS & Europe

Russian Gold Reserves tonnes 2000 1909.8 1857.7 1828.56 1778.86 1800 1715.84 1680.1 1615.22 1600 1542.66 1498.74 1460.39 1414.54 1352.21 1400

1200 Jul 2015 Jan 2016 Jul 2016 Jan 2017 Jul 2017 Jan 2018 Jul 2018

Source: Trading Economics, World Gold Council

Share in F Gold Assets

50%

40%

30%

20%

10%

0% Australian uan Canadian Pound Gold Euro U.S dollar dollar dollar sterling

Source: Bank of Russia

all of the RUB35.2bn (USD558mn) in OFZs, “First, we were surprised to see such end of the summer, at which point new with non-residents snapping up a third low balance of the current account, waves of maturities for large, corporates, of the fixed-coupon bonds, according despite the rise in oil price, as well as in September and December could mean to head of the Finance Ministry’s debt the amount of funds withdrawn from that the road to recovery would be department, Konstantin Vyshkovsky, the banks. The liquidity shortage in even more prolonged. cited by Bloomberg. The recovery was June reached USD3bn, according to attributed to the passing sanctions our estimates. That is the amount De-dollarizing Risks scare, when it became apparent the needed to bring the basic spreads In order to boost FX liquidity, the MinFin threat of additional US sanctions on back to normal levels; at the moment could introduce regular FX swap sales Russian local debt was exaggerated. they widened close to levels typically for major banks, providing dollars for seen in December.” roubles held as collateral. While this Still, estimates of hard-currency assets would technically be “tapping into the on banks’ balance sheets as far as May According to the analyst, June’s out flows reser ves,” some of it could be offset by already sug gested a deficit looming on were linked to large dividend payments, soaking up the current account surplus the horizon, said Poryvay, and hopes while in April there were external liabilities through market interventions, which of a recovery over the summer were to service, but the peak has now passed. brought in USD30bn into federal reserves diminished by stronger-than-expected The bank’s estimates suggest that the last year, upwards from USD14bn a outflows from the banking sector. status quo is likely to remain until the year before.

48 www.BondsLoans.com Russia, CIS & Europe

Banks draining hard currency liuidity has become increasingly costly

120 USD (bn) FX Liquidity Surplus 180 Basis points 1y IRS - 1y XCC 100 Highly Liquid Hard Currency Assets 160 140 80 Balance Sheets 120 60 100 80 40 60 20 40 20 0 0 26 june 26 November 1 7 26 January 26 March 1 26 April 1 26 June 2 2 2 2 2 2 2 6 6 6 6 6 6 -20 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 july August 1 September October 1 7 December 1 February 1 8 may apr 1 5 oct apr 1 6 Jul oct 1 6 apr 1 7 Jul apr 1 8 Jan oct 1 7 Jul Jan 1 6 Jul Jan 1 7 Jan 1 8 1 1 1 1

1 1 1 1 1 5 6 7 8 1 5 5 7 8 8 8 7 1 8

7 8 1 7 7

Source: Bloomberg, Raiffeisen

However, as Poryvay and other observers If viewed through the prism of ongoing readjustment – from around 58 to over have pointed out, Nabiullina and other de-dollarization of the economy, this 62 per USD in April. officials’ comments suggest they don’t move provides some value, and may in see the current shortage of FX as a fact be quite shrewd if one considers “At the moment the local currency is major threat, and are in fact quite the current global market environment, quite strong, as it appreciated on the satisfied with the high cost of dollar where USD overleveraging is beginning corporate tax payments. But if the credit, encouraging businesses and to weigh on some emerging economies. dollar shortages continue, RUB will consumers to borrow in local currency. gradually depreciate.” Shortly after “These initiatives aim to decrease the the conversation with Poryvay, the This view is also supported by the move share of hard currency assets, should rouble indeed fell on the news of new in early August to increase mandatory be supportive to decreasing currency- US sanctions, retreating to its lowest provisions requirements on retail foreign related risks and positive for the stability since November 2016 overnight and currency deposits to 7 from 6% from of the banking sector in the long run,” nearing 70. It is currently trading at August 1, in addition to increasing risk Yalovskaya said. just over 68 per USD. weights for FX-denominated loans and lifting provisions on corporate FX deposits She expects banks and non-bank The FX risk has also largely closed to 8 from 7%, while requirements on borrowers to have sufficient hard other sources of dollar funding rouble deposits remain unchanged. currency to repay foreign debt that for firms, both in debt and equity. is coming due. Megafon, Russia's second biggest “By raising the provisions on banks’ forex mobile operator recently announced deposits the Central Bank is disincentivising “Since 2014, banks and corporate it was delisting from the London Stock lenders from raising their deposit rates, borrowers have significantly decreased Exchange; the number of Russian which they could have been lifted in order their external borrowing, and therefore companies trading in London dropped to compensate for the USD deficits,” the demand for hard currency for the to 50, from 70 in 2011. Commodity Poryvay explained. “That suggests to debt repayment in 2018-2019 has been traders like Oleg Deripaska’s EN+ us that the CBR is comfortable with the gradually decreasing.” and Polyus Gold have remained on current level of deficit.” the market – and suffered as a result, Several experts noted that, if push comes with shares plunging every time a “It appears that the CBR wants to to shove, the CBR may start doling out new round of sanctions, or even a encourage people to hold their savings dollar loans to banks, while the MinFin hint of one, is announced. in RUB, thus lowering the share of hard could pause the purchasing of USD. currency assets on banks’ balance sheets. Similarly, several sources told Bonds In essence they are pushing Russian Rouble Trouble & Loans about attempts by Russian companies to borrow in roubles on The problem with this approach, corporates to issue Eurobonds over the local market, and if they still want to however, as Poryvay pointed out, is the past 6 months, scrapped for borrow in FX, they will have to approach that sooner or later it will put more reasons varying from poor market international lenders or their Russian pressure on the rouble, which has been backdrop to high pricing and subsidiaries,” the Raiffeisen analyst added. fairly steady after a sanctions-related low demand.

JULY / AUGUST 2018 49 Russia, CIS & Europe

Nonresidents of OF holdings USD

60 billion U.S. report on Crimea debt sanctions annexation 40

20

0 2014 2015 2016 2017 2018

Source: Bank of Russia, Bloomberg

With the corporate sector now faced But a more sinister “solution” was struggle to offload them in a short with over USD34bn worth of foreign floated in the early days of August by time span without significant discounts debt payments in the second half of president Putin’s economic advisor (particularly corporate bonds which 2018, according to the Central Bank, with Andrey Belousov, who has proposed are fairly illiquid),” the authors noted. net payments of USD12.6bn scheduled a USD7.5bn tax hike for Russian mining, to Q3, followed by USD21.7bn in Q4, chemical and fertilizer companies – For now, as Aleksashenko noted, Russian FX liquidity is becoming hard to come as they are paying lower taxes than corporates are well enough positioned by, particularly for those companies the oil and gas sector – providing an to deal with upcoming maturities and who have most of their revenues additional RUB500bn (USD7.5bn) in dividend payments. “And the current in roubles. tax revenues. account is very strong, so with a free- floating rouble it is not a problem for Government to the Rescue? The plan, which was leaked via an anyone having roubles to purchase FX.” One factor that could exacerbate both anonymous social media account, has problems is recent legislation that was been likened to the expropriations of But without truly committing to economic passed to provide some protection to the post-Soviet years and condemned diversification and carrying out deeper, Russian state-linked corporates that by some of the major business leaders structural reforms, the government risks are either under – or facing the threat in the country. isolating the economy and cutting off of – Western sanctions. the remaining channels of external Meanwhile, as a Raiffeisen bank report funding before it is able to establish In order to support the sanctioned indicated, the HQLA in June was lower an alternative source and mobilize a corporates, the government has scrapped than the FX current account surplus (by sufficiently ample internal reserve. the requirement for large companies to around USD2.8bn) for the first time in repatriate their dollar revenues. There 6 years, resulting in the hard currency are also discussions about creating deficit in the banking sector. This makes Delaware-style “tax-haven” territories it increasingly harder to compensate across the country, which would allow for the systematic shortages created by corporates and individuals to repatriate the corporate sector liabilities, which their capital without significant losses, will only get worse with the removal of and even perform transactions in capital repatriation laws for exporters. foreign currencies and securities without restrictions; these initiatives, “The banks still have a significant admittedly, have been opposed by the share of Eurobonds (around USD51bn) Central Bank. on their balance sheets, but would

50 www.BondsLoans.com Russia, CIS & Europe

Ruble bond holding by Russian banks RUB trn

9.0 8.0 7.0 2.8

6.0 3.2 2.8 2.7 2.4 2. 2.3 2.2 2.3 2.1 2.1 2.0 2.1

5.0 1.8 1. 1.8 1.8 1. 4.0 3.0 46 45 44 45 45 47 48

2.0 41 42 42 42 43 43 44 44 44 45 41 1.0 0.0 1/01/17 1/02/17 1/03/17 1/04/17 1/05/17 1/06/17 1/07/17 1/08/17 1/09/17 1/10/17 1/11/17 1/12/17 1/01/18 1/02/18 1/03/18 1/04/18 1/05/18 1/06/18

Corporate ruble bonds

Source: Reuters

JULY / AUGUST 2018 51 How Serbia Improved its Fiscal Position and Catalysed the Local Capital Markets Branko Drcelic, Director of the Public Debt Administration at the Ministry of Finance, Serbia sat down with Bonds & Loans to discuss how the country moved from chronic deficits to a healthy surplus, catalysing the emergence of a local currency debt capital market in the process.

Q Bonds & Loans: How would you assess Serbia's fiscal position? What tools does the government have in store to deal with pressures, both internal and external?

A Branko Drcelic: We are in a very unique position at the moment, coming from a place where we had deficit of 10% of GDP several years ago to one where we now run a surplus, which has helped strengthen our debt repayment ability. If you look at structure of our debt, 40% is in euros, 20% in US dollars, 20% in Serbian dinars, and the rest in a basket of other currencies.

This is also the first time we have what one could call a thriving local government securities market, and linked to projects. We have very ambitious Q Bonds & Loans: That’s encouraging we are going to focus our borrowing in plans over the next 5 years, and we are to hear. Just a few years ago, Serbia’s the domestic market through Serbian putting in place the necessary steps fiscal position wasn’t nearly as robust dinar benchmark bonds. Next year we to improve the structure of highways as it is today. Can you share some won’t have euro issues on the local and railways, energy projects and other insight into the steps taken to improve market, only dinar bonds. critical infrastructure assets around that position? the country. Last year we issued 3 and 7-year A Branko Drcelic: Successful benchmark notes, now we are looking This year we are buying US dollars on implementation of the IMF programme to do 5 and 10-year issues. Average the market, and will repay EUR1bn – which we completed with high marks, maturity in RSD used to be one year which will mature in December 2018. that was key. It expired in February this around five years ago, now we have We are looking to push dinar debt up year. As you pointed out, at the end of maturities stretched to 3.7 years, so we to 27-28% and decrease the share of 2014 the country’s fiscal situation was are elongating the curve. This is part hard currency debt, reducing our FX pret t y bad, and the first set of measures of a broader diversification strategy exposure. It’s also an important for we implemented was to cut expenditures to decrease the share of euros and improving our credit rating – if we want – cut salaries, transfers to pension funds, other foreign currencies as a proportion to go from BB to BB+, the share of dinar and cut costs of goods and services; of our public debt. Encouraging the debt needs to rise. and on the revenue side we improved participation of non-residents is tax collection through reform of the tax very important because they actively We aren’t too worried about the next administration and the implementation of invest in longer-dated securities. Non- couple of years in terms of shocks or risks, a better system for collection. This vastly residents now hold around 30% of public and in fact see significant opportunity improved the country’s fiscal position. We RSD debt. to improve our fiscal position. Nex t year, also had the benefit of a declining interest gross financing needs will decrease. payments bill. Interest payments in 2016 We have some outstanding credit lines This year it’s EUR4bn, and next year totalled roughly RSD127bn; this year from the World Bank and EIB, as well as EUR3bn, so we’ll have less pressure they will total roughly RSD103bn, and China EXIM, but this borrowing is largely on our debt management strategy. they will fall further next year. This has

52 www.BondsLoans.com helped create more budgetary room Q Bonds & Loans: To what extent do Q Bonds & Loans: What are some of for maneuver. you think exogenous factors like Brexit the Ministry’s medium-term financing or impending global trade wars will objectives? To what extent is Serbia If the macro environment remains positive, weigh on Serbia’s ability to continue looking to raise fresh funding and we are likely to improve the situation apace with the fiscal consolidation diversify its funding base? further, which will help create space to and market development plans? improve salaries and social benefits in A Branko Drcelic: We have a clear view the country. A Branko Drcelic: Let’s put it this in our strategy – borrow in local currency, way: In 2011, when we issued for the borrow in euros, and if you can’t, borrow The IMF recently adopted a new programme first time in USD, Europe was worried in US dollars. But we always need to with Serbia, which will last two or three about its debt levels – and we paid a keep an eye on other markets, like the years, though it’s important to stress it huge price because of the unresolved renminbi and other strategic currencies, isn’t quantitatively-based, there are no situation in Greece. There were times or regions like the GCC – where we have stric t macro figures we need to adhere to; when the market for local debt was developed strong relationships over the it ’s defined around struc tural reform – to completely closed for any new issues, past decade. improve and reform public administration. and as you likely recall, Europe as we knew it then was at risk of breaking Now that we have a surplus, we are a Q Bonds & Loans: How are you down. Now, any Serbian deal in RSD bit more relaxed. But it’s important to encouraging the development of local will likely be a big success because the be ready to tap the market. In 2020, fixed income market? Where do you market is still much more favourable we need to repay USD1.5bn, in 2021, see the most exciting opportunities today than it was at that time, and will USD2bn, so that may be the time we for fixed income investors in Serbia be cheap from a historical perspective. look to alternatives. over the next 5-year horizon? In other words, we can still benefit in the current environment. We are funding energy efficiency A Branko Drcelic: We started issuing projects through deals with German longer-tenor government securities in Serbia is a very small country. There is lots and Japanese development banks. We the local market in order to accelerate of talk about trade wars and rising interest are struggling with some environmental its development. This is very important rates. If borrowing costs rise, of course challenges, but I think as we come in part because banks were the biggest it will impact us, but we have decreasing closer to EU accession, the environment par t of the financial market – and they financing needs, so that will help us. The will become a higher priority, which used to be the biggest buyers of local internal controls and tax administration could make green bonds particularly debt. In 2012, the banks were buying up systems are better now, allowing us to interesting for us in four or five years. to 1-year bills, nothing longer; now they track and reduce expenditure. More fixed are buying everything up to 5-years. control. More fixed spending. So net for net, we are in a better position to respond We stopped issuing 1-year bills and to some risk factors. started placing 3 and 7-year notes. The 3-year is yielding around 3.4%, Serbia ield Curve Sep 5-year around 3.85%. To put this in perspective, 3-month bills in 2009 were Serbia Government Bonds yielding 18%. Our outstanding USD 5% 7-year was 12% in 2015 first quarter. 4.5% This helps local banks lend longer-term 4% to local corporates. The borrowing costs in RSD is now very low for many 3.5% corporate borrowers. Same in EUR. It was very important when we designed 3% these benchmarks issues that it was directly reflected into the local credit 2.5% markets, including the banking sector. In 2 4 6 Residual Maturity the past, some larger corporates would struggle to manage their FX exposure Serbia (3 Sep 2018) 1 ago ago because of a lack of suitable hedging Rating Agency Rating Outlook Interest Rates instruments or local currency options. Standard & Investors Service BB Central Bank Rate 3.00% Now, there are sufficient instruments Moody's Investors Service Ba3 on the local market. There is space to Fitch Ratings BB further reduce the cost of borrowing in dinars, but it may be challenging given Source: Bloomberg the oligopolistic nature the market.

JULY / AUGUST 2018 53 Asia Corporate Borrowers in India Stuck Between a Thin Bond Market and Tightening Banks

orporate borrowing in India is set to get a lot more challenging as investors search for higher coupons and banks tighten up their Clending practices following a build-up of non-performing loans, according to analysts. It is unclear whether even the country’s largest corporates are immune to the sandwiching of rising interest rates and a banking sector in flux.

In Q2 2017, India’s bond markets offered among the highest real interest rates in the emerging world, stoking strong interest among global fixed income investors and enticing a wave of hard and local currency issuances. Much of that took place against a backdrop of low inflation and relatively stable interest rates, with a global glut for yield fuelling record demand for emerging market assets.

The Difference a Year Makes According to analysts at Maybank, the past few months widened to 75bp Yields on 10-year government bonds regional outflows are largely being on average at the 10-year end of the shifted upward from roughly 6.5% in June driven by monetary policy tightening curve, and up to 100bp in some cases, 2017 to peak at just under 8% (7.99%) in in Europe and the US, coupled with the compared with an average of 50bp early June 2018, settling back down to ECB’s stated balance sheet reduction during the same period last year. 7.87% later that month. The Reserve Bank ambitions and a more hawkish view of India, the country’s Central Bank, hiked emanating from the US Federal Reserve. The pernickety non-performing loan interest rates 25bp to 6.25% in early June But the RBI’s tightening action has crisis currently embroiling the country’s after being kept at 8-year lows in order to seemingly failed to stem a rout on lenders is adding fuel to the fire, with tame inflation, which jumped from just the rupee, which could intensify if NPLs likely to worsen to more than 12% under 1.5% in June 2017 to just under emerging market investors strengthen of all outstanding loans by March 2019, 5% by mid-2018. their defensive positions or remain a rise from 11.6% the same time this unplacated by the country’s (and its The rupee fell to INR69.09 per USD, an companies’) growth prospects. all-time low, that same month, driven by a stronger US dollar, higher oil prices and Widening Spreads Asia foreign portfolio outflows – weighing on Corporates looking at the bond market the country’s precarious current account for recourse have seemingly held off, 54 balance. Year to date, foreign portfolio in part due to rising costs. Corporate Corporate Borrowers in India: Stuck Between a Thin Bond Market and investors have dumped about USD4.2bn bond sales – which in India mostly take Tightening Banks in stock s and bonds, par t of a wider selloff place through private placement – fell of Asian assets; foreign investors sold 63% through April and May this year 57 USD3.8bn worth of bonds in India, Thailand, alone, according to official statistics. Green Sukuk: The Nexus of Islamic South Korea, Malaysia, and Indonesia last Finance and ESG month alone, and of that, Indian bond Spreads between Indian government outflows accounted for USD2.9bn. bonds and corporate debt have over

54 www.BondsLoans.com Asia

more pressure on corporates in the near term. The agency estimates borrowers in the BBB, BB and B categories are likely to have total financing needs of roughly INR1.4-1.7tn (between approximately USD20.1-24.7bn) in fiscal year 2019.

Banks operating under the revised Prompt Corrective Action Framework, which imposes stricter risk profiling for banks and has led to tightened lending in some cases, are also at risk of exacerbating the funding challenges of these entities.

“The impact will also vary by sector. Sectors such as infrastructure, logistics and real estate – which are categorised by modest cash flows and a high proportion of borrowers in the sub-investment grade – are likely to face further challenges in mobilising additional financing from the system or even refinancing loans running down,” he explains in a recent report.

“On the other hand, players in the oil & gas sector, metals and mining, asset financiers and automobile are likely to be less affec ted – driven mainly by their strong/improving credit profiles and relatively robust cash flows.

An elevation in working capital needs – year. Gross non-performing loans on Refi Challenges Could Weigh driven in part by the recently introduced the books of public sector lenders, Further on Growth GST – is likely to combine with an adverse which control about 70% of all banking Against that backdrop, borrowers are external and business environment to assets, are forecast to jump 0.7% being squeezed by a confluence of fac tors increase the need for further funding to 15.6% during the same period, ranging from a volatile external and for small and medium sized businesses. according to official forecasts. domestic interest rate environment But with a sizeable shift among some to a clampdown on borrowing among of the larger borrowers away from the On the plus side, analysts agree that some of the nation’s largest lenders, increasingly costly capital markets since the Insolvency & Bankruptcy explains Soumyajit Niyogi, an associate towards the domestic loan market Code (IBC) – the flagship framework director at India Ratings & Research. manifesting, analysts aren’t sure put in place to recognise and resolve whether SMEs will face a crowding out. distressed assets – was enacted in “While we don’t expect the environment 2016 and more recently a series to pose much of a problem for some “ We are seeing a significant slowdown of capital infusions (to the tune of of the nation’s larger blue-chip in capital market volumes year on year, INR2.1tn) for banks, the bulk of the companies, we expect a sizeable owed in part to the rising cost of the distressed assets on banks’ balance portion of smaller companies could bond market,” explains Jayen Shah, sheets have already been recognised. be affec ted – par ticularly BBB, BB and Executive Vice President and Head B credits,” Niyogi told Bonds & Loans. of Debt Capital Markets at IDFC Bank. This isn’t to suggest that the problems these assets cause for the country’s The rating agency believes many of these “Many of these borrowers are being put lenders are well behind them, but companies will be forced to borrow in off by rising cost s in the capital market s it’s important inflection point in a order to finance higher input costs – owed and turning to their relationship banks much longer narrative. Admitting in part to an adverse FX environment for capital, but when that is combined to (the full scale of) the problem is – and GST-related changes. But the with the additional pressure on banks the first step towards solving it, the challenges – in terms of cost of funding given the scale of the NPL challenges saying goes. and available liquidity – is likely to pile they are facing – and subsequent impact

JULY / AUGUST 2018 55 on how these banks lend going forward, India: Annual Change in GDP we could see smaller companies down Annual % change in GDP the curve squeezed out of the market.” 10 Silver Lining: Priority Sector Lending and NBFCs 8 Companies down the credit curve - as well as smaller and medium-sized 6 corporates -aren’t completely shut out of the market. Non-bank financial 4 companies or NBFCs are playing a much more pivotal role in financing these 2 entities than ever before. 0 Compared with traditional domestic 2012 2013 2014 2015 2016 2017 2018 lenders, which would be pleased with high single-digit asset growth, NBFC Source: FT, Bloomberg loan books are reportedly set to grow at roughly 19-21% in 2019 according to ICRA, a rating agency. They are also These include agriculture (at least 18% gains pace, corporate borrowers will no increasingly involved in unsecured of loans), micro and small & medium- doubt find crucial windows through which lending, which for the rights sums sized enterprises (at least 7.5%), export to navigate their entry (or re-entry) to puts them in direct competition with credit, education, housing, social the markets – at least in the near term. banks and the capital markets. infrastructure and renewable energy. That’s not to say these loans aren’t The real challenge going forward, Niyogi “NBFCs have also become more involved commercially driven – they have to make says, is that wage and employment in the capital markets for fundraising sense from a bankability perspective growth is being outpaced by credit over the past six months,” said one – but it means that, by Niyogi’s count, growth, which – if the current pace of Mumbai-based banker. “We have 4 up to 20% of companies that would economic growth continues – could firm mandates at the moment and are have otherwise struggled with fast- become problematic down the line. waiting on the sidelines for the market to approaching maturities and rising provide a window [for issuing]. So they are working capital costs should still be “A lot of the focus on asset growth at these providing additional deal flow at a time able to access cost-competitive funding. banks has been placed on corporate when others are looking more closely banking, and the mechanisms being put at the bank market, and their funding Stressed assets related to the SME in place to avoid distressed debt appear will have a direct positive impact on segment that fall outside of priority to be sound and functioning correctly. growth through on-lending to medium sector lending could add 1-2% to gross and smaller-sized companies.” NPLs over the next few years, depending The question is whether economic on the bank and the stage of the loan growth is really keeping pace with The other countervailing force at work cycle they find themselves in. credit growth – that’s more of an here is the priority sector lending open-ended question, and something mandate, which requires banks to GDP Growth Lagging that could become an issue over the allocated 40% of net credit to sectors As the external environment stabilises nex t five years if the economy doesn’t deemed to be in the strategic interest along with domestic inflation and interest see a noticeable uptick in growth,” of the economy. rates, and as the banking sector clean-up he explained.

PSBs NPL ratio development Private banks NPL ratio development 14 14 12 12 10 AQR 10 8 8 % % 6 6 4 4 2 2 0 0 F11 F12 F13 F14 F15 F16 F17 F18 F11 F12 F13 F14 F15 F16 F17 F18 Gross NPL ratio Standard restructured loans Gross NPL ratio Standard restructured loans Source: Company's data, Moody's, ING

56 www.BondsLoans.com Green Sukuk The Nexus of Islamic Finance and ESG Despite Indonesia's reputation as a heavy emitter of greenhouse gasses, the Sovereign green sukuk was hailed as a game changer for both Islamic and ESG investing. Luky Affirman, Director General of Budget Financing and Risk Management, Ministry of Finance, Indonesia believes its inaugural transaction in February is the first of many to come as the government looks to double down on its commitment to climate change mitigation.

Q Bonds & Loans: Can you give us we looked at every project closely, and level, it was challenging. After we issue a sense of the strategy behind the identified ones that qualified as ‘green’. either sukuk or conventional bonds, our green sukuk? What were the key We collaborated with UNDP throughout obligations tend to be quite minimal, drivers for moving down the green this process, and we concluded that and concentrated within the Ministry route over traditional fundraising securing green financing would actually of Finance itself. Now, for green alternatives, and what were some be much easier once the projects were sukuk or green bonds, strong cross- of the key steps taken in the run-up already developed. The next step was governmental coordination is required to the transaction? to complete the green bond and sukuk from the outset to identify projects framework, a set of guidelines for how we and ensure their green qualification, A Luky Affirman: We really were design the kinds of projects that qualify and after the issuance, we still need aiming to kill two birds with one stone. for these instruments, the processes to coordinate on data collection and Indonesia has ratified the 2015 Paris used to determine qualifying projects, reporting. Coordination for reporting Climate Agreement and has been trying the reporting of use of proceeds and the is supremely important because we to steer its activities in line with this impact of those investments. We felt the rely on other ministries. But the good framework. Indonesia was the first framework needed to be reviewed by news is that the entire government developing country to voluntarily pledge an independent auditor, and engaged is strongly committed to its climate to reduce Greenhouse Gas emissions Norway-based Cicero to achieve this. change mitigation obligations, and we at COP 15 in Copenhagen in 2009. They assessed our framework and gave are unified in terms of the vision we us a ‘medium green’ status, a status are striving towards, so buy-in wasn’t At the same time, we are always looking conferred to projects and solutions that a challenge in itself. to generate more innovative approaches constitute important steps towards a to financing, to create new benchmarks longer-term vision. I am optimistic about we can proceed for borrowers in the country and to tap with this strategy. The first transaction into new investor bases. Combining At this point, we were finally in a position is always the most challenging one, but these two key objectives, we explored to issue green instruments. Now, green with the infrastructure and processes a range of funding options and came bonds have been done before. But now in place, it will become much easier up with a plan to issue a green bond. green sukuk, for sovereigns, had never going forward. As a fairly frequent sukuk issuer, we really been done before. That made also began to see some interesting it challenging for us in the sense that Q Bonds & Loans: As this was a first for similarities between sukuk and green we weren’t sure whether the offering Indonesia, what was the government’s bonds, particularly in terms of their was interesting or compelling enough experience developing its own ethical underpinnings, so we began for investors. Were they going to take reporting capabilities in relation to speaking with our colleagues and funding a gamble on the first instrument of its the use of proceeds? What kind of partners about whether it would be kind? We worked closely with our joint impact reporting has the government possible to integrate the two. lead managers, and it turns out the committed to as part of this transaction? response was very strong. It has been a long and challenging journey. A Luky Affirman: We borrowed When we began the budget tagging Q Bonds & Loans: What was the techniques and strategies from those process almost two years ago, which process of getting buy-in from the we’ve observed in the months running included aligning the Ministry of Finance, various ministries like? up to the transaction but we are still the National Development Planning surveying more standardised formats Agency (BAPPENAS) and the Ministry A Luky Affirman: Getting buy-in for reporting. This raised important of Environment and Forestry, where wasn’t a challenge, but on an operational questions for us. For instance: Should we

JULY / AUGUST 2018 57 be securing the expertise of an external where climate change is influenced by new investors, many of them dedicated auditor like PwC or EY? Or should we specific variables in relation to those ESG fund managers. Going forward, be looking at more specialist auditors? projects: exposure, sensitivity and once the market becomes more stable, What kind of capacity do we need to capacity of the ecosystem. We will we would like to see some positive develop across different ministries? make this available in an annual report. feedback on pricing.

We are still developing our internal Q Bonds & Loans: What were Another benefit is that we’ ve managed reporting capability in conjunction with your expectations on pricing and to open the gates for private sector UNDP, which helped us established the distribution? Do you think the fact that borrowers to issue ESG-focused initial framework. We have committed it was a ‘green’ issuance change either transactions – we have seen two so far, to specific uses of proceeds, which were of those aspects of the transaction? one issued by Sarana Multi Infrastruktur mainly for projects related to land use in July, and OCBC NISP in August. change and forestry, including peat A Luky Affirman:The main goal was fires and energy, as well as waste to expand our investor base, and the Q Bonds & Loans: Given that this management. New fossil fuel based theory was that with more investors, the was the first green transaction, what electric power generation capacity, large- price would be compressed downward. were some of the key learnings you scale hydropower plants and nuclear We went to the market in February, found throughout – from origination and nuclear–related assets will not be did the roadshow in early January, and to execution – and what advice would eligible under the framework. Fossil just before we issued pricing guidance, you give to debut green borrowers? fuel infrastructure is excluded from the markets became very skiddish. We eligibility for energy efficiency projects. needed to wait a few weeks before we A Luky Affirman:This is a long-term found the right window to execute. So we journey, so commitment combined with We are committed to tracking how the didn’t see a big difference one pricing, leadership is key. If you have this in sukuk proceeds make their way into but I think that was largely because of place, coordination across government qualified projects, as well as the impact. the tough market conditions at the time. and systems and process integration For adaptation projects, for example, a becomes easy. Finding the right partners Resilience Index Information System was But if we look back to our overall objective is also essential. We have great partners developed by the Ministry of Environment of tapping new investors, we were quite and banks that understand both the and Forestry, which measures resilience successful. We managed to attract 39 green and sukuk markets.

58 www.BondsLoans.com PANTONE PROCESS BLACK C

PANTONE 3285 C