Looking beyond the World Bank debt study

Building a sustainable and efficient government funding programme is one of the keys to stability and growth for any country.

But to achieve an appropriate balance between domestic and international borrowing, a country’s debt managers must have a full range of options open to them. Getting there is not always easy.

A recent report from the World Bank titled “Why are more sovereigns issuing in Euros? Choosing between USD and EUR-denominated bonds” offers some interesting insights into the different motivations that help shape a country’s international debt issuance.

What particularly interests me is that it puts the spotlight on three Latin American countries – Peru, Chile and Mexico – where Euroclear has had a role in helping develop international investor interest.

The study asks the question why more sovereigns are issuing in euros, but it could just as easily have asked what these countries are doing to diversify their investor base and maximise the range of funding options open to them. Increased issuance in euros is only part of the story.

Peru is a good example. The country has been working to reduce its dependence on dollar borrowings for a decade or more. Yet, while there was a major euro-denominated issue in 2015, it was only partly about sourcing new funding.

A secondary objective, says the World Bank study, was to reach a broader base of investors. And that was seen as a prelude to the main event – getting investors into local currency (Nuevo sol) bonds.

Historically, the domestic Nuevo sol market was illiquid. There were also legal and logistical obstacles for any foreign investor, with respect to participation, asset protection and transparency.

As from 2014 onwards, Euroclear worked with the Peruvian authorities to achieve the reforms needed to make the local currency bond market ‘Euroclearable’. The reforms were completed mid- 2017 and the first Euroclearable bond was issued in July 2017.

This PEN 10 billion bond was oversubscribed three times, and had a higher liquidity in the local market.

The increase in the liquidity and a 70% participation by international investors, prompted an increase of the Peruvian local currency bonds in the JPM Bond Index by 41 bps.

Mexico has worked hard since the Tequila crisis of 1994 to reduce its dependence on international debt. As the study makes clear, some four-fifths of all government debt – which has long been Euroclearable – is now denominated in pesos.

But Mexico has still issued euro-denominated debt. Why? One reason according to the World Bank is to ensure its international debt is included in the relevant international bond indices.

Inclusion in the bond indices increases the international investor participation and reduces the yields on the debt.

Since the corporate debt follows the yield curve of the government debt, a decrease in the government debt yields actually helps corporates in reducing the cost of borrowing. With this as an objective, the Mexican market authorities wanted to make their corporate bonds (Cebures) Euroclearable, starting with Pemex, the state owned oil giant.

Euroclear worked with the Mexican authorities to make the Cebures Euroclearable. When PEMEX, as the first big Mexican corporate issued their premier Euroclearable bond beginning of 2015, they saw the liquidity jump up by 300%.

The result inspired the Bank of America Corporate Bond Index to include settlement in Euroclear as a criteria for inclusion in their bond index and subsequently the PEMEX issuance became part of the BAML Corporate Bond Index.

In Chile’s case, the study notes that the country aims to limit FX borrowing to 20% of the government debt portfolio and has been issuing in euros since 2014.

But just as importantly, it wants to reduce the proportion of inflation-linkers within its domestic debt down from 65% to 50% of the total.

One way of achieving that is to attract more international investors into the local bond market. Again working with Euroclear, the Chilean authorities have overhauled elements of the tax and regulatory framework to make them more foreign investor-friendly.

As a result, the local government bond market became Euroclearable a year ago. The first Euroclearable government bond that was launched saw record foreign investor participation jump from 5% to 20% and a growth in liquidity by a few times. Chile’s weighting in the J.P. Morgan local currency bond index subsequently rose from 0.1% to 1.34%.

These three examples go some way to demonstrating the complex issues countries have to deal with, and the role Euroclear can play in helping solve them. This is no small matter.

Broadening and deepening a country’s capital markets, and creating the conditions in which foreign portfolio investors feel comfortable investing, can create its own virtuous circle – reducing long-term government borrowing costs, providing new headroom for development spending and making it easier for entrepreneurs to raise capital and create jobs.