Deal of the year: HSBC

Risk Awards 2018: How a $2bn repo helped solve Egypt's currency crisis

Christian Deseglise
Christian Deseglise, HSBC

Sugar was in short supply, rice and cooking oil more expensive, and the people – as one citizen told the New York Times – were ready “to snap”.

This was Egypt 12 months ago, as a shortage of US dollars forced importers into the ‘grey’ market for foreign exchange, where the unofficial rate was almost double the official, pegged exchange rate.

The ministry of finance and the Central Bank of Egypt were seeking $12 billion from the International Monetary Fund, but to get it they would have to close an existing financing gap, and boost reserves to cope with the liberalisation of the Egyptian pound – a condition of any IMF package. HSBC solved the problem via a $2 billion structured repo trade.

“It was a very important transaction for us,” says ‎Tarek Amer, governor of the central bank. “The situation was difficult, but that was when HSBC came to us with the idea for a reverse repo transaction. The turnaround of the situation since then has been, I think, unprecedented.”

The repo transaction was executed – and syndicated – in early November last year. IMF support was announced a day later.

After the peg to the US dollar was removed, the Egyptian pound lost almost 50% of its value against the greenback in the immediate aftermath and has since been trading at around 17 pounds to the dollar. The devaluation produced a very big spike in inflation – which surged to over 30% in November 2016 – but the shortage of foreign currency in Egypt quickly abated.

The central bank’s foreign currency reserves rebounded to new highs of more than $36 billion this year – having dipped to $15 billion in 2016. Subsequently, the bank has lifted a raft of restrictions that were introduced when dollars were in short supply, including limits on foreign exchange transfers, the use of debit and credit cards abroad and controls on the repatriation of dividends by commercial lenders. In a sign of investors’ returning confidence in Egypt, the central bank claims there has been more than $80 billion in currency inflows from offshore and onshore investors since the flotation of the Egyptian pound in November 2016.

This chain of events would have been difficult without the deal HSBC put together.

The governor told us jokingly several times that this was really to reduce his blood pressure at the moment of the flotation, so he’d sleep better at night knowing there was an additional $2 billion
Christian Deseglise, HSBC

“It was extremely helpful for them,” says Christian Deseglise, global head of central banks and co-sponsor of sustainable finance at HSBC in New York. “I’m not sure what would have happened without that – most probably the IMF would still have approved the package – but it was definitely a critical element at a critical time.”

Prior to the repo, the central bank had been able to plug two-thirds of its $6 billion financing gap bilaterally through loan agreements reached with other central banks, most notably the People’s Bank of China. However, with food prices rising and public anger growing, Egypt still needed to raise a further $2 billion – partly because the IMF does not like lending to countries that are in arrears on existing debt, and partly because Amer wanted a bigger cushion to deal with the flotation of the currency.

“The governor told us jokingly several times that this was really to reduce his blood pressure at the moment of the flotation, so he’d sleep better at night knowing there was an additional $2 billion,” Deseglise says. “So those were the two most important consequences of the transaction. First to bridge the financing gap, and second to give them the ammunition to free-float the currency.”

Sourcing that ammunition would be difficult, however, for a country that had spent a long time absent from international capital markets following the Arab Spring revolution in 2011. HSBC’s solution drew on a deal it participated in to help Argentina, when the Latin American country had been in a similar situation.

The bank proposed a one-year term syndicated repo transaction in which it faced the Central Bank of Egypt as the sole arranger, with the financing to be collateralised with US dollar bonds issued by the sovereign. Some tweaks to the standard reverse repo template were required though, given the lack of appetite for Egyptian sovereign exposure at that time.

Recovery rates were enhanced, for instance, by over-collateralising the deal. If there was a default on the repo, this provision meant lenders would have access to $4 billion of collateral, rather than an amount equivalent to the $2 billion that was lent. As an additional level of security, the transaction included a bespoke cash-margining arrangement based on the nature of the collateral. This meant if the things began to go wrong banks could begin deleveraging through the margin payments being received.

Vinay Raj
Photo: Geraint Roberts
There is no point in raising the funding at the cost of making access to the public markets more difficult in the future
Vinay Raj, HSBC

“What we wanted to do was create a transaction that would enhance the credit of the borrower without them having to provide a form of collateral they didn’t have at that time to provide,” says Vinay Raj, managing director and head of financing solutions for global markets at HSBC in London. “The [overcollateralisation and cash margining] gave enough comfort to the lending bank group to raise the necessary financing for the deal.”

Importantly for the Central Bank of Egypt too, a repo transaction would not negatively impact the yield curve of the sovereign in the public debt markets in the way a bond issuance might.

“There is no point in raising the funding at the cost of making access to the public markets more difficult in the future,” Raj adds. “So we needed to source it outside of the bond investor base so they will still have access to those investors once the programme has been completed or implemented. And this was the best way to generate enough interest from the banking group at a time of extreme uncertainty and difficulty.”

A significant hurdle had to be overcome in order to make the collateral provisions work, however, as Egypt did not hold the eurobonds that would be needed to secure the proposed transaction. To get around this, the ministry of finance agreed to issue $4 billion of sovereign bonds, which were transferred directly to the central bank.

Transferring the newly issued bonds from the ministry of finance straight to the central bank was not entirely straightforward, since the proximity of the two institutions could raise a question as to whether the bonds had actually been issued at all. A lot of work was required by the central bank, the syndicate and their lawyers beforehand, therefore, to ensure there was a clear accounting mechanism between the two entities, and legal clarity on whether the bonds had been issued properly.

Just two months after discussions between HSBC and the Central Bank of Egypt began, the repo was executed in early November 2016. Once this was done there was one further innovation. HSBC, along with the other syndicate banks, distributed part of the risk to investors. This resulted, the bank says, in the creation of an entirely new market for structured sovereign assets.

One year on, the policy decisions HSBC’s deal facilitated appear to have achieved all their objectives.

Deseglise and Raj do not go so far as to say the deal HSBC put together saved the Egyptian economy. The credit for that, they say, should go to the government and the central bank for their bravery in taking a painful, but necessary, package of financial reforms. They are, however, proud the financing played an important part in making those reforms feasible.

“The message of confidence sent by having some of the largest and most reputable financial institutions in the world backing the country when they were embarking on a very ambitious programme of reform was very well received. It was a big mark of confidence from the international banking community,” says Deseglise.

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