LatAm corporates eye China for bonds and swaps

Latin American firms are eyeing up the dim sum bond market after America Movil’s debut issuance in February. Other avenues for investment between China and Latin America, such as currency swap arrangements, are also in development

China is dancing to a Latin beat

America Movil usually only makes waves outside its Mexican home market when the global rich lists are published and its owner, Carlos Slim’s, billions are totted up. But news in February that the telecoms firm had become the first Latin American firm to tap Hong Kong’s dim sum bond market, if not overshadowing the mogul’s $49 billion fortune, drew temporary attention away from it.

The sum involved was small: some 1 billion yuan ($160 million), with demand double the amount on offer, but with increasing financial ties between Latin America and China the future significance was large. 

The offshore renminbi market only started in July 2007, when China Development Bank completed the first issuance for 5 billion yuan. Since then, its growth has been healthy, with 116 issuances totalling 180 billion yuan and around 580 billion yuan held in deposits, with research outfit Chatham House predicting the market could be worth up to 7 trillion yuan ($1 trillion) by 2020.

According to Katia Bouazza, co-head of global capital markets for the Americas at HSBC Securities, which was the sole bookrunner on the deal, the move by Movil fitted the pattern of previous moves into offshore RMB issuance by other firms.

“The issuers that use this market are looking at a way of diversifying funding and the investor base. For issuers, this gives them a market to complement the markets they are currently using. For the time being, it is an attractive addition to other sources they have,” she says.

And it’s most attractive for international firms looking to expand business in China. With no need for the higher level of liquidity in more established offshore bond markets and with restricted growth opportunities in developed markets, companies such as America Movil see the dim sum market as providing a strategic foothold for expansion into the Chinese mainland, something arguably more important to their medium- and long-tem business models.

“This issuance in renminbi allows America Movil to access an important investor base while using proceeds for payments for their Chinese vendors,” says Bouazza. “This is also a new market with high relevance and growing importance, and therefore it makes sense for the company with interests in China to further diversify its funding sources and investor universe in the CNH [offshore renminbi] market.”

Over the last decade, total trade levels between China and Latin America have rocketed, growing on average by 32% a year and currently amounting to 6.6% of China’s global trade flow. China’s biggest trading partner in Latin America is, unsurprisingly, Brazil, the region’s biggest country, while China became Brazil’s biggest global trading partner last year. Exports to China grew by 44% in 2011 compared with 2010, and account for 16% of Brazil’s total trade, worth around $77 billion. As such, the most obvious candidate to step up next for issuance in the dim sum bond market is mining major and iron ore provider Vale, for whom China constituted some 32% of revenues in 2011 – Brazil itself was responsible for only 18% of Vale’s 2011 revenues.

“One could expect that some Brazilian companies like Vale might follow America Movil’s lead into the dim sum bond market,” says Alberto Bueno, managing partner with Brazil-based policy and regulation consultancy firm Prospectiva. “Embraer is another likely candidate. Nevertheless, market conditions are changing quickly and I would not know if, at this precise moment, it is financially interesting to issue debt in renminbi rather than in USD, even if you consider hedging costs to pay a Chinese supplier in renminbi. In any case, America Movil’s issuance was small compared with Vale’s latest global bond issue of $1 billion last month. Thus, Vale could flirt with the dim sum bond market as a symbolic move to please Chinese authorities.”

For aircraft manufacturer Embraer, annual 2010 results show that North America’s revenue contribution fell from 43% in 2008 to 13%, while Asia-Pacific now constitutes at least 22% of their business. Embraer forecasts delivering 1,885 new aircraft to China alone by 2020. This compares with 2,585 to the rest of Asia and around 3,000 to Europe and 3,400 to North America. Oil major Petrobras, which currently exports between 200,000 and 220,000 barrels of heavy crude oil a day to China – roughly 10% of its total output – also stands out as a company with a potential interest in taking advantage of the huge mainland market possibilities.

Vale declined to comment on the possibility of a renminbi issuance when approached by Asia Risk. Embraer had not responded by the time this article went to press. Even though Petrobras chief financial officer Almir Barbassa said recently that the company was watching for opportunities to issue bonds in the Japanese yen, with regard to tapping into the dim sum market Petrobras would only say it was “always evaluating alternative sources to raise funds”.

Bouazza believes the dim sum market will grow in importance as China develops its trade and business relations with Latin America. “If an issuer wants to have visibility in China, then they will look at the market. We have to be very clear that this is not a market that competes with the dollar market. It’s very different in terms of size, volume and tenoring, so it has to make sense to the issuer in terms of doing business in China or using it as a strategic way for building an investor base and increasing visibility in China.”

“I don’t think it is a pipeline where everyone is lining up – you need to match investors’ demand with issuers’ objectives, both in terms of maturity and in terms of plain vanilla or more complex issuances,” she adds.

Swap service

Issuing in the dim sum market is not the only way to access local currency in capital controlled markets – the other is a currency swap arrangement, which facilitates bilateral trade, hedging out foreign exchange risk and providing the cash to conduct business in a foreign territory. And there could be potential movement in establishing such an arrangement between Brazil and China.

February ushered in the start of a dialogue between the China-Brazil Business Council (CEBC), based in Brazil, and major Chinese financial institutions on establishing a currency swap arrangement between China and Brazil.

The mechanics of the arrangement are much the same as with an interest rate swap: agreeing to swap an amount of cash at a set exchange rate over a set period of time. The key discussion opened by the CEBC in February was the possibility of establishing such an arrangement between China and Brazil.

“I interviewed the president of the Bank of China to talk about the internationalisation of the renminbi. What Chinese banks in Brazil and the Chinese government are talking about is a swap service, using renminbi and not using dollars,” says CEBC’s André Soares. “It is a new subject and Brazilian companies want to know more about it and we are talking with firms on their thoughts on the issues, whether they are thinking about swaps or trades in renminbi.”

An industry insider who preferred to remain anonymous expanded on why currency swap arrangements would appeal to major Latin American firms.

“It will depend on which sectors the companies are from, whether they want a currency swap or to raise money through bonds. If they are commodities exporters, they will receive a lot of renminbi and they need something to do with the renminbi. Or they will engage in buying or importing things with this money, or buying shares in funds or bonds – because somehow this money has to flow back to China. I don’t think Latin American firms will be interested in saving in renminbi just because of the currency appreciation,” says the source.

“If you are a company only doing business with China, importing/exporting, then a currency swap is more suitable because you reduce your transaction costs. The only thing is you do need something to do with the renminbi, and what companies do with this will vary depending on their business model,” the source adds.

Since 2008, China has signed bilateral currency swap agreements with 16 countries. Although there remains an absence of further detail, China announced a deal in principle with Japan in December last year and at the end of February a three-year swap with Turkey worth $1.6 billion.

On this, Argentina was actually Latin America’s pioneer, signing up with China in 2009. With the world currently awash with dollars following two rounds of quantitative easing and close-to-zero interest rates from the US Federal Reserve, Philip Wee, senior currency strategist at DBS Bank in Singapore, points out the short-term reasoning for countries signing up to these agreements.

“The bilateral currency swap arrangements emerged strongly after the 2008/09 global crisis. The crisis demonstrated the real risks that shortages in USD liquidity posed to world economic, trade and financial activities. For emerging markets, there is the post-crisis motivation to reform the international financial system by reducing reliance on the USD in an increasingly multi-polar world economy,” he says.

“While China had plenty of dollars in its reserves, its major trading partners did not have the dollars to complete trade transactions. This was probably a key motivation behind the push to promote more renminbi-denominated trade settlements in recent years. Now, the issue is what will happen when the US begins to tighten its monetary policy. We think the US consolidation process will start next year after the presidential elections and countries are concerned there will be a sudden withdrawal of dollar supply. The availability of liquidity is no longer as reliable due to US/EU deleveraging,” Wee adds.

Point of discussion

Given the recent fiery rhetoric from Brazil’s president Dilma Rousseff and finance minister Guido Mantega about taking all available measures to combat the perceived damage of quantitative easing to Brazil’s domestic industry, using a currency swap to remove the forex risks that a weak dollar poses to the Brazilian real would be one such measure.

With the discussions underway over such an arrangement, the foundations are starting to be put in place and the benefits to Brazilian firms should be sufficient to eventually ease any qualms over such an agreement, even if CEBC’s Soares admits there is a long way to go in the process.

“This is really only just starting now. The Bank of China has only been in Brazil since 2010 and only started operating last year. They came over, helping companies like Petrobras and Vale to do business with Chinese companies, but this swap issue is still very much in discussion. China has tried to come up with a letter of agreement over a currency swap with the Central Bank of Brazil and the government, but there is still a lot of detail to be discussed,” says Soares.

Despite certain grumbles between China and Brazil – the latest spat being accusations that China’s ban on Vale’s giant iron ore ships docking in Chinese ports are more about protectionism than logistics – Latin America is a major target for China, as DBS Bank’s Wee makes clear. “Within emerging markets, China’s Ministry of Commerce considers Asia and Latin America as the engines driving growth – they were the top two overseas direct investment destinations in 2010,” he says. “Latin America is emerging as one of China’s fastest growing trading partners. Between 2000 and 2010, total trade between China and Latin America increased 14.5 times versus 7.4 times between China and the Association of Southeast Asian Nations.”

So what of the future for the renminbi? How far off is the day when it challenges the dollar as the world’s reserve currency?

“It’s hard to have the vision right now that the renminbi will challenge the dollar, certainly in the next five years or so,” says HSBC’s Bouazza. But according to DBS’s Wee, China has its eye on a specific short-term milestone.

“China is hoping that these efforts to internationalise its currency, by promoting its use for both trade and investment purposes, will help it achieve its goal for the renminbi to become part of the IMF Special Drawing Rights basket of currencies at the next IMF review in 2015,” he says. This basket currently consists of the US dollar, euro, sterling and yen.