Where are the Latin American Borrowers in Renminbi?

Latin Finance, September 2015

Back in February 2012, when America Movil launched a RMB1 billion (US$158 million) three-year bond in the so-called dim sum offshore renminbi market, it was supposed to herald a wave of issuance in the Chinese currency from Latin American borrowers.

For a short while, it looked like that’s what would happen. Later that year, Banco Santander Chile raised RMB500 million in two-year paper to become the first Latin American bank to approach the dim sum market; the first letter of credit in the Chinese currency came for a Peruvian retailer through Citi the following year; and the development banks, CAF and Cabei, approached the market alongside Brazil’s Banco BTG Pactual and Banco Bradesco.

But that’s it – 11 tranches in the history of the market, worth less than $1 billion between them, and only Cabei in the last two and a half years. It has not been the onslaught debt capital markets bankers had hoped for.

Could that be about to change? In May, Chinese premier Li Keqiang met with Chilean president Michelle Bachelet and while there, named Santiago as the first offshore RMB hub in the region, and only the second in the Americas. The People’s Bank of China and the Banco Central de Chile said they had signed a memorandum of understanding to make China Construction Bank Chile the clearing bank for RMB in Chile, and perhaps elsewhere on the continent.

Perhaps this is the spur that will prompt Latin American issuers to start looking at the currency in earnest? To answer that, it is first useful to understand why issuers aren’t more active.

The first thing to point out is that the America Movil deal back in 2012 was something of a one-off. It reflected a coincidence of interests with the Chinese telecom group Huawei. America Movil was doing more and more procurement of network equipment from Chinese exporters, chiefly Huawei, and it made sense for both sides to pay them in the Chinese currency if possible. It reduced currency risk for the exporters, and allowed America Movil to negotiate better terms. “The reason America Movil decided to take the plunge was Huawei being able to offer a discount of some sort if they were paid not in dollars but RMB,” recalls Tim Yip at HSBC, which was a bookrunner on the deal. “But it’s not every day you have an $80 billion market cap company looking to issue debt in China.”

Other deals would only make sense if they were supporting financial activity, and that has not often been the case yet.

“For the RMB to become trade nationalised it would need to go through phases: first being used as a trade settlement currency, then as a financing currency,” Yip says. “At the moment Europeans are using the RMB as a financing currency, and that is why we are seeing repeat issuance from Volkswagen, from Bosch and from Siemens in RMB, or from Caterpillar and other repeat issuers in the US.

“In Latin America, though, people are still stuck in phase number one, the trade settlement stage.”

For others, it’s just about the numbers. Corporacion Andina de Momento (CAF), the Development Bank of Latin America, launched a three-year RMB600 million deal through Standard Chartered and HSBC in December 2012, one that was twice oversubscribed and considered a success. But it’s about to expire. Why haven’t there been more? “We’ve always been keeping an eye on the market,” says Gabriel Felpeto, Director, Dirección de Políticas Financieras y Emisiones Internacional, at CAF in Venezuela. “But the size and the volatility in the swap market has resulted in the after-swap cost rising. We don’t need the currency: we hedge back these transactions into dollars, and the swap has not been favourable for us.

“At the time,” he adds, “we were expecting the size of transactions would increase gradually. This has not happened. To be honest, maybe expectations were too high.”

This swap question is crucial, because an issuer doesn’t necessarily need renminbi funds like America Movil did; it is perfectly practical to swap the proceeds back to dollars. Then, the question becomes one of pricing, economics and diversification. “There is a swap market deep enough for borrowers to swap back to dollars, especially oil and gas majors,” says Yip. “The market is open for them. We often see Libor-focused borrowers like the World Bank raise offshore RMB, not because they have needs for the currency, but because it is attractive when swapped back into dollar libor.” In July, HSBC led a RMB600 million three-year RMB trade for the World Bank, “and that institution has very aggressive targets against dollar Libor,” he says. So for a Latin American multinational seeking cheap funding and diversity in currency, it ought to make sense.

Frances Cheung, head of rates strategy for Asia ex-Japan at Societe Generale, adds: “Dim sum bond issuance by international name has picked up, taking advantage of the higher CNH CCS [CNH being offshore RMB, CCS being the cross-currency swap].” So if is possible pricing may become attractive again. But still, without a large amount of underlying financing activity, there’s not an obvious spur for more issuance.

It’s possible that the recent announcements in Santiago will change this. There are now 17 offshore RMB centres globally, and in many cases their appointment has been followed by widespread issuance from banks and companies within those jurisdictions. This has happened in Singapore, London, Frankfurt and Paris (though not universally: South Africa and Hungary have been granted the same status this year without prompting a lot of issuance yet).

But the establishment of a centre will not, in itself, be enough: trade flows will also drive use of the currency, and issuance. The two are linked – the setting up of a clearing bank in Chile is partly intended to drive economic and trade ties between the two countries – but ultimately there needs to be an underlying business case.

In this respect, the fall in commodity prices is not helpful, and nor is flagging growth in China. If China was still seeking ever greater quantities of commodities from Latin American providers like Vale or Petrobras, the consequent trade flows would prompt greater use of the Chinese currency. But China is instead shifting towards a model based on domestic consumption rather than endless growth and urbanisation, which indeed is part of the reason that commodity prices have fallen in the first place.

“China is undergoing a rebalancing of its growth model,” explains Magdalena Forster at Deutsche Bank. “The economy is gearing for a higher share of domestic consumption and services and a lower share of investment. As a consequence, the composition of Chiense commodity imports is likely to change,” with a slowdown in demand for base metals and oil, and an increase for food and natural gas. “Latin American countries are among the top suppliers of commodities to China and, in turn, China is a key market for them,” Forster says: Venezuela, Cuba, Peru, Brazil, Uruguay and Chile sell between 15 and 25% of their exports to China. “Chile and Venezuela are the economies most exposed to China’s economic rebalancing,” given their focus on copper and oil respectively, while Uruguay, as a food exporter, might actually benefit. Brazil and Peru, exporting both hard and soft commodities, are more difficult to assess, but in aggregate, changes in China are likely to mean less trade flows between the two locations rather than more.

Still, commodites aren’t the whole story. “We observe more flows within the South, broadly speaking, and in particular China and Latin America,” says Sergio Schmukler, lead economist in the Development Research Group of the World Bank. He bases this view on analysis of bilateral data of portfolio flows, syndicated loans, and mergers and acquisitions.

Still, that doesn’t necessarily mean greater use of the RMB as a funding currency. “Issuance in RMB [from Latin America]: we don’t see it,” he says. “The dominant currencies are still the dollar and euro, or local currency. The RMB is used much more in reserves, through currency swap arrangements between central banks.”

It’s generally true to say that Latin American credits see more investment interest from Asia, even if it isn’t in the Chinese currency. “We have been actively seeking to increase Asian investment into our bonds for some years,” says Felpeto at CAF. “Traditionally, it [Asian participation in benchmark paper] was less than 5%; today, I would say it is 10-15%.” Partly, this is a matter of effort: CAF roadshows and goes to see central banks and sovereign wealth funds in Asia. Partly, it reflects the fact that CAF, having been upgraded since its RMB bond, is increasingly attractive to Asian central banks in particular.

For the RMB, a considerable change could be about to appear. Generally, issuers in China’s onshore bond market – so-called panda bonds – are heavily restricted, and must use the currency domestically. But there is discussion underway to change the rules so that supranationals would be permitted to issue onshore and swap the proceeds out again. At the time of our interview with CAF, the institution had just learned about the possibility the previous week, but was looking closely. “That would be a very interesting market for us,” says Felpeto. “The size of the market would be huge. That would be a total game changer.”

But we have to remember to look at this from a local, not a global, perspective. A couple of years ago the optimism around Latin American engagement in the currency was enough to prompt a detailed economics brief for the Inter-American Dialogue think tank penned by JP Morgan economist Jahangir Aziz, but he raised an issue that remains relevant now. “There are few technical barriers when settling trade transactions in RMB,” he said, noting Latin American firms could conduct transactions in RMB in Hong Kong easily. “The more important question is whether, beyond the current examples of RMB-denominated lending and currency swapping, there is sufficient demand in latin America to use RMB when settling transactinos. While the possibility of RMB appreciation is attractive to some, Latin America’s much higher domestic interest rates mean that returns on Chinese deposits or papers will be particularly lucrative only in the event of a sharp RMB appreciation. And while some Latin American firms would find it useful to reinvest RMB-based proceeds in China, they are in the minority.” He concluded that “Latin America’s interest in RMB internationalization remains fairly limited,” and he was right: it still is.

When looking at portfolio flows, it’s worth studying both directions separately. There has not, generally, been huge institutional interest from Latin America into China in portfolio investment terms, but again, this maybe about to change. Another part of the May announcement in Santiago was the allocation of RMB5- billion of the Renminbi Qualified Foreign Institutional Investor (RQFII) quota system to Chile, as well as a RMB22 billion currency swap deal. RQFII allows RMB raised offshore to be used to buy stocks and bonds in China’s domestic onshore markets. Again, this was a first for Latin America, although Brazil does have a currency swap line with China.

That RQFII allocation may change the way Latin American institutions view Chinese assets. While Chile is a relatively low-population country in Latin American terms – certainly compared to Brazil – it has powerful and sophisticated pension funds, its administradoras de fondos de pensiones, which are permitted to invest up to 80% of their assets in international markets. Much of that money is outsourced to international managers, many of whom know their way around China’s domestic markets.

“You would not imagine, yet, that many Latin American institutional investors would have RMB in the portfolio,” says Yip. “But on the other hand, you would imagine that given the close political ties between Chin and Uruguay, Peru and Brazil, those countries will have some reserves in RMB.”

In the other direction, China wants to diversify its funds; its sovereign wealth fund, the China Investment Corporation, exists to do exactly this. As long ago as 2011 its then-chairman in Liqun said he was seeking investment opportunities in Latin America. Whether through that or other entities, investment from China into Latin America is expected to increase: Premier Li’s South American tour also took in Brazil, where he talked of plans to invest up to $53 billion for infrastructure projects. And aside from direct investment, Chinese loans to Latin America in 2014 hit $22 billion – more than the World Bank and the Inter-American Development Bank combined – according to estimates from Inter-American Dialogue, a think tank. The same group estimates that Venezuela has received $56.3 billion of lending or investment since 2007.

“It’s not just about China wanting to sell more,” says Schmukler at the World Bank. “Another part is China wanting to be there investing, wanting to diversify, or trying to get the resources that they might need for the future.

“China is trying every trick in the book to maintain 7% economic growth this year,” says one economist, “and everyone realises it will be heading into a downward interest rate cycle, with further cuts expected. The only way to sustain that growth rate is not to rely on domestic consumption, but to go and explore new territories. People like Bank of Communications and China Commercial Bank are looking at acquisition opportunities in Latin America. Of course there would be operational risk involved but I cannot see Chinese state-owned companies having any other choice.”