The launch of the first synthetic bond in Sierra Leonean leones highlights the importance of mobilising international capital into frontier-market currencies, as a tool to reduce the reliance of local borrowers on the dollar
In brief
- FMO issued bond in partnership with The Currency Exchange Fund (TCX)
- The new bond provides a way to transfer foreign-exchange risk from borrowers “that cannot and should not bear it”, to investors looking for exposure to frontier-currency debt.
- Large part of the bond was bought by funds that invest in emerging and frontier markets
Dutch development bank FMO has just issued the first-ever synthetic Sierra Leonean Leone (SLL) bond, in partnership with The Currency Exchange Fund (TCX).
FMO issued the bond, with an equivalent $7.5 million counter value (around SLL 85 billion) and a term of 3 years, with TCX providing the Sierra Leone exposure.
The new bond provides a way to transfer foreign-exchange risk from borrowers “that cannot and should not bear it”, to investors that are looking for the risk and return of frontier-currency debt.
The term ‘synthetic’ refers to the fact that while the bond performance is linked to the SLL, the reconciliation of all cash flows is in US dollars.
Jos Kramer, senior vice president at TCX, comments: “With still very low interest rates in developed markets, there is an increasing interest among larger international investors with a certain risk appetite to broaden their horizon and start looking at frontier markets, given the higher yield that you can get in these markets.”
“Mobilising international investors into frontier-market currencies is an important tool to reduce the reliance of local borrowers on the dollar.” And this is where the new bond comes in.
How it works
The original exposure to Sierra Leone, one of the world’s poorest countries, emanated from renewable energy investments.
Energy companies receive local-currency income, but international lenders fear the risk of being repaid in local currency.
By hedging with TCX, lenders can offer local currency to their clients, even in countries with very shallow financial markets and limited or even non-existent hedging possibilities, like Sierra Leone. This protects both lender and borrower from exposure to foreign-exchange risk.
By ‘selling’ this SLL risk in its book through a local-currency bond, TCX reduces its exposure to the West African country, which in turn allows the fund to support more loans in leones.
Triple-A credit risk
FMO issued the note with support of ING Bank, who placed it with international investors. Without disclosing any names, Kramer says a large chunk of the bond was bought by funds that invest in emerging and frontier markets, whose investors include pension funds from Nordic countries.
The investors bought FMO’s triple-A rated notes with a coupon that reflected the risk exposure of the Sierra Leonean market. This combination of AAA credit risk with frontier market risk and return represents an innovative asset class for which there is clear demand from global investors, according to FMO.
“It also helps that the bond is offshore. It’s settled in Luxembourg, which means you don’t run the risks that you would run if you would enter onshore to buy a local-currency bond,” Kramer notes.
He adds: “The combination of FMO, a responsible lending institution with high ESG standards, and TCX, which does not support speculation when onboarding currency risk in its portfolio, allows investors to allocate their resources to a responsible investment.”
Frontier Index
For Sierra Leone the synthetic bond is new, but TCX has experience in working with shareholders, banks and other parties on the issuance of bonds and notes denominated in or linked to local currencies.
The forex-hedging organisation does not issue these bonds itself, but it hedges the local-currency payment obligations deriving from these bonds with the issuing institution – these are usually multilateral development finance institutions that are also shareholders of TCX.
TCX recently launched a dashboard on its website, showing the development of the TCX Frontier Index – consisting of frontier-currency bonds – over time and its performance and volatility compared to other bond indices.
Kramer: “We aim to increase transparency around frontier-currency fixed-income instruments and support the sustainable growth of local-currency markets.”
The Frontier Index currently covers 72 bonds in 22 frontier currencies where TCX acted as hedging counterparty to the issuer. “It turns out that these frontier-market bonds are doing quite well.”
“We think it’s a good model to focus attention on frontier markets, but at the same time it benefits TCX, its shareholders and their clients. By hedging more of these bonds issued by our shareholders, we reduce our exposure, freeing up capital and thus creating more room to hedge and ‘transform’ hard-currency loans into local-currency loans.”
