2018 - 2019 Edition of Citi Perspectives for the Public Sector

Citi Perspectives for the Public Sector |  2018-2019 37 • Favorable economics 7 —— as there is no derivative execution by the borrower (typically rated well below investment grade in EMs), there is no significant credit or capital charge associated with the swap counterparty risk exposure. It is important to note that Basel III/IV imposes particularly high charges for long-tenor currency or commodity swaps. A derivative between a high-rated MDB and a bank, typically executed under a daily-margining CSA, results in trivial capital charges —— In the case of a commodity indexation, the commodity option premium (payable by the borrower) can be embedded in the loan interest payments and thus paid in arrears, over time • The involvement of an MDB provides the invaluable stamp of approval and technical validation of the transaction to the borrower. This is critical as risk mitigation strategies may often be politically sensitive due to complexities of risk management and hedging solutions. In addition, internally justifying payments of premiums for risks which may or may not materialize, as well as potentially capping upsides, can prove politically difficult. ... Citi is able to successfully quote large long- duration frontier currency swaps and facilitate execution of the local currency conversion... Currency conversion While there is growing demand from borrowers and lenders to re-denominate hard currency debt to local currency, emerging and in particular frontier markets suffer from under- developed or non-existent swap markets (and local debt capital markets). By combining its uniquely broad presence in EMs, its trading capabilities, and its longstanding relationships with local investors, 8 Citi is able to successfully quote large long- duration frontier currency swaps and facilitate execution of the local currency conversion (i.e., “de-dollarization”) in these challenging markets. In our experience, an exceptional de-dollarization transaction in emerging markets typically involves (in addition to the local borrower and MDB) local investors, 9 international investors 10 and a highly rated local currency MTN issuer. Most importantly, a dealer (such as Citi) is required with trading capability in the given local currency so it can absorb the residual risks involved in such elaborate executions. Some frontier currencies however have illiquid swap markets and very limited and/or negligible demand in the domestic and international debt capital markets. An interesting solution 7 As compared to an outright derivative execution by the borrower. 8 i.e., pension funds, insurance companies and financial institutions. 9 Local pension funds or insurance companies looking for credit diversification in long-tenor local currency assets. 10 Those looking for off-shore access to local currency exposure. INTERNATIONAL INVESTORS LOCAL INVESTORS SPECIALIZED FUND ON-SHORE (EM) OFFSHORE MINISTRY OF FINANCE USD Loan Loan Payments redenominated to Local Currency USD Currency Swap Local Currency Local Currency Indexed MTN Local Currency USD Currency Swap Local Currency Local Local Currency Currency Indexed Bond USD Currency Local Swap Currency Local Currency USD Currency Swap DEALER MDB MDB RDB