2018 - 2019 Edition of Citi Perspectives for the Public Sector

Citi Perspectives for the Public Sector |  2018-2019 39 Other types of conversion — interest rate and commodity The same loan modification paradigm may be used to implement USD interest or commodity price exposure management solutions. An example of a USD interest rate solution is the embedding of a cap on Libor on an MDB loan, protecting the borrower against a future rise in USD interest rates, or, fixing the interest rate for the term, while allowing prepayment without the so-called “breakage amount” risk due to reduction in interest rates. Finally, many emerging economies are heavily dependent on the production and export of their commodities to the global markets, which makes them prone to highly disruptive economic cycles, accompanied by severe fluctuations in commodity prices. Conversely, commodity-consuming economies carry the same (albeit opposite) exposure to the commodities they may heavily import. Indexation of interest payments of an MDB loan to the price of a relevant commodity carries the same aforementioned benefits as a risk management tool (i.e., executional simplicity, cost reduction and MDB stamp of approval). De-risking solutions can have a formidable impact on the further development of emerging currency derivatives and debt capital markets. Example of an MDB loan’s commodity — indexation for a commodity: (Brent oil) consumer OFF-SHORE ON-SHORE (EM) Option Premium Change in Commodity Price USD Loan USD 3M Libor + 0.0% (if Brent > $X) USD 3M Libor + 1.2% (if Brent < $X) MINISTRY OF FINANCE (Bent Importer) Conclusion Emerging economies’ balance sheets are still heavily funded via foreign currency (USD, EUR) floating rate loans. Since the principal revenue streams of the majority of borrowers are generated in local currency, borrowing in foreign currency creates foreign exchange risk. Likewise, commodity dependence — whether exporting or importing — creates commodity price risk, which, along with currency risk is one of the most volatile market factors in the financial universe. Moreover, these market factors are often impacted by global events, unrelated to the local country’s dynamics, threatening its ability to attain its budgetary and overall sustainable development goals. MDB loan modification as a risk management tool carries tremendous benefits in implementing an appropriate hedging strategy — from its simplicity to economics and internal political benefits. It is the most efficient way of leveraging MDB’s excellent credit rating, technical expertise, commitment to emerging markets and derivative execution capacity with multiple banks to promote prudent and simple risk management solutions. In addition, as demonstrated via several recent high profile transactions in the frontier markets of Latin America, these solutions have a formidable impact on the further development of emerging currency derivatives and debt capital markets. MDB DEALER