Increasing urbanization across the world has sent the global demand for infrastructure investments soaring. Public transport, telecom, utilities and energy are prime examples of sectors in the process of being upgrading to fit the demands of the 21st century.
The equipment required for large-scale infrastructure upgrades usually has to be imported, and the sheer scale of the investments require long-term financing and, preferably, access to hard currency. But, if there is one thing that importers in these sectors often lack, it’s hard currency, as the bulk of their revenues – whether it’s public budget funding or consumer spending on fares, subscriptions or electricity – are in the form of local currency.
“Many importers in developing markets are found in the non-tradable sectors, meaning that their locally-rendered services are settled in local currency, while the goods they are importing are typically denominated in hard currency, such as USD or EUR,” says Matías Mayora, Head of Private Side Structuring for Europe at Banco Santander in London. “Having an income stream in local currency and expenses in hard currency creates a mismatch that they need to cope with.”
The solution, he says, is local currency financing, which reduces the currency exposure and minimizes the risk for both borrower and lender. “By matching the currency of assets and liabilities, clients can mitigate the impact of foreign exchange volatility on public budgets and development programs,” Mayora concludes.
One example is the new Bus Rapid Transit (BRT) TransMilenio system in Bogotá, Colombia, where Volvo and Scania are to deliver over 1,400 buses to the operators awarded the concessions to service the different routes. The BRT concept has become the system of choice in a growing number of cities, particularly in Latin America, by offering a transport mode that combines the capacity and speed of a metro with the flexibility, lower cost and simplicity of a bus system. Efficient public transport is instrumental to sustainable urbanization in offering an alternative to private cars that cause congestion and CO2 emissions.
Long track record
Based on elevated platforms in the middle of the street, BRT requires purpose-built, often bi-articulated, buses to maximize capacity and minimize emissions per passenger. Only a handful of the world’s bus makers are able to manufacture this type of bus, and two of them are Swedish: Volvo and Scania, both with a long track record and production facilities in Latin America.
“Landing a project of this size is not possible without well-structured financing and the availability of local-currency borrowing was a cornerstone in making the project viable,” says Oscar Entrambasaguas, Senior Underwriter at EKN.
As it were, Volvo invited EKN to partner up at an early stage and cooperated with Banco Santander in Spain to provide the necessary financing of 440 Volvo buses, backed by guarantees from EKN. (The remaining 260 buses delivered by Volvo were financed via an investment fund.)
Our cooperation with EKN enabled us to set up a financial structure that actually enhanced the commercial benefits of the offers provided by Scania and Volvo
“Our cooperation with EKN enabled us to set up a financial structure that actually enhanced the commercial benefits of the offers provided by Scania and Volvo,” says Jose Luis Vicent, Executive Director Global Export & Agency Finance at Banco Santander in Madrid.
The structure involved a local-currency loan that allows both the importer to repay principal and interest in Colombian pesos (COP), and Volvo and Scania to have the flexibility to receive payment in either COP or USD upon delivery of the buses.
“To the borrower it’s like having a COP loan but to the lender it’s like providing a USD loan. Neither the exporter nor the importer incurs FX risk at any point,” says Vicent.
In structuring a cross currency loan, the bank uses derivatives instruments such as currency swaps and futures. This, however, requires the existence of a market in these instruments, which is not the case for highly volatile currencies from countries with a generally poor economic outlook. Colombia, on the other hand, is the only country in Latin America that has never defaulted on its sovereign debt. A stable currency favors local currency financing, inasmuch as it paves the way for a market in cross-currency swaps and forward contracts over extended periods.
“The mere existence of such a market is what enables us to hedge,” says Mayora. “Five years ago we couldn’t have done this deal – and it’s the sound Colombian macro-prudential economic policy that has paved the way.”
Since COP is a non-transferable currency, the loan was structured as a so-called synthetic loan. The term "synthetic" loan is generally used to describe an artificial financial instrument where a loan is denominated in a base currency but disbursed and repaid in a different currency. It is a hybrid between a local loan and a cross-border loan, where no local currency actually crosses the border, hence “synthetic” is an appropriate label.
Besides relieving the importing bus operators of exposure to currency risk, there is another huge benefit to funding based on hard currencies such as USD or EUR, namely the lower interest rate available compared to smaller currencies. Even when hedging costs are added, the total cost to the borrower comes out lower than if banks had funded locally in COP, explains Vicent:
“The lower funding cost of high-grade European banks plus the cost of the hedge would still entail a lower rate than a Colombian bank could offer. European banks also benefit from the proximity to the ECAs of large exporting countries, and relationships do matter in the case of large and complex deals.”
The participation of EKN made the deal more attractive to all parties involved, he adds:
“The support from EKN allows for longer debt tenors and the possibility of setting up a structure that suits the bus fleet providers , which operate under long-term concession agreements and consequently wish to finance their long-term capex on attractive terms.”
The complexity of the financial setup required flexibility, reveals Entrambasaguas: “The structuring of the loan required EKN to provide cover outside the scope of standardized guarantees. EKN undertakes to settle possible claims in USD, but in the case of default EKN assumes a debt denominated in COP. We have to issue multiple guarantees, each covering different sums depending on the exchange rate.”
A structure that eliminates currency risk obviously reduces the risk of the borrower defaulting, which in turn enables lower guarantee fees, which enhances the commercial value of the Swedish exporters’ offering in the process.
Additional pair of eyes
In addition, Vicent points out, EKNs involvement lends a quality stamp to the transaction: “It’s good to have an additional pair of eyes scrutinizing the deal. And, obviously, a risk cover backed by Sweden’s triple A rating allows us to price the loan more favorably, which in turn benefits the Swedish exporters involved.”
“In general,” Mayora inflicts, “a loan supported by risk cover from a triple A rated environment can be priced at 75 bps less than a loan backed by a triple B rated insurer, for example.”
In this case, the buyers and sellers also benefitted from Santander setting up a pre-hedge to remove the currency risks over the period from when the contracts were signed up until actual delivery of the vehicles. Given that the bus producers can only manufacture a certain amount of buses in a day, this period can last several months or even a year. “We resolve the uncertainty by asking the bus makers to re-denominate their contracts into COP and then we provide them with a pre-hedge through a forward contract that pays them in USD on the day of delivery,” says Mayora, adding that Santander’s presence in Colombia as well as its good relationship with Volvo and Scania made this possible.
Vicent agrees: “The possibility to support these companies with the help of EKN makes the financing more convenient and more attractive, the tenors and the rates would not have been as beneficial without EKN cover, which certainly enhances the commercial capabilities of Swedish exporters.”
Understanding how tax regulations apply in this particular transaction was also crucial, ensuring compliance with any tax obligations, while finding the optimal solution in consideration of the double taxation treaties.
In concluding, Vicent sums up the attractiveness of the Bogotá deals: “A good product with a good technology at a good price goes hand in hand with good long-term financing that makes it even easier to sell the deal.”