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Why you should issue in local currency

04 May 2016
Richard Kemmish

When the first issuers come from a new covered bond jurisdiction outside the Eurozone their first decision should be whether to issue in their own currency or in euros. I’m presuming there that they have already decided to structure their covered bonds in a way that will appeal to Euro-centric norms, even if they intend to fund local at first.

They should establish a local currency market first for both systemic and selfish.

Taking the selfish motives first.
It is easier to issue a bond in the same currency that the underlying assets are denominated in. Swaps are getting more expensive and more onerous, this is compounded in new jurisdictions with worse credit ratings – for obvious reasons  - and with new assets or structures. Credit committees trying to establish credit lines for those swaps are understandably sceptical (the default setting for credit committees) about assets or structures they have never seen before – whether statutory conditional pass throughs in Poland or prima cassa mortgages in Romania.

Sometimes the swap problem is compounded by local regulatory concerns about reliance on swaps and a lack of development of the swap infrastructure (step one: get a legal opinion on the enforceability of an ISDA contract in that country. Step 2: throw it away and get a new opinion on the ISDA amended for covered bond swap specificities). 

Then there is the greater level of understanding of domestic creditors. Unrated issuer? Odd mortgage features? Unstable political environment? All of these are a major problem for foreign investors but something that domestic investors understand and tolerate. Actually they don’t have any choice. Whilst a foreign investor gets to choose which country to take risk in, local investors don’t.

Greek investors didn’t get fired for investing in Greece. Foreign investors did.

But perhaps the most important advantage of the domestic investor base is that it will stand you in good stead when you do start to issue off-shore. Because of its better understanding of local issues and, lets face it, its captive nature – not much choice but to reinvest the proceeds of maturing covered bonds into new covered bonds – the domestic investor base makes refinance risk far less of a problem.

As emerging market covered bonds become more widespread, the rating agencies will have to spend more time worrying about the possibility of that particular country being closed out of the capital markets and therefore unable to refinance bonds if covered bonds are going to be rated much better than the country that they come from.
Finally, the signal effect. In the early days of British covered bonds I remember the common argument: if British investors don’t buy them, why should I? Of course there were good counter-arguments – British investors don’t buy any covered bonds, it’s nothing to do with concerns about Britain per se.

So much for the ‘selfish’ reasons. What about the benefits to the local market (which in turn of course help local issuers too)? This I will have to postpone to the next post.

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