Chile hopes its political stability, open market tradition and good economic housekeeping ought to make it attractive to investors in the emerging market space – one of great opportunity and promise, but also prone to sudden and chaotic shifts.
For example, the sovereign dollar bonds returned 1.6% in the last 12 months, the highest return among the investment-grade countries in the region, even as the price of copper, its biggest export, plunged to its lowest level since 2009 and the country only grew 1.5% in 2016 - the lowest figure in seven years.
However, through the years Chile has had a hard time attracting foreign investors, regardless of the fact that, that the South American country has one of the most developed local bond markets in the world. International accounts own only 5% of Chile's outstanding local debt.
In Chile, predominately only state or state-related enterprises tap the international markets. Companies, usually take advantage of the local markets, making full corporate dollar bonds rare.
The reason is that the local Chilean capital market is highly developed and is able to cover almost all of the financing needs that corporates might have. Not only can corporates access it at very low costs, but it also provides the size, tenor and even type of funding that suits all types of Chilean enterprises.
Furthermore, pensions funds or AFPs - a -US$176bn- business - are reliable local investors that have contributed profoundly to the success of the Chilean local markets.
So great is their portion of the local market that Chilean bonds account for 51.4% (US$89bn) of the AFPs industry's overall investments in 2016, the highest in the last ten years and, well above the 46.9% allocation at the end of 2015, which amounted to a US$17bn increase. Not since April 2009 had Chilean fixed income held such a prominent place when it reached 55.8% of AFPs total investments.
The AFPs also compete with Chilean insurance companies and mutual funds for the new investment grade issuances in the market.
Greg Saichin, Global Head of Emerging Markets Fixed Income at Allianz Global Investors, believes that the Chilean corporates are overbanked with lower disclosure requirements, and, for this reason, they don´t feel the need to post bonds that would require a higher scrutiny bar to clear.
“It is somewhat similar to Turkey, where banks are liquid and take care of most corporates that are worth serving.”
These corps, he adds, have a chance of getting local currency funding through domestic capital markets, which can be tapped by foreign buyers not holding a local clearing account through euroclearability.
Only the biggest corporations, such as banks or the state-owned copper giant Codelco, who’s financing needs are substantially higher, require funding in dollars or euros.
According to a source in the Treasury who talked with Bonds and Loans, the government has a firm “commitment” to support corporates, they provide to the international market benchmarks that could be used as references for state-related corps and private entities. But only the biggest Chilean companies can access this market due to the minimum size required to be attractive for international investors.
“The dollar and euro markets are the most liquid and accessible markets for Chilean companies. In this regards, it is important to mention that the equivalent cost in USD for a local issuance in local currency, although variable, is usually cheaper than hard currency. That is despite the fact that the Republic has issued in USD market in the past three years to provide a benchmark for the corporates”. The Ministry added.
Chile now Eurocleared
However, the tide seems to be shifting since February this year, when the southern country issued its first Euroclearable local currency bond with hopes of moving closer to greater inclusion in the main indices that could lure substantial foreign capital.
Now, international investors will be able to access the domestic Chilean capital markets more quickly. The Chilean Ministry of Finance and Euroclear have partnered to align Chile's post-trade processes with international standards.
Belgium-based Euroclear, specializes in the settlement and safekeeping of domestic and cross-border securities for bonds, equities, and derivatives, making it easier for foreign investors to trade.
Access to an international settlement system usually brings more foreign capital to a market, often lowering bond yields, as was the case in Russia, where rouble debt became "Euroclearable" in 2013.
Bonds will be offered, sold and settled through Euroclear Bank’s account in Deposito Central de Valores (DCV), the Chilean Central Securities Depository (CSD).
Latin America's highest-rated sovereign at Aa3/A+/AA- has also eliminated capital gains tax and bolstered the sizes of key benchmark bonds. In 2016 it approved a law that switched the withholding tax burden from the custodian to the borrower.
“In January 20, 2017, previous to these modifications in the tax system, a new method of issuing in the local market was applied, whereby a local bond is issued through a book-building process, but with both local and foreigner investors allowed to participate,” a source in the Treasury said.
They also mentioned that foreign participation was around 20% of the total amount issued (US$1.5bn), higher in comparison to the estimated participation of 5% in the full stock.
BNP Paribas, Citi, Goldman Sachs and JPMorgan were chosen to coordinate the issuance that carries a 4.5% annual coupon and is due in February 2021.
By making the bonds clearable through Euroclear, Chile has aligned its capital market infrastructure, and the move is expected to deliver tangible benefits - such as reducing the cost of borrowing, increasing liquidity in the local markets and bolstering investment in the economy.
With this action, the finance ministry also hopes to boost its weighting in local currency indices such as JP Morgan's GBI-EM index, which is tracked by funds managing some US$185bn of assets. At the moment, Chile's weighting on the GBI-EM is just 0.1%, considerably lower than the 1.16% that former market pariah Argentina is expected to get when it is included in the index at the end of February.
Nor has Chile been able to join the exclusive club of emerging market countries that qualify for inclusion in Citigroup's World Government Index (WGBI). The only country in Latin America to be included so far is Mexico. Chile is intent on growing its participation in these sorts of indexes, with the idea of becoming more competitive in the fixed-income market and gaining more liquidity.
According to the Treasury contact, in 2016 a liability management program was implemented for the sovereign bonds in order to bundle the maturities profile in certain points (approx. 5, 10, 20 and 30 years), which were defined as benchmarks. This move is expected to maintain more reliable and liquid prices for these points, which is crucial for both foreign and local investors.
However, even if talks with the banks that run these indices have already begun, it will take sometime before they can see tangible results.
So far, Chile's Congress has authorized US$11.5bn in debt issuance this year, and the government is still assessing how much of will be sold domestically and internationally.
The Euroclearable format is seen as less costly and more appealing to investors than Global Depositary Notes, which Chile has used in the past to sell peso-denominated securities to international accounts.
Saichin believes that we are likely to see more Euroclear deals from several other countries in Latin America.
“Although choice is not vast as in the local markets, this feature allows investors to gain exposure to those credits in local currency. For the issuers, it provides a mechanism that would enable them to make their offer available to nonlocal investors that are capable of settling in Euroclear.”
Other countries like Colombia and Argentina are already preparing future Euroclearable deals, while countries like Panama, Costa Rica and Peru are expected to follow.