This issue’s question
“Since the financial crisis, corporates in emerging markets (EMs) have been able to borrow increasingly cheaply in foreign currencies, leading to record dollar denominated bond issuance in Asia. Where should EM corporates focus their funding strategies following the rate lift-off recently embarked upon by the Federal Reserve?”
Thiam Hee Ng
Asian Development Bank
With the Federal Reserve raising its interest rate, US dollar funding will become more expensive for the region’s corporates looking to issue US dollar bonds. At the same time, the more volatile economic environment and increased risk perception of emerging markets will likely further push up the cost of borrowing in US dollars.
Corporates that have borrowed in US dollars are facing higher debt servicing cost now with most of the region’s currencies having depreciated against the US dollar. In some cases, the increased debt servicing cost from depreciation has far exceeded the savings from lower interest rates from issuing dollar denominated bonds. This highlights the risk of borrowing in US dollars for corporates especially if the borrowing is unhedged or if the corporates do not have substantial US dollar revenue which can help serve as a natural hedge.
One alternative would be to explore funding in other currencies. The cost of borrowing in euro and Japanese yen remains low. However, going down that route would mean corporates would be exposing themselves to exchange rate risk. Also the offshore bond markets in these two currencies are smaller and less liquid.
Going forward, Asian corporates should look more towards using the domestic bond markets to satisfy their funding needs. For domestic oriented firms borrowing in local currency, this will help mitigate the exchange rate risk. This is especially true if they expect the US dollar to appreciate further.
Asia Pacific Banking & Capital Markets Leader and Global Emerging Markets Leader
Ernst & Young
Given current regional economic uncertainty and exchange rate volatility, yet interest rates rising following a prolonged low cost period, corporate treasurers in emerging Asia Pacific (APAC) are increasingly challenged in servicing and refinancing their USD-denominated debt. Effectively, higher real rates and lower capital availability are spurring them to revisit funding options to optimise on capital efficiencies.
For now, we expect bank financing to remain the dominant source of funding for regional corporates, with these loans proving to be most cost effective especially for seasoned organisations with good track records. Bank financing continues to account for approximately 50% of corporate borrowing in EMs as compared to below 25% for peers in developed markets. As such, despite the region’s slowdown raising risk premiums for EM borrowers (particularly for industries such as energy and power, materials and real estate that are at higher default risk due to weaker demand from core markets like China), banks are still competing to capture big ticket lending opportunities and jostling to offer more attractive loan pricing to the blue-chip clientele.
Nonetheless, with steadily increasing USD-denominated rates as the Federal Reserve tightens policy, corporates in EMs that depended heavily on foreign currency loans for inexpensive financing while generating cash flow domestically could consider less-volatile local currency alternatives. Those that rely largely on shorter tenured loans are also exposing their organisation to rising rates and should lock in borrowing costs over longer repayment periods in advance of further expected rate increments.
Besides financing corporate activities via loans, bonds offer further funding diversification for EM corporates. While issuance has tapered drastically since H215 (with investment banking fees from bond issuance for the full year declining 18% globally), bonds remain a popular funding choice for EM corporates. However, credit quality has been deteriorating over the last three years with defaults for speculative grade corporates likely to increase. While EY is taking a sanguine view on the corporate debt market, banks are raising yields in response to growing corporate risk (perceived or otherwise) and bonds will become an increasingly expensive form of funding in the mid term. But despite a less robust debt market, bonds will remain a viable fund-raising option primarily for well-established corporates, though fund raising will be tougher for sectors struggling with the current downturn.
For EM corporates with USD and other foreign currency denominated bonds, those that lack natural hedges and sufficiently sophisticated currency risk hedging mechanisms are likely to face currency mismatch challenges and increased credit and refinancing risk. This would encourage the development of more robust in-house treasury departments, as well as spur the respective local currency bond markets to enhance services to corporates seeking more efficient onshore replacement funding and protection from forex volatility. This obviously does not happen by chance and would need support from EM governments to raise market efficiencies, transparencies, and foster higher issuer and investor participations.
Meanwhile, fund raising via follow up equity offerings and new public listings will remain lacklustre until turbulence in global markets eases and investor confidence returns. Investment bankers already felt the pinch in 2015, with a 13% year-on-year fall in global fees from equity products. Waning risk appetites will continue to dampen corporate’s enthusiasm to list their shares until the markets turn calmer.
All in, despite the current market volatility, investment grade corporates continue to benefit from a reasonable selection of funding options. It is the smaller, newer organisations that lack established track-records we see struggling to realign their funding strategies following the recent rate increases. With bank financing getting increasingly scarce for this demographic, there is a massive white space for alternative lenders such as peer-to-peer and debt and equity crowdsourcing platforms to expand rapidly into the EM regions with alternative, more accessible funding options.
Senior Partner & Managing Director
The Boston Consulting Group
Before addressing current funding strategies, it is important to understand the situation in years prior. If you go back a few years, the APAC markets had high growth rates. It was a time when the prospects looked desirable: the appreciation of exchange rates and low interest rates in OECD markets, for instance. There was the view that it was a great opportunity to raise capital and the ability to pay down debt was seen as good. Now, with the US interest rates starting to rise and EM currencies declining, the attractiveness of foreign debt and the ability to service that foreign debt from domestic earnings is a difficult issue.
In terms of the right cost of capital, even sophisticated treasuries are not very consistent in their approaches. There are a variety of ways in which corporates have thought about, and are thinking about, their cross border funding and capital raising. In addition to the moving parts of exchange rate changes and interest rate changes, the fundamental growth drivers in EMs have been changing – all of which results in differences in terms of funding approaches corporates in Asia are adopting today versus five years ago.
With the Federal Reserve announcing higher rates, the strength of the US dollar resulted in a reduction in how much funding corporates wanted to do in USD. Now the Fed is being encouraged to slow down the rate of interest, or the timing of the rate increases. The inflationary pressures that were beginning to appear in the US are abating – for instance, if the price of oil stays put, then it reduces the likelihood that US rates will increase. In some ways, this is a counterbalance to the fact that US funding will appear less attractive than it was some time ago.
This uncertainty points to the need for corporates to undertake scenario-based assessments of the alternatives available. They need to model what the company’s cash flows will be given different situations. If, for example, they are orientating debt in renminbi, corporates should question whether the currency is likely to appreciate or depreciate, what the ability is to pay down current debt, how much of it would be serviced by revenues from where the company is operating in renminbi and where it will need to be serviced from revenues in other parts of the world. It is about knowing what kind of cash flow stress each scenario would create on the different parts of the business that have different underlying currency and interest rate dimensions. Corporates should be using a structured set of analytic techniques, not relying on their conviction or a single point estimate, in order to lead a more comfortable position from which to service the debt.
Where home market weakness may diminish the capacity to service foreign currency denominated debt, detailed cash-flow modelling and liability matching is even more critical when assessing options. However, for some of the leading EM corporates, foreign currency financing for acquisitions abroad may make sense if focused on foreign revenue-generating options. All in all, assessing the impact of the large number of moving macro parts – some of which are outlined above – requires: sound analytical framework, development of different business scenarios and active dialogue with lenders to fully appreciate the range of options available.
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