In a twist on the old cliche about Brazil, it seems at times that covered bonds in Latin America are the instrument of the future, and always will be.
Bolstering this view is the buzzed-about deal from Panama's Global Bank - touted as the region's first - which was pulled in early May, although reports say the originator will try again with the $200 million, five-year deal.
A spokesperson from sole bookrunner Deutsche Bank did not return a request for comment as of press time.
Global Bank is not the only participant raising hopes only to dash them. After passing legislation on covered bonds, Peru has not yielded a single deal, and Mexico, another candidate, has yet to move on proposed legislation.
There appears to be confidence, though, that a deal will eventually emerge, as expressed by participants at the 2012 SiLAS conference, hosted by Euromoney Seminars and LatinFinance.
On a panel discussing the instrument, Michael Morcom, head of Latin American agency and trust sales at Citibank, said that the growing interest from global investors in local currency bonds could bode well for covered bonds from the region.
"It has a payment profile that looks like a corporate bond, [so] it's easier to put a [currency] hedge on it," he said.
The vehicle of global depositary notes (GDNs) could enable foreign investors to indirectly buy into domestic covered bonds.
GDNs are akin to ADRs. As explained in a paper by Chadbourne & Parke Partner Marc M. Rossell published in the International Financial Law Review, GDNs are issued by a U.S. bank and backed by a custodian in the country where the underlying paper has been sold. Foreign investors can buy GDNs without holding the underlying bonds, and therefore do not have to set up a local custodial account in the Latin American country in question.
Payments in GDNs are made in dollars, which means investors do not have to hassle with the conversion and transfer of the local debt payments. The investors are, however, fully on the hook for foreign currency fluctuations, something that many may be seeking at any rate. In addition, the fees paid to the custodian and depositary bank are fully borne by the investor.
Citibank issued one of the few GDNs late last year, a $70 million, 10-year deal backed by a peso issuance by Mexican oil giant Pemex with a coupon of 7.65%. Listed on the Irish Stock Exchange, this transaction animated talk of GDNs from other Latin American issuers.
Should this mechanism work for covered bonds, originators will still need a local framework to issue a deal that would later - or simultaneously - back GDNs.
In Brazil, as there is no overarching covered bond legislation, players are exploring different ways of issuing a deal, according to panelist Enrico Juca Bentivegna, a partner at local law firm Pinheiro Neto.
Bentivegna showed how there were two possible avenues for a bank to issue a covered bond in Brazil. Each had its advantages and disadvantages. A bank could use a receivable investment fund (FIDC), the most popular vehicle in the country for securitization. In this scenario, the bank issues the bond on balance sheet - as is standard for a covered bond - which is guaranteed by shares in an FIDC. Investors would therefore have recourse to the FIDC in addition to the bank.
But this could possibly involve the need to sell shares in the fund and speed up payment flow in the event of distress, among other downsides.
Another way would be for the bank to issue bonds secured by a fiduciary assignment, as exists in Brazil. This option would look more like a covered bond structured in a country with legislation covering the instrument. Fiduciary assignment is not subject to the bankruptcy of a bank and therefore should be treated as a segregated asset in the event of insolvency.
One of the main downsides to this avenue is that fiduciary assignment and its effects on insolvency have not been tested in Brazil.
Wherever covered bonds do materialize in Latin America, the crisis in Europe has shown that there is a sovereign risk component to these deals. The "rates product" of yesterday has now given way to an instrument with a credit component and more differentiation among deals, participants said.
And while Latin American players are still waiting for the first covered bond deal, an emerging market in another region is advancing. After debuting its first covered bond last year, Turkey has a second one in the works, said panelist Magchiel Groot, senior investment officer in the financial markets department of Dutch development bank.