NEW YORK-Devaluation insurance seems to be the buzz word these days - at least it was early last week at Fitch's Latin America conference. The modish new phrase has market participants grappling for a definition and an answer to what it means for the future of the market.

Overseas Private Investment Corp. (OPIC) presented this in the recently hyped-up AES Tiete transaction (ASR 4/23/01 p.13) - what one source termed as "the deal of the year." While many are still trying to figure out what devaluation insurance is, others are saying it is as noteworthy as the debut of the political risk insurance (PRI) provided by the Multilateral Investment Guarantee Agency (MIGA) in last year's MSF Funding LLC transaction (ASRI 8/14/00 p. 1).

PRI does not provide any protection for currency devaluation. "There is a big market demand for devaluation insurance and OPIC seems to have an adequate response to what the market wants," the analyst said. "It's a milestone that allows for a lot more domestic asset financing at investment-grade levels that have not been done before. It opens up an important and larger market."

Market reaction

Because it is so new, many market players are trying to understand what devaluation insurance is and how it works. "The reason everyone is talking about it is because it's unheard of," said a source at the InterAmerican Development Bank (IDB). "Most of us don't understand how they can do it, it's one thing that's very difficult. Everyone knows about this one transaction and we will see if anything will follow."

A sovereign risk analyst who has had the opportunity to absorb this new type of risk says it is a liquidity facility. Currency devaluation is something that seems to recover in a few years, according to the analyst. Therefore, the way the insurance coverage works is that if a company does not have sufficient funds for foreign exchange, OPIC will pay the difference and the company will later reimburse OPIC with interest. OPIC will rely upon an agreed index of inflation that is instilled in the pricing.

Additionally, the insurance has a replenishable feature. The analyst offered this example: If there is a 50% devaluation in Brazilian currency over the next few years and AES Tiete cannot generate enough local currency, OPIC will step in and pay the difference, maybe $15 million U.S. dollars to the bondholders; as OPIC recovers, it may get $5 million back in the first year, which will be added back to the coverage and OPIC will only be short by $10 million.

"If you understand how the replenishable feature works, the nominal value is more than it appears," the analyst said.

The possible problems

An ambiguous factor is if the amount that OPIC will provide will be enough. The company has said it will limit what it will pay out at any one time to $35 or $40 million. OPIC sources say it is not committing itself to a lot of projects as it is a wait and see' process. Additionally, OPIC is awaiting the arrival of its new president, Peter Watson, for further action.

As to whether or not the AES Tiete deal will stimulate other transactions with devaluation insurance remains to be seen. Some sources believe it will not, for the simple fact that there will not be enough providers or because people don't understand it and will need to learn more about it.

But other sources said they expect devaluation insurance to become a prevalent factor, similar to PRI.

While it took quite awhile for the market to grasp PRI, it is now something that "everybody is doing," said the IDB source. In the beginning, OPIC was the only company to offer it; today, however, there are a variety of companies that offer PRI.

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