The last of five essays compiled in SCI's inaugural SRT Journal explores Latin America's burgeoning SRT market

Thanks to trailblazing deals issued by Santander, the Latin American (LatAm) SRT market is open for business and is perhaps the sector’s most promising emerging market. Enabled by multilateral development banks (MDBs), Santander has completed at least three transactions in two years with deals in Brazil, Mexico and most recently the SCI Award-winning Project Patagonia transaction in Chile.

Looking back, SRT is not entirely new to the region, but is instead gathering steam after a long period of dormancy. As Mascha Canio, head of credit and insurance linked investments at PGGM, explains: “In 2007 we did an SRT transaction in Brazil with Banco Real, who was part of ABN Amro Bank. Of course, a lot happened in the meantime with the GFC and other events.”

Jurisdictions where SRT is relatively untested pose different challenges to those experienced in established markets. How does a new issuer or investor navigate a regulatory environment still in development, deal with risk and establish relationships with key stakeholders?

Regulations
It is helpful to look at LatAm’s SRT market less as one homogenous region like Europe, and instead as one divided along regulatory lines. Among the jurisdictions where transactions have been completed, some have securitisation rules in place and some do not.

In jurisdictions where the rules have been implemented, LatAm transactions look very similar to their European counterparts. As Edmund Parker, partner at Mayer Brown, explains: “Where the Basel 3 capital rules are implemented, you can structure a synthetic securitisation referencing an asset class, creating an unfunded CDS guarantee from a multilateral institution, and tranche it to achieve better regulatory capital.”

This is not to say that it is impossible to do deals in jurisdictions without the Basel 3 rules; however, these can only be done by multinational banks to achieve capital relief on a group level – similar to how SRTs were undertaken on Norwegian assets prior to the implementation of the SecReg in the EEA, but only by multinational banks with assets in the jurisdiction and not by local players with no cross-border presence.

Parker adds: “Obviously, if you don’t have the rules in place at a jurisdictional level, you can’t get capital relief at a local level. Institutions can sometimes find it worthwhile to do the deals even without the rules in place, if the capital relief obtained at group level is sufficiently appetising.”

This can create barriers to getting a market up and running. Xavier Jordan, chief investment officer of global capital markets at IFC, explains: “A fundamental reason that Europe is so effervescent is that entities like the ECB create overarching multi-country regulatory frameworks. As such, issuers in other regions including LatAm have to rely on single country regulatory scaffolding.”

European banks who have issued the asset class successfully in Europe therefore join with MDBs like the IFC to open up new jurisdictions.

Another key barrier caused by the lack of an ECB-like regulatory body is that regulators can (and have) changed their minds about SRT. Mexico had SRT rules in place in 2018 when Santander completed its first transaction in the jurisdiction. By the time the second rolled around, Mexico had repealed them.   

Therefore a lack of securitisation rules does not make doing deals impossible, but having them in place does make it easier. As Parker explains: “Brazil has implemented rules allowing for capital relief where there is a credit risk mitigant or an unfunded guarantee from a multilateral institution. This provides an enormous opportunity for issuance.”

Practical considerations
Emerging markets demand more consideration than established ones. Among these is how the regulatory environment evolves from its infancy into a system which enables SRT transactions to take place.

Parker says that where local rules track European CRR legislation it can be helpful for issuers to have a trusted European counsel who can facilitate a strong relationship with either local counsel or the local regulator. This allows guidance to be provided to the local regulator as to how gaps are dealt with under the corresponding European rules. Jurisdictions which are yet to see transactions can benefit from looking to the European framework. For example, the EBA’s published Q&A on CRR provides publicly available regulatory interpretations of many aspects of regulatory capital rules, which can be most helpful to any local regulator as it forms its own views. 

Parker further explains: “The rules in Europe are massive and complicated. CRR itself is hundreds of pages long, and it is supplemented by technical standards, guidelines, EBA reports and Q&As. New jurisdictions might have only have a fraction of that detail implemented. Having an insight into how the same issues have been dealt with in Europe can greatly benefit a local regulator looking to improve its first few synthetic securitisations.”

He adds issuers should be careful in choosing their counsel on this: a tactful and helpful approach, which points to helpful provisions in Europe, is likely to be most successful.

For investors, the attractiveness of SRT is the same in LatAm as it is elsewhere. Canio explains that for PGGM: “SRT allows you to access exposure to assets you typically can’t find elsewhere, because of the types of clients that banks have, such as corporate clients and revolving credit facilities. There is a lot of operational hassle with clients being able to withdraw and prepay, etc. This doesn’t fit well with how institutional investors are set up, but it’s an interesting product to have exposure to.”

Another interesting element for PGGM is the multiple contact points SRT issuers have with borrowers. “Term loan and bond investors have a more limited flow of information, and hence we see value in that which we typically see reflected during due diligence.” The risk-return profile is also of interest, as is the change SRT issuance can ignite through conditions such as ESG requirements attached to transactions.

Then there is the inevitable matter of patience. Deals in new jurisdictions can, and often do, take years between inception and completion. Investors need to be as generous with their time as they are with their cash in such scenarios: “Where possible, I think you do want the regulator to allow for capital relief, which requires the regulator to understand the product and put up a framework to support it. This takes time.”

Although this is not a role investors are expected to take, Canio finds that involvement in the process can be helpful: “The relationship between regulators and banks is like an enforcer, so there’s a general mistrust between the two. The investor can help remove some of that mistrust if it has been involved in the market for a number of years. In the end, all three parties - the issuer, the regulator and the investor - need to agree on the majority of points for these transactions to work.”

What about MDBs?
As it does in Central and Eastern Europe, the IFC is playing an important role in opening up the LatAm market. The MDB can front up to 100% of protection on an underlying credit portfolio and then syndicates junior risk associated with the latter to other investors. Alternatively, it can and does invest in mezzanine tranches directly – with the possibility of doing so with the junior tranche on the horizon.

Jordan explains how the former alternative works: “Multilaterals could take SRT technology and graft it onto vanilla risk sharing. If we can identify someone to take the riskiest capital portion, it enables us to do much more business than might otherwise be the case in certain circumstances. If you work with smart investors in this way, and there are quite a few who are very interested in diversifying beyond Europe, it can bring a lot of value to the market.”

The value goes beyond the monetary. Parker points out that an MDB’s guarantee on a slice of the reference portfolio makes for an easy-to-understand structure compared to the more intricate SPV model. This improves the explainability of the product, which is of paramount importance when convincing regulators of its merits.  

He notes: “This comes down to having fewer defined regulations. When you have quite light rules, simplicity is best.” Parker adds that MDBs tend to have good understanding of the region and are well-placed to assess credit and reference portfolios.

The guarantee can also encourage the involvement of investors who may otherwise be unable to participate. As Canio explains: “For us, one challenge is we do put up cash while we don’t want to take the credit risk to the issuer, and therefore the collateral needs to be very highly rated. That’s where an MDB could come in to guarantee or to issue collateral in, for example, Mexican pesos.”

The IFC also pursues a developmental impact angle to its transactions. Jordan summarises the role of the IFC like this: “We fundamentally prefer to introduce new asset classes and always need to have a thematic impact narrative in the investments we make. We introduce debut transactions to the market and also regulators to the product, to the extent it’s necessary. Once the first deal is complete, we can continue to be a strategic investor in the space - to the extent where we add new dimensions to it, in terms of development impact, as far as redeployed RWA/capital is concerned.”

The impact narrative is a another key consideration for the IFC, according to Jordan: “ESG is a twofold issue. We cannot take exposure to ESG eruptions in reference portfolios – which means SMEs are tactically advantageous as there’s less ESG risk in the asset class than, say, infrastructure. We also have the impact we want to make – if it’s SME loans we might encourage more SME lending, on other portfolios we might encourage more green lending, or if the underlying asset class is ESG loans to start with then sustainability features are already likely baked into a reference portfolio.”

Jordan says the key themes IFC likes to focus on for the moment are the environment, gender and SMEs. Sometimes the jurisdiction pushes the IFC towards one of these aims, for example in Poland a lot of energy is generated by coal in a time when much of Europe is seeking to transition to renewable energy, making low-hanging fruit of an environmental focus. “Project Patagonia” in Chile frees up capital for women-only mortgages.

However the bank ultimately decides which ESG target to assume: “We can’t jam a thematic lending story down their throat. We typically sit down with the bank and set out our priorities and ask what theirs are. But to a certain extent we’re leaning on an open door, as ESG imperatives are not something we have to convince a lot of banks to consider seriously.”

He adds there is an incentive which keeps issuers “on-target” in terms of RWA/capital redeployment trajectories. In the majority of cases, the IFC does deals with WALs of 3-4 years, meaning capital relief needs to be extended. “If things aren’t on a positive trajectory, we won’t be particularly amenable to such extensions.”

The future
In addition to Mexico, Chile, and Brazil, Colombia and Peru are additionally considered to be of interest for issuers. This is mostly driven by US banks which either already have a presence in LatAm or which desire to advise or act on behalf of issuing banks in the region.

Parker explains: “The interest we’ve had from US clients is palpable as that’s where a lot of LatAm desks tend to be, partially because of dollarisation. Arranging a transaction on behalf of a local bank in LatAm could be appealing.”

He has previously said Brazil has the potential to reach the volumes seen in European jurisdictions like Poland and Austria.

Canio explains what investors would look for in a new market: “We would really look at the institution itself first – their market standing and the size of the book. That’s very important. Where the bank is, because there are some countries like Venezuela where we don’t want to have any exposure. You want a relative level of economic and political stability, because there are some countries where the risk isn’t worth it.”

In general, the rule of thumb seems to be large economies as well. The exception to this rule seems to be Argentina. Suggestions that economic reforms by its current president would make the market more investable were met with the cold shoulder. It will likely be considered off bounds until it reaches long-term political and economic stability.

In short, LatAm has gathered steam as the emerging market to watch, overtaking Asia and the middle east which had been considered the next big thing besides the US. Canio says that LatAm may currently be the most promising emerging market for SRT in terms of jurisdictions which have completed transactions – although she adds “We’ve been working on more than just LatAm – I think they’re all exciting”.

For Jordan, Asia is especially worth considering: “Japanese banks already use this product. While the banks are well capitalised, you might see them take an interest on behalf of their emerging market franchises. For example, a bank in Singapore may be interested in achieving group-level relief for subsidiaries in, say, Indonesia. You could also see Japanese banks buying protection on regional portfolios. This is me guessing the future, but outside of the very sophisticated South African banks, Asia is the best shot.”

Joe Quiruga

SCI’s SRT Journal is sponsored by Arch MI and Mayer Brown. All five essays can be downloaded, for free, here.