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Update on Argentina: Perspectives on Debt and FX Markets
The Argentine political crisis has unraveled rather quickly, exacerbating the country’s already dire economic situation. Apart from the market and economic turmoil that is unfolding in the country, we have now reached a situation where capital controls are in place. Such controls prevent investors from executing ARS/USD FX transactions. While local bond trades can still be executed with certain counterparts, market liquidity is challenging as without access to liquid offshore FX (offshore Blue Chip Swap (BCS)), bond flows are centralized onshore and are settled in the Argentine peso. The main issue is in regard to executing FX transactions from the peso into the US dollar, which for international investors happens in tandem with each bond trade. These restrictions on FX transactions have given rise to concerns that the pricing of the three FX trading channels for the peso may begin to diverge, similar to what had happened during previous such crises. The three currency channels/exchange rates are spot, local USD BCS (essentially trades that are matched with local corporate flows) and offshore USD BCS. International asset managers trade via the offshore BCS rate. The concern now is that the spread between spot and offshore BCS may begin to diverge, similar to what had happened during the capital control period of 2011-15. During the period, the spread exploded from around 10% initially (roughly where it is now) to around 100%. However, at that time, Argentina was in an even worse situation and was printing a lot of money. The view in general is that the circumstances today are different – in particular, the more prudent monetary policies being employed today should prevent that situation from repeating again.
FX Rates Explained:
Spot = T+0 (settled for cash today) – no longer relevant for referencing as one can execute FX transactions via bonds given the new capital controls, but this remains the non-deliverable forward fixing date
Local USD BCS = Where locals can buy the USD and park it in their local bank accounts. The risk in a worst-case scenario is the USD being forcefully converted into the ARS
Offshore USD BCS = Where one can generate the USD offshore, which eliminates the risk of the USD being frozen or converted into the ARS
Currently, local banks (including international banks that trade from a local office) are not allowed to provide offshore USD/ARS BCS FX rates to foreigners. This has almost completely prevented offshore asset managers from trading in local bonds. However, global banking hubs, such as London, Hong Kong and New York, can still trade via offshore BCS facilities. As a result, most traders now focus on ways to facilitate these offshore flows and creating liquidity via their main offices. We expect this channel to open up in the next few days and weeks and see some steps in this direction already being undertaken. This means, even as there are hardly any facilities to trade in FX currently, one could execute bond trades with certain counterparts. Also, there is a possibility that more of this could be done in the coming days. The overall situation remains quite fluid, and we are in touch with our local contacts to tap into liquidity as it arises and also to determine the process, timing and magnitude of any authorization procedures that are required with the central bank.
Foreign Ownership of Local Debt:
Thankfully, local Argentine debt makes up only 0.17% of the key emerging market debt (EMD) benchmark, namely the JPM GBI-EM Global Diversified Index. Inclusion in the benchmark is now under review given the capital controls in place and the prospect of selective default or debt re-profiling that was announced recently. Repatriation of coupon proceeds out of Argentina has also been stopped, which means coupons due in October may not be paid. The three ARGTES local bonds in the benchmark have a current market value of US$4 billion. Of this, as per publicly available information, US$1.76 billion is being held by Franklin Templeton, which one can safely assume to be a long-term holder. A further US$420 million is being held by several ETFs. If all assets benchmarked to the JPM GBI-EM Global Diversified Index were to be neutral weighted to Argentina, they would be holding approximately US$400 million worth of bonds. This means, if J.P. Morgan were to remove the bonds from the index, there would be a potential selling wave worth about US$800 million. Not all investors may choose to sell immediately, but we assume that the preference would be to get capital back quickly, rather than run the risk of being trapped indefinitely.
Unlike many active managers, our exposure to Argentina is quite manageable given the low index weight of the country. We are monitoring the situation closely in order to achieve what is best for our investors. This may involve tapping into market liquidity sooner rather than later so as to secure the return of capital, rather than painfully waiting for any formal announcement in regard to the index. We have familiarity navigating similar experiences in Egypt and Nigeria successfully and expect to do so in the current situation in Argentina as well.
The views expressed in this material are the views of David Furey through the period ended 09/09/2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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