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BUSINESS LAW CURRENTS
TRANSACTIONAL SIMPLICITY, TAX BENEFITS DRAW
LATIN AMERICAN DEBT ISSUERS TO GDNs
By Juan L. Pena and Matthew S. Poulter, Linklaters
APRIL 10, 2012
As Latin America becomes increasingly influential in a volatile global economy,
debt issuers in the region have attempted to take advantage of their relative
strength by tapping into sophisticated investors around the globe. The evolution
of emerging economies, particularly in more developed Latin American financial
systems, has yielded a confluence of domestic and international markets. There
has been an increased demand for debt issuances from companies and sovereigns in the region. In addition, Latin American domestic markets have grown
substantially, partly due to increased privatization of pension systems in the
region that, as a result, have accumulated an increasing amount of liquidity.
One alternative occasionally used before GDNs became a viable option was to
hold the bonds in a custody account instead of taking delivery in the investor’s
home country. In the GDN structure, a part of the issuance is kept in a local
custody account against the issue of U.S. dollar-denominated securities, and
the bonds denominated in local currency can be issued in the local market.
Any interest (or eventual principal) payable is paid in the local currency into
the custody account and then paid to GDN investors in U.S. dollars by the
depositary bank, which performs all administrative and foreign exchange
functions in exchange for certain fees paid by GDN holders.
These events have allowed local currencies to remain relatively strong against
the U.S. dollar, unlike in previous global financial crises, providing a strong
yield in real terms as inflation levels have approached U.S. levels in most Latin
American countries. In Brazil, for example, the real continues to strengthen
with an ever-increasing demand by foreign investors in their equity and debt
markets.1 With this relatively rosy picture in place, and with alternatives like
European issuances saddled with an increasingly shaky euro, international
investors are logically turning to opportunities in growing Latin American
economies.
Banks with a strong presence in Latin America debt markets view GDNs as an
opportunity to assist sophisticated investors in expanding their options and to
increase exposure to local currencies, while having the transactional simplicity of
U.S. dollar-denominated securities. For example, banks such as Citi, Deutsche
Bank and J.P. Morgan, which are big players in the Latin American debt markets,
have marketed GDNs extensively to sovereigns and certain corporates in Latin
America over the last few years. These three banks also have active depositary
functions that lend expertise to the investment banking teams advising GDN
issuer clients.
In order to cater to these international investors, global banks are using creative
products and finding mixed demand. For example, some banks have issued
notes governed by New York law, more familiar to international investors than
the domestic law, and cleared them through international clearing systems,
while keeping them denominated or indexed to local currencies such as
Colombian pesos, Brazilian reais, Peruvian nuevos soles or Chilean Fiscal Units.
They have also used domestic law-governed notes cleared through international
clearing systems, accomplished through so called “bridges” between local
depositaries. An increasingly popular alternative employed by some banks,
including Morgan Stanley and HSBC, as well as regional banks such as Banco
de Chile, are global depositary notes (GDNs).
Another draw for issuers is the ability of GDNs to fix currency mismatches.
For example, if an Argentine corporate wanted to issue debt to fund a major
domestic expansion, in order to maximize distribution they would ideally want
to issue their debt in either U.S. dollars or euros. In doing so, they would be
forced to service their debt in the currency of the security, rather than in their
local currency, although they utilize the revenues received in Argentine Pesos.
GDNs give this company the benefits of allowing servicing in Pesos, and the
simultaneous advantage of having a wider audience for a U.S. dollar or euro
debt instrument. As with any cross-currency investment, investors worried about
foreign exchange or devaluation risks can hedge against these risks in a GDN
through swaps or FX derivatives.
GDNs are debt instruments that represent the underlying debt security of foreign
companies or sovereigns. GDNs have the same interest rate, maturity date, and
other terms of the underlying debt security, but they trade and settle in U.S.
dollars. GDNs also allow for principal and interest payments in U.S. dollars.
Citibank has been credited with developing this structure and employed it in
the largest offering of bonds the Republic of Peru had ever issued at that time.2
The GDN structure has become increasingly popular with sovereigns in Latin
America over the past several years. For example, the Republic of Peru issued
GDNs representing U.S.$1.2 billion (S/.4.75 billion4) in 2007, U.S.$1.5 billion
(S/.4,3 billion) in 2010 and U.S.$530 million (S/.1.6 billion) in February 2012.
Although access to liquidity, a large investor pool and administrative ease
continue to be the primary benefits of GDNs for both investors and issuers,
recent GDNs have also seen significant tax advantages. For example, in
December 2011, Petróleos Mexicanos (Pemex), a Mexican state-owned
petroleum company with total assets of roughly U.S.$113 billion, priced a 10-year
GDN at par to yield 7.65%. Because it was tradable in U.S. dollars, the Pemex
GDN took advantage of local tax laws and avoided a large tax hit.5 The tax
benefit, as well as the overall strength of Pemex, helped double the targeted
MXN$5 billion offering size to MXN$10 billion (approximately U.S.$734 million).
This transaction seems to have marked the beginning of what will likely be a
large number of such deals in Mexico. Juan Pablo Newman, Mexico’s director
of debt issuance, recently announced at a Latin Finance forum that the country
had increased its debt ceiling by U.S.$7 billion for net public indebtedness.6
GDNs serve a similar purpose to American Depositary Receipts (ADRs), except
that GDNs function as debt instruments rather than equity securities. Considering
that ADRs have been around since 1927, when J.P. Morgan issued the first
depositary receipt program,3 it may seem surprising that GDNs are only now
gaining momentum. Recent deals suggest that some companies and sovereigns
have been unable to fund growing projects and expenditures relying solely on
their traditional investor bases. Reaching out to international investors was
historically problematic, due primarily to a lack of liquidity in the local market
and an inability to clear bonds denominated in local currency through DTC,
Clearstream or Euroclear.
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BUSINESS LAW CURRENTS
Not all GDN issuances have been such large, high-profile deals. The Dominican
Republic enacted a so-called Hacienda Global Depositary Note Program, which
began in 2007. To date, it has issued debt in relatively small quantities 11 times.7
This program highlights the successes that GDNs can have in smaller, less liquid
markets.
Emerging Markets Currencies Soar On Hopes of Global Growth, The Wall Street Journal,
Prabha Natarajan, February 1, 2012.
1
World’s Best Investment Banks: 2008, Global Finance, Platt, Gordon, September 2008.
2
JPMorgan Depositary Receipts: Reference Guide, pg. 18, available at https://www.adr.
com/Home/LoadPDF?CMSID=88b09551120043cface03554006845cb accessed on
January 23, 2012.
3
Yields on non-U.S. instruments are often higher than those of U.S. bonds.
GDNs offer an attractive way to try and capture this yield, keeping demand for
this new and exciting product at elevated levels. The tax and liquidity benefits
and currency mismatch advantages, relatively low yields in the United States
and Europe, years combined with the transactional simplicity of employing U.S.
law – more familiar to international investors – will likely keep GDNs at the
forefront.
Offering Memorandum dated July 19, 2007 for S/.4,750,000,000 6.9% Bonos Soberanos
Due 2037 in the Form of Bonds or Global Depositary Notes.
4
Pemex Uses Unusual Form to Sell Local Bonds to Foreign Buyers, Dow Jones Newswires,
December 1, 2011.
5
Mexico Could Issue As Much as $10 billion in Debt in 2012 – Official, The Wall Street
Journal, Erin McCarthy, January 19, 2012.
6
Dominican Republic Hacienda Global Depositary Note (GDN) Programs, available
at http://wwss.citissb.com/adr/common/file.asp?idf=1823 and accessed on
January 27, 2012.
7
ABOUT THE AUTHOR
Juan Lázaro Peña is an attorney in Linklaters’ New York office who focuses his
practice on M&A and corporate transactions and has experience in cross-border
mergers and acquisitions and carbon finance transactions. Prior to joining
Linklaters, Juan was a banking associate on the Latin America Team – Andes
Region at JPMorgan Chase.
Visit us online at http://currents.westlawbusiness.com
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Matthew S. Poulter is an attorney in Linklaters’ New York office who focuses
his practice on cross-border finance transactions in the capital markets and
banking areas. He has extensive experience advising corporate, investment
banking and sovereign clients in the United States, Latin America, Europe
and Africa in a variety of U.S. and cross-border capital markets transactions,
including SEC-registered and Rule 144A/Regulation S offerings of equity and
debt securities. Matthew also has experience in high-yield debt transactions,
representing underwriters, issuers and bridge lenders on a variety of new
money, refinancing and acquisition finance transactions.
2