Daniel Baeza, VP Latin America at Frontclear, talks to Global Investor’s Louise Fordham about the organisation’s role in developing money markets in emerging and frontier economies, and its work in Latin America to date.
Financial markets development organisation Frontclear was established in 2015 with a particular focus on catalysing repo and derivative markets across emerging and frontier economies. It has a two-pronged approach to achieving this aim: issuing guarantees to cover a lender’s counterparty credit risk and facilitating money market knowledge, regulatory and infrastructure development through a technical assistance programme.
The firm’s activities span emerging and frontier markets in Latin America, Africa, Asia, the Middle East and CIS. “What we tend to see in these jurisdictions are multiple barriers that prevent local financial institutions from enjoying a stable and inclusive money market. There is a lack of connectivity in terms of liquidity, and there is no way of hedging risk locally,” says Daniel Baeza, vice president for Latin America at Frontclear.
Smaller banks can encounter challenges accessing liquidity, he explains, which can create balance sheet issues and result in inefficient asset liability management. Frontclear helps these institutions to access local and global money markets through its guarantees.
Baeza says: “We facilitate the use of local currency and local securities as collateral, which opens up a pool of assets for local borrowers to use what would otherwise not have a lot of liquidity as the secondary markets tend to be quite shallow in these countries.”
Eligible collateral includes government bills and bonds in hard or local currency for repo transactions, and USD cash, local currency cash, government bills and bonds for swaps. Frontclear guarantees up to 100% of the transaction exposure with a maximum notional value of $40 million.
The organisation originates trades based on the liquidity and hedging needs of local financial institutions. This includes drafting term sheets and initial discussions with beneficiary banks (lenders). Once the local institution has selected a lender and the terms and conditions of the deal have been agreed upon by the two entities, Frontclear will finalise the guarantee with the lender.
It also conducts this process on a bilateral basis upon the request of a lender. In both cases, Frontclear will open local custody accounts to support collateral management.
Understanding the hurdles
The organisation’s guarantee facility is complemented by its technical assistance programme. “After we close the guarantee we have seen first-hand what the hurdles in the market are, not just theoretically but in practice. That gives us a lot of leverage when it comes to setting up a technical assistance programme and tailoring it exactly to what that particular jurisdiction needs,” says Baeza. “We will then sit down with the regulators, give them an assessment of the hurdles we faced when closing the deal, and explain how technical assistance can help bridge the gap between local regulation - which may not be working to its full potential - and international best practice.”
Through the programme, Frontclear brings together local financial institutions, market infrastructure providers and regulators, as well as international associations and experts, with the objective of facilitating interbank activity and increasing market efficiency, inclusivity, and stability. It also runs educational initiatives to enhance understanding of derivatives and money markets.
Latin American activities
In May 2019, the organisation held a Technical Assistance on Derivative and Money Market Development event in San José, Costa Rica. This was based on a tailored programme for the Costa Rican market, and drew on the firm’s real-life experiences of a recently-executed non-deliverable forward (NDF) in the country.
The event comprised of a regulatory roundtable that brought together the Central Bank of Costa Rica, the Superintendence of Financial Institutions, the Securities Superintendence and Ministry of Finance with the International Swaps and Derivatives Association (ISDA), The Currency Exchange Fund (TCX), international law firm White & Case, and a local legal expert on the derivatives market. On the back of this, the organisation will work with regulators to develop an action plan to address challenges in the market.
In addition, more than 40 treasury, legal and credit team representatives from Costa Rica’s regulated financial market took part in a one-day ISDA course, which was organised in partnership with the country’s banking association.
“The roundtable was an eye-opening event, it allowed regulators to discuss and understand key structural, legal and operational building blocks necessary for a liquid derivatives and money market. Frontclear’s initiative offers an opportunity to strengthen our financial market,” commented Bernardo Alfaro, Superintendent of Financial Institutions, Costa Rica.
Elsewhere in the region, Frontclear hosted a roundtable with Honduran regulators in Tegucigalpa in February, with participation from the Central Bank of Honduras, Honduras Stock Exchange, and National Commission on Banking and Insurance. The discussion covered the role guarantees and technical assistance can play in the market, as well as exploring what steps need to be taken to expand from a largely overnight market to a longer-term money market.
Frontclear is also active in Ecuador, where it recently closed a repo transaction. Its technical assistance programme in the country centres round the efficiency of cross-border transactions and enforceability from an ISDA and GMRA perspective. These are also focal points for its efforts in the Dominican Republic, where it is partnering with the local banking association to support local outreach.
The organisation is in the early stages of its activities in El Salvador, with the aim of accelerating the development of the interbank market to enhance liquidity. “Regulators recently approved measures to allow banks to lend to each other. The interbank market was non-existent just a few months ago,” says Baeza. “There’s still a long way to go but we’re building up the momentum that’s already there, teaming up with the banking association, and looking to meet with market regulators.”
Sharing international best practice
These activities are supported by the establishment of strong relationships with local market participants as well as partnerships with international organisations. “Partnerships are a very important part of our process,” stresses Baeza. “For example, we have worked alongside ABN AMRO in Africa where they have shared their expertise on clearing and trading systems.”
The organisation has also partnered with the Overseas Development Institute (ODI) Fellowship Scheme to post fellows in central banks and regulatory agencies in emerging and frontier markets.
In addition, it works closely with ISDA and the International Capital Market Association (ICMA), and has also worked alongside the International Monetary Fund (IMF). “As we focus on money markets, we’re usually focused on the short-end of the curve whereas the IMF tends to focus on the long-end, so we complement each other,” says Baeza.
Moving towards onshore-onshore development
To date, Frontclear has closed $355 million in issued guarantees, facilitating more than $600 million-worth of transactions. Recent transactions include a repo agreement between the European Bank for Reconstruction and Development (EBRD) and Armenian bank Armswissbank, a cross-currency total return swap transaction between Fidelity Bank Ghana and Société Générale, and cross-border, cross-currency swap transactions between Société Générale and the Development Bank of Mongolia.
The organisation is currently building up its capital base, which will enable it to support larger transactions and expand the number of countries in which it is operating. PROPARCO, TCX, Germany’s Federal Ministry of Economic Cooperation and Development (BMZ), EBRD, Cardano Development, Dutch development bank FMO, FSDA Africa, and the UK’s Department for International Development through UK Aid are among its current funding sources and investors. KfW, the German development bank, counter-guarantees Frontclear’s guarantees.
Over the medium- to longer-term, Frontclear plans to broaden its focus from offshore-onshore transactions to onshore-onshore transactions. “Issuing guarantees to local players to lend out to other local players is very important to us because it is in the market’s best interest that liquidity flows from one end to another. That will mean going from a bilateral transaction to more of a multi-party or umbrella guarantee structure, which we call TradeClear,” says Baeza.