CASE STUDY Helping De-Risk South Africa Supporting local currency financing for state-owned enterprises OVERVIEW The World Bank is supporting South African clients diversify their sources of funding and mitigate their foreign exchange (FX) risk by making local currency financing available. Eskom, largest of the country’s 13 state-owned enterprises, accounting for 95 percent of the nation’s energy generation, transmission and distribution, as well as Land and Agricultural Bank of South Africa (Land Bank), with 29 percent market share in the agricultural sector, have high financing requirements. Any mismatch between their revenues, which are in local currency, and debt obligations exacerbates their FX risk. Photo credit Thinkstock currency, the South African rand (ZAR), but their Background debt exposure is partly in hard currencies. South Africa’s smooth and peaceful political transition to constitutional democracy, along with a Financing Objectives sustained record of macroeconomic prudence • Diversify the range of funding sources available to leading to steady GDP growth, has been one of the South African borrowers for longer maturities in most remarkable political achievements of our time. ZAR, either via a US$ to ZAR swap offered by After the 2008 global economic crisis however, IBRD, or via Automatic Conversion to Local growth has decelerated, slowing to an estimated Currency (ACLC) upon disbursement of any non- 0.28% in 2016; and unemployment, poverty, and ZAR denominated IBRD loan inequality remain a challenge. • Mitigate foreign exchange rate risk for South Africa, To address these challenges, the South African by making South African rand financing available government is promoting infrastructure investments at competitive rates and inclusive agricultural development, among other • Eskom: (i) enable Eskom to access the market for national priorities. Borrowing is one of the options to long-term currency swaps at competitive rates; (ii) finance government programs and state-owned maintain the variable spread component of the enterprises (SOEs). IBRD loan vs. the fixed spread, which is over 40 bps higher South African SOEs, which are highly-leveraged and • Land Bank: provide long-term financing for Land with approximately 40 percent of their total debt Bank, in South African rand, to sustainably scale- denominated in FX1, run the risk of foreign exchange up Land Bank's financing in agriculture to benefit rate exposure. Their revenues are in domestic emerging farmers 1 IMF Country Report No. 16/218 Financial Solution o No need to post collateral, for entering into swaps with market counterparties In South Africa, where the US$/ZAR swap market is Market access through WB Treasury’s relationships highly liquid for relatively longer maturities, the with major financial institutions, which give it access solution was customized in line with client demand. to market intelligence on the US$/ZAR swap market Eskom: IBRD is using currency swap transactions to and experts with extensive foreign exchange-linked convert tranches of the disbursed IBRD loan, derivatives and capital markets knowledge. An transforming the loan obligation from US$ to ZAR. additional benefit for the client is to gain access to The loan is converted into a fixed rate in ZAR, with a long-dated cross currency swaps at competitive residual variable spread that is adjusted every six price (due to IBRD’s AAA counterparty credit risk). months depending on movements in IBRD’s Advisory work with the client on the mechanics of borrowing costs and the FX rate. The World Bank structuring the transaction. was able to access longer maturities in the US$/ZAR market at competitive rates and pass these on to Eskom. The loan was initially committed in US$ and Outcome subsequently converted to ZAR using the loan’s IBRD supported South Africa by making local embedded conversion options. Between 2013 and currency financing available for longer maturities at 2017, IBRD executed 14 swap transactions with competitive terms. Since 2013, approximately US$ tenors ranging from 21 to 25 years and notional three billion local currency (ZAR) financing has been amounts ranging from US$ 100 to 300 million. made available to South African SOEs so far, such Land Bank: IBRD is using currency swaps to convert as Eskom (USD eq. 2.9 billion, out of the US$3.75 the loan amount to ZAR at the time of each billion loan) and Land Bank (USD eq. 6.6, out of the disbursement. Using the loan’s Automatic US$93 million loan). Conversion to Local Currency feature agreed with the borrower, each amount withdrawn from the loan Mitigating FX risk and diversifying South Africa’s account is automatically converted by IBRD upon funding sources in ZAR will promote investments in withdrawal from US$ to ZAR for the longest maturity much needed infrastructure and support ambitious available for such amount. The applicable interest plans to scale-up agricultural financing, which has rate following the conversion is determined by potential to benefit the larger region. converting a Variable Rate comprising 6-month US$ LIBOR plus a spread into a Variable Rate comprising As South Africa is the economic power house of the 3-month ZAR-JIBAR-SAFEX Rate for each Sub-Saharan Africa (SSA), economic conditions in Interest Period plus a spread (including the residual the country have important spillover effects on its variable spread), as well as a transaction fee. IBRD neighbors, and indeed, on the SSA region as a will execute US$ to ZAR swaps with the market whole. The local currency financing through IBRD every time there is a request for disbursement. Thus, has the potential of influencing SSA markets, as the the client will not be exposed to foreign currency, as rand circulates freely in the Common Monetary Area it will receive and repay the loan always in ZAR. (CMA) formed by South Africa, Lesotho, Namibia, and Swaziland whose currencies are pegged to the Benefits for the Client rand. Through interest rate and exchange rate movements, policy actions in South Africa By having the World Bank intermediate the swaps immediately affect economic conditions in the CMA. that accompany each conversion, South African borrowers benefit from: Local currency financing is one of the many ways the Hassle-free transactions World Bank Group helps member countries become o No FX mismatch between borrowing and debt more resilient to economic shocks. IBRD’s triple-A servicing obligations, as these are all in ZAR credit rating, market presence and convening power o No need for negotiating and signing legal allow the World Bank Treasury Financial Products documents, such as the ISDA Master team to develop innovative new products to help Agreement, designed to document over-the- clients maximize financing and mitigate risk. counter derivatives transactions. o The ACLC feature can already be embedded in the loan (Land Bank example) For information: Miguel Navarro-Martin, Manager of Banking Products mnavarromartin@worldbank.org, +1 (202) 458 4722