Late last year, when Uruguay went looking for a loan, instead of going to the US or Europe the sovereign looked to Chile. And when it issued a $142.5 million, inflation-linked bond denominated in Chilean pesos, Uruguay became the first Latin borrower to issue an intra-regional bond.

The November deal enabled Uruguay to diversify its funding base and reach an entirely new investor. Uruguay’s Chilean peso deal also represented a step toward developing the local Latin American capital markets. Heinz Rudolph, international financial coordinator at the Chilean Ministry of Finance, says the Uruguayan bond marked an important advance toward “the internationalization of the Chilean peso.” The bond pays a semi-annual coupon of 7% over Chile’s inflation rate.

A Promising Market
Uruguay, which like Chile enjoys an investment-grade rating, sold the six-and-a-half year, fixed-rate bond through bookrunner Chase Securities, now JP Morgan. Chilean pension funds were the primary buyers, taking about three-fourths of the oversubscribed issue. International investors bought the rest.

Moctar Fall, managing director of emerging markets at JP Morgan, notes that Uruguay had already issued in the dollar and Euromarkets earlier in the year, so the peso bond launch enabled it to tap into a promising new market.

Chase arranged a cross-currency basis swap from Chilean pesos into dollars. The swap enabled Uruguay to reduce the cost of the bond issue and hedge interest rate risk by exchanging the Chilean inflation-rate benchmark for a floating US dollar interest rate. By issuing in pesos and swapping into dollars, Uruguay was able to bring the cost “between 10 and 15 basis points inside its dollar curve,” says a banker close to the deal.

Carlos Olivares, a fixed income trader at ASP Cuprum in Santiago, says Chilean pension funds were attracted to the bond because they were able to buy investment-grade paper with a return of 100 basis points above Chilean government bonds.

According to Rudolph, Chilean pension funds have $36 billion in assets, and the central bank allows the funds to invest up to 16% in foreign securities. He says the funds currently invest around 2% in fixed-income securities and 9% in equity issues, leaving capacity for strong foreign credits to raise capital in the peso bond market. Rudolph expects these assets to grow, adding that Congress is reviewing a proposal to raise the foreign investment ceiling for Chile’s pension funds from 20% to 35% in the next year.

The peso market is striving to become self-sufficient locally, Rudolph says, to the point where it will be fully capable of funding Chilean corporates. He says that public Chilean companies with currency mismatches-such as utilities, for example, which have revenues in pesos and liabilities in dollars-can reduce their exposure to currency fluctuations by issuing peso-denominated debt.

In addition to building a thriving local market for Chile’s institutional investors, the ability to attract foreign investors to peso-denominated debt is crucial to encourage economic growth. Rudolph is eager to build a large base of foreign investors buying Chilean pesos and says the involvement of international investors in the Uruguayan issue is an important step “in recognizing the Chilean peso as a currency in which you can raise funds.”

Moctar Fall adds, “The Uruguayan issue publicly demonstrates how developed the market in Chile is, [especially] when two non-Chilean issuers raise funds in the market within the year.”

The World Bank issued the first Chilean peso-denominated bonds in May, a 55 billion peso (about $104.6 million), five-year public issue with a fixed-rate coupon of 6.6%. This came after the World Bank’s precedent-setting Mexican peso issue in February. Chase was bookrunner on both of these deals.

Start of a Trend?
Both Rudolph and Fall expect other international issuers, such as the International Development Bank, to float bonds in Chilean pesos this year. Fall says he also expects to see both sovereign and corporate borrowers to begin tapping the peso market in the coming months.

Not everyone is as optimistic that the Uruguayan issue heralds the start of a trend in the Latin markets.

A pension fund manager in Santiago warns that if the government eases regulations that restrict pension funds from hedging currency exposure in fixed-income instruments, the funds are more likely to invest in foreign currency issues abroad rather than in pesos.

Although he expects to see more peso-denominated debt from foreign corporate issuers in the near term, if regulations change, he doesn’t envision the future growth that some analysts are predicting.