Local

Currency Matters

Structuring Local Currency

Transactions: Case Studies
August 2012

www.tcxfund.com
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Structuring Local Currency Transactions: Case Studies

1 Synthetic Loan (NonDeliverable Swap)

Box 1: Transaction example
An international provider of longterm funding approves a 10 year loan for the construction of a
power plant in the east of Sri Lanka. Given that electricity income is typically charged in LKR, the
funding of the project in USD results in a currency mismatch for the borrower as the cost of debt is
now dependent on the value of the LKR over the life of the loan. The international lender thus
wishes to denominate the loan in Rupees, thereby eliminating this risk and thus reducing its credit
risk. In order to hedge the associated market risk with a local currency loan, the lender enters into
an offshore nondeliverable currency swap with TCX. This allows the lender to earn a guaranteed
USD denominated return whilst the borrower receives local competitively priced Sri Lankan
Rupee Loan. By providing hedging and local agency services, TCX facilitates the creation of a local
currency business line for its international investors and in this manner achieves its mission.

The sequence of cash flows can be chronologically described as follow ;

On the day of disbursement both parties have agreed upon a loan denominated in LKR. The lender,
an international development finance institution (DFI) disburses a 10yr term loan transferring
USD from his offshore bank account to the onshore bank account of his client (borrower). The
client will exchange the USD for LKR in the spot market to use the proceeds (in LKR) to achieve its
economic objective.

Thetermsyntheticreferstothefact
that,althoughtheprincipleamount
oftheloanisfixedinRupeeandthe
interest rate payable by the
borrower is determined using local
interest rate benchmarks, the
actual payment flow between the
lender and its domestic client is
settled in hard currency (often
USD),offshore

At the moment of disbursement, the DFI (lender) puts in place a cross

currency swap with TCX to hedge its currency exposure. Under the term of
the swap the lender receives Libor 6m + 3% in USD from TCX (its credit
margin on the borrower) and pays 13% in LKR to TCX over 10 years. The
rate of 13% quoted by TCX will be used by the lender to underwrite a local
currency agreement at 13% LKR per annum. The hedge intends to protect
the lender from LKR depreciation. The lender is able to provide a loan in
LKR instead of USD because it could hedge the currency and interest rate
exposure with TCX. The product provided by our investors to Sri Lankan
borrowers that involves a loan and a USD/LKR cross currency swap is
called a synthetic loan.

The client has now to pay the first interest payment on the term loan (and amortize a portion of
the loan if applicable). The preagreed interest amount in LKR (13%) is traded in the spot market
at a local bank or bureau de change for the equivalent in USD. Payments are denominated in LKR
with the payment obligations converted to hard currency on the date of payment, and payment
delivery in the lenders bank account (eg in London).

It is interesting to note that the
swap is a nondeliverable swap in
the sense that the lender does not
pay a 13% flow in LKR to TCX
against of payment of 3% in USD
fromTCX.TCX(thepaymentagent)
offsetthetwoflowsonaUSDbasis
so that one single cash flow is paid
orreceivedinUSD

A word of caution is that TCX uses

generally a central bank fixing for
nondeliverable swaps. As a result,
the borrower is required to remit
the funds to the lenders in USD at
each fixing at the prevailing fixing
rate (although the loans are
denominated in LKR). That
obligation creates a liquidity risk
fortheborrowerwhohastomatch
the fixing rate of the swap when
trading the USD/LKR in the spot
market.Thedifferencebetweenthe
centralbankfixingrateandtherate
traded in the spot market can
generate a profit or a loss for the
borrower.

At this stage two scenarios may occur (i) the LKR has depreciated in which
case the USD amount that the client obtained from the spot market is less
than the initial USD interest payment expected by the lender. This loss is
borne by TCX which under the swap pays the difference to the lender. The
borrower is immune to a potential LKR depreciation as the stream of
interest payments have been defined in LKR or (ii) the LKR has appreciated
in which case the amount of USD remitted offshore on the bank account of
the lender is superior to the initial USD interest expected by the lender.
This surplus is a gain for TCX recouped under the swap.

Time has come to repay the principal. Again, the borrower exchanges the
principal amount pre agreed in LKR as stated in the loan agreement into
USD at the payment date and transfers the USD offshore onto the lenders
account.
Again in case of a depreciation of the LKR the lender receives an USD
principal eroded by the LKR depreciation. TCX will settle the difference
with the lender under the swap agreement.

2 Domestic local currency loan structure

Box 1: Transaction example
An international provider of longterm funding approves a 10 year loan with a 5% interest rate for
the construction of a power plant in Dominican Republic. Given that electricity income is typically
charged in DOP, the funding of the project in USD results in a currency mismatch for the borrower
as the cost of debt is now dependent on the value of the DOP over the life of the loan. The client
wishes obtain from the lender a local currency loan denominated in DOP, thereby eliminating this
risk and thus reducing its credit risk and improving its funding and rating. In order to hedge the
associated market risk the lender enters into an offshore conditional deliverable currency swap
with TCX. This allows the lender to earn a USD denominated return whilst offering to the borrower
a local competitively priced Dominican Peso Loan. In that case, the lender margin of USD 5% fixed
is translated to DOP 22% fixed. By providing hedging, TCX facilitates the creation of a local
currency business line for its international investors and in this manner achieves its mission.

TCX
currently
only
offers
deliverable swaps in Dominican
Republic (DOP), Ghana (GHS),
Honduras (HNL), Kenya (KES),
Nigeria (NGN), Tanzania (TZS),
Uganda (UGX), West African CFA
Zone (XOF), and Zambia (ZMK) .
Morecountrieswillbeaddedbased
on demand, thus please contact us
shouldyouwishtodoadeliverable
swap (domestic loan) in another
country

On the day of disbursement, TCX Client transfers the USD principal of the
loan directly to TCX. TCX via its settlement partner(s) conducts an
auction for the conversion of the USD into DOP. The auction typically
includes both local and international banks active in the relevant market to
ensure the best rate available in the market is obtained. The DOP are
delivered directly to the borrower.

The DFI (lender) hedges the Currency and Interest Rate Risk of the USD loan through a Cross
Currency Swap with TCX.

Upon repayment of the principal and/or interests, the borrower transfers the funds in local
currency directly to TCXs banking account onshore. At the same time, TCX transfers the USD cash
flow stream back to the TCX Client after having simultaneously run auction to exchange the clients
DOP into USD. The elegance of the structure is that TCX uses the foreign exchange rate resulting
from the auction at each fixing date of the swap as opposed to a central bank fixing like it usually
does for nondeliverable swaps. As a result, the liquidity risk borne by the client is now shifted to
TCX.

Please note:

The spot FX bidask spread1 is priced into the deliverable swap. This is to reflect the transfer of
liquidity risk to TCX. Please note that this is not an additional charge, as the borrower would
also incur a bidoffer spread when converting LCY into HCY for offshore payment under the
synthetic (nondeliverable structure). The inclusion of the bidoffer in the swap provides the
borrower with pricing certainty;

TCXs settlement partner has 20 years experience in settling spot trades in emerging markets
and thus we are able to minimize operational and settlement risk;

The full process including the auction is fully transparent with an audit trail to provide comfort
to TCX Clients;

The deliverable swap is conditional in that the structure reverts to a nondeliverable swap
upon (i) a default event under the loan agreement and (ii) convertibility / transfer risk event;

In order for TCX to provide the deliverable swap, additional information on the borrower will
be required including KYC documentation. We thus encourage you to contact us early in the
life of the transaction to ensure we can meet your timeline requirements.

Clearance of the central bank may be required in some countries (ex. PHP) prior to
disbursement to rapatriate the funds thereafter offshore.

1 The bidask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and
the price at which a market taker will buy ("bid") from a customer.

2.1

Comparing synthetic versus domestic

Both structures have advantages and disadvantages which should be considered. These are
summarised on the following page.

Pros and cons of synthetic verus domestic structures

Synthetic loans
(Nondeliverable swaps)

Domestic loans
(Conditional deliverable swaps)

Pros Available for all currencies Superior spot rates via auction process
where TCX can trade
Auction rate used in both swap and
Dollar settled flows
loan agreement, thus no potential for
mismatch
Limited legal risk
Loan admin simplified for TCX Client
No extra charges
Borrower pays domestically and is not
responsible for conversion of funding
Transfer and mitigation of liquidity
risk to TCX
Enhanced development impact
Cons TCX Client responsible to Currently only available in 9
currencies
source liquidity and manage
physical flow of funds
Local FX controls and regulations,
legal risk can complicate structure
Spot rate used in swap may
differ from actual rate used in
Costs for execution the payment
loan agreement
services
Transfer risk and liquidity risk

for borrower

In summary, the following table sumarizes the risk allocation between the contracting parties in
the two structures.
Risk allocation in synthetic and domestic structures

Synthetic loan

Domestic loan

(Nondeliverable
swap)

(Conditional
deliverable swap)

Market Risk

TCX

TCX

Credit Risk

Lender

Lender

Hedge / Loan Match Risk Lender or Borrower

None

Liquidity Risk

Borrower

TCX

Convertibility Risk

Lender or Borrower

Lender / Borrower

Settlement Risk2

Lender or Borrower

TCX

This is the risk of the local bank that performs the transfer does not perform.

3 Direct hedging of exposures for clients of investors (NonDeliverable

Swap)

Box 1: Transaction example
An international provider of longterm funding (the lender) approves a 5 year loan to a local
microfinance institution (the borrower) in Kyrgyzstan with a 5% interest rate for the expansion of
the banks micro and SME portfolio. Given that the borrower on lends to its customer base in Som
(KGS), the funding of the project in USD results in a currency mismatch for the borrower as the
cost of debt is now dependent on the value of the KGS over the life of the loan. The client wishes to
hedge with TCX, thereby eliminating this risk and thus reducing its credit risk and improving its
funding, rating and prudential ratios. In order to hedge the associated market risk the client enters
into an offshore nondeliverable currency swap with TCX. This allows the lender to earn a USD
denominated return whilst the borrower synthetically receives a local competitively priced KGS
Loan. By providing hedging, TCX facilitates the creation of a local currency business line for its
international investors and in this manner achieves its mission.

The sequence of cash flows can be chronologically described as follows:

The client agrees with an international lender upon a longterm loan. After fulfillment of all pre
conditions, the client obtains a disbursement of the principal amount from the lender, paid in USD,
which is immediately exchanged for KGS in the spot market. The KGS proceeds are used to pursue

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the economic raison dtre of the loan (i.e. servicing micro and SME customers). For illustration
purposes, lets assume that the terms of the loan are the following : the client borrows USD from
the lender at a fixed interest rate of 5% per annum over a certain period.

At the same time as receiving the loan proceeds, the client enters into a cross currency swap with
TCX to hedge the underlying loan disbursed in USD. Again, for illustration purposes, let us assume
that the terms of the swaps are the following ; the client hedges the full loan principal and the
stream of interest payments defined in the loan agreement over the maturity of loan. Regarding
the interest payments, the client will be receiving from TCX a stream of interest rate in USD set at
5% fixed of the notional corresponding to what the client must pay to its lender under the existing
loan agreement. In exchange of what the client will pay to TCX in KGS a rate of 6m TBill + 530bp
(benchmarked against prevailing rates on the execution of the trade). Furthermore, all future
repayment obligations of the loan principal are agreed to be hedged with TCX at an FX rate equal
to the spot rate on the moment of the closure of the deal (T2).

The ability of the client (borrower)

to hedge directly with TCX enables
him to hedge USD liabilities
contractedwithnonTCXinvestors.

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In other words, the aggregate liability of the client, when combining

the USD loan with the hedge provided by TCX, is now transformed
into a KGS liability against a local benchmark (6m TBill). All
interests and principal repayment obligations for the USD loan are
mirrored in the swap and transformed into floating KGS obligations.
The lender is now fully hedged against any currency moves in the
USD/KGS. The benefit of the swap is that the client has now
managed to transform synthetically a USD loan into a KGS loan.

The 5% annual interest paid by the client to the DFI in USD cancels out with the USD leg of the
swap where TCX pays USD 5% to the client whereas the client pays KGS 6m TBill + 530bp to TCX
under the KGS leg of the same swap.

The cash flows sum up in this fashion ;

() the client pays USD 5%

under the loan agreement to the lender

(+) the client receives USD 5%

under the swap agreement from TCX

() the client pays KGS 6m TBill + 530bp

under the swap agreement from TCX

=
() the client pays KGS 6m TBill + 530bp

through the swap the client achieved to secure a

synthetic loan in KGS at 6m TBill + 530bp

This structure allows the client to define the characteristics of the swap (notional, timing of
implementation of the hedge, type of rate chosen, swapping the credit margin or not, maturity of
the swap) to offset with greater precision the currency risk mismatch embedded in its balance
sheet.

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Currency Risk vs. Interest Rate Risk
It is interesting to note that the client has swapped a USD fixed liability (5% USD loan) into a
floating KGS liability (6m TBill + 530bp). The currency risk is fully hedged. The interest rate risk
is hedged as well as long as the client underwrites loans on the same floating benchmark (6m T
Bill + the margin of the bank). If the client was to swap fixed USD vs. fixed KGS whilst on lending to
its customers on a floating basis, the bank would inevitably run an interest rate mismatch.

When time has come to repay the principal, the borrower exchanges KGS into USD to repay the
principal amount denominated in USD to the lender. Simultaneously, the client receives from TCX
(in case of a USD appreciation since the trade date), or pays to TCX (in case of a KGS appreciation
since the trade date), the difference of the agreed notional on both sides of the swap. This value
will compensate the client for any changes to the USD/KGS exchange rate since the trade date.
Please note that in exchange for the benefit in case of a KGS appreciation, the client has given up on
any gain on the loan principal in case of an appreciation of the KGS against the USD. The swap
matures with the loan final principal repayment.
To summarize in this case the investor provides a USD loan to the local client, who hedges the
resulting obligation with TCX. This has the benefit of avoiding complications at the level of the
investor and in the loan, but may have drawbacks as it requires TCX to accept the end client as its
counterparty. An additional benefit of this structure is the ability to decouple the clients currency
hedging needs from the specific investor loan, in terms of timing or other transaction terms. This
option is only available to institutions which have a funding relationship with a TCX Investor

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(DFIs). This structure offers a clear advantage as advocated by (Barry Eichengreen, Ricardo
Hausmann and Ugo Panizza, The Mystery of the Original Sin, 2003) as market participants may
prefer to separate these risks in order to facilitate the pricing of risk and thus facilitate the
development of market liquidity.

TCX was created to absorb market risks more specifically foreign exchange and interest rate
risks. TCX therefore seeks to minimize its credit risk exposure.
In currency derivatives, credit risk at the start of a swap is zero because the amount payable and
receivable by each party is exactly in balance (the deal is priced to achieve this balance). However,
as time passes, FX and interest rates fluctuate, disrupting the balance and leading to one party
owing the other money. If that party defaults, the net amount owed is lost by the other party.
Through Interim payments a minimum transfer amount is paid by TCX to its counterparty or
received by TCX from its counterparty to mitigate the evolution of the value of the swap (the mark
tomarket.) The two parties are entitled to make payments arising out of a mutual agreement. The
terms of this bilateral agreement are confined in Credit Support Annex (CSA). Collateral is the
industry standard way to mitigate the credit risk arising from "in the money" derivative positions.
More information can be found on : https://www.tcxfund.com/tradingwithtcx/collateralterms
withnoninvestors

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Further information

Please contact the TCX Structuring Team for further information and to explore specific
transaction opportunities. Please refer to TCXs website, www.tcxfund.com, for more details on
TCXs investment products and the requirements to trade.

TCX Structuring Team: Per van Swaay, Jorge Gomes, Jerome Pirouz

Email:

structuring@tcxfund.com
Tel:

+3120 531 4851
Address:

TCX Investment Management Company B.V.



Sarphatikade 14
1017 WV
Amsterdam
The Netherlands

www.tcxfund.com










Disclaimer
The Currency Exchange Fund N.V. (TCX) is structured as an open end investment fund. The statutory managing
director of TCX is TCX Investment Management Company B.V. (TIM). According to 1:12 sub 1b Act on financial
supervision TCX and TIM are exempted from the obligation to obtain a licence from the Authority for the
financial markets as only qualified investors may invest in TCX. The contents of this presentation should not be
considered as an advice to participate in TCX or purchase any securities offered hereby.

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