This Smetrix white paper traces the evolution of emerging market sovereign finance in the foreign and domestic financial markets, starting from the era preceding the Bretton Woods system through the wave of capital account liberalization in emerging market countries. The paper discusses the differences in risk perceptions held by domestic investors versus foreign investors. These differences spur the creation of debt instruments which are designed specifically for the sovereign's domestic investors. Also discussed are the differences between domestic dollar debt instruments and the cross-border debt instruments designed for foreign investors in the international capital market. By investing in the domestic dollar debt instruments, domestic financial institutions such as banks can more productively use their economic and regulatory capital under Basel II.

Through the use of graphical metaphors, this presentation explains the concepts that underpin the newly developed financial technique of multibank future flow securitization. These concepts are needed to understand how multibank securitization benefits both investors and originators of future flow backed transactions, by enabling a more efficient collateral structure and realizing savings on transaction costs through issuance-size economies of scale. The superior structural benefits are achieved by aggregation of the future flow receivables at the national level through the backing of the sovereign.

This paper discusses a new way for sovereigns to manage external debt with the help of the domestic banking system. The focus is on the use of future flow securitization as a debt-management and risk-reduction tool administered on the macroeconomic level. This direction represents an evolution from the earlier practice in other countries where future flow securitization was performed only at the single bank level solely for microeconomic benefits

Previous attempts to create securitization facilities at the sovereign level for countries have been hampered by a lack of suitable assets to securitize. In reality there is no lack of securitizable assets, if the sovereign government and its banking system were to use modern information technology to create a new financial infrastructure without interfering with its present business processes. The sovereign government can benefit by having significantly lower cost external financing because the securitized facility has the potential of attaining credit ratings that are significantly higher than the sovereign’s conventional debt credit rating. But the benefits go beyond low-cost financing as a much more stable and robust capital structure can be created at the national level. The new capital structure will also allow the sovereign government to reduce the level of sovereign risk at any given level of leverage as indicated, for example, by the debt-to-GDP ratio. Reducing the sovereign risk will decrease the yields required by the market for the government’s borrowings as well that of every borrower in the country.

This paper examines the differences between single-bank versus multibank securitizations made possible by aggregation at the sovereign level. The evolution of single-bank transactions is examined, tracing the adoption of solutions to address inherent problems with the structure. Some of these solutions have become customary features in the now prevailing model of single-bank securitization but which may not be well suited for the newly developed multibank securitization structure. A fundamental weakness of future flow transactions is that the fate of the securitized asset cannot be separated from the fate of the originating bank because the flows do not exist at the time of the transaction and future generation of flows is entirely dependent on the continued existence of the originating bank. Moreover, investors have no recourse to the underlying bank should it stop operating and fail to continue generating future flows. In response to this risk, single-bank structures have evolved to heavily rely upon early amortization triggers to remedy all sorts of problems occurring at the originator level where the investors have no recourse. This paper explains how, in contrast to single-bank transactions, the risk-reward tradeoff involving various transaction events are now quite different so that many conventional practices which are customary for single-bank transactions may no longer be appropriate for the multibank securitization structure.

By using newly developed structured finance methods in combination with isolation techniques used to shield receivables from sovereign interference in future flow securitization, it is now possible to aggregate an entire country’s incoming future flows, such as worker remittances, into a national special purpose vehicle. Unlike the previous model of single-bank securitization wherein the special purpose vehicle owning the future flows borrows funds in the international capital markets, the national special purpose vehicle does not borrow funds for itself. Instead it enters into specialized financial contracts such as swap agreements with onshore issuers of existing-asset securitization to enable those issuers to access the international capital market. In so doing, the special purpose vehicle can provide the lowest cost solution to manage the foreign exchange availability and transferability risks in cross-border securitization. The difficulty of obtaining swaps from commercial third parties that assure foreign exchange availability and transferability has often been cited as the major obstacle in completing cross-border existing asset securitizations. National remittance aggregation provides a sustainable and self-reliant solution.