TCX: local currency innovation in developing countries

Sep 2007
Amsterdam, the Netherlands, September, 04 2007 - A global partnership of financiers, led by Dutch development bank FMO, creates a large and innovative fund to develop local currency products in developing countries worldwide. The Currency Exchange Fund N.V. (TCX) will start up with a transaction capacity of US$ 1.2 billion for long-term local currency financing by its investors. The result: drastically reduced default probability, improved business sustainability and a major contribution to the development of local capital markets.

 The technicalities

The eleven participating institutions will use these hedges to create and/or increase their local currency denominated product offering to clients in developing countries and emerging markets.

TCX is a unique cooperative effort of a large number of (sub) emerging market investors, enjoying clear benefits of size and scope. The investors joining TCX in the first close will commit in aggregate approximately US$ 300 million in equity. Initial transaction capacity will reach up to US$ 1.2 billion, increasing with expected further commitments in the short term.

TCX investors will pay special attention to the Sub-Sahara Africa region, and to the microfinance, housing and infrastructure sectors.

Addressing Market Failure

Numerous financial crises attest to the real existence of the currency risk to entrepreneurs and their local banks. Well-known hyper-devaluations in Asia, Turkey, Russia and Argentina in the late 1990s and early 2000s illustrate the devastating effects that unstable financial systems can have on the local and regional economy. Many companies found themselves unable to service suddenly very expensive dollar and euro debt after such a crisis. This instability also has a profound effect on the economy and society as a whole: it can take a developing country up to 10 years to recover from such a set back.

A solution to this problem has now been found by FMO. TCX assumes the currency risks previously transferred by international financiers to the local entrepreneurs and their local banks, and by doing so improves their business sustainability and reduces defaults. The upsides are profound to both financier and companies alike. Companies are no longer exposed to currency risks that they cannot manage and systemic risk becomes limited. At the same time, financiers have a much broader commercial market to address with long-term local currency products.

Spread the risk

TCX research proves that the risk of investing in a spread portfolio including a large number of currencies and interest rates, diversified across all regions in the developing world, is only 25% of the risk of investing in any single currency. In other words: true global risk diversification works much better than regional diversification, especially under very stressed market circumstances. By pooling local currency risk, TCX is the first to introduce the concept of a well diversified portfolio of developing country currencies.

Competition needed

The market for local currency financing is large, and TCX will not be able to provide for it alone. It is expected that the initiative will spark interest from others who will follow suit rapidly. Local currency hedging mechanisms such as TCX have the potential to create very positive economic impact in developing countries. Furthermore, TCX's substantial hedging requirements will have a substantial effect development of local capital markets.

Source : FMO, News

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