MICROCAPITAL PAPER WRAP-UP: Microfinance Foreign Exchange Facilities: Performance and Prospects, by David Apgar and Xavier Reille of CGAP

microfinance exchange

By David Apgar and Xavier Reille, published by CGAP (Consultative Group to Assist the Poor), April 2010, 12 pages, available at: http://www.cgap.org/p/site/c/template.rc/1.9.43712/

“Microfinance Foreign Exchange Facilities,” a paper recently published by CGAP (Consultative Group to Assist the Poor), reviews methods microfinance institutions (MFIs) and microfinance investment vehicles (MIVs) use to deal with foreign exchange risk. It considers the nascent microfinance hedging market by detailing the operations of The Currency Exchange Fund (TCX), Cygma Corp and MFX Solutions LLC (MFX). It concludes by examining the importance of local-currency markets and additional development of the microfinance hedging market.

Foreign exchange risk, a key issue to the development of microfinance, is most significant when a MFI operating in an illiquid domestic currency receives a hard-currency loan. Fluctuating exchange rates through the term of the debt may adversely affect the MFI, though some MFIs pass this risk on to borrowers, meaning that even successful borrowers may be unable to pay back a loan. While large organizations operating in relatively liquid currencies can execute swaps and forwards, many MFIs are either too small or operating in markets where those instruments are not readily available. In a currency forward, two parties agree to exchange future payments in different currencies at an exchange rate that reflects expected future interest rates associated with the two currencies. A swap occurs when two parties exchange equal value loans in two different currencies with interest rates reflecting anticipated currency movement and institutional credit quality. These tools allow any financial institution to replace uncertain currency movement with a certain locked-in exchange rate.

TCX, a microfinance-only currency hedging fund created in 2007, addresses this problem by offering swaps and forwards to institutional investors in emerging market currencies. TCX has raised USD 590 million, including roughly USD 89 million from the Dutch government as of April 2010. TCX plans to hedge three to six times the total amount invested and requires a minimum investment of USD 5 million. TCX was designed to manage only emerging market foreign exchange and interest rate risk, accepting no default risk. As a result, use of TCX is limited to institutional investors, a requirement effectively disqualifying MFIs from direct contact. These MFIs must deal with financial intermediaries, such as MFX, another company profiled.

MFX offers non-deliverable swaps and forwards to MIVs and to MFIs which cannot deal directly with hedging organizations such as TCX. In non-deliverable instruments, the principal, or notional amount, of the hedge is not exchanged, which means parties only exchange the net difference between their positions. These tools are commonly used to hedge relatively illiquid currencies. MFX has raised USD 13 million and hedges 10 to 18 times that amount. The organization has a USD 20 million guarantee from the Overseas Private Investment Corporation, an agency of the United States government acting to promote international economic development. Commercial investors accept this guarantee in lieu of collateral or a formal rating. To work with MFX, MFIs must also be rated by MicroRate, a MFI rating agency established in 1997.

Cygma Corp was founded in 2007, to advise MIVs on management of foreign exchange risk. Cygma is planning to begin offering a fund to absorb the foreign exchange risk MIVs bear on currency swaps. The fund is intended to raise USD 50 million and cover up to ten times that amount.

By Matthew Castner, Research Assistant

About CGAP:

Housed at the World Bank Group, CGAP (Consultative Group to Assist the Poor) is an independent policy and research center dedicated to providing financial access for the world’s

poor. CGAP is supported by over thirty development agencies and private foundations. Its mission is to provide market intelligence, to promote standards and to offer advisory services to governments, microfinance providers, donors and investors.

About The Currency Exchange Fund (TCX):

TCX, a currency hedging fund created in 2007, offers swaps and forwards to institutional investors in emerging market currencies. In a currency forward, two parties agree to exchange future payments in different currencies at an exchange rate that reflects expected future interest rates associated with the two currencies. A swap occurs when two parties exchange equal value loans in two different currencies with interest rates reflecting anticipated currency movement and institutional credit quality. TCX has raised USD 590 million, including roughly USD 89 million from the Dutch government as of April 2010. TCX plans to hedge three to six times the amount invested with a minimum investment of USD 5 million. TCX was designed to manage only emerging market foreign exchange and interest rate risk, accepting no default risk. As a result, use of TCX is limited to institutional investors, a requirement effectively disqualifying MFIs from direct contact. These MFIs must deal with financial intermediaries to access the services of TCX.

About MFX Solutions LLC (MFX):

MFX offers non-deliverable swaps and forwards to MIVs and to MFIs which cannot deal directly with hedging organizations such as TCX. In a currency forward, two parties agree to exchange future payments in different currencies at an exchange rate that reflects expected future interest rates associated with the two currencies. A swap occurs when two parties exchange equal value loans in two different currencies with interest rates reflecting anticipated currency movement and institutional credit quality. In non-deliverable instruments, the principal, or notional amount, of the hedge is not exchanged, which means parties only exchange the net difference between their positions. These tools are commonly used to hedge relatively illiquid currencies. MFX has raised USD 13 million and hedges 10 to 18 times that amount. The organization has a USD 20 million guarantee from the Overseas Private Investment Corporation, an agency of the United States government acting to promote international economic development. Commercial investors accept this guarantee in lieu of collateral or a formal rating. To work with MFX, MFIs must also be rated by MicroRate, a MFI rating agency established in 1997.

About Cygma Corp:

Cygma Corp was founded in 2007, advising MIVs on management of foreign exchange risk. Cygma is planning to begin offering a fund to absorb foreign exchange risk MIVs bear on currency swaps. A swap occurs when two parties exchange equal value loans in two different currencies with interest rates reflecting anticipated currency movement and institutional credit quality. The fund is intended to raise USD 50 million and cover up to ten times that amount.

About MicroRate:

MicroRate was founded in the United States of America in 1997 with the intent to objectively evaluate microfinance institutions (MFIs), thus increasing transparency. As a result, MicroRate hopes to drive additional funding into microfinance. MicroRate has evaluated more than 500 MFIs worldwide, and claims to perform its evaluations not through “rigid rating formulas,” but through evaluation of critical risk. The organization has offices in the United States, Peru and Morocco as of 2010.

About Overseas Private Investment Corporation (OPIC):

OPIC is an “independent U.S. government agency” that supports companies that invest in “less developed countries.” It provides financing through direct loans as well as guarantees, political risk insurance, and investment funds. It currently works in over 150 countries.

Source: www.microcapital.org

Category: Payday loans

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