London, 19 July 2021 -- Moody's Investors Service ("Moody's") has today
assigned an A1 foreign currency long-term issuer rating to The
Currency Exchange Fund NV (TCX). The outlook is stable.
The main factors underpinning TCX's A1 rating are:
(1) The strong support from a diverse group of mostly highly rated shareholders
and government supporters;
(2) TCX's very strong liquidity profile with very large liquidity
buffers and prudent liquidity policies;
(3) Its moderate capital adequacy which reflects solid levels of paid-in
capital and other funding support in order to mitigate market risk,
in particular foreign-currency risk; and
(4) Prudent and high-quality risk management policies and practices,
which are however essential for TCX's risky and highly volatile
business model.
The stable outlook reflects Moody's expectation of solid growth
in TCX's business volumes over the coming years coupled with continued
strong shareholder support. It also balances the volatile business
profile with prudent and high-quality risk management policies
and practices Hence, risks are broadly balanced as reflected in
the stable outlook.
Moody's considers that governance considerations have been a key
factor in this rating action.
RATINGS RATIONALE
ORGANIZATIONAL STRUCTURE AND STRATEGY
TCX is a specialized finance vehicle, providing currency hedging
solutions on illiquid emerging market currencies to Multilateral Development
Banks (MDBs) and Development Finance Institutions (DFIs). It is
owned by a group of more than 20 MDBs, DFIs as well as several microfinance
investment vehicles, and also receives financial support from a
group of highly rated governments.
TCX's mandate is to support the shareholders' development
activities by enabling them to provide their borrowers in emerging and
frontier markets with financing in their own currency, while shifting
the currency risk to TCX. Since its inception in late 2007,
TCX has hedged approximately $9 billion worth of loans provided
to borrowers in emerging and frontier markets. The company operates
as public limited liability company and is based in Amsterdam, the
Netherlands.
TCX's primary products are (typically non-deliverable) cross-currency
swaps and to a lesser extent FX forwards. The basis of its transactions
is that TCX must be additional to existing financial markets solutions,
i.e. TCX only offers hedging solutions where no market exists
or only at longer maturities than the market offers. TCX gives
preference to its shareholders or their designated entities, with
shareholders typically accounting for 85-90% of business
volumes. TCX commits on a best-effort basis to execute hedging
transactions per year with each of its shareholders of at least their
respective capital contribution. As of end-2020, TCX
provided hedging on 55 currencies. Given its developmental focus
and multilateral shareholder structure, Moody's rates TCX
under its Multilateral Development Banks and Other Supranational Entities
Methodology.
RATIONALE FOR THE A1 RATING
FIRST FACTOR: STRONG SUPPORT FROM DIVERSE GROUP OF MAINLY HIGHLY
RATED SHAREHOLDERS AND GOVERNMENT SUPPORTERS
The first driver of today's rating action relates to TCX's
member support. TCX benefits from a group of very highly rated
shareholders, with currently 76% (end-2020:
69%) of shareholders rated Aaa. The largest shareholders
are Kreditanstalt fuer Wiederaufbau (KfW, Aaa stable), the
European Bank for Reconstruction & Development (EBRD, Aaa stable)
and the Development Agency of the Government of the Netherlands (FMO,
Aaa stable) with a share of around 16% each. The European
Investment Bank (EIB, Aaa stable) and the International Finance
Corporation (IFC, Aaa stable) are also significant shareholders
with around 10% each.
Moody's key indicator for the ability of shareholders to provide
support to an entity in case of need is the weighted average shareholder
rating which in TCX's case stands at "A1", being
skewed lower by the presence of small impact/microfinance investors who
are unlikely to provide additional support for TCX in case of need (given
their own size and other limitations). But the support from the
highly rated MDB and DFI shareholders has been long-standing and
increasing over time. TCX performs a crucial service for them,
which helps them to achieve high developmental impact with limited financial
cost.
In addition, TCX received an unfunded commitment from the European
Union (Aaa stable) for a total amount of €145 million in December
2020, which Moody's considers to have some similarities to
callable capital and therefore considers in its assessment of contractual
willingness to support.
SECOND FACTOR: STRONG LIQUIDITY PROFILE REFLECTING LARGE BUFFERS
AND PRUDENT POLICIES
The second factor driving the A1 rating is TCX's very strong liquidity
profile with a very large liquidity buffer of over $1 billion,
which is invested in highly rated instruments and cash, as TCX strives
to minimize any other risks apart from the market risks inherent in its
business. Treasury assets are also highly liquid, with around
80% having a remaining tenor of less than one year. TCX's
liquidity buffers are sufficient to withstand even severe stress scenarios;
Moody's key indicator for the availability of liquid resources is
therefore assessed at the highest level.
Also, Moody's considers TCX's liquidity policies to
be very prudent, with frequent and sophisticated stress testing
being undertaken.
THIRD FACTOR: MODERATE CAPITAL ADEQUACY METRICS REFLECTING SOLID
LEVELS OF PAID-IN CAPITAL AND OTHER FUNDING SUPPORT
The third factor underpinning TCX's A1 rating relates to its moderate
capital adequacy which reflects solid levels of paid-in capital
and other funding support, counterbalanced by a risky and highly
volatile business model. Since inception, shareholders have
provided substantial paid-in equity in the form of Class A shares,
totaling $795.5 million as of end-2020, including
earnings which are fully retained. However, shareholders
can redeem their shares on a quarterly basis, subject to an annual
cap of 20% of total outstanding shares and several other restrictions
under TCX's control. In addition, shareholders have
a one-off option to redeem their shares in full in 2045.
These are unusual features compared to the typically permanent provision
of capital for MDBs. Moody's reflects these by only accounting
75% of the shares as capital in its capital adequacy calculations.
Several shareholders have over the past years redeemed shares, although
they tended to not actively use TCX. None of the original and large
Aaa-rated shareholders has ever redeemed shares.
In addition, the governments of Germany (Aaa stable), Switzerland
(Aaa stable) and the United Kingdom (Aa3 stable) have provided financial
support in the form of convertible subordinated loans which mature in
December 2045 and amount to $189.3 million. The subordinated
loans convert into Class B shares in a scenario in which TCX's shareholders
decide to wind down the Fund. They then rank junior to Class A
shares. For this reason, Moody's aligns their treatment
with that of the Class A shares, by assigning 75% equity
credit to the loans.
While the Dutch government has provided similarly subordinated loans (for
an amount of $81.5 million) Moody's does not incorporate
these into its calculation of equity, given that they mature on
31 December 2025. Useable equity of $738.6 million
compares to development-related assets of $1.8 billion;
these include both the primary and the hedging portfolio, which
reflects Moody's view that the hedging is effective in reducing
TCX's market risk exposure.
TCX's solid levels of paid-in capital and other funding support
provide buffers to TCX's risky and highly volatile business model.
Asset quality is low given TCX's focus on emerging and frontier
market currencies and the most illiquid parts of currency hedging,
while the performance of the currency portfolio is highly volatile.
The large number of currencies in which TCX trades provides some risk
diversification as do concentration limits that are strictly enforced.
That said, the effectiveness of diversification is constrained by
the correlation of some of the traded currencies.
In most years, TCX generates a profit, which is fully retained
and added to useable equity, but Moody's also considers the
years in which regional or global currency crises have generated significant
losses for the Fund, in particular 2014/2015 and 2018. That
said, last year TCX generated a small profit, despite the
highly synchronized deprecation of most of its traded currencies in the
early months of the pandemic.
FOURTH FACTOR: PRUDENT AND HIGH QUALITY RISK MANAGEMENT POLICIES
AND PRACTICES
The company's comparatively high risk profile requires a sophisticated
risk management, and in Moody's view TCX's policies
and practices are of high quality and appropriate for its business model.
Its practices and standards closely follow Basel rules for commercial
banks and are adapted to reflect TCX's specificities and its predominant
exposure to market risk. TCX performs tailored, extensive
and frequent stress testing, which supports long-term capital
planning and a high awareness of the business risks across the firm.
The company makes use of specialized external expertise such as an independent
Pricing Committee, which validates the Fund's pricing methodologies
and valuation of the Fund's positions. Reporting, data
availability and transparency are of very high quality and frequency.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS
Environmental considerations are not material to TCX's rating profile.
That said, the currencies of emerging markets in which TCX is active
might be negatively affected by natural disasters.
Social considerations are not material to TCX's rating profile.
Even though social considerations can have an impact on a country's
exchange and interest rates, thereby impacting TCX's development
asset credit quality as well as liquidity through additional margining
requirements, the impact is only indirect and the diversification
of its currency exposure offsets this risk.
Governance considerations are material to the rating and are a driver
for assigning the A1 rating. The riskiness of TCX's activities
requires sophisticated risk management. In Moody's view TCX's
policies and practices are appropriate for its business model, and
incorporate strict exposure limits, stress testing, the existence
of an independent pricing committee and very conservative liquidity management.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody's expectation of solid growth
in TCX's business volumes over the coming years coupled with continued
strong shareholder support. TCX's business volumes have been
significantly below expectations in 2020 due to the pandemic and the resulting
inability of many of its investors to generate their intended business
volumes. In addition, MDB/DFI borrowers had to restructure
their loans, with the consequent need to also restructure the related
derivatives. The volume of new primary deals was $985 million,
lower than the target of $1.3 billion as per TCX's
current strategy for 2019-2022. TCX now targets a primary
production portfolio of $1.25 billion for 2021 and has pencilled
in an annual production target of close to $2.7 billion
by 2025, implying annual portfolio growth of 20%.
While ambitious, Moody's expects that the portfolio growth
will continue to be accompanied by further capital injections so as to
ensure a sufficiently high capitalisation; during the pandemic shareholders
continued to support TCX with additional capital injections of $44
million from several existing and one new shareholder. Late last
year, the unfunded guarantee with the European Union was signed,
and will likely be activated to a large extent or fully in 2021.
The stable outlook also reflects Moody's view that risk management
will remain prudent and of high quality, limiting the risks to the
business and to TCX's senior counterparties.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Upside rating potential could develop if paid-in equity was made
permanent and shareholder support became more skewed towards very highly
rated entities. While TCX has solid levels of capital and subordinated
loans at its disposals, we do not give full credit to these given
shareholders' redemption rights. Upside rating potential
could also emerge if callable capital increased significantly.
Downside rating pressure could develop in a scenario of severe losses
and sharply deteriorating asset performance coupled with evidence that
shareholders were unwilling to provide additional capital. In such
a scenario, TCX's capital levels would trend lower,
potentially approaching the trigger levels at which shareholders would
have to decide on the voluntary winding-down of the Fund.
The principal methodology used in this rating was Multilateral Development
Banks and Other Supranational Entities Methodology published in October
2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1232238.
Alternatively, please see the Rating Methodologies page on www.moodys.com
for a copy of this methodology.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and
sensitivity analysis, see the sections Methodology Assumptions and
Sensitivity to Assumptions in the disclosure form. Moody's
Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of
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same series, category/class of debt, security or pursuant
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Moody's general principles for assessing environmental, social
and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.
At least one ESG consideration was material to the credit rating action(s)
announced and described above.
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am Main 60322, Germany, in accordance with Art.4 paragraph
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Kathrin Muehlbronner
Senior Vice President
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
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Alejandro Olivo
MD-Sovereign/Sub Sovereign
Sovereign Risk Group
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