Securitising Zimbabwe`s Minerals: A Case Study

Abstract

Following the dollarization of the Zimbabwean economy in 2009, the country has seen its economic fundamentals improve. Inflation has been reigned in, and the Gross Domestic Product (GDP) growth has been on an upward trajectory. However, Zimbabwe`s total external debt overhang continues to stifle the recovery of the country`s economy, as investors are not willing to lend to the country, and this has had adverse effects on the country`s Foreign Direct Investment (FDI) flows. Zimbabwe`s external debt overhang is currently estimated at around US$10.7 billion, which is a gigantic, 111% of the country`s GDP. IMF Report, (2012)

To circumvent the problem of external debt, which continues to be a major impediment to the economic recovery of the country, various scholars have put forward several solutions which include, declaring Zimbabwe as a Highly Indebted Poor Country (HIPC), and securitisation of the country`s mineral resources.

This study looks at securitisation of mineral assets in the Zimbabwean context, how this process can be achieved and the likely positive benefits this process can avail to the country. Theoretical and empirical evidence will be highlighted in analysing the process of securitising Zimbabwe`s mineral resources. The likely pitfalls of the process will also be examined and plausible recommendations will be offered on how best to securitise the mineral resources.



Obert Mpofu- Minister of Mines and Mining development


To put the argument into context, it is necessary to get a clear picture of the nature and scope of Zimbabwe`s mineral resource base so as to ascertain the feasibility of securitising Zimbabwe`s mineral resources.

Table: Minerals in Zimbabwe (reference: Investment Opportunities in Zimbabwe, Government of Zimbabwe, 2006 - as printed in the ZIIC Investor's Prospectus 2009)

Mineral	Estimated Resources	Current Annual Extraction Rates
Gold	13 million tonnes	20 tonnes
Platinum	2.8 billion tonnes	2.4 million tonnes
Chromite (Great Dyke)	930 million tonnes	700 000 tonnes
Nickel	4.5 million tonnes	9 000 tonnes
Coal	26 billion tonnes	4.8 million tonnes
Diamond	16.5 million tonnes	Infancy
Iron Ore	30 billion tonnes 300 000 tonnes
Copper	5.2 million tonnes
Coal-bed Methane	Largest known reserve in sub-Saharan Africa

With the second largest deposits of platinum in the world, it is apparent therefore that, there is a significant scope for securitising Zimbabwe`s minerals to extinguish debt,. And attract the much needed funding to the country.

What is Securitisation?

Securitisation is the creation and issuance of tradable securities, such as bonds, that are backed by the income generated by an asset, a loan, a public works project or other revenue source Financial Times, (2012). Another useful definition of securitisation is the creation of asset backed securities. These are debt securities that are backed by a stream of cash flows, and it is these assets with predictable cash flows that are turned into securities that can be traded in financial markets. Moneyterms.com, (2013)

Securitisation in the Zimbabwean Context

Various proponents pushing for the securitisation of Zimbabwe`s mineral assets argue that the country is ‘too rich to be in debt’, given the vast mineral deposits the country has. This is seen as a more viable solution in addressing the economy`s attendant challenges such as liquidity shortfalls, and the debt overhang.

By securitising Zimbabwe`s expansive deposits of minerals such as Platinum, Diamonds and Gold, the country would then be able to leverage on these assets to access funding. Using the future cash flows from the sale of these minerals, Zimbabwe would then be able to service the debt securities. In simple day to day illustration, this can be likened to ‘having a cow, you have not yet milked’. One can therefore leverage on the expected milk to be obtained in the future to access funding today rather than wait for cash flows from the sale of milk in the future. Therefore, by securitising her mineral deposits today, Zimbabwe can unlock streams of cash flows for infrastructure development, debt servicing, and addressing the liquidity challenges that are saddling the local economy.

Other Countries that have Securitised Their Mineral Resources

<!--[if !supportLists]-->·         <!--[endif]-->Mexico- Petreolos Mexicanos (Pemex)

Ketkar R, & Ratha D (2005) note that, in mid-1993, a majority-owned Mexican subsidiary of Pemex securitised a share of future receivables to be generated from the sale of Mexican crude oil to designated U.S.-based oil companies. The securitisation resulted in an offering of $366 million of 7.53% trust certificates maturing in 2000. Standard & Poor gave the securities an "A" rating, marking "the first time that foreign currency debt securities indirectly issued by an agency of the Mexican government have been rated higher than Mexico's foreign currency senior debt rating of BB.

In Africa, several countries have leveraged off their natural resources to obtain funding, thereby creating value in their economies basing on future cash flow receivables from their mineral assets. Angola and the Democratic Republic of Congo (DRC) are the most notable examples of countries that have done so. DRC, for example attracted over US$8 billion from foreign investors, when it securitised its future receipts from its diamond mines. A clear benefit is that countries that have managed to securitise future receipts, such as Brazil and Peru, avoid the downside risk associated with their countries` poor sovereign ratings, and thus attract interest from foreign investors. This is because the asset backed securities will be issued indirectly by an agency or third party of the parent country, therefore delineating the securitised asset from the country risk.

How Can Zimbabwe Successfully Securitise its Mineral Resources?

 Kothari V, (2010) highlights that, securitisation involves several distinct processes. First, the subject assets must be identified. Although the assets to be securitised may be financial or operating assets, the vast majority of securitisations to date, and those with which most practitioners are familiar, are those involving financial assets, generally in the form of loans such as mortgage loans, automobile loans, and credit card loans. Irrespective of the nature of the assets to be securitised, as a general matter, the assets must possess, or be capable of being structured to possess, standard or similar characteristics and terms so as to produce a stable cash flow, or, at a minimum, possess an aggregate rate of default that is reasonably quantifiable for specified time periods.

Once the assets that are to form the basis of the securitisation have been selected, those assets generally are transferred from their owner (sponsor or originator) or owners to a special purpose vehicle (SPV or purchaser), which can take several forms, including corporate and trust. The SPV, in turn, markets to investors, securities backed by the assets transferred to the SPV, and uses the net proceeds it receives from the issuance of the securities to make payments to the sponsor for the acquired assets, thereby providing immediate liquidity to the sponsor. Particular securitisations may involve additional steps.

 Zimbabwe`s securitisation will  be a future flows securitisation that seeks to raise funds based on expected future cash flows from the sale of its minerals.  Ketkar S & Ratha D, (2005) suggest that, since mineral prices generally fluctuate depending on the market forces of demand and supply, there is a need to provide some form of price floor using various hedging instruments.

The country would be the originator, since it owns the mineral resources to be securitised. It will sell the assets on its books and receive the funds generated from such a sale. In a true sale, Zimbabwe would transfer both the legal and beneficial interest in the assets to the Special Purpose Vehicle (SPV)

A Special Purpose Vehicle is an entity which would buy the assets to be securitised from Zimbabwe as the originator. It is typically a low-capitalised entity with narrowly defined purposes, and usually has independent trustees/ directors. The objective of securitisation is to remove the assets from the balance sheet of the originator; hence the SPV plays a critical role inasmuch as it holds assets in its books and makes an up-front payment for them to the originator.

Investors would then buy a participating interest in the total pool of future receivables from the sale of the mineral resources, and receive their payment in the form of interest and principal repayments according to a predetermined arrangement. They may be individual or institutional investors like pension funds, global hedge funds or insurance companies.

Since the investors would take on the risk of the asset pool rather than the originator, an external Credit Rating Agency is vital. It would assess the strength of the future expected cash flows and the mechanism designed to ensure full and timely repayment. Ratings agencies would also monitor the extent of credit and liquidity support provided and the strength of the legal and regulatory framework.

The various organisations and companies who are the prospective future buyers of Zimbabwe`s mineral products are called Obligors. When they ultimately buy the country`s minerals, they pay the sum owing to the SPV. The credit standing of the obligor is thus critical in the securitisation process, since it is cash flows from them that the entire deal will be hinged upon.

The Agent/ Trustee will be responsible for overseeing that all parties to the securitisation deal perform in accordance with the securitisation trust agreement. They are also responsible for collecting the payment due from the obligor and transfer of the payment to the SPV. They will also be tasked with pursuing all legal remedies against defaulting obligors.

Usually, an investment banker will be responsible for bringing together the originator, credit enhancer, the investor, and other parties to a securitisation deal. The investment bankers are called Structurers, and help in the structuring of the securitisation deals.

Since the investors in the securitisation deal take a direct exposure on the performance of the underlying collateral, and have limited recourse to the originator, they seek additional comfort in the form of Credit Enhancement. This refers to all mechanisms by which investors seek to buffer themselves against losses on the assets collaterising their investment.  Credit enhancement generally takes two forms, external which includes insurance, 3^rd party guarantee or internal, which entails credit tranching or over-collaterisation.

Benefits of Securitisation to Zimbabwe

<!--[if !supportLists]-->·       

   <!--[endif]-->Liquidity

One major advantage of securitising Zimbabwe`s mineral wealth, is the creation of liquidity in the local economy. At present, the economy has remained hamstrung due to the operational challenges caused by tight liquidity. By leveraging off its mineral resources, the country can unlock vast streams of cash flows other than waiting for revenues from future sales. Other scholars are also of the opinion that asset securitisation provides cheaper and long term external financing. This is mainly because, by transferring the mineral resources ownership to an SPV, this effectively delineates the sovereign risk of the parent country from that of the trust holding ownership of the mineral assets. The credit ratings thereof, are likely to be more favourable, hence attracting lower costs of funding. An example, is the Pemex securitisation deal whereby, the receivables from the crude oil future sales where rated AA+, whereas Mexico`s sovereign rating was ‘Junk’ status, resulting in a 7. 53% yield.

<!--[if !supportLists]-->·         <!--[endif]-->Increased Access to international Financial markets

At a time when Zimbabwe`s participation in International financial markets Is curtailed due to the existence of its large external debt overhang, securitising mineral resources could provide an easier way for the country to gain access in the financial markets. External investors who would otherwise not have had any dealings with the Zimbabwean government can now participate in the buying of the securities linked to the future receivables from the sale of minerals in the country. Furthermore, the fact that risk is mitigated through the use of an SPV, and processes such as Credit Enhancement, add to the allure of dealing with asset backed securities. Therefore, by carefully structuring the securitisation deals, Zimbabwe would entice the pique of foreign investors in international financial markets, and raise the much needed Foreign Direct Investment.

<!--[if !supportLists]-->·         <!--[endif]-->Informational Externalities

Future flow deals involve a much closer scrutiny of the legal and institutional environment—the existence as well as the implementation of laws relating to property rights and bankruptcy procedures—than unsecured transactions. In trying to structure away various elements of sovereign risk, highly trained professionals from investment banks, legal firms, and international rating agencies spend enormous amounts of time and energy examining the investment climate in a country, including the ways in which the sovereign can affect the performance of a private (or public) sector entity. They also closely study the risks facing the sovereign itself. Thus, these deals can produce enormous informational externalities by clarifying the legal and institutional environment and the investment climate obtaining in the country, and ways to possibly improve it.

<!--[if !supportLists]-->·         <!--[endif]-->Securitisation As A Strategic Tool

Mining is generally an industry that requires large sums of capital outlay. For the diamond industry, which is still in its infancy in the country, securitisation may be used strategically to unlock value in these mines which would need vast capital outlays which the country does not have at the moment. The government could identify strategic mines which are currently being under-exploited, and securitise their mineral resources and obtain funding to operate these. The positive spin-offs thereof, would have a catalytic effect on the whole economy, as jobs would be created, thereby boosting local demand, which would translate into a ready market for local manufacturers.

Furthermore, prices of minerals fluctuate significantly over time, for example, the price of copper is at an all-time 7- month low of $7, 449 a ton on Tuesday 02 April 2013, affecting countries like Zambia who are heavily dependent upon that mineral. To counter this volatility in mineral prices, governments could securitise their mineral holdings now, and stave off possible future losses as a result of adverse movements in the prices of the minerals.

Demerits of Securitising Zimbabwe`s Mineral Assets

<!--[if !supportLists]-->·         <!--[endif]-->Reducing Future Fiscal Flexibility

Assigning a future stream of revenue to service collateralized debt amounts to an earmarking operation and reduces future fiscal flexibility.  Kothari V, (2010) argues that, by limiting the resources under the control of the budget, the government`s ability to respond and adjust for changing macro-economic conditions is impaired. In the specific case of securitising future receivables, a particular concern (in addition to the problem of an inflexible debt service schedule discussed above) is that the related escrow accounts can lock in cash that would otherwise be available to the government. These idle cash balances represent an inefficient use of resources because they could be used for other purposes, for example, reducing short-term borrowing costs. The government could find itself in the position of building up cash balances in the SPV, while simultaneously borrowing at high interest rates or running arrears. Further, if a certain government revenue item (e.g., social security contributions or revenue shared with the provinces) is used as collateral, the government’s ability to alter the structure of that item (e.g., to reduce social security contribution rates or to alter the terms of revenue-sharing agreements) may also be constrained.

<!--[if !supportLists]-->·         <!--[endif]-->High Costs Incurred.

The structuring of a collaterisation deal involves the incidence of substantial set-up costs. These may be in the form of structuring fees, ratings agencies fees and the numerous legal costs that are involved in a securitisation deal. This would imply therefore, that the economic scope of securitising minerals is greatly undermined. In this respect therefore, the Zimbabwean government would stand to lose through these high set-up fees.

<!--[if !supportLists]-->·         <!--[endif]-->Performance Risk

 Most future flows securitisation deals are subject to performance risk. In the Zimbabwe scenario, this concerns the ability of the country to sustainably continue exporting its mineral resources in the international markets. For example, the friction between the Kimberly Process Certification Scheme and the Zimbabwean government over the mining and sale of its diamonds in international commodity markets is an example of inherent performance risk the country has.  If the country were to fail to extract and then sell its minerals, it would have no means to service its debt obligations, and this presents a significant downside risk to international investors.

<!--[if !supportLists]-->·      <!--[endif]-->Securitisation mortgages the country`s future underground resources

As financial markets become increasingly sophisticated, markets routinely analyse credit-enhanced instruments, such as collateralized bonds, by examining their risk components. Moreover, markets often strip the instruments and trade the risk components separately. The transaction costs associated with such strips and the relative illiquidity of the components typically lead markets to value credit-enhanced instruments somewhat below the value of their component parts. In cases where a future receivables arrangement is used to reduce the cost of borrowing, consideration should be given to whether the country would be better off issuing plain vanilla debt and using the cash that would otherwise have been used to back the future receivables arrangement to reduce the amount of such borrowing.

<!--[if !supportLists]-->·         <!--[endif]-->Possibility of an Increase In Fiscal Deficit

Mineral securitisation, by enabling financing that would otherwise not be available, may allow a government to run a higher deficit (and borrow more) than it would otherwise have done Gianviti F, (2003). This higher deficit should be assessed on the basis of its macroeconomic implications, namely, whether the higher debt and deficit are sustainable and the quality of the composition of the higher deficit, for example, whether the higher spending is for productive investment. As a rule, the use of future receivables borrowing to evade financing limits weakens the link between the sustainability of fiscal policy and the availability of financing. The critical question is whether the post-borrowing fiscal position is consistent with sustainability or whether the government is using the collateralized borrowing as a means to “over borrow” and to postpone needed adjustment.

Of particular importance is the debt overhang that can result from the ‘boom-bust’ cycles of commodity prices. Commodity-producing developing countries tend to increase their borrowing when commodity prices, and thus the value of collateral, is high. A subsequent fall in prices could leave countries with a substantial amount of inflexible debt and a much-reduced flow of resources to service it.

Recommendations

It can be concluded that mineral resource securitisation can provide a relatively cheap and easy way for low-middle income countries to raise developmental finance, especially when they have an unfavourable sovereign rating. Zimbabwe therefore can structure several securitisation deals to mitigate the sovereign risk and gain access to international markets and obtain the needed liquidity to boost the economy. The large external debt overhang the country is saddled with can thus be extinguished by the proceeds from the securitisation deals.

However, issues arise when one considers the effects of mortgaging the country`s mineral wealth on future generations. In effect, we will be punishing future generations for consumption expenses incurred in the past and this is unsustainable for the future of the country. Various analysts concur that the model for securitising mineral resources does not work for countries with huge debts, but merely for countries that require external financing for developmental purposes such as infrastructure development, thereby making Zimbabwe an unlikely candidate for securitisation.

The Zimbabwean economy could stand to benefit by identifying strategic mineral resources and collaterising them to unlock economic value in the economy, however, careful considerations of the legal framework in the country ought to be taken into account, together with the implementation of other strategies to revive the economy.

Reference List

Gianviti F, “Assessing Public Sector Borrowing Collateralised on Future Flow Receivables: IMF Working Paper”, 2003

Kothari V, “Securitisation: The financial Instrument of the Future, 3^rd Edition”, 2006, Wiley Finance

Ratha D, & Ketkar S, “Recent Advances in Future-Flow Securitisation”, World Bank Paper, 2005

Zimbabwe International Investment Corporation (ZIIC) Investor`s Prospectus, “Investment Opportunities In Zimbabwe”, 2009

http://www.highbeam.com [Securitisation of Oil, Gas and other natural resource assets: Emerging Financing Techniques]

www.moneyterms.co.uk

www.vinodkothari.com