Impact investors may be missing an opportunity to restore sustainable emerging market growth and earn commercial returns by providing desperately needed restructuring support and growth capital to good emerging markets businesses suffering from macro events outside of their control.
Emerging market businesses are accustomed to suffering from macro shocks outside of their control. In that sense, COVID-19 is just an extreme example of a regularly occurring phenomenon. The current emerging market debt cycle will likely be magnified by pre-existing conditions of prolonged period of shortage of private capital in emerging markets ex-Asia, a recent dramatic increase in indebtedness, and a heavy impending maturity calendar.
Since 2015, emerging market external corporate debt has increased by nearly 50%, and upcoming corporate maturities total ~$1.3 trillion between 2021 and 2025. Using the Latin American Debt Crisis of the 1980s and the East Asian Crisis of the 1990s as benchmarks, the coming financial and social dislocation in emerging markets due to COVID-19 – and the need for companies to restructure their balance sheets – may be without precedent.
At a company level, well-executed corporate restructurings effectively reset the fair value of a company’s liabilities, de-lever the business, decrease its cost of capital, and pave the way for additional growth capital. The key to any restructuring is to “right-size” the balance sheet, which usually requires third-party intermediation between a company and its existing creditors. Investors can maximize their positive impact by backing management teams and shareholders who have demonstrated a longstanding commitment to building their businesses, enabling the survival and rehabilitation of companies that contribute to their communities. As with all impact investments, part of the restructuring package should include clear impact-oriented goals to measure and monitor throughout the life of the investment.
In 2007, for example, Albright Capital invested in Electro Sur Medio, a large electricity distributor in the Ica region of Peru. At the time, only about 80% of the region’s roughly 700,000 population had access to electricity, and the company served almost 20% of the region’s population. The company was in bankruptcy. Together with others, Albright bought the debt at a discount, and subsequently converted the debt into equity and helped to revitalize the company. This preserved local jobs and ensured continued provision of essential power services in the region.
Risk mitigation is of course always a priority for any emerging market investment, and helping businesses develop robust environmental, social and governance, or ESG, policies which adhere to UN Sustainable Development Goals standards is a priority for us. In some cases we catalyze change and improvement. Two examples are Torresec, a company in the digital infrastructure space that Albright Capital supported with an investment, and LatAm Trade Capital, a small and mid-sized market focused financial services firm that also had our support.
Emerging markets are positioned to suffer more than their developed-market counterparts in the wake of COVID-19, in large part due to governments’ inability to provide adequate fiscal and financial support to their economies. Last month, the IMF released an analysis estimating that approximately one third of all emerging markets have little ability to counteract COVID-induced recessions. In early September, one of the key architects of the Latin American and East Asian debt restructurings, William R. Rhodes, penned an article titled “Mounting Prospects for an Unprecedented Emerging Market Debt Crisis.” Finally, a set of well-known academics including Reinhart and Rogoff recently published an article detailing the coming “Debt Pandemic.” Key to their analysis was the “dramatic” decline of international private capital flows to emerging markets.
Impact investment asset managers, with their focus on positive impact through ex-ante intentionality and robust measurement and monitoring of non-financial returns, are well suited to play a leading role in helping emerging market companies restructure to survive this macro shock. The overarching goal should be to forestall widespread liquidations, job losses, deterioration in essential services, and financial sector instability. Unfortunately, few impact investors have the needed restructuring expertise to support companies in stress or distress.
Development finance institutions have traditionally limited their engagement in this area to supporting struggling existing portfolio companies, policy advisory (e.g., the World Bank’s Insolvency and Debt Resolution team), and programs to acquire and resolve nonperforming loans portfolios (i.e., the IFC’s Distressed Asset Recovery Program).
While the socioeconomic benefits of restructuring distressed companies are well understood, investments involving bankruptcy or company restructurings do not generally comply with established preferences within the impact investment and development finance communities to provide primary capital and avoid buying secondary debt at a discount.
From an impact measurement and monitoring perspective, it is indeed easier to assess lives changed via the building of something new versus the restructuring and revitalization of something pre-existing. Moreover, all restructurings, whether sovereign or corporate, require hard decisions. The aftermath of these decisions can generate adverse publicity, which frequently obscures the overriding potential positive impact of thoughtfully executed restructurings. It is crucial to emphasize that, hard decisions notwithstanding, restructurings need not, and should not, be hostile processes seeking to extract rather than enhance value. Well-executed corporate restructurings can provide both company-specific and systemic positive impact. Moreover, the absence of impact investors and development finance institutions in the space risks relegating this important role to investors unconstrained by the social implications of their actions.
At a systemic level, providing restructuring solutions and enabling the survival of good emerging market businesses is essential for sustainable economic growth and advancing the overall Sustainable Development Agenda. The goal is to avoid widespread liquidations and/or large numbers of “zombie” companies, in favor of organized and fully transparent restructuring processes. Coupled with impact-oriented guidance, impact investors that step into this role can offer emerging market businesses the opportunity to survive, revitalize, and realize their commercial and impact potential.
The pandemic has magnified the pre-existing shortage of critically needed capital in emerging markets, creating both the impact opportunity just described as well as the chance to generate strong financial returns inherent in major credit dislocations. Impact investors can thus earn commercial returns while supporting the survival and recovery of emerging market businesses, and ultimately helping emerging markets emerge more resilient from this unprecedented shock.
Gregory Bowes is co-founder and managing principal at Albright Capital.