Foreign Investment in Costa Rican Bonds

Arias | Diego Gallegos, a partner at ARIAS Costa Rica and an expert in banking and capital markets, presents this article regarding legal considerations for foreign investors interested in Costa Rican debt bonds.

Article 121, subsection 15 of the Political Constitution limits the Costa Rican government’s legal authority to issue sovereign debt bonds in international markets. Consequently, any issuance of external debt—including issuances under Rule 144A/Regulation S in the United States—requires prior approval by a two-thirds majority of the Legislative Assembly. Given that the conditions for an international issuance are not always met, Costa Rica offers two types of instruments available to foreign investors: domestic debt bonds and external debt bonds.

Regarding external debt bonds, foreign investors already familiar with Rule 144A issuances generally do not need to analyze additional legal considerations; they can rely on established regulations concerning trading, disclosure, payment mechanisms, and other procedures.

Domestic debt bonds generally offer a more attractive interest rate than external debt bonds and may be denominated in the local currency—the Costa Rican colón, which has appreciated by more than 30% against the US dollar over the past four years; however, they also require familiarity with and comfort regarding local regulations.

Foreigners may participate in the Costa Rican securities market by complying with local regulations. To do so, they must first engage a brokerage firm and a custodian, who will be able to purchase, hold in custody, and sell securities on their behalf.

Domestic debt bonds are public debt instruments that promise the payment of principal plus interest. They are authorized under the Budget Law, issued by the Ministry of Finance, and backed by the Central Government. The National Treasury defines the terms of each issuance, including the interest rate (whether fixed or variable), the currency (such as US dollars, Costa Rican colones, or another currency), any applicable discount, and other relevant characteristics. Interest and principal payments are made through the brokerage firm to designated accounts and are subsequently deposited by the brokerage firm into the client’s account.

Foreigners may participate in the Costa Rican securities market by complying with local regulations. To do so, they must first engage a brokerage firm and a custodian, who will be able to purchase, hold in custody, and sell securities on their behalf.

Domestic debt bonds are public debt instruments that promise the payment of principal plus interest. They are authorized under the Budget Law, issued by the Ministry of Finance, and backed by the Central Government. The National Treasury defines the terms of each issuance, including the interest rate (whether fixed or variable), the currency (such as US dollars, Costa Rican colones, or another currency), any applicable discount, and other relevant characteristics. Interest and principal payments are made through the brokerage firm to designated accounts and are subsequently deposited by the brokerage firm into the client’s account.
Domestic debt bonds are traded through the Central Bank’s Book-Entry System (SAC). The Central Bank manages the registry of sovereign and public debt issuances. Once settlement occurs, the custodian records the transaction in the SAC, which maintains the register of the securities’ ultimate holders.

All transactions are executed through the National Securities Exchange (BNV). The BNV clears domestic securities market transactions and transmits net securities and cash positions via the market settlement service for settlement in the accounts held by custodian and settlement entities at the Central Bank.

In addition to the legal nature, trading logistics, and settlement mechanisms described above, foreign investors must also consider the tax implications of investing in domestic debt bonds. Any tax analysis must address considerations regarding permanent establishment and withholding tax. The permanent establishment analysis requires reviewing several factors; however, investing in local bonds without any additional activity should not, in itself, constitute grounds for determining the existence of a permanent establishment. Foreign investors should also note that any interest income transferred abroad will be subject to a 15% withholding tax, which must be withheld by the custodian or the brokerage firm, as applicable.

In summary, foreign investors wishing to invest in Costa Rican-backed bonds can acquire either internationally issued or locally issued bonds. While external debt bonds offer greater familiarity to foreign investors, domestic debt bonds can provide higher yields and exposure to the local currency. When pursuing these higher yields, investors should be comfortable with the workings of securities market regulations as well as the potential tax implications of their investment. At Arias, we have advised various clients on structures involving local bonds and continue to see interest from foreign investors in these types of instruments; we therefore invite you to contact us if you have any interest in or questions regarding this topic.

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