The Euromarkets: evolution, structure, instruments

Michel Henry BOUCHET




The Euromarkets: evolution, structure, instruments
Origins and developments Eurocredits and Eurobonds Legal Clauses in Syndication Capital adequacy guidelines Tax, accounting and regulatory framework



Origins Development Structure Instruments Volume



The Euromarkets: evolution, structure, instruments
Preparation: Clark, Chap. 5, pp. 113-130 Madura: Chap. 3 Eiteman, Stonehil & Moffett, MBF, chapter 13 BIS Annual Report, Chap. VIII BIS Quarterly Review, Statistical Annex Bouchet: Credit Creation, Multiplication and Maturity transformation in the Euromarkets, USC, United States. Milton Friedman, The Euro-dollar Market, Federal Reserve Bank of Saint Louis, July 1971. ISMA Annual Report BIS Annual Report

What is a Eurocurrency?
Any freely convertible currency, such as a $ or a DM or £, deposited in a bank outside its country of origin. It is the residency of the bank and not its nationality that determines the ³euro´ nature of the deposit. Eurocurrency deposits are typically short-term deposits <1 year, whereas eurocredits are longer term, hence a maturity transformation in the Eurobanks¶ balance sheets.

The Balance of Advantage for The Borrowers Availability of international capital in larger amounts and to a wider range of borrowers than in the fixed-interest bond markets Capital is available more quickly. with fewer formalities and with fewer conditions (balance of payments financing) Flexibility against interest and exchange rate risk with currency options and variable roll-over period length (despite drawbacks of floating and unpredictable LIBOR cost of Eurocredits) MH BOUCHET (c) CERAM 6 .

aimed at discouraging foreign issuers from borrowing from US investors. borrowers wishing to raise US$ denominated debt came to Europe. The Eurobond market was born.The EUROBOND MARKET Whilst the international financing of public and private projects has existed since the 19th century. the market in its current form began life in the early 1960s. MH BOUCHET (c) CERAM 7 . where a growing pool of investors was ready to provide those funds without the burden of expensive taxes. US tax law also made difficult for US multinationals to fund their overseas subsidiaries from within the USA. the vast majority of international borrowing had been channeled through NY. The driving factor behind its growth and development was the tax regime introduced by the US government in 1963. Until that time. After 1963.

Euro commercial paper and debt denominated in Euro. label for all these forms of borrowing as ³international securities´. international FRNs. structured in a number of innovative ways. and more appropriate. global depository receipts. MH BOUCHET (c) CERAM 8 . As a result the term Eurobond has given way to a wider. and issued to investors from every corner of the globe.The EUROBOND MARKET Since the 1960s the market experienced rapid growth. The range of instruments traded has grown substantially.a measurement of the total volume of outstanding international bond issues. and medium-term notes. market size . and includes warrants. reached some US$3 trillon equivalent. Dealers and brokers worldwide trade issues denominated in a host of currencies. In 1999.

Since 1969.The EUROBOND MARKET The international nature of the market means that it is not subject to the same controls which govern the primary and secondary markets in purely domestic securities. MH BOUCHET (c) CERAM 9 . Membership has now exceeded 700 institutions based in some 50 countries. ISMA (International securities market association) has performed a central role by providing a global framework of industry-driven rules and recommandations which regulate and guide trading and settlement in this market.

They are issued in bearer form. IFIs or country governments. and denominated in a currency other than that of the country of placement.EUROBONDS Eurobonds: long-term financial instruments issued by MNCs. and coupon payments are made yearly. Highly tradeable securities. Eurobonds are underwritten by a multinational syndicate of investment banks and simultaneously placed in many countries. Liquidity in the secondary market is monitored by Euro-clear. The US$ accounts for about 50% of eurobonds. MH BOUCHET (c) CERAM 10 .

Bonds Contractual obligation on the part of the seller/issuer of the bond (the borrower) to pay a fixed amount per year for a set number of years to the buyer of the bond (the lender). At maturity. Coupon= number of $ paid the lender per year Maturity= number of years over which the bond runs Par value= original sum borrowed Coupon rate= coupon expressed as a % of the par value MH BOUCHET (c) CERAM 11 . the borrower repays the original face value of the sum borrowed.

The coupon rate is established by competitive pricing in the market. When the market rate of interest fluctuates. par value and coupon rate are invariant over the life of the bond. the price of the bond will adjust in such a way that the ratio coupon/price will equal the current interest rate.Bonds Coupon. MH BOUCHET (c) CERAM 12 . The coupon rate is set so that the bond will be able to compete with comparable instruments in terms of maturity. yield. credit risk« The bond can be traded on the secondary market at a market price which depends on the current market rate of interest for that type of bond.

the smaller M.Bonds P= M (1 + i) n M is bond value at maturity. n is number of years. For a given P. the higher i. MH BOUCHET (c) CERAM 13 . P is present value. i is interest rate. There is an inverse relationship between bond prices and interest rates.

. an investor can work out the price he would be willing to pay for a bond given his yield requirement. This if price is given. Bond price and YTM are held together by the following equation: M C C C + «.Price and YTM of a Bond Price and yield to maturity are mirror reflections of each other.e.+ ______ P = _____ _____ + ______ + 2 (1+y) 1 (1+y) (1+y) n (1+y) n The YTM is essentially the bond¶s internal rate of return. Alternatively. i.. and compare it with his own required rate of return to see if the bond is a worthy investment or not. that discount rate which makes the present value of all the bond¶s future cash infloxs equal to the current price of the bond (initial investment oputlay) MH BOUCHET (c) CERAM 14 . The two are inversely related and one is neded to arrive at the other. an investor can calculate the yield on the bond.

The US Treasury securities are used as proxy for risk-free return. As of end-2001.Yield curve Yield spreads refer to the difference between the yield on a given bond at the time of issuance and the yield on US Treasury securities of comparable maturity or other comparable government securities if the bond is issued in other currencies than the US$. the US10-year rate is the base rate as opposed to the 30-year rate till 2000. MH BOUCHET (c) CERAM 15 .

Eurobond Yield Curve in Per cent as of May 15. and October 24. 2001 7 6 5 4 % % % % % % % 5 7 MH BOUCHET (c) CERAM YE YE YE 5/99 /99 / 5 16 . 2000 and November 30.

They manage the clearing of transactions on settlement date. MH BOUCHET (c) CERAM 17 . Euroclear and Cedel have a network of custodian banks where the certificates are deposited in bearer form for safekeeping.Clearing procedures in the international bond markets International Securities Market Association (ISMA) Euroclear (created by Morgan in 1968) CEDEL (Centrale de livraison des valeurs mobilières) created in Luxembourg in 1970 Eurobonds are engraved certificates.

Argentina) Market risk remains high due to concentration on 5 major countries (Argentina. Brazil and Russia) MH BOUCHET (c) CERAM 18 . Ukraine. Mexico. Korea.Emerging Markets Eurobonds High risk/high yield with low default track record (premium of 20 basis points compared with US corporate borrowers for identical ratings) historically. defaults only in the 1930s and late 1980s but recovery rate is better for sovereign debtors than corporate debtors (75% vs 40%) problem of comparability of treatment with Paris Club and London Club debt (Pakistan. Ecuador.

as opposed to a handful of banks in the loan market. hence the link between the the euro¶s weakness and the popularity of the euro-denominated bond market (US$300 b worth of securities issued in euros during the first half of 1999) MH BOUCHET (c) CERAM 19 . This in turn enables companies to raise larger amounts of debt. which had an immediate downward effect on the value of the ¼.Eurobond Market By spreading the risk among thousands of investors. Many companies took benefit of the depreciating euro in the fist half of 1999 to borrow in Euros and swap the proceeds into US$. the bond markets lower the cost of risk and thus reduce the cost of funding for companies and other borrowers. both private and institutional.

The Eurobond Market Size Gross= completed new bond and note issues in US$ billion Net= Gross .redemptions and repurchases Q2 8 Gro et Sto k 8 MH BOUCHET (c) CERAM 20 .

Secondary market trading share/volume in 2003 12% Brady Euro onds Local Other 46% 37% US$1 00 billion MH BOUCHET (c) CERAM 21 .

Currency Breakdown of the international securities market Net bond and note issues in US$ billion 800 700 600 500 400 300 200 100 0 1997 1998 1999 2000 2001 2002 22 $ ¼ Y Other 45% 34% MH BOUCHET (c) CERAM .

5 billion PPR ¼ 1.8 billion Olivetti ¼ 2. ¼ 2.2 billion Vivendi Univ.2 billion Danone ¼ 1 billion MH BOUCHET (c) CERAM 23 .3 billion Artemis ¼ 1.Largest issuers of Euro-denominated convertible debt in 2001-03 France Telecom ¼ 6.4 billion Lafarge ¼ 1.

as benchmark government bond: October 2003 China¶s rating = A2 (Moody¶s) * 10-year US$1 billion dollar tranche arranged by Goldman Sachs. at 53 bp over USTB * 5-year ¼400 million euro tranche arranged by Deutche Bank. Merrill and Morgan.5 billion dollar and euro-denominated issue. BNP and UBS.China and the global bond market US$1. at 7 bp over Euribor MH BOUCHET (c) CERAM 24 .

11/2003: the EBRD is about to issue a US$150 million rouble bond in Russia¶s market for onlending purposes MH BOUCHET (c) CERAM 25 . with ANB Amro and Morgan Stanley as lead managers. a 14% rise. the US Agency Freddie Mac launched five-year two ¼denominated bond issues of ¼5 billion respectively as part of Euro-reference note programme.Currency diversification and Eurobond issues Between September and November of 2000. Multicurrency and global bond issues reach US$815 billion in 2000.

Eurobond Market Deutsche Bank Morgan Stanley Warburg Dillon Reed ABN Amro Merill Lynch Lazard Frères JP Morgan Salomon/Citibank BNP-Paribas Barclays Commerzbank Credit Suisse First Boston MH BOUCHET (c) CERAM 26 .

Samuraï market MH BOUCHET (c) CERAM 27 . and reduction in the required reporting history from 3 years to 12 months. They include recognition of international accounting standards. In 11/1993. the SEC adopted measures to simplify the listing of foreign companies in US markets. easier registration procedures.Bond markets Yankee market: issues have to satisfy SEC listing requirements. These require higher standards of accounting and disclosure than typical for Eurobond issuers.

International Debt Markets and Instruments International Securities Market Fixed and floating rate/medium to long-term bond issues Eurobond straight fixed-rate issue Floating-rate note Equity-related issue MH BOUCHET (c) CERAM 28 .

mediumsourced in the Eurocurrency markets I. Euronote facilities: short-term. because the notes are placed directly with the investor public. provided by international investment and commercial banks (fees for underwriting and placement services). and the securitized form allows the ready establishment of liquid secondary markets. MH BOUCHET (c) CERAM 29 . negotiable promissory notes. The euronote is substantially cheaper source of ST funds than syndicated medium-term debt instruments short.Eurocurrency market Instruments 1: EURONOTE MARKET Market of short.

Eurocurrency market Instruments II. Issuing procedures with arranger or placing agent and tender panel. MH BOUCHET (c) CERAM 30 .Note-issuance facility (NIF): A medium-term legally-binding commitment under which a borrower can issue a short-term paper in its own name. underwritten by banks which are committed either to purchase any note the borrower is unable to sell. or to provide credit.

and the longerterm international bond. This allows a firm to sell S/MT notes through a cheaper and more flexible issuance facility than ordinary bonds. Maturity: from 1 year to < 10 years Small denominations (from $2 to $5 million) MH BOUCHET (c) CERAM 31 . the corporation could issue notes on a continuous basis without having to obtain new registrations for each additional issue.Eurocurrency market Instruments III. Market expansion when the SEC instituted Rule # 415. allowing companies to obtain shelf registrations for debt issues: once the registration was obtained.Euro medium-term notes (EMTNs) It bridges the gap between the ST euro commercial paper issued in domestic markets < 6 months.

To receive interest.Eurocurrency market Instruments 2: The Eurobond Market A Eurobond is underwriten by an international syndicate of investment banks and other securities firms and is sold exclusively in countries other than the country in whose currency the issue is denominated: $-denominated bond issued by a US company. MH BOUCHET (c) CERAM 32 . Eurobonds are offered simultaneoulsy in a number of different capital markets. Eurobonds offer tax anonimity and flexibility. the bearer cuts an interest coupon from the bond and turns it in at a banking institution listed on the issue as paying agent. but sold to investors in Europe and Japan.

Eurocurrency market Instruments The Eurobond Market 1. Straight fixed-rate issue: bearer bonds. MH BOUCHET (c) CERAM 33 . full principal repayment upon final maturity. or a specified number of shares per bond. Equity-linked bonds: convertible bonds or bonds with equity warrants (amounted to $64 billion in 1997. The borrower is able to issue debt with lower coupon payments due to the added value of the equity conversion feature. Coupons are normally paid annually. The market value of an ELB is composed of the naked value and the conversion value. Right to acquire equity stock in the issuing company (sometimes with detachable warrants containing the acquisition rights). The conversion to stock prior to maturity is at a specified price per share. 2. fixed coupon. and $32 billion in 1998). set maturity date.

FRNs: since the early 1980s. FRNs are directed at institutional investors MH BOUCHET (c) CERAM 34 . medium-term notes where the interest is fixed as a percentage above sixmonth LIBOR. and issued in pre-determined and uniform amounts. Pays a semi-annual coupon determined on variable-rate base.Eurocurrency market Instruments The Eurobond Market 3. fixed interest periods. Negotiable and transferable securities with flexible interest rate.

Argentina was the first borrower ever to issue a global bond on 12/1993 with a US$1 billion placement. Some market participants estimate that EMCs such as Brazil and Argentina have been able to reduce the interest rate on funds raised through global issues by as much as 30 basis points.Global bonds Global bonds are issued simultaneously in several major international markets and allow issuers to tap into broader demand and obtain lower rates than those availabe in a single market. MH BOUCHET (c) CERAM 35 .

MH BOUCHET (c) CERAM 36 . 11/2000: Banco de Credito raised a $100 million 7-year bond backed by its inflow of hard currency electronic transfers.Peru and the Global Bond market 12/98: Telefonica del Peru (TDP) launched a $150 million 10-year bond backed by telephone receivables via JP Morgan.48% DCR and A3 by Moody¶s. The $ flow was transferred to the offshore trustee for the benefit of the certificate holder. The bonds were rated A. (the structure was substantially over collateralized): arranger: ING Barings. with a 7. The deal was priced at 315 bp over 5-year UST bills.

1% at a spread of 610 bp over US Treasuries (Deutsche Bank/Merrill Lynch) 03/2002: Peru reopened the issue.875% coupon. The bond carries a 9. MH BOUCHET (c) CERAM 37 .Peru and the Global Bond market 01/2002: Peru raised $500 million of 12-year bonds. priced to yield 10. pricing $250 million-worth of 12-year bonds at 575 bp.

) Interest Rate Switching: Selection of a new basis for interest calculations on an existing loan. The options may include LIBOR.Financial Clauses in Eurocurrency financing Bullet Maturity: One-time payment of principal at maturity. MH BOUCHET (c) CERAM 38 . a domestic rate. (The mechanism is intended to bring about a better match between the currency mix of debt service payments and the currency composition of external receipts. the prime rate or a fixed rate. to which a margin is added. Currency Redenomination: Switching of loans denominated in one currency or currencies into the currency of the creditor country or into ECUs.

Romania. Ukraine. tradeable instruments) MH BOUCHET (c) CERAM 39 . Ecuador and Venezuela (US$60 billion question!). Russia.Legal clauses in Eurocredits Problem of ³comparability of treatment´ between various categories of creditors: Axiom: an emerging market is a market from which you cannot emerge in an emergency! Ex.: Paris Club insists on involving Eurobond investors in refinancing and restructuring workouts.e. Rumania alone owes US$863 million eurobonds (i.. Test cases: Pakistan.

the clause is intended to prevent the obligor to grant a preferential repayment schedule to other banks which have not signed the convention and which would be paid ahead of normal maturity terms. In rescheduling agreements. it can provide the debtor with the opportunity to accelerate repayment of the loan on a voluntary basis and/or provide for acceleration of repayment due to changes in laws affecting the creditor.Legal clauses in Eurocredits Prepayment clause: The prepayment clause is a standard clause in loan agreements between a debtor and a creditor bank. MH BOUCHET (c) CERAM 40 . In its various forms.

no one lender may be placed in a more favorable position than its co-lenders with respect to payments received and/or recovered. MH BOUCHET (c) CERAM 41 . terminated. Thus. payments received or recovered by any one lender must be shared on a pro rata basis with all co-creditors under the loan agreement. cross-default: A legal wrinkle which allows one creditor to declare default and exercise its remedies against the borrower in cases where other loans of the borrower have been suspended. Further. accelerated or declared in default by other creditors.Legal clauses in Eurocredits pro rata sharing : A legal covenant in commercial bank agreements which specifies that debt service payments are to be made through the agent bank for allocation on a pro rata basis to all creditor banks.

Ex. Mandatory repayment clause: standard clause in loan agreements that stipulates certain circumstances under which repayment is accelerated. the provision is intended to neutralize "free rider" banks which do not participate in debt restructuring and new money agreements. In the context of rescheduling agreements. The debtor. Ecuador¶s default on Brady bonds in October of 1999! MH BOUCHET (c) CERAM 42 .Legal clauses in Eurocredits . The provision applies across the universe of public sector borrowers so that a voluntary prepayment of one or more credits by one borrower would trigger mandatory prepayment not only by that borrower but also by the other public sector borrowers. must repay all lenders on a pro rata basis. by being obligated to prepay any one creditor.

Pari-passu clause: Clause inserted in lending and restructuring agreements that provides for a strict equality of treatment among various categories of debts and various families of creditors. MH BOUCHET (c) CERAM 43 .Legal clauses in Eurocredits Optional prepayment provision: The optional prepayment provision permits the borrower to prepay all or part of the loan provided it prepays all lenders under the agreement on a pro rata basis.

MH BOUCHET (c) CERAM 44 .. IMF¶s position: Ecuador needs to find out some US$500 million to cover its balance of payments shortfall until the end of next year. the IMF is acquiescing in a country¶s decision to default on its debts to the international bond markets.1 billion in Ecuador¶s overall external indebtedness of US$13 billion... For the first time in 55 years.September-October 1 : The debt default of Ecuador in the limelight Ecuador: Brady bonds account for US$6. The Brady bonds have been subject to a lot of financial engineering. including the stripping of the collateral out of the bonds. and about US$1 billion to cover its budget shortfall. and probably more since Ecuador has foreign currency denominated domestic debt.

hence an unequal and unfair treatment of creditors! Subordination: ranking of current debt compared to future debt obligations in case of default MH BOUCHET (c) CERAM 45 . The objective of such a clause is to prevent a situation where a debtor would allocate significant assets to other creditors.Legal clauses in Eurocredits . In the case of a debt refinancing agreement. exports of goods. the debtor agrees with the banks not to provide any other group of creditors with security interest on the country's reserves. Negative Pledge provisions : they deal with the granting of security interests by a borrower over its assets to its creditors. and public sector companies' assets. thereby effectively subordinating the unsecured bank credits.

How do Negative Pledge clauses work in practice? Mexcobre/Paribas Citibank/Bancomext Pemex/JP Morgan Brady bonds and zero-coupon collaterals All required special waivers from IFIs! MH BOUCHET (c) CERAM 46 .

Collateralization schemes To facilitate the placement of debt instruments in the international bond market issuers use various structures of enhancements. Pemex issue in Japan secured by four offshore drilling platforms in the Gulf of Mexico. Assetbacked securities allow borrowers to tap the bond markets at considerably lower rates. Mexican company raised $200 million to finance a highway construction project through a bond issue backed by prospective toll revenues. MH BOUCHET (c) CERAM 47 . Mexican insurance group launched an issue of mortage-backed securities with the bonds secured against US$-denominated mortgages granted to Mexican residents.

WB¶s private investment bank. MH BOUCHET (c) CERAM 48 .5 billion bond with a WB US$250 million collateral to guarantee sequential payments on the bond.Asset-backed securities October 1999: Argentina issued a $1. borrowing for each payment the supranational¶s triple A credit rating. responded positively to a request to provide guarantees to Philippines¶ private sector companies tapping offshore debt markets.3 billion WB backed bond (Goldman Sachs and JP Morgan as advisers) November 2001: IFC. January 2001: Colombia issued a US$1. to help bring down borrowing costs in the capital markets.

2002 Debt Exchange offer In a historic transaction.21 billion of Bradys (mainly PDIs and Flirbs) for a new $ 30 million. Peru returned to the global bond market for the first time in 74 years to exchange $1. generated NPV savings of $30 million. 10-year global bond. The new bond was priced 50 bp below the outstanding Bradys and qualified for JP Morgan¶s EMBI+ index of most liquid and traded investments.PERU: Jan. The exchange reduced Peru¶s debt load by $280 million. MH BOUCHET (c) CERAM 49 .

PERU ¶s London Club Debt Secondary Market Price (% of face value) YTM 7% PDI Asian crisis FLIRB v nv nv t t r s t s t s c v ai in in ly il c de oc ar ar no de ju av fe ar ju ju ja ja ju se se se MH BOUCHET (c) CERAM 50 ju ne .

EMBI Spread Peru vs. Global.2003 MH BOUCHET (c) CERAM 51 . 1 .

Brady Bonds? Default on interest payments triggers exercice of interest gurantee and of principal collateral guarantee Bullet Payment at maturity LIBOR= 9 1/2 LIBOR = 5 1/4 t0 t10 t20 MH BOUCHET (c) CERAM t30 52 .

How to assess and calculate the market value of a collateralized Brady Bond? Brady bonds comprise defaulted London Club debt. often including a rolling 18-month interest guarantee. by using a risk-adjusted discount rate. MH BOUCHET (c) CERAM 53 . repackaged and backed by 30-year US Treasury bonds as collateral. 1. Calculate the risk-adjusted NPV of the guaranteed and nonguaranteed streams of interest payments and the principal payment at maturity. Strip the bond by separating the risk from the no-risk elements (interest and principal) 2.

4 billion Pars.year bond 2000: Argentina: US$2.7 billion Brady exchange 1999: Philippines: US$1 billion Bradys for new 10-year bond 1999: Brazil: US$2 billion Pars.New Ball Game 1 2003: Brady Debt Exchange Offers Enhanced liability management gives rise to debt exchanges: 1997: Brazil: US$4 billion Bradys for new 30-year global bond 1997: Argentina: US$2. Flirbs.2 billion Bradys for new global bond 2000: Ecuador: Eurobonds and Bradys for new 12-year and 30-year global bonds 08/2003: Venezuela¶s $3.3 billion Bradys for new 30-year global 1997: Venezuela: US$4 billion Brady exchange 1997: Panama: US$0. Discounts. NMBs for new 10. FRBs for new 15year global bond 2000: Brazil: US$5.8 billion buyback of 2007 bonds financed by new 2010 notes paying a below-market coupon MH BOUCHET (c) CERAM 54 .

with maturities ranging from 2 to 30 years. with high bond yield and coupon increases by 25 bp for every notch Moody¶s or S&P rating cuts < A category.25 bn and ¼2.6 bn deal in June 2000).Larger and more complex ever bond issues 03/2001: France Telecom launched US$16 bn multicurrency bond issue (>Deutsche Telekom¶s $14.75bn 3-year fixed rate bond. £. and ¼. sold to >600 different investors! MH BOUCHET (c) CERAM 55 . with eight tranches in $. 11/2001: France Telecom (Baa1/BBB) completes ¼5 bn fundraising in the European bond market with twotranches short-dated deal: 18-month floating rate tranche of ¼2.

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