Bonds without Borders E-Book

Chris O'Malley

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Series
• Sprache: Englisch

Seitenzahl: 769

Veröffentlichungsjahr: 2014

Beschreibung

Bonds without Borders tells the extraordinary story of how the market developed into the principal source of international finance for sovereign states, supranational agencies, financial institutions and companies around the world. Written by Chris O'Malley – a veteran practitioner and Eurobond market expert- this important resource describes the developments, the evolving market practices, the challenges and the innovations in the Eurobond market during its first half- century. Also, uniquely, the book recounts the development of security and banking regulations and their impact on the development of the international securities markets.

In a corporate world crying out for financing, never has an understanding of the international bond markets and how they work been more important.Bonds without Bordersis therefore essential reading for those interested in economic development and preserving a free global market for capital.

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Bonds Without Borders

A History of the Eurobond Market

CHRIS O’MALLEY

This edition first published 2015 © 2015 Chris O'Malley

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Library of Congress Cataloging-in-Publication Data

O'Malley, Chris.    Bonds without borders : a history of the Eurobond market / Chris O'Malley.       pages cm    Includes bibliographical references and index.    ISBN 978-1-118-84388-8 (cloth)  1. Euro-bond market–History.   I. Title.    HG3896.O43 2015    332.63′23094–dc23

2014029870

A catalogue record for this book is available from the British Library.

ISBN 978-1-118-84388-8 (hbk) ISBN 978-1-118-84387-1 (ebk) ISBN 978-1-118-84386-4 (ebk) ISBN 978-1-119-01084-5 (ebk)

Cover Design: Wiley Cover Images: top photo: ©iStockphoto.com/peepo             bottom photo: ©iStockphoto.com/ricardoinfante

To my dear sister Kath, and sister-in-law Jan, who lost their battles with cancer during the writing of this book.

Contents

Foreword

Introduction: Fifty Years of the Eurobond Market

Chapter 1 Before the Beginning        To 1962

Notes

Chapter 2 Building the Base        1963–1969

Notes

Chapter 3 Oil and Turmoil        1970–1979

Notes

Chapter 4 Masters of the Market        1979–1984

Notes

Chapter 5 Going Global        1985–1989

Notes

Chapter 6 The Derivatives Dash        1990–1995

Notes

Chapter 7 Convergence and Credit        1995–1999

Notes

Chapter 8 Of .Com's and Cons        1999–2004

Notes

Chapter 9 Mark-to-Model        2004–2007

Notes

Chapter 10 Busts and Bailouts        2007–2010

Notes

Chapter 11 Sinking Sovereigns        2011–2013

Notes

Postscript

Notes

Glossary

Index

End User License Agreement

Guide

Cover

Table of Contents

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Foreword

Bonds Without Borders is a testimony to a fascinating period in the development of the international financial markets. Chris O'Malley in his different positions at Credit Suisse First Boston and Samuel Montagu was an active participant in the fastest growing securities market in the world. He has undertaken the difficult task of describing the different stages of the history of modern international bond markets. His painstaking research into the defining moments of the market deserves great applause and most importantly gives the reader a fascinating picture of the dynamic pioneering work of investment banks and their people. It shows their unlimited commitment to the expansion and creation of a borderless world in which capital is moved to where it is most needed, with the best risk adjusted returns. The missionary spirit of people like Chris helped to put together, piece by piece, a market that today provides US$2.5 trillion to supranationals, governments, and corporations alike.

Chris's insights into the workings of the market have allowed him to concentrate on the essentials and enable the reader to understand the enormous progress achieved over the years in allocating capital through free markets. This book catches the spirit which drove the markets towards globalisation; providing an enormous benefit to emerging countries, and helping billions of people to achieve economic progress. This book offers a very timely reminder of how important open markets are for the unrestricted flow of ideas, goods, people and capital. Chris O'Malleys' book makes a significant contribution to a better understanding of the great benefits open financial markets have brought to the world.

In addition, this book demonstrates how important it is for the actors in the market to exercise their profession with the necessary care and prudence.

Hans-Joerg Rudloff Chairman of Kidder Peabody 1978–1980, Chairman of Credit Suisse First Boston 1989–1998 and Chairman of the investment bank at Barclays from 1998 to 2014

Introduction: Fifty Years of the Eurobond Market

It was Paul who came up with the idea. Instead of singing the usual love song lyric of ‘I love you’, it should be in the third person ‘She loves you’ and other band members would respond with the refrain ‘yeah, yeah, yeah’. A few days after writing the song, The Beatles gathered at Abbey Road Studios, London, on 1 July 1963 to record ‘She Loves You’ for release as a single. Released in the following month it was a gigantic success, becoming the best-selling single of 1963, and remains the best-selling Beatles' single in Britain. It was the breakthrough that led The Beatles to international success.

As that recording session in Studio 2, Abbey Road was getting under way, five miles away in Gresham Street in the City of London a group of senior international bankers and lawyers were signing a subscription agreement for an international bond issue for Autostrade, an Italian road builder. It was the first of a new type of financing targeted at international investors. This new ‘Eurobond’, as it came to be known, represented an historic breakthrough in the international financial markets.

*   *   *

The Eurobond market, the largest international capital market the world has known, has a confusing name. Eurobond doesn't refer exclusively to bonds issued in Europe or indeed, bonds denominated in the euro currency. (Nor does it refer to the term chosen by the authorities during the current financial crisis to describe a possible European sovereign bond underwritten jointly and severally by all Eurozone governments.) The term Eurobond defines the type of security rather than the currency or domicile of the obligation.

A web search reveals the popular, but imprecise, definition that it is a bond issued in a currency other than the currency of the borrower. But this could also describe a ‘foreign bond’. A foreign bond issue is one offered by a foreign borrower to investors in a national capital market and denominated in that nation's currency, for example, the Kingdom of Norway issuing a dollar bond in New York. Helpfully, foreign bond markets have all attracted nicknames: so a foreign bond in the US market is a ‘Yankee bond’, a foreign bond in the Japanese domestic market is a ‘Samurai bond’, and a foreign bond issued in the Australian market is a ‘Kangaroo bond’, and so on. A foreign bond issue will always follow the rules and practices of the relevant domestic securities market.

Whereas a Eurobond issue is one denominated in a particular currency, but sold to investors in national capital markets other than the country of issue. It is a bond issue specifically targeted at cross-border distribution, hence the title of this book. It does not follow the rules of a particular domestic market. In the modern era this cross-border status is protected by documentation which protects the investor's right to receive payment free of any national withholding taxes. However in earlier times, before national tax regimes, this cross-border characteristic was less clear.

Over half a century the Eurobond market has grown into the world's largest international capital market, with approximately $20trn equivalent of bonds outstanding as at mid-2013. For many years it grew at a compound rate of 20%. The market has played a pivotal role in the worldwide flow of capital. Indeed such has been the success of the market in Europe that it has replaced most domestic bond markets and even foreign bond markets. Visiting regulators from Asia, for example, are surprised to find that the UK does not have a domestic corporate debt market nor indeed an active foreign bond (i.e. ‘bulldog’) market. Such is the efficiency and depth of the Eurobond market, with its opportunity for worldwide distribution, that issuance in the UK domestic market has become redundant and all financing is channelled via the Eurobond market. This is the case in most European jurisdictions.

The Eurobond market has offered an ever-increasing range of instruments, currencies and innovative product structures. The response of certain domestic markets might be to limit the range of permitted currencies and products, whereas the Euromarkets characteristic response has been to remain flexible and open to innovation and change. Indeed the Eurobond market has benefited by exploiting the inefficiencies in individual domestic markets. This book describes the developments, the market practices, the challenges and the innovations in the Eurobond market during its first half-century. The story, of course, is a cumulative one. Innovations arrive, but they stay and are developed further and create new markets of their own with new customers and new expertise. It is difficult to take in the immense size, complexity and interdependency of the modern debt capital markets. The founding fathers probably had a pretty clear overall picture of the workings of the debt capital markets, whereas today's market participants are typically focused on small areas of those complex markets. Their expertise and understanding are largely limited to those sectors.

The generation that developed the Eurobond market are long retired. Today's practitioners know little of the origins of today's global market; indeed many have only known markets in the midst of the financial crisis. After more than a decade training capital market practitioners I have found that today's market participants tend know what to do, but have little grasp of why things need to be done the way they are. For example, they will know what the requirements of SEC Rule 144A are, but have little understanding about why and for what purpose it was introduced. So the 50th anniversary of the market seems a good point at which to pause and look back on the market's history and answer some of the ‘whys?’. To this end this text is targeted at students and new market participants; although I hope it will also be read by older or former market participants, as a source of interest and, perhaps, nostalgia.

*   *   *

Any breakdown of the history of the Eurobond market is inevitably arbitrary, but there are some clearly defined stages in the market's development. The period from the inception of the market until 1984 saw the gradual opening up of the international markets and a period of deregulation. This regulation had resulted from the protectionist attitudes in the post-war era. Economies had shielded themselves from outside economic forces by exchange controls, restrictive fiscal regimes, and domestic markets closed to outsiders. By the end of 1984 in Europe, most of these national barriers had been removed. Arguably, the mid-1980s was the most liberalised and unfettered period for international securities markets in modern history. There were few securities market regulators and concerns about investor protection were still some way off.

The next discernible period is from 1984 until 1999, or until the introduction of the euro. As markets liberalised in Europe and opened up to foreign competition, the need to put in place codes of conduct and measures to protect the interests of individual investors grew. Europe was building the foundations of the single market. Increasingly, governments and regulators were concerned about the globalisation of the markets and the integrity of the financial system. The Basel Accord was one of the early products of this concern, and the Group of 30 report on derivatives in 1993 a further signal. These concerns were well justified as market crises continued, threatening the financial system as capital flowed increasingly freely across international borders. There were times when the old protectionism looked attractive again, as evidenced by Malaysia closing its economy in response to the Asian crisis in 1998.

The introduction of the single European currency in 1999 heralded the modern era of the markets and resulted in the conversion of the international debt market into a largely dual currency market. With the disappearance of the legacy currencies, market convergence plays and currency plays became redundant and investors focused on credit. The rise of this credit market occurred in a low nominal interest rate environment, which followed a long period of high interest rates. Investors, hungry for high returns, were enticed to consider riskier credits or looked to invest in structured derivative products which would provide, higher, leveraged returns. This pursuit of high, if not excessive, returns inevitably led to a crisis which has shaken the global financial system to its roots; first in the form of a global banking crisis then leading on to a disturbing sovereign debt crisis.

This then raises the issue of regulation. Previous histories of the Eurobond market have either pre-dated, or chosen to ignore, the development of financial markets regulation. But our story would make little sense if we did not cover regulatory matters, and the profound impact of regulation on the Euromarkets both now and in the future. Key landmarks in the development of European, and where relevant, US regulation are addressed in the text.

*   *   *

But what is history? The eminent historian Professor E.H. Carr, in a series of lectures under the same name, argued that the ‘facts’ of history are simply those which historians have selected for scrutiny. Historical facts come to us as a result of choices by historians influenced by their own perspective and experience. So it is with the current volume. This is not a comprehensive history of the cross-border debt markets, although it is an attempt to catalogue the development of the investment grade bond market over the last 50 years. Many related areas of the international bond and money markets only receive a cursory mention or, indeed, no mention at all; from commercial paper to repo, to emerging markets, high yield or Islamic sukuk. The path the reader treads is, to a degree, the path the author trod, and the areas of focus in the text reflect the bias of the author's own interests.

My own career in ‘high finance’ came about somewhat by accident. In the early 1970s the City was still largely dominated by alumni of the British public school system and ‘Oxbridge’. I was an economics undergraduate at Manchester University. The university had just embarked on the pioneering idea of an ‘Appointments Bureau’; a special office to assist graduates in getting employment when their studies finished. Central to the Appointment Bureau's services was a computer dating facility which matched undergraduates up with suitable companies. I had little interest in the prospect of work after my studies but was obliged to participate in the service and was matched with Dunlop, the tyre and sports equipment manufacturer. Having come from an area of Birmingham where Fort Dunlop, the original tyre factory, was a major employer, this appeared to me to be an uninspiring choice and I did not take up the offer to pursue the match. However as my time at university drew to a close I was summoned to the Appointments Bureau to give an account of my job search. Of course I had done nothing; student life in the 1970s was far too much fun to bother about a career.

The afternoon arrived when I must visit the bureau and I began to panic. Then, by chance, on afternoon television the then Chancellor of the Exchequer, Denis Healey, was speaking at a conference about curbing the excessive pay, or taxing more heavily, stockbrokers and merchant bankers. That was it! I turned to my girlfriend and said, ‘I don't want to work, but if I have to, I want to earn a lot of money!’ The manager at the Appointments Bureau was somewhat taken aback when an hour later I announced to him that I wanted to be a stockbroker or merchant banker. He knew little of this profession but recalled that one such company had approached the University. After a search, he found details of a stockbroker called Phillips and Drew, and, what's more, they were having an open day for graduates the following day. As the university would pay my expenses I found myself early the next morning on the train to London.

I joined Phillips and Drew in July 1974 and began working on Local Authority Bonds. This was a very active market in which Phillips and Drew had a dominant position. (Unfortunately the Hammersmith and Fulham swap fiasco in 1988 would effectively close the market down.) My destiny was to move into the government bond or ‘Gilt-edged’ department. However in July 1977 Phillips and Drew decided to enter the burgeoning Eurobond market and hired Philip Howard from Deltec to set up the business. I was offered a role to be Philip's assistant, which sounded a far more exciting prospect to me than a life in long gilts. As the department grew, with further recruits, my prospects of partnership seemed to grow more remote, so I moved to another stockbroking company, Savory Milln where I set up a Eurobond desk myself. In time my sales activities in this minnow of a player became well known to Brian Berry, head of trading at Crédit Suisse White Weld and ultimately to his boss, Oswald Gruebel. At the AIBD's Venice AGM, Mr Gruebel hired me as head of sales for Crédit Suisse First Boston (CSFB). (Mr Gruebel would go on, of course uniquely to be CEO of both major Swiss banks, Crédit Suisse and UBS.) These were vintage years for CSFB when they dominated the new issue league tables under the inspired guidance of Hans-Joerg Rudloff. But CSFB was a highly competitive and aggressive environment and three years later when approached by Samuel Montagu I moved to the UK merchant bank. Samuel Montagu was one of the original Eurobond houses and at this time had hired David Potter from CSFB to lead a renewed thrust into the Euromarkets. The bank was also attractive as, through its partial ownership by Midland Bank, it gave access via Midland's controlling interest, to Trinkaus and Burkhardt, the German private bank; which was key as the deutschemark primary market was just opening up in 1984. I became head of global bond sales for Samuel Montagu, running teams in London, New York, Hong Kong and Tokyo and serving on the bank's Board for nine years. In time, Midland Bank took full ownership of Samuel Montagu and thereby became the first British clearing bank to own a London merchant bank, now renamed Midland Montagu.

Midland Bank's fortunes waned after its disastrous purchase of a majority share in Crocker National Bank of California in 1980. In 1987 HSBC took a 15% investment in Midland and in 1992 HSBC Holdings plc acquired full ownership of Midland Bank. As my sales role would now be confined to Europe, I suggested to management that I change direction and establish a department for capital markets coverage for the Middle East, India and Africa. This business grew steadily over subsequent years with an increasing number of bond and loan issues for borrowers from the region until the Asian crisis blew up in 1998. In the belt-tightening which followed, HSBC closed many peripheral operations and my department fell victim to the cuts.

Before long, Robert Gray, Managing Director of HSBC, and Chairman of the International Primary Market Association (IPMA) approached me to work as a consultant to IPMA covering membership and IT initiatives, in particular developing a cross-market bookbuilding system, IPMA Match. As IPMA's finances were strained I also developed and ran a training course for the primary markets, the IPMA Diploma. When IPMA merged with ISMA in 2005 to form ICMA, I became a Senior Advisor to ICMA and the IPMA Diploma joined the suite of courses run by ICMA Executive Education as the Primary Market Certificate. I now run courses on a wide range of topics from the Debt Capital Markets to European Regulation. This background has left me well placed to embark upon the current text.

One of the original plans, particularly for the earlier part of the book, was to interview prominent market participants to record their experiences. While interviews are used, their use was limited as it became apparent that people's memories over a span of fifty years can be hazy; oft repeated stories contained different details or numbers each time they were recounted. It therefore proved a more fruitful strategy to search out as much available source material as possible, hopefully recorded closer to the time of the actual events, to make the narrative as accurate as possible. Yet even amongst source publications there are often discrepancies in the information, for as simple a matter as the coupon and term of a particular bond issue. Euromoney, EuroWeek and IFR (International Financing Review) articles written at the time proved an immense help. Any inaccuracies that still remain are my responsibility.

Completing this volume would have been nigh on impossible without the kind assistance of the Board and senior management of the International Capital Market Association, both in terms of their generous support and advice and the access they afforded to ICMA's internal archives and publications.

Further thanks must go to Euromoney Publications with their flagship publications Euromoney and EuroWeek (now renamed Global Capital), and Thomson Reuters with ‘IFR’; they have chronicled every development in the Eurobond market since the 1970s. They are an essential and often quoted source of detailed bond market information.

Special thanks also go to Stanilas Yassukovich and Robert Gray for reviewing the text and for Hans-Joerg Rudloff for kindly agreeing to write the Foreword.

My thanks must also go to colleagues and friends in the market, and participants on my training courses, who have encouraged me to stick with the book when occasionally my enthusiasm waned.

Most importantly I must thank my long-suffering wife, Brenda. Throughout my career in the market, when I worked long hours in London or spent extensive periods abroad, she managed to bring up a large family without a great deal of help from me. And now for more almost three years she has put up with me huddled every day in my office at home while the house and garden fell into neglect.

On finishing the narrative, my wife, who had been clearing out her parent's home, presented me with a booklet entitled, A Guide to the Eurobond Market, dated 1979. This was an internal publication from Phillips and Drew. I had been one of its authors 35 years ago, and had not seen the document in 30 years. Yet here I was many years later undertaking the same task but on a bigger scale. Why?

Perhaps it is the sense of good fortune for having lived through such an exciting time in international finance, to have been given so much responsibility, to have travelled the world, and been well rewarded for doing so. I only need reflect on the gulf between my career and the working life of my own father; a semi-skilled welder in a Midlands car factory for 40 years; more than 10 years of which were spent on the night shift.

Perhaps it is a sense of fellowship. At the end of the day markets are simply about people, and I have been lucky enough to work with many fine and talented people in the cross-border markets; many are friends still. I cannot express it better than Stanislas Yassukovich did years ago in the AIBD Gazette in April 1982 on the occasion of the passing of the eminent euromarketeer, André Coussement:

No-one can fail to be impressed by the statistical evidence of the Eurobond market's importance in the world financial scenery. Statistics only tell part of the story, however. At the end of the day, regardless of the league tables, the rankings, the size of the issues, or the turnover which may illustrate the contribution of a particular institution or group of firms to the market as a whole, it is still the people who count: it is the individual operators who have influenced the general course of the market and its tone at any particular moment in its evolution.

CHAPTER 1Before the BeginningTo 1962

The origins of bond markets can be traced back to governments and their need to borrow, particularly in times of war. In the late Middle Ages, the Republic of Venice was involved in recurring conflicts with neighbouring states. The authorities, concerned about the strains on the state treasury, took to drawing forced loans from their citizens in proportion to their wealth. Such debt paid 5% interest per year and had an indefinite maturity date. Initially regarded with some suspicion, they came to be seen as valuable investments that could be bought and sold. The bond market had begun.

From the medieval Italian city states to warring European powers looking to finance military campaigns, the issuance of interest-bearing debt has enabled them to pursue their ambitions. Much of this debt, like that of Venice, was undated with governments creating a permanent funded debt burden. The amount of debt that could be issued depended on the investor's confidence in the ability and commitment of the issuer to make the required payments under the contract. Unfortunately sovereign issuers were prone to renege on their debts or change the terms substantially, so the investor's preference was originally for short-dated, high interest loans.

During the latter part of the 16th century the Dutch attained an increasingly dominant position in international trade, especially the lucrative spice trade, a position previously occupied by the Portuguese and Spaniards. Amsterdam became the city where merchants and bankers could obtain bills of exchange to settle their trading activity.1 At the time, it was customary for a trading company to be set up for the duration of a single voyage, financed by a small group of merchants, and to be wound up upon the return of the vessels. Investment in these expeditions was a high-risk venture, not only because of the dangers of sickness, piracy and shipwreck, but also because of changing market conditions for the imported goods. The further a trading expedition ventured, the greater the risks involved, and the greater the number of investors required to finance it. In 1602 the Dutch government sponsored the formation of the Dutch East India Company, which was given a monopoly over Asian trade for a continuous period of 21 years. It was the first company to issue shares and the offering attracted more than a thousand Dutch investors. As the financial outcome of voyages was not known until a particular expedition was completed, the shares varied widely in value and a secondary market soon developed between merchants, investors and speculators. As Asian spices were imported in bulk to meet the seemingly insatiable appetite in Europe, huge profits accrued to the shareholders.

The Dutch came to dominate trade in Europe. They were favourably positioned at the centre of a network of European trade routes. Dutch traders shipped wine from France and Portugal to the Baltic countries and returned with grain for countries around the Mediterranean. By the 1680s, an average of nearly 1,000 Dutch ships entered the Baltic Sea each year. The Dutch were also able to gain control of much of the trade with the young English colonies in North America.

The accumulation of capital in the enormous amounts generated in this period caused a demand for productive investment opportunities. Wealthy investors with cash balances found that investing in loans and securities was a more portable and flexible way of managing their wealth, rather than relying solely on the revenue from their estates or their trading ventures. So it was among the merchants of Amsterdam that active trading in securities first developed and led to the establishment of the Amsterdam Stock Exchange and the Bank of Amsterdam.