The European bond market, before and after the Euro
On the 1st of January 1999, eleven European countries made history. The European financial market was recast following the most significant policy initiative in the history of finance.
Before the European Monetary Union, bond markets in Europe were predominantly domestic, segmented by currencies and conventions. By creating a single currency and eliminating exchange rate risk, EMU gave birth to an integrated European market. Gone were the lira, franc, guilder, mark and other domestic currencies. The euro had arrived.
The single currency had a profound impact on the way debt was issued and traded in Europe. The late 1990s and early 2000s were characterised by close collaboration between European treasuries, who took decisions concerning the harmonization of issuance.
In a spirit of cooperation, considerations regarding transaction size and duration factored into an informal pan-European issuance calendar, reducing the negative impact of competition between countries. They also moved to standardise conventions, adapting a common standard for the day-count of outstanding issues and adopting the TARGET settlement system. Many private sector issuers followed, making corporate bonds more liquid and easier to price and trade.
Soon transaction sizes become larger in the primary market. In 1998 there were just three bond issues in European domestic currencies above €1 billion equivalent, all from Tecnost. In the summer of 1999, the financing vehicle for Olivetti’s takeover of Telecom Italia raised € 15.65 billion!
EMU brought collaboration and competition in equal measure. Issuers introduced benchmark syndications to better target large institutional investors and raise “brand awareness”. The product range expanded to include floaters and a diverse array of MTNs. Always quick to innovate, France introduced inflation-indexed bonds and was soon followed by other European treasuries. The market became increasingly competitive.
There were big changes on the demand side, too. Before EMU, investor activity was largely domestic. Soon, euro denominated bonds were being distributed to mutual funds, pension funds and life insurers on a pan-European scale not witnessed before. Commenting on a Euro denominated issue by US insurer Principal Life in 1999, a syndicate manager at CSFB observed, “we sold 30 per cent of this deal in France. In the past we might have sold 3 per cent there”.
Eurozone governments led by example and the dealer community followed, homogenising issuance and secondary trading practices in order to compete for new business. As a result, underwriting fees were eroded, which in turn, led to more issuance from public and private sector issuers.
Pan-European trading platforms sprang up to cater to this new integrated market. MTS won the race in the cash market, creating EuroMTS to offer trading capabilities for the most liquid European government bonds. Its success lay not only in its technical prowess, but also in its “liquidity pact” – a commitment from market makers and issuers to follow rules fostering mutually beneficial liquidity in the secondary market. In the German bond market, trading focused on the derivatives side, with futures managed by EUREX. The volume of trade on EUREX increased tenfold between 1996 and 2001 from €172 billion to €1.6 trillion, killing off Bund futures trading on London’s LIFFE. Screen trading trumped open outcry.
In the aftermath of EMU, the volume of issuance in corporate bonds, covered bonds and asset-backed securities was hugely impressive. Indeed, after the dawn of the Euro, private issuance more than doubled to $657 billion in 1999. It’s fair to say it was private issuers – rather than governments, agencies and supranational – that drove the growth of the European bond market in its infancy.
This was a period of great change for dealers, as well as issuers. The Maastricht Treaty was heavy on fiscal discipline, restraining the total volume of government bonds issued in the Eurozone. As a result, public sector issuance in the Eurozone fell off a cliff, from $414 billion in 1994 to $111 billion in 2000. To make matters worse, falling foreign exchange and arbitrage trading volumes led to a dramatic decrease in revenues. There was widespread concern – bordering on panic – that EMU could sink trading desks and entire departments, with market participants estimating they could lose 60% of European bond business and 30% of swap business due to the elimination of the 10 local currencies.
However, in business, as in life, timing is everything. Fortuitously, the negative effects of EMU for dealers were counter-balanced by a global surge in private bond issuance. In turn, this fostered the growth of the European banks, trading platforms and exchanges, creating positive feedback loops that reinforced market activity and investor demand. The effective scrapping of the Stability and Growth Pact in 2003 then took over, leading to a wave of public sector issuance that continues to this day.
The story of the Euro and its implementation is a one of change, adaption and explosive growth. All this happened less than twenty years ago. Imagine where we’ll be twenty years from now?