Under the hood of the Eurobond Market

Over the past few months, we have been working very closely with one of our major customers to gain a better understanding of the underground “plumbing” that drives global bond issuance.

Perhaps unsurprisingly, this hasn’t been a straightforward task, but we’ve learned a lot about how bonds are created, issued, settled, and paid for. We’ve gained a deep insight into the roles of the Central Securities Depositories (or “CSDs” such as Euroclear and Clearstream), the issuing and paying agents (“IPAs”), and the listing exchanges, and importantly, we’ve been able to map out how those institutions interact with borrowers, dealers and investors. It’s been enlightening, teaching us about the market, its history and the products that Origin should be looking to build in the future.

What’s been fascinating to learn is that Europe, in fact London, is the center of the first truly international bond market. Domestic bond markets existed for many decades, and continue to exist to day (with Chinese and America two of the largest), but the international capital flows that we take for granted in today’s fixed income markets are the result of a half century of innovation centered right here in London.

The eurobond market commenced with an issue by Autostrade in July 1st 1963, raising funds for the construction of motorways in Italy. The issue, lead managed by London-based SG Warburg, was a US$15m 5.5% 15-year. Autostrade chose to issue in USD in London rather than in New York in order to avoid the US Interest Equalization Tax that raised the cost of foreign borrowing in the US market by 1%. And the banker on the deal, Siegmund Warburg, recognised the opportunity to connect them with a pile of offshore US Dollars that was previously sitting unused in Swiss bank accounts. After that first deal, Eurobonds’ popularity exploded as American companies leapt in, recognising a tax-efficient way to fund foreign subsidiaries.

Issuers and dealers quickly saw the value of the market’s opacity. At issuance, only a few parties knew exactly who was buying eurobonds. That anonymity suited many international operators in the 1960s. Indeed, investors were a varied bunch, some of who probably wouldn’t pass KYC checks today!

The eurobond was also an extremely innovative financial product, allowing banks to get creative and structure debt issuance in a way that accommodated the requirements of their clients, be they issuers or investors. This flexibility meant that the international eurobond system quickly grew to rival traditional, highly-structured domestic fixed income markets.

Tax efficiency, anonymity and flexibility meant that new issuance volume took off. In the second half of 1963, $35m of eurobonds were sold. In 1964, the market was $510m. Total issuance passed $1bn by 1967. Later, fuelled by London’s Big Bang and the launch of the euro, the market has grown to be one of the world’s largest, accounting for 30% of the $100trn of outstanding debt.

By rolling up our sleeves and going under the hood of the system that supports the eurobond, we’ve been able to understand how the structure of the fixed income market in Europe differs from the US. A fundamental difference is, of course, that securities in the European market remain ‘bearer’ issues, relying on physical documentation with no direct link to the end investor, whilst the US government outlawed this method of issuance in the 1980s to clamp down on tax evasion.

At that time, authorities here in Europe (particularly in the beating heart of the eurobond market in Margaret Thatcher’s London), chose to do the exact opposite. They recognised that issuers and dealers valued an international debt capital market that protected their identity, whilst allowing them to benefit from tax “optimisation”.

This decision placed London at the heart of the swelling eurobond market, allowing the old City and the new Canary Wharf to cement London’s place at the top of the world’s financial system, comparable to New York in both size and importance. Brexit means that the continuation of this status remains unclear, but the rise of the eurobond has played a key role in London’s boom. The City made the eurobond just as much as the eurobond made The City.

With London in the driving seat, the eurobond market remained bearer. Of course, with the rise of technology, there have been changes to allow them to be “dematerialised.” But, ultimately, there is still a certificate, a “global note”, that is held with the CSD for safekeeping, and there is an IPA that manages all the payments on behalf of the issuer. It may sound old fashioned but, by understanding the circumstances around its historical origin, we can see why it was constructed the way it was. The importance of anonymity, flexibility, and international portability are what make the system attractive.

Now of course, there are ways it can be improved. And we’ll soon be revealing a little more about the work we’ve been doing in the background in this space here at Origin. One thing we’ve learned is that, despite the age of technology that has changed so much in financial services, the supposedly arcane eurobond market continues to play a central role in the global financial system. We don’t see this changing anytime soon and it’s vitally important that our business at Origin is capable of leveraging its power.