Definition of The International Bond Market

Organisation of the Eurobond Market

Eurobonds are different from foreign bonds. Foreign bonds are issued by a borrower in a domestic capital market other than its own and usually denominated in the currency of that market. Eurobonds are issued in Eurocurrencies by an international syndicate of banks in several international financial markets. Because Eurobonds are issued and traded on international financial markets, they are not subject to the rules and regulations that are common to most domestic bond markets, although there are inter professional rules and regulations issued by ISMA. Issuers are also subject to the rules and regulations of the monetary authorities in their country of residence. In any case, the development of the Eurobond market is synonymous with the absence of withholding tax.

The first Eurobond borrowing dates back to 1963 when the interest equalization tax (IET) imposed by the United States stopped the development of the Yankee bond market dead in its tracks. A Yankee bond is a foreign bond issued in the US market, payable in dollars and registered with the SEC. Eurobond issues characteristically have shorter maturities than those found on domestic markets. The large majority of Eurobond issues have maturities less than or equal to five years. The development of the Euronote facility and Euro MTNs in the 1980s reinforced this tendency. Euronotes are short-term, fully negotiable, bearer promissory notes, issued at a discount to face value and typically of one, three or six-month maturity. Euro MTNs are medium-term bearer notes of small denomination with maturities ranging from one to five years.

Issuing Procedures

Issuing procedures have evolved since the Eurobond market’s inception. At the beginning, the traditional issuing procedure, called “European”, was cumbersome. Syndicates often contained as many as several hundred members for the jumbo loans of USD 1 billion or more. Final investors were institutions like pension funds, investment funds and insurance companies, as well as private individuals attracted by the absence of withholding tax and the anonymity of bearer certificates.

“European” Issue Procedure

The European issue procedure starts with a lead manager who has a mandate from the borrower to organize the operation. As in the Euroloan syndication, the lead manager is responsible for negotiating the overall conditions of the issue concerning the coupon, price, maturity, etc. He is also responsible for organizing the syndicate by finding other banks that want to participate. The borrower, of course, can require the participation of certain institutions and most syndicates will include one or more institutions with the same nationality as the borrower.

These are three major dates in the issue procedure. The first is the launch date when a new issue’s invitation telexes are officially sent out to the syndicate. The second is the pricing date, when the final terms of the issue are completed. The third is the closing date, when a new issue’s proceeds are paid to the borrower by the lead manager by the borrower.

The entire syndication process can be described in six stages

Preliminary negotiations and preparation. Potential issuers and lead managers negotiate on their respective needs and capabilities. This stage ends with a written proposition to the prospective borrower on the different financing possibilities con- cerning the amount of the issue, the coupon rate, the maturity and the issue price.

Preplacement. Once the mandate has been received the lead manager starts looking for partners. He sends telexes, confirmed by letter, inviting prospective underwriters and sellers to participate in the syndicate. On the launch day a prospectus containing the relevant information on the proposed issue is distributed. In the ensuing period – across about two weeks – the institutions that have been invited to participate sound out potential investors and make their decision on whether or not to participate and for how much.

Fixing the final terms of the issue (pricing day). Based on the response to his invitation, the lead manager fixes the final terms of the issue, making any modifications that he feels necessary. Once this has been done, the underwriting agreement is completed and signed by the lead manager and the other underwriters.

Apportioning securities (offering day). On the day following pricing day, the lead manager sends out telexes to the institutions that agreed to participate, stipulating the number of securities that will be allocated to them.

Placing the issue. During the next two weeks the selling group actively places the issue with final investors and the lead manager supervises the grey market to keep the price in line with the issue price.

Closing the issue (closing day). The issuer receives the net proceeds of the issue (amount less commissions). The actual securities are issued and distributed to the final investors.

Bought Deal

In this procedure the conditions are fixed by the lead manager and proposed to the issuer. The issuer has a short time to accept or reject them. This package system is much more rapid than the European procedure and the syndicates much smaller.

Instruments and Trading Techniques

The three main types of Eurobonds are:

Fixed rate issues or straight bonds

Floating rate notes (FRNs)

Equity-linked bonds, either convertible or with warrants attached.

The heart of the market consists of the fixed rate issues but, at one time or another depending on market conditions, the other two types have known periods of popularity.

Fixed Rate Issues

The face value of a typical fixed rate Eurobond varies between USD 1000 and USD 5000 with maturities of three, five, seven and ten years. Maturities are linked to the economic uncertainty prevailing at any time with different clientele compartments for the different maturities like Short and medium-term maturities in Euro sterling.

On the other hand, longer maturities are destined for institutional investors and are issued by the list system. In this system the managers offer portions of the issue at a fixed price directly to a list system. In this system the managers offer portions of the issue at a fixed price directly to a list of investors who have one day to accept or refuse. The contractual guarantees of a fixed rate issue are typically very stringent. They do not, however, usually include collateral default.

Rates are often fixed as a spread with respect to a benchmark rate in the domestic market of the currency in question, such as US Treasury bonds for the dollar, gilts for sterling, etc. If the issuer is already in the market, the spread is determined in relation to its past issues. If it is new to the market its reputation and credit rating will determine the spread.

Floating Rate Notes (FRNS)

FRN are typically issued with higher face values (USD 5000, 10,000, and 100,000) than fixed rate issues because they are directed at institutional investors. The interest rate is variable and determined periodically. It is quoted as a discount or premium to a reference rate, such as six-month Libor + 1%. This spread can be fixed once and for all or can vary over time. The reference rate is often Libor but other reference rates are also common such as the T-bill for the dollar. The periodicity of the reference rate determines the reference period for the FRN. Thus, the interest rate on an FRN referenced to one-month Libor would be revised monthly and the interest rate on an FRN referenced to three-month Libor would be revised quarterly. Semi annual is the most common reference period.