International Debt Markets

Intermediated Versus Non-intermediated Debt Markets

 Funds can be moved from savers to borrowers either through a financial intermediary such as a commercial bank or directly through a securities market. For this reason, debt markets can be classified according to whether or not a financial intermediary stands between borrowers and savers. In an intermediated debt market, a financial institution such as a commercial bank channels loanable funds from individual and corporate savers to borrowers. In a non-intermediated (or direct) debt market, borrowers such as governments and large corporations issue securities directly to the public without using a financial institution as an intermediary.

Commercial Banks as Financial Intermediaries

Commercial banks develop a need to “go global” as they follow their customers into foreign markets. International commercial banks provide a complete line of financial services to facilitate the overseas trade of their customers. In addition to commercial credit, commercial banks provide a variety of ancillary services including market-making in spot and forward currency, invoicing, collection, cash management, and trade financing through letters of credit, banker’s acceptances, or forfaiting purchasing medium – to long – term receivables at a discount from face value). International banks also often provide interest rate and currency risk management services.

Non intermediated (Direct) Debt Markets

Bonds issued directly to the public fall under the non-intermediated debt category. The U.S. Government is the world’s largest single borrower, so not surprisingly, the United States heads the list of government bond markets. The Size of national corporate bonds markets generally follows the ranking of government bond markets. The U.S. corporate bond market is the world’s largest corporate bond market. Large U.S. based corporations rely more heavily on the public debt market than do their counterparts in most other countries, although publicly traded bonds also play a major role in the financing of corporations in the United Kingdom. In most other countries, commercial banks assume a more prominent role in allocating debt and equity capital. Despite the rapid growth of euro-denominated bond and equity markets, small and midsize corporations in Europe still raise most of their capital through commercial banks.

Internal and External Debt Markets

The fact that bonds can be issued in other than the functional currency of the borrower suggests another way that debt markets can be categorized. Debt placed in an internal market is denominated in the currency of a host country and placed within that country. Debt placed in an external market is placed outside the borders of the country issuing the currency. Government regulation and intervention are nearly absent in the short-term external Eurocurrency market. In contrast, internal markets for long-term debt capital are closely monitored and regulated by local authorities. Government influence in the long-term external Eurobond markets is a little less direct than in internal markets, but no less important. Government regulation of internal and external bond markets is discussed in the cussed in the following section.

Domestic and International Bonds

Debt issues can be further categorized according to whether they are sold into domestic or international markets. Domestic bonds are issued by a domestic company, traded within that country’s internal market, and denominated in the functional currency of that country.

International bonds are traded outside the country of the issuer. International bonds come in two varieties Foreign bonds are issued in a domestic market by a foreign borrower, denominated in domestic currency, marketed to domestic residents, and regulated by the domestic authorities. Eurobonds are denominated in one or more currencies but are traded in external markets outside the borders of the countries issuing those currencies. Large borrowers that are well-known internationally sometimes find that their financing costs are lower in foreign bond markets or in the external Eurobond market than in their own domestic bond market. These opportunities arise because of disequilibrium in the international parity conditions; in particular, cross-market differences in real borrowing costs. Smaller borrowers from non-EU countries typically find that their borrowing costs are lower for domestic bond issues than for international bond issues because of the higher information costs faced by international investors. Borrowers from Emu-zone countries often raise funds in the highly liquid external Eurobond market, most commonly in euros but also in dollars, yen, or pounds sterling.

Domestic Bonds and National Bond Markets

The most prominent bonds selling in national bond markets are domestic bonds. Because they are issued and traded in an internal market, domestic bonds are regulated by the domestic government and are traded according to the conventions of the local bond market. The “GMAC zr 15” listed as a domestic bond is a zero coupon dollar denominated bond issued by General Motors Acceptance Corporation, maturing in the year 2015, and traded on the band trading floor of the New York Stock Exchange.

Domestic bonds are preferred by domestic investors. Borrowers in the domestic market tend to be domestic Government. Domestic borrowers often get better prices for bonds issued domestically than bonds issued in foreign countries. European corporation are finding that euro-denominated bonds offer attractive interest rates relative to bank financing – without the bother of a commercial bank looking over their shoulder.

The success of the euro corporate bond market will come at the expense of lending by European commercial banks. A study by the Bank for International Settlements estimates that one-third of European banks’ corporate loans business will be diverted to public debt and equity issues after the introduction of the euro. Many European commercial banks are expanding their investment banking activities as their commercial lending business is displaced by public debt issues.

Corporate and government bonds in Canada, Japan, and the United States are issued as registered bonds. In countries requiring that bonds be issued in registered form, each issuer maintains a record of the owners of its bonds.

The convention in European countries is to use bearer bonds. Bearer bonds are not registered and can be redeemed by the holder. The principle advantage of bearer bonds is that they retain the anonymity of the bondholder.

European bond dealers quote bond prices as an effective annual yield that assumes annual compounding. Foreign bonds are issued in another country’s internal market and denominated in the local currency. Foreign bonds are issued by a foreign borrower but traded in another country’s internal market and denominated in the local currency. Foreign bonds are issued in the local currency to make the bonds attractive to local residents and regulated by local authorities. Bond trading conventions on foreign bonds typically conform to the local conventions rather than those of the borrower. Foreign bonds are known as “Yankee bonds” in the United States, as “Bulldog bonds” in the United Kingdom, and as “Samurai bonds” in Japan.

Eurobonds – Necessity is the Mother of Invention

The second type of international bond is the Eurobond.

Eurobonds are issued and traded in the external bond market.

Eurobonds are issued and traded in the external bond market. The FNMA 7.40 04” bond issue in the Eurobond category. Several thousand Euroband issues now trade in the secondary market. The most common Eurobond currencies are the U.S. dollar, Emu-zone euro, British pound sterling, and Japanese yen.

The Swiss franc is notably absent from the list of Eurobond currencies. The Swiss Central bank, Banque Nationale Suisse, does not allow Swiss banks or foreign banks with Swiss branches to trade Eurobonds denominated in Swiss francs. The Swiss foreign bond market trades more foreign bonds than any other national bond market because it substitutes for the nonexistent Swiss franc Eurobond market.

Global Bonds

A global bond is a bond that trades in the Eurobond market as well as in one or more national bond markets. To appeal to a global investor base, borrowers must be large and AAA-rated and must borrow in actively traded currencies. The World Bank established this market with a series of dollar-denominated issued in the late 1980s. Historically, global bonds have been denominated in dollars to take advantage of high liquidity in the dollar market. Since 1999, global bonds are increasingly being issued in euros. Matsushita Electric Industrial Company was the first corporate borrower to tap the global bond market.