Euro brings cut-price bonds
The introduction of the single European currency has slashed the costs of bringing a bond in Europe, but US banks are making more of the situation
A Bank for International Settlements’ working paper (no. 134) published this September reveals, perhaps unsurprisingly, that underwriting costs in corporate euro bond issuance have fallen since the introduction of the single currency. But the broader findings should make Europe’s investment banks sit up, as their North American counterparts have increasingly been stealing market share.
The Cost of Barriers to Entry: Evidence from the Market for Corporate Euro Bond Underwriting by Joao A.C. Santos at the Federal Reserve Bank of New York and Kostas Tsatsaronis at the Bank for International Settlements (BIS), illustrates just how the currency eroded many barriers that had segmented the European corporate bond market along currency lines pre-1999. This led to a market comparable in size to that denominated in US dollars and fostered greater underwriting competition.
The more homogenous market and the expanded investor base that emerged post-EMU allowed underwriters to compete on a pan-European basis and provide issuers with a greater choice – not confined to national boundaries and established business links as was the case pre-euro.
Investment banks have been able to exploit economies in the provision of underwriting fees, while European borrowers have steadily benefited financially by combining their purchasing of commercial and investment banking services.
Eliminating market segmentation, which previously made it hard for firms to benefit from using as an underwriter the bank with which they had a relationship, resulted in a seismic shift of underwriting business towards larger international investment banking houses, particularly from the US.
The conclusions show that the euro did not lead to an intensification of business links between euro area borrowers and bankers from the same country, but quite the opposite. BIS analysis reveals that while European bankers have seen their share of euro area bonds declining since the adoption of the single currency, US bankers have seen their market share mushroom to account for 25% of bookrunning mandates compared with 3.6% between 1994 and 1998.
Firms have gravitated towards the larger underwriting houses – indicating that prior relationships were less important than placing capacity – and have enjoyed a reduction in underwriting fees without concurrently paying higher credit spreads for bonds at issue.
Heightened demand from a larger and broader investor base sparked improvements in secondary market liquidity, which in turn enhanced the attractiveness of euro-denominated bonds. 1999 proved a watershed year with the number of euro-denominated issues in the international bond market exceeding those from the US for the first time.
Using the IFR Platinum database, the authors analysed 3,110 fixed-coupon bonds issued by the private sector (January 1999–June 2001). Against a global downward trend in fees over 1994–2001, which saw value-weighted fees for 2001 being 84 basis points below their 1994 level, Europe-specific bond issues saw average gross fees fall to 0.426% by 2001 from 1.553% in 1994 under legacy currencies. Prior to the euro’s introduction, the wedge between fees on US and European issues averaged 55bp, but virtually disappeared after the euro’s introduction.
Given that the average bond denominated in a legacy currency was $206m, borrowers incurred an additional $1.14m equivalent in underwriting fees by not issuing in US dollars. Indeed, had the total sample of euro issuance in 2000 been executed on the terms of 1994’s average percentage underwriting fee, some $615m in fees would have been paid by borrowers – saving 87bp.
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