Single currency sparks thriving eurobond market

News Analysis: The euro's impact on debt markets - and corporate activity - is an untold success story
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UNTIL A WEEK ago, the headlines on Europe's new currency at least had the merit of being consistent. "Euro hits new lifetime low", they read, almost daily. Buoyed by strong economic data and worries over the dollar, the tide finally turned last week, but the impression remains of a weak and sickly currency that struggles to justify its existence over those it replaced.

Look beyond the headlines, however, and in a number of respects the new currency is beginning to do just what it was supposed to. One area is prices, where there is already strong evidence of homogenisation towards the lowest common denominator. But perhaps the biggest unwritten success story of the euro so far is the region's fast-developing bond market.

Currencies seem to tell a story, bonds do not, which may explain the under-reporting of some astonishing facts. The volume of new euro issues in the second quarter of the year rose by 43 per cent compared with a year ago. This marked a sharp acceleration from the equally strong 32 per cent in the first three months of the euro's life.

"The decline in the euro/dollar has been virtually irrelevant for developing growth in the eurobond market," said Eden Riche, head of international investment grade debt capital markets at Donaldson, Lufkin & Jenrette (DLJ). "We have seen an explosion in both the number and the size of the issues."

According to the Bank for International Settlements, the launch of the euro in January was a big factor in the 58 per cent surge in long-term international debt securities in the first quarter to a record $415bn. It said activity in the new currency posted an 84 per cent gain from the 1998 average for the 11 legacy currencies and the ecu, to $147bn.

The real growth is in corporate bonds. UK companies to have tapped the euro debt markets includes Railtrack, which is raising 3bn euro to help fund its pounds 27bn investment programme, and Pearson, which has sold 400m euros in five-year bonds.

Corporate bond issuance is almost three times what it was a year ago, having grown by 22 per cent between the first two quarters of the year. The 9.4bn euro Olivetti bond for the Telecom Italia takeover was the largest corporate bond issue ever in the EU. Without it, the deal might have been impossible.

A solid grounding for the development of a vibrant European debt market is provided by the 11 euroland countries, who together have tradeable debt more than 20 per cent larger than the US Treasury market. Emerging markets such as Argentina are also tapping in.

According to Graham Bishop, of investment bank Salomon Smith Barney, the development of the euro-denominated bond market has been a considerable success story. "Investors have shown their willingness to finance imaginative takeover bids, which may start a trend towards a bottom-up restructuring of EU industry and commerce."

There are a number of reasons for the growth of the market. Despite the currency's mixed start, the launch of the euro removed large amount of currency risk between the 11 countries.

For overseas investors the creation of a single capital market has vastly increased liquidity and therefore encouraged demand. Before economic and monetary union, euroland's capital market consisted of 11 markets of varying sizes, driven largely by the prejudices of local investors. Foreign investors who want to match their sources of funding to the markets in which they operate now need only carry one transaction, as opposed to up to 11.

Another key driver is the European Union's commitment to create a single market in financial services, to stand alongside open markets in goods, services and labour movement. According to PaineWebber International, European companies obtain 70 per cent of their funding from banks and 30 per cent from the markets - roughly the opposite of the United States.

"It is easy to guess that European companies will, in a more integrated market place, develop a greater affection for market funding, though I wouldn't expect them to reach US levels of passion," said Alison Cottrell, PaineWebber's chief economist.

Thomas Mayer, of Goldman Sachs, predicts an increasing shift to both debt security and the use of new share issues. The resulting fall in the volume of bank loans could trigger an end to the overcapacity of banking within the EU, he believes.

While the number of credit institutions has fallen between 1985 and 1997, the number of bank branches has remained virtually unchanged. The concentration on capital market activities in wholesale banking will probably not force the existing banks out of business, Mr Mayer said. "However, it will reinforce consolidation and lead to an overdue reduction in capacity".

One danger of a flight of capital out of the banks and into the markets is that it may take the best creditors out of the banks' balance sheets - that could in turn threaten the stability of the European financial system.

Eden Riche of DLJ, which was involved with a 6.35bn bond deal relating to the Olivetti takeover of Telecom Italia, said the upside was that Europe would develop a more sophisticated debt market. One result will be that bond market deals will become more related to other financial activities such as mergers and acquisitions (M&A). Mr Riche said funding for the Olivetti deal was facilitated by the creation of the eurobond market. "A company with big ambitions can realistically look to challenge much larger targets on the basis that it can finance itself at much better rates," he said.

This pan-euroland capital market is likely to change the pattern of M&As. While 340 M&A deals of size were completed within EU states between 1995 and the first quarter of 1998, there were only 82 cross-border deals.

"The euro will change everything it touches," said Alison Cottrell. "If the single market in goods and services forced companies to review what they did and how they did it, a single financial market prompts a similar rethink by both borrowers and lenders of how such activity can and should be funded."