Euro Market

EURO MARKETEURO MARKET

A Euro market is a A Euro market is a market market for deposits and loansfor deposits and loans in in currency that exists outside currency that exists outside the borders of the home the borders of the home country of that currency. country of that currency. Thus it is beyond the Thus it is beyond the control or jurisdiction of control or jurisdiction of the monetary authorities of the monetary authorities of that country. A market for that country. A market for banking outside the banking outside the regulatory control of the regulatory control of the country of origin of country of origin of currency.currency.

Geographic coverage Geographic coverage

Developed in Europe, spread Developed in Europe, spread to other areas like Asian to other areas like Asian dollar market, Petro dollar dollar market, Petro dollar market, Euro Yen market, market, Euro Yen market, Euro dollars and Euro + Euro dollars and Euro + Sterlings, Euro-Marks, Euro-Sterlings, Euro-Marks, Euro-Sw.Fcs (outside Switzerland)Sw.Fcs (outside Switzerland)

OriginOrigin

E.M. came to light in 1957 – E.M. came to light in 1957 – late 19th century witnessed late 19th century witnessed exchange of foreign deposits.exchange of foreign deposits.

In the post World War II era, In the post World War II era, communists deposited the communists deposited the dollar currency earning in dollar currency earning in European banks to avoid European banks to avoid possible deposits freeze by possible deposits freeze by U.S. Then started lending – U.S. Then started lending – borrowing. borrowing.

Contributory Factors for E.M. DevelopmentContributory Factors for E.M. Development

Regulations on Regulations on Liabilities / Liabilities / Deposits Deposits

Limitation on Limitation on maximum interest maximum interest rates on deposits – rates on deposits – Regulation Q Regulation Q Hence U.S. banks Hence U.S. banks could not compete could not compete with banks in with banks in London in rates on London in rates on deposits, flow of deposits, flow of funds to London funds to London based banks with based banks with high interest rates. high interest rates.

Regulations on Regulations on Assets / LoansAssets / Loans

Glass – Steagal Glass – Steagal Act Act (1933) (1933) restricted banks restricted banks from entering into from entering into investment investment banking, banking, brokerage and brokerage and insurance. insurance.


Federal Federal Reserve Reserve Regulation .M. Regulation .M. Reserve Reserve requirements on requirements on deposits – deposits – deposit deposit insurance – insurance – Absence in Absence in Europe banks. Europe banks.

Capital controlCapital control under voluntary under voluntary credit restraint credit restraint programme programme (1964-74) due (1964-74) due to BOP to BOP problems in problems in U.S. U.S.


Convenience Convenience

and cost and cost advantages to advantages to hold dollars hold dollars deposits outside deposits outside U.S. U.S.

Foreign Direct Foreign Direct Investment Investment Regulations Regulations Restriction on $ Restriction on $ overseas overseas investment i.e., investment i.e., controls and controls and restrictions on restrictions on borrowing funds borrowing funds in the U.S. for in the U.S. for reinvestment reinvestment abroad abroad


OPEC surpluses in OPEC surpluses in the 70s, the oil the 70s, the oil boom, rise in boom, rise in prices etc., prices etc.,

Other limitations in Other limitations in the 1960s and 70s the 1960s and 70s on obtaining loan on obtaining loan within U.S. that did within U.S. that did not apply not apply overseas. overseas.

U.S. interest U.S. interest equalization tax – equalization tax – 1963-74. It was a 1963-74. It was a tax on U.S. tax on U.S. residents’ earnings residents’ earnings on foreign on foreign securities. securities.

General FactorsGeneral Factors

Removal of controls on Removal of controls on capital movements by OEDCcapital movements by OEDC leading to quicker integration of leading to quicker integration of

international marketsinternational markets closer link between the closer link between the

exchange and marketexchange and market variety of funds flow variety of funds flow

General FactorsGeneral Factors

Growing BOP deficits of Growing BOP deficits of majority of developing majority of developing countries.countries. growing financial needsgrowing financial needs innovation in financial servicesinnovation in financial services

Revolution in communication Revolution in communication technology – technology – CHIPS / SWIFTCHIPS / SWIFT

General FactorsGeneral Factors Role of Role of Narrow Spread Depositors’Narrow Spread Depositors’

demand for the highest yield – demand for the highest yield – borrowers to pay the lowest cost. borrowers to pay the lowest cost. Due to absence of reserve Due to absence of reserve requirements, deposit insurance and requirements, deposit insurance and other costly regulation Eurobanks other costly regulation Eurobanks can offer higher interest on deposits.can offer higher interest on deposits.

- Due to absence of controls/ - Due to absence of controls/ regulations, sheer size and a number regulations, sheer size and a number of informal contacts the banks can of informal contacts the banks can charge lower borrowing costs.charge lower borrowing costs.

ConsequencesConsequences

Just as the Euro dollar has Just as the Euro dollar has brought about economic brought about economic miracles by providing finance miracles by providing finance to economic development and to economic development and world trade, it has also to a world trade, it has also to a great extent contributed to great extent contributed to destabilization of exchange destabilization of exchange rate system.rate system.


Freely circulating mass of Freely circulating mass of Euro-market funds is much Euro-market funds is much larger than the reserves in the larger than the reserves in the central banking system. central banking system. Consequently, in case Consequently, in case speculative forces dominate speculative forces dominate exchange market, the central exchange market, the central bank’s defensive mechanism, bank’s defensive mechanism, intervention is rendered intervention is rendered ineffective.ineffective.


The central banking system The central banking system reserves of about $ 1000 bn reserves of about $ 1000 bn are no match to freely are no match to freely circulating mass of Euro-circulating mass of Euro-funds of about $ 2500 bn to $ funds of about $ 2500 bn to $ 3500 bn. 3500 bn.

Expanding Size of the market Expanding Size of the market due to multiplier effect.due to multiplier effect.

Emergence of Off-shore Emergence of Off-shore Banking CentresBanking CentresSingapore,Singapore, Bahrain,Bahrain, Manila, Manila, Hongkong,Hongkong, Nassau,Nassau, Jersey, Jersey, London, London, New York New York International Banking facility. International Banking facility.

System of Two-way QuotationSystem of Two-way Quotation

Parallel markets – Euro-markets are Parallel Parallel markets – Euro-markets are Parallel marketsmarkets

TraditionalTraditional ParallelParallel

Loans fully securedLoans fully secured UnsecuredUnsecured

Self-liquidatingSelf-liquidating Not necessarilyNot necessarily

Lender of Last ResortLender of Last Resort No L/RNo L/R

Monetary controlsMonetary controls Market left to it own devicesMarket left to it own devices

Confirmist approachConfirmist approach to business to business Rates are informal, totally Rates are informal, totally

flexible & business flexible & business expeditiousexpeditious

UsesUses

Borrowing at lower interest in the short Borrowing at lower interest in the short run to lend at higher rate in the long run.run to lend at higher rate in the long run.

Arbitrage operation Arbitrage operation - Space long run- Space long run- Arbitrage- Arbitrage- Interest rate- Interest rate- Time arbitrage- Time arbitrage

Financing foreign trade operationsFinancing foreign trade operations

Improving liquidity through SWAP Improving liquidity through SWAP operationsoperations

Funding loan assetsFunding loan assets

InnovationsInnovations

Syndicate loan + bondSyndicate loan + bond

Swaps Swaps

In between these two, several hybrid In between these two, several hybrid varieties – encompassing features varieties – encompassing features of bond, syndicate loan and swaps of bond, syndicate loan and swaps have been developed in response to have been developed in response to emerging needs circumstances emerging needs circumstances including including circumventing regulation, circumventing regulation, tax and other policy frames, tax and other policy frames, securitization – transforming credits securitization – transforming credits into negotiable instruments.into negotiable instruments.

Borrowers in the Euro market issue Borrowers in the Euro market issue Short Term Bonds / Promissary Short Term Bonds / Promissary Notes – backed by standby facilities.Notes – backed by standby facilities.

Mechanics of Euro Dollar MarketMechanics of Euro Dollar Market

Call funds: 7 to 15 days, Call funds: 7 to 15 days, 1month to 12 months.1month to 12 months.

Market in long term thin.Market in long term thin. Dealing through brokers / Dealing through brokers /

Direct.Direct. Mostly foreign exchange Mostly foreign exchange

Dept. handle Euro currency.Dept. handle Euro currency. System of two-way System of two-way

quotations – bid and offer. quotations – bid and offer.

Mechanics of Euro Dollar MarketMechanics of Euro Dollar Market

Stipulating credit limit on Stipulating credit limit on borrowers.borrowers.

All transactions are spot.All transactions are spot. Usual amount is 1 mn and it might Usual amount is 1 mn and it might

be as low as $ 25,000.be as low as $ 25,000. Wholesale market.Wholesale market. Banks run: graded maturities-i.e., Banks run: graded maturities-i.e.,

borrow short and long term.borrow short and long term. Variety of interest rates: LIBOR, Variety of interest rates: LIBOR,

SIBOR, BIBOR, HIBOR, JIBOR SIBOR, BIBOR, HIBOR, JIBOR etc. etc.

Facilities / Instruments / Facilities / Instruments / InnovationsInnovations

In response to changing In response to changing economic, legal and fiscal economic, legal and fiscal circumstances, variety of circumstances, variety of innovative instruments innovative instruments have have been been developed for lending developed for lending and borrowing in the Euro and borrowing in the Euro currency markets. currency markets.

Facilities / Instruments / Facilities / Instruments / InnovationsInnovations

Traditionally through issue Traditionally through issue of bonds or borrowing of bonds or borrowing directly from the banks or directly from the banks or through a method of through a method of syndicated loans borrowing syndicated loans borrowing was carried out. But in was carried out. But in response to a changing response to a changing environment, products like environment, products like Euro issuance facilities have Euro issuance facilities have been developed. been developed.

Facilities / Instruments / Facilities / Instruments / Innovations Innovations

Euro 2000 coupon bonds, a hybrid Euro 2000 coupon bonds, a hybrid variety, combination of bond variety, combination of bond market and syndicated loan market and syndicated loan market. market.

Since 1980s, two area of Since 1980s, two area of innovationsinnovations

Hybrid variety => syndicated loan Hybrid variety => syndicated loan marketmarket

Swaps => Bond market produce Swaps => Bond market produce hybridhybrid

The cause of hybrid – shift towards The cause of hybrid – shift towards securitization – transformation of securitization – transformation of credit into negotiable instruments. credit into negotiable instruments.

Euro-Note Facilities: Euro-Note Facilities: bonds of short-term maturitiesbonds of short-term maturities

NIFsNIFs = Note Issuance Facilities= Note Issuance Facilities RUFsRUFs= Revolving underwriting = Revolving underwriting

facilities facilities TRUFTRUF = Transferable RUFs= Transferable RUFs MOFFMOFF = Multioption Financing = Multioption Financing

Facilities Facilities BONUSBONUS = Borrowers Option = Borrowers Option

Financing Facilities Financing Facilities ECPsECPs= Euro Commercial Papers= Euro Commercial Papers

Bonds of shorter maturity; Bonds of shorter maturity; bearer promissory notes bearer promissory notes issued by borrowers – issues issued by borrowers – issues backed up by standby facility backed up by standby facility – substituted in case notes are – substituted in case notes are not sold. not sold.

Euro bonds MarketEuro bonds Market

Euro bonds are unsecured obligations Euro bonds are unsecured obligations of a borrower issued to investors all of a borrower issued to investors all over the world.over the world.

Earlier they were at fixed rates of Earlier they were at fixed rates of interest. interest.

A large variation emerged as a result of A large variation emerged as a result of changing market conditions. changing market conditions.

E.g. E.g. FLOATING RATE NOTES (FRN)FLOATING RATE NOTES (FRN): :

A large variety of A large variety of FRNFRN..

Types of BondsTypes of Bonds 1.1. Straight bondsStraight bonds =>=> Fixed couponFixed coupon

2.2. Convertible bonds =>Convertible bonds => with option to with option to convert equity shares of issuing …. Dual currencyconvert equity shares of issuing …. Dual currency

3.3. Convertible bonds => convertible into shares Convertible bonds => convertible into shares dominated into different currency.dominated into different currency.

4.4. Bonds with warrants =>Bonds with warrants => warrants provide warrants provide option – purchase shares or traded separately.option – purchase shares or traded separately.

5.5. Option bonds => with option of receiving Option bonds => with option of receiving interest/principal in different currencies.interest/principal in different currencies.

6.6. Zero coupon bond => No interest during life Zero coupon bond => No interest during life time but issued at substantial discount to par.time but issued at substantial discount to par.

7.7. Foreign bonds =>Foreign bonds => Issued in domestic Issued in domestic capital markets. capital markets.

SWAPSSWAPS

Most common forward Most common forward transaction is SWAPS => transaction is SWAPS => SWAP involves buying and SWAP involves buying and selling same amount of selling same amount of foreign currencies for foreign currencies for different maturities.different maturities.

SWAP does not change or SWAP does not change or affect position in foreign affect position in foreign currency. currency.

Interest rate swaps Interest rate swaps and currency swaps.and currency swaps.

Exchange of fixed to floating Exchange of fixed to floating rate of interest rate vice-rate of interest rate vice-versa.versa.

In currency swaps both In currency swaps both principal and interest amount principal and interest amount are swaped.are swaped.

SWAP is a financial transaction SWAP is a financial transaction which involves two parties which involves two parties agreeing to exchange streams of agreeing to exchange streams of payment over time on the basis of payment over time on the basis of certain understanding, from one certain understanding, from one interest base to another, one interest base to another, one currency to another, or involving currency to another, or involving both – used for obtaining low cost both – used for obtaining low cost financing, obtaining high yielding financing, obtaining high yielding assets, change in currency assets, change in currency exposure, A/c management or exposure, A/c management or speculation.speculation.

Syndication of LoansSyndication of Loans

The process of making a loan The process of making a loan jointly as a syndicate by using jointly as a syndicate by using common loan documentation is common loan documentation is known as syndication.known as syndication.

Based on principle of Based on principle of ‘Risk Spreading”.‘Risk Spreading”.

Minimising exposure to a single Minimising exposure to a single borrower. borrower.

Techniques of SyndicationTechniques of Syndication Best Effort Syndicate:Best Effort Syndicate:

Lead Manager or (Lead Bank) will Lead Manager or (Lead Bank) will not underwrite – but undertake to not underwrite – but undertake to offer loan to the banks with offer loan to the banks with certain terms and conditions.certain terms and conditions.

In the case of poor response, the In the case of poor response, the syndicate called off; borrower syndicate called off; borrower resorts to alternate method.resorts to alternate method.

Techniques of SyndicationTechniques of Syndication

Club Syndicate:Club Syndicate:

Limited Group of banks Limited Group of banks undertake to provide the undertake to provide the funds syndication functions funds syndication functions shared by the banks – known shared by the banks – known as private placement. as private placement.

Techniques of SyndicationTechniques of Syndication

Firm Commitment Syndication:Firm Commitment Syndication:

Lead Manager undertakes the Lead Manager undertakes the responsibility to provide full responsibility to provide full amount of loan and then offer to amount of loan and then offer to the market, in case of poor the market, in case of poor response. The Lead Manager response. The Lead Manager invites bids and makes available invites bids and makes available all details.all details.

Lead Manager =>Lead Manager => Role =>Role => Lending banksLending banks. .

Euro Market

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