Bonds without Borders

A History of the Eurobond Market

Chris O'Malley

• Publisher: Wiley
• Year: 2014
• Print ISBN: 9781118843888
• eBook ISBN: 9781118843871
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

Bonds without Borders tells the extraordinary story of how the market developed into the principal source of international finance for sovereign states, supranational agencies, financial institutions and companies around the world. Written by Chris O'Malley – a veteran practitioner and Eurobond market expert- this important resource describes the developments, the evolving market practices, the challenges and the innovations in the Eurobond market during its first half- century. Also, uniquely, the book recounts the development of security and banking regulations and their impact on the development of the international securities markets.

In a corporate world crying out for financing, never has an understanding of the international bond markets and how they work been more important.Bonds without Bordersis therefore essential reading for those interested in economic development and preserving a free global market for capital.

CHAPTER 1
Before the Beginning
To 1962

The origins of bond markets can be traced back to governments and their need to borrow, particularly in times of war. In the late Middle Ages, the Republic of Venice was involved in recurring conflicts with neighbouring states. The authorities, concerned about the strains on the state treasury, took to drawing forced loans from their citizens in proportion to their wealth. Such debt paid 5% interest per year and had an indefinite maturity date. Initially regarded with some suspicion, they came to be seen as valuable investments that could be bought and sold. The bond market had begun.

From the medieval Italian city states to warring European powers looking to finance military campaigns, the issuance of interest-bearing debt has enabled them to pursue their ambitions. Much of this debt, like that of Venice, was undated with governments creating a permanent funded debt burden. The amount of debt that could be issued depended on the investor's confidence in the ability and commitment of the issuer to make the required payments under the contract. Unfortunately sovereign issuers were prone to renege on their debts or change the terms substantially, so the investor's preference was originally for short-dated, high interest loans.

During the latter part of the 16th century the Dutch attained an increasingly dominant position in international trade, especially the lucrative spice trade, a position previously occupied by the Portuguese and Spaniards. Amsterdam became the city where merchants and bankers could obtain bills of exchange to settle their trading activity.¹ At the time, it was customary for a trading company to be set up for the duration of a single voyage, financed by a small group of merchants, and to be wound up upon the return of the vessels. Investment in these expeditions was a high-risk venture, not only because of the dangers of sickness, piracy and shipwreck, but also because of changing market conditions for the imported goods. The further a trading expedition ventured, the greater the risks involved, and the greater the number of investors required to finance it. In 1602 the Dutch government sponsored the formation of the Dutch East India Company, which was given a monopoly over Asian trade for a continuous period of 21 years. It was the first company to issue shares and the offering attracted more than a thousand Dutch investors. As the financial outcome of voyages was not known until a particular expedition was completed, the shares varied widely in value and a secondary market soon developed between merchants, investors and speculators. As Asian spices were imported in bulk to meet the seemingly insatiable appetite in Europe, huge profits accrued to the shareholders.

The Dutch came to dominate trade in Europe. They were favourably positioned at the centre of a network of European trade routes. Dutch traders shipped wine from France and Portugal to the Baltic countries and returned with grain for countries around the Mediterranean. By the 1680s, an average of nearly 1,000 Dutch ships entered the Baltic Sea each year. The Dutch were also able to gain control of much of the trade with the young English colonies in North America.

The accumulation of capital in the enormous amounts generated in this period caused a demand for productive investment opportunities. Wealthy investors with cash balances found that investing in loans and securities was a more portable and flexible way of managing their wealth, rather than relying solely on the revenue from their estates or their trading ventures. So it was among the merchants of Amsterdam that active trading in securities first developed and led to the establishment of the Amsterdam Stock Exchange and the Bank of Amsterdam.

With only a modest domestic government bond market, wealthy Dutch investors became interested in loans issued by foreign governments. Dutch public loans offered yields of only 2–3% whereas foreign government loans offered 4–6% yields. Consequently European states became accustomed to funding part of their budget deficits by selling bonds to wealthy international investors through specialist intermediaries, based in Amsterdam.

Prominent amongst these intermediaries was Hope & Company. The firm was founded in 1762, but members of the Hope family – originating in Scotland and arriving in Amsterdam via Rotterdam – had already been involved in the money and commodity trade since 1720. In the aftermath of the Seven Years War (1756–1763), after Henry Hope had joined the firm, Hope & Co. arranged numerous loans for the governments of Sweden, Russia, Poland, Portugal and Bavaria. Many of these loans were made in exchange for trading privileges. The Portuguese loan was made in return for an exclusive concession to market diamonds from the Portuguese colony of Brazil. Hope & Co. sold the diamonds on the Amsterdam market, and the sale proceeds provided the interest and principal on the loan. This activity contributed to Amsterdam becoming the leading diamond centre of Europe.

The bank floated 10 loans for the Kingdom of Sweden between 1767 and 1787 and 18 loans for Russia from 1788 to 1793.² The first loan to Catherine the Great's Russia was for Fl.3m in 1788 at a rate of 4.5% and many more followed. In return for these loans, Hope & Co. obtained the right to export sugar to Russia, and sell Russian wheat and timber to countries throughout Europe. In fact Hope and Co. remained bankers to the Czars until 1917.³

The bank was also involved in financing plantation owners in the West Indies, taking payment in kind: sugar, coffee or tobacco, which Hopes would then sell on the Amsterdam market. For the majority of these loans, Hope led a syndicate of prominent English and Dutch investors who provided the funds, while Hope & Co. collected a handsome commission of 5–9%.^*

The securities trading methods and practices established in Amsterdam spread to other financial centres. As markets grew rapidly, speculative booms developed, most notably, the South Sea Bubble in London and the Mississippi Bubble in Paris. The first led to restrictions on joint-stock companies in England while the second led to the French government establishing the first formal stock exchange in Paris in 1724. Paris and London continued to vie with Amsterdam as growing financial centres throughout the 18th century although their focus was on domestic government stock and issuance by domestic joint-stock companies. Amsterdam remained the principal centre for international trading.⁴

* * *

From 1789 to 1815 revolution, then war, spread through Europe with profound consequences for the developing securities markets. The French Revolution of 1789 had a significant impact throughout Europe, with the proclamation of a Republic in 1792 and the execution of King Louis XVI the following year for ‘crimes of tyranny’ against the French people. The outbreak of European wars, originally intended to defend and then spread the influence of the French Revolution, prompted the Republican government in France to renege on a major part of the previous monarchy's debts.

Napoleon Bonaparte seized power in 1799 after overthrowing the French revolutionary government. There followed a series of wars where French forces battled various coalitions of European nations between 1803 and 1815. French power rose quickly as Napoleon's armies conquered much of Europe.

But as the conflict spread, other governments also ceased to pay interest on their debts and in some cases even acknowledge their indebtedness, all the more so if such debts were owed to foreign investors. Numerous sovereign defaults ensued and the international securities markets collapsed.

In 1803 Britain declared war on France and, aided by its island status and naval supremacy, remained at war until 1815. The British government, in addition, paid out large sums of money to other European states, so that they would remain at war with France. But the cost of war drained Britain's resources, and ran up a considerable national debt. The British government was borrowing heavily, not only to build up her own forces, but also to subsidise her European allies whose capital markets were no longer operating.

Between 1810 and 1814, the Netherlands was annexed to France and the French franc circulated in place of the ‘gulden’. International trading links broke down. As the Amsterdam market suffered, so that of London prospered. International trade increasingly gravitated towards British merchants.

Yet during this period of turbulence a landmark bond transaction took place involving for the first time on a major scale, cooperation between the financial markets. This was ‘the Louisiana Purchase’. Spain had secretly granted the Territory of Louisiana, in North America, to France in 1801. The territory stretched across the entire Mississippi Valley, to the Rockies in the west, to Canada in the north and southwards to the Gulf of Mexico. An area roughly equivalent to a third of the United States today, encompassing all or part of 15 US states. Louisiana was of diminishing strategic importance to France and Napoleon believed that it could be a liability in any future war with Britain. When approached to sell it to the US government, he agreed.

The sum needed for the purchase was beyond the means of the US government and so help was sought from the two leading merchant banks at the time, Hope & Co. of Amsterdam and Barings of London. Barings had well-established connections with both the US and France, and Hopes were the leading issuer of sovereign loans, and the banks themselves were linked through family connections. Negotiations were conducted during a brief period of peace between Britain and France. The size of the transaction was unprecedented, as France demanded FF100m for the territory. The parties agreed that the financing could only be achieved by the issue of US government bonds and the price finally agreed was FF80m (equivalent to $15m). After the American bonds had been issued, the French government then sold them on to Hopes and Barings at a discount of $87½ per $100. The bonds were issued in 1804, and rank among the first US securities issued in the international markets. The coupon of 6% was payable half yearly in Amsterd...

Table of contents

• Cover
• Series
• Titlepage
• Copyright
• Dedication
• Foreword
• Introduction: Fifty Years of the Eurobond Market
• Chapter 1 Before the Beginning    To 1962
• Chapter 2 Building the Base    1963–1969
• Chapter 3 Oil and Turmoil    1970–1979
• Chapter 4 Masters of the Market    1979–1984
• Chapter 5 Going Global    1985–1989
• Chapter 6 The Derivatives Dash    1990–1995
• Chapter 7 Convergence and Credit    1995–1999
• Chapter 8 Of .Com's and Cons    1999–2004
• Chapter 9 Mark-to-Model    2004–2007
• Chapter 10 Busts and Bailouts    2007–2010
• Chapter 11 Sinking Sovereigns    2011–2013
• Postscript
• Glossary
• Index
• End User License Agreement