Download THE ROLE OF EURODOLLAR BOND ISSUANCE IN EMERGING

CRISIL Young Thought Leader 2012
THE ROLE OF EURODOLLAR BOND
ISSUANCE IN EMERGING MARKETS
- Gitanjali Maria
Final Year, LIBA, Chennai
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Table of Contents
Executive Summary ................................................................................................................... 3
THE EURODOLLAR BOND AND EMERGING MARKETS ............................................... 4
International Bond Markets ....................................................................................................... 4
The Eurodollar Bond Market ..................................................................................................... 5
Emerging Markets ...................................................................................................................... 6
The Role of Dollar in International Trade and Economy .......................................................... 6
Advantages of Issue of Eurodollar Bonds ................................................................................. 6
Disadvantages of Eurodollar Bond Issuances ............................................................................ 7
India and the Eurodollar Bond Market ...................................................................................... 7
Foreign Currency Convertible Bonds (FCCB) ...................................................................... 8
Advantages of Eurodollar bond Issues to India ..................................................................... 8
Disadvantages of Eurodollar bond Issues to India ................................................................. 9
China and the Eurodollar Bond Market ..................................................................................... 9
Developing the Eurodollar Bond Market in China ................................................................ 9
Pros ...................................................................................................................................... 10
Cons ..................................................................................................................................... 10
Brazil and Eurodollar Bond Market ......................................................................................... 10
Russia and the Eurodollar Market............................................................................................ 11
Other Emerging Markets.......................................................................................................... 11
Conclusion ............................................................................................................................... 12
REFERENCES ........................................................................................................................ 13
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Executive Summary
Despite the economic downturn and recession of 2007 and its effects still spiralling into
everyday lives in many countries across the world, dollar - the reserve currency of the world
since post world war II and the domestic currency of United States of America, the largest
economy for the last few decades, still reigns supreme. Investors around the world still
consider this currency to be a safe bet and are flocking to it. With no other currency able to
take up the position of the dollar, demand for dollar has remained steady and even risen in
some cases.
Eurodollar bonds are debt instruments in use since the 1960s used to tap the dollar reserves
present in countries other than the US. With diminishing trade and financial barriers,
governments and private players from across the globe have found the Eurodollar bond
market attractive to raise funds. Emerging economies with growth rates averaging 6- 8% even
amidst the downturn have found these bonds attractive to finance their infrastructure and
other projects and to stimulate their economies due to its low cost of financing and ease of
issue.
This paper specially focusses on Eurodollar bonds with respect to the four leading emerging
economies – India, China, Brazil and Russia, which are collectively termed the BRIC nations.
It focusses on the dollar reserves of these nations and the response of the companies and
governments of these countries to the opportunities and threats in the Eurodollar bond
market.
Within the present economic scenario and foreseeing a future that maintains the same
currency equations at least for the next five years, activity in the Eurodollar bond market is
bound to remain high, with probably a few emerging economies emerging as possible
financial centres for Eurodollar issuances.
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THE EURODOLLAR BOND AND EMERGING MARKETS
International Bond Markets
The international bond markets are important centres of financial activity where governments
and businesses raise funds to meet their various expense requirements through issue of bonds.
Bonds are fixed-income securities or debt instruments through which investors lend money to
an entity borrowing funds for a definite period of time at a fixed interest rate. Compared to
equity market, the global bond markets are twice as large at almost $100 trillion dollars
compared to the $53 trillion of equity market.1
The following figure captures the growth of bond markets in the last decade. The
international bond market has grown to occupy 30% of the overall world bond market
indicating that the geographical and regulatory barriers to raising capital has diminished over
the decade.
Figure: 1
The international bond market can be divided into three sub-segment markets:
Domestic Bond Markets
Foreign Bond Markets
Euro Bond Markets
The Domestic bond markets are fixed income financial markets for buying and selling of
bonds issued locally by domestic borrowers and usually denominated in the local currency.
1
http://en.wikipedia.org/wiki/Bond_market
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The foreign bond market involves issue of bonds in a local market by a foreign borrower in
the local currency. Such bond issues are supervised by the local market authorities.
The Eurobond markets are for issue of bonds in countries other than the one in whose
currency the bond is denominated and outside of the country of the issuer. These bonds are
not traded on any particular national markets and are not regulated by any specific agency. Of
all the international bond issues, 80% are Eurobond issues.
The Eurodollar Bond Market
Eurodollars are dollar deposits outside of the United States and bonds issued to tap the
Eurodollars are called Eurodollar bonds. The Eurodollar market is one of the world's primary
international capital markets, and companies use Eurodollars to settle international
transactions, to invest excess cash, and make short-term loans, and finance imports and
exports.2
The Eurodollar market grew in London in the 1960s and banks and institutions set up offices
in London to tap a share of this lucrative market. The first Eurobond was issued by
Autostrade in 1963.The Eurodollar bond market later boomed in 1973 with the large
availability of petro-dollars as the oil prices rose.
Figure 2 shows the growth of Eurodollar bonds and points to how there has been a growing
interest in the Eurodollar bond market especially in the years the dollar gained strength.
Figure 3 shows the percentage of Eurodollar bond issuances in the Eurobond markets. With
the relative importance of Euro and other currencies increasing the percentage of Eurodollar
issuances in the Eurobond market have decreased when compared with the 1965 – 1980
period when the Eurodollar had almost a 75% share.
Eurodollar Bond Market
Growth
Billion USD
15000
10000
5000
0
1980
1990
Figure: 2
2000
2010
Figure: 3
But with the European countries struggling to save the Euro, the demand for dollars is poised
to rise thus giving a boost to the Eurodollar markets.
2
http://www.investinganswers.com/financial-dictionary/world-markets/eurodollar-1017
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Emerging Markets
Emerging markets are nations with social or business activity in the process of
rapid growth and industrialization. The economies of China, India, Brazil, Russia, Mexico,
Indonesia and Turkey are the seven largest emerging economies of the world.3 Out of these
Brazil, Russia, India and China together have been labelled the BRIC nations by Goldman
Sachs executive Jim O’Neill. These nations are the fastest growing emerging markets and
represent the typical characteristics of countries passing though this transformational phase.
The Role of Dollar in International Trade and Economy
Dollar is the reserve currency of the world. 80% of the world’s trade transactions take place
in the US Dollar. All major transactions like repaying debt to world bodies like IMF and
World Bank and supporting aid and capital in foreign countries are paid in the US Dollars.
Therefore all countries generally keep a portion of their free reserves in US dollars. The same
is true for companies around the world too. This increases the importance and relevance of
the US Dollars to both governments and private companies.
Advantages of Issue of Eurodollar Bonds
Emerging nations because of their large requirements of capital to fund growth often explore
the international markets to raise funds in currencies like dollar, Euro etc. With free markets,
private companies of one country are allowed to tap the resources present in other parts of the
world and to set up their own subsidiaries or to enter into joint ventures with foreign partners.
All these transactions and investments are generally represented in dollar terms and therefore
require entities to raise funds in this currency.
Some characteristics of Eurodollar bonds that give it an edge over other bonds are:
It gives the issuer freedom to choose location of issue and can be issued in any
country other than the issuing country and the US.
These bonds have high liquidity and small par values.
There is no currency exchange risk as the bond is issued and repaid in US Dollars.
Eurodollar bond market is a free market without any regulations. The Eurodollar bond
markets are self-regulated and not subject to the regulations of Security Exchange
Commission (SEC).
Eurodollar bonds can be brought to market more quickly than Yankee bonds since
they do not have to meet the strict SEC registration requirements.
Being a bearer bond, Eurodollar bonds are easily transferable and requires less
investment and effort from the issuer side.
3
http://en.wikipedia.org/wiki/Emerging_markets
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Credit rating is not required for Eurobonds and subscription mainly depends upon the
reputation of the issuer.
The income is essentially untaxed and there are is greater flexibility in making issues
than in purely national markets.
Coupon interests needed to be paid on the Eurodollar bonds are less than that for other
foreign bonds due to perceived tax benefits. This reduces the cost of debt service to
the issuing entity.
Underwriting charges on Eurodollar bonds are only 1% compared to the 2.5% on
Yankee bonds thus reducing costs.
Disadvantages of Eurodollar Bond Issuances
If the debt is not matched against a foreign currency asset, the Eurodollar bond
issuing firm may be open to foreign exchange risk.
There are some additional costs that may have to be met for issuance.
India and the Eurodollar Bond Market
Though the international bond market and Eurobond markets have been in existence for over
half a century and more now, India’s foray into these markets have been relatively recent. It’s
only post liberalization of the economy that many Indian companies have forayed to raise
dollar funds from abroad. Till 1991, Indian issues in the Eurodollar bond market and other
international bonds markets where limited to the few issuances by Public Sector companies
that had the backing of the Indian government.
India’s trade deficit caused due to import of large quantities of crude oil continuously
increases its demand for dollars to meet its import requirements excess to its exports. Figure 4
gives India’s foreign exchange reserves. It points that while Indian government and private
sector may need to raise dollars from international markets, India in its current position may
not develop into a market for Eurodollar bond issuances from foreign players.
Figure: 4
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Foreign Currency Convertible Bonds (FCCB)
FCCBs when issued in dollars and outside of the US can be considered a category of
Eurodollar bond markets. Compared to plain vanilla Eurodollar bonds, FCCB holders have
the option of converting the bond to equity of the company at the time of maturity if the
company’s share is trading a particular agreed upon price. FCCBs have lower coupon
payments on them thereby reducing the debt-financing of the company. The investors are also
at an advantage as they can also enjoy the fruits of company’s share capital appreciation.
Almost 90% of the Indian companies have entered the international markets through FCCB
issuances. The FCCB issuances from India post 1991 are shown in Figure 5 and Figure 6.
Figure: 5
Figure: 6
Source: http://www.thehindubusinessline.com/markets/article3731514.ece
Majority of India’s FCCB issuances have been dollar denominated and traded on the
Singapore and Luxembourg stock exchanges. Since 2001 there have been 291 deals in FCCB
bonds by Indian companies. Total money raised was around $26.5 billion. FCCB issuances
picked up from 2004 with deals worth around $2.2 billion that year. They peaked in 2007
with deals worth around $7.5 billion.4
Advantages of Eurodollar bond Issues to India
It is a low cost mode for raising capital due to lower interest rates and lower inflation
in European and some of the Asian markets
There is no change in control or ownership of the company
4
Business Line, August 5, 2012
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There is greater visibility for Indian companies due to international exposure
There is a large inflow of money which is treated by the government as FDI
From the Indian government point of view, issue of Eurodollar bonds help to contain
currency fluctuations within the country and also helps in boosting its Forex reserves.
It is a way for companies to obtain financing in an economy where financing is hard
to obtain.
It also allows companies and government to obtain funds in dollars to create dollar
liabilities to match against dollar assets.
Disadvantages of Eurodollar bond Issues to India
Currency fluctuation risks can adversely affect issuer’s repayment abilities.
Poor performance of stock markets can stall the conversion of debenture amounts to
equity.
Refinancing FCCBs to a later date due to adverse economic environment or other
reasons may require the issuer to pay higher coupon interest rates.
The companies and the country may lose its rating/image if non-repayment issues
arise.
Some of the companies that had issued FCCBs and Eurodollar bonds prior to 2007 and faced
repayment issues include Suzlon Energy Limited, Wockhardt Group etc. Most of these
FCCBs were issued in 2007 when the rupee dollar conversion was Rs.42. This has since then
plummeted to a low of Rs. 57.
China and the Eurodollar Bond Market
China today is the fastest growing emerging economy and the largest exporter. Known as the
manufacturing hub of the world, China is a mass exporter and exports products to the
American, European and other Asian markets. It is poised to become the largest economy of
the world surpassing the USA by 2016. Its fast paced developmental initiatives require large
amounts of capital investment. Its exports provide the country with large dollar revenue
inflows. China’s foreign reserves (in dollars) have steadily grown over the years and are
almost at $3200 billion making it an attractive centre for Eurodollars. Zhenhai Refining &
Chemical, Qingling Motors Co and Huaneng Power International are some companies
planning Eurodollar bond issuances n 2012.
Developing the Eurodollar Bond Market in China
Being the world’s largest Exporter, China holds millions of dollars from international trade.
A large portion of its foreign currency assets are held by the State in the form of foreign
exchange reserves.
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This huge reserve of dollars in the Chinese economy can pave way for development of a large
scale euro-dollar bond market in China. Several companies have already explored this
market. Goldman Sachs, the investment major, has issued seven year US dollar-denominated
bonds in China.
Pros
Developing a euro-dollar bond market in China can bring more bonds business to
China's financial institutions.
Financial products such as corporate bonds and government debts that used to be
underwritten by financial institutions in the US can be transferred to China bringing
more underwriting business to China's financial institutions.
Developing a euro-dollar bonds market can also increase the income return of China's
foreign currency assets with increased efficiency of investments and profit returns for
holders of the bonds. Such a market will bring a new financing channel at a low cost,
which is helpful for China's overseas investments, especially for small- and mediumsized companies.
It will also help China build its own international financial centre.
Issue of Eurodollar bonds by Chinese firms and government abroad will help china
fund its infrastructure and other projects at a lower cost.
Cons
Although China has the basic condition for building a euro-dollar bonds market, it
will need to make some adjustments on some of its financial regulations such as
foreign currency reserves regulations, separating Yuan market and Eurodollar bond
market and adjusting its regulations on capital accounts.
Brazil and Eurodollar Bond Market
Brazilian companies had been major players of the Eurodollar bond markets during its
growth phase from 1965 – 1980 till it was adversely affected by higher dollar rates. Brazil reentered the international bond markets actively from1995 but compared to its other South
American peers like Argentina and Mexico its issues have been comparatively less due to its
higher level of international reserves.
With rapid strides in growth, many public Brazilian firms today use international financing in
their capital structure mix. Brazilian companies usage of Eurodollar bonds fluctuates with the
value of the Real (R$) and is still small considering the size of Brazil's economy. Their
reluctance to issue bonds abroad may be related to the low availability of means for hedging
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foreign exchange risk. Generally, Brazilian companies tend to issue bonds abroad when the
Real appreciates relative to the dollar and foreign exchange rate volatility is low. 5
Hence despite remarkably high domestic borrowing costs, the usage of the international bond
market by Brazilian companies was low. With Brazil emerging as a strong international trade
player, its dollar reserves have also steadily increased reducing its dependence on
international debt markets. In an environment of high foreign exchange volatility and
liquidity crunch of dollars, Brazil actively engaging in the Eurodollar markets is remote,
despite its huge needs for investment and foreign capital to finance its developmental
projects.
Russia and the Eurodollar Market
The Eurodollar bond market rose in the 1960s with Russia (then USSR) trying to protect its
dollar reserves and raise further dollar money from markets other than the US during the
cold war era. After the break-up of USSR and the economic rebuilding of Russia in progress,
Russian companies have been actively exploring the Eurodollar markets for raising capital.
Gazprombank, a 35.5 percent-owned by state-controlled gas company Gazprom, No.2 bank
VTB (2011) and Russia's top lender Sberbank are some of the prominent Russian entities that
raised capital through Eurodollar bond issues recently.
Russia’s demand for dollars are bound to rise considering the projects and plans to be
undertaken by the Russian companies and government. Till a change in the reserve currency
takes place (possible internalization of Reminibi), Russian demand for dollars is to remain
steady and so will its Eurodollar bond issuances also.
Other Emerging Markets
With an increased supply of dollars outside the United States and with easy options of
financing like the Eurodollar bonds, other developing nations like Sri Lanka, Barbados,
Nigeria etc. have also actively entered the Eurodollar markets. While Barbados $200 million
bond saw orders almost four times more, Sri Lankan government has issued a $1 billion
Eurodollar bond with the objective of increasing its dollar reserves and to finance its
infrastructure projects. Nigeria’s $500 million Eurobond issue in 2011 was primarily done to
put the country on the global finance map and to have transparent and internationally
observable benchmark against which international investors can accurately price risk.
International organizations like IMF, Asian Development Bank etc. also issue Eurodollar
bonds to fund their initiatives.
5
The World of Financial Crisis and the International Financing of Brazilian Companies By Andre Carvalhal and
Ricardo Pereira Câmara Leal
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Conclusion
Emerging economies have a need for dollar reserves to finance projects, import requirements
and as Forex reserves. Other than few economies like China, majority of the other emerging
economies have a trade deficit and are therefore dollar deficient. As long as the dollar
remains the reserve currency of the dollar, the activity in the Eurodollar markets too shall
persist. The objectives of Eurodollar bond issuances vary from country to country depending
on their specific need at a point of time. Emerging economies will contribute to a major
chunk of Eurodollar bond issues due to their high dollar demands. But once they are able to
gain a firm position with respect to their trade equations and able to generate dollar revenues
in surplus to their needs, they may emerge as probable contenders for Eurodollar market
issuances. Hence either way emerging economies are going to continue to play a greater role
in the Eurodollar bond markets.
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REFERENCES
http://www.emergingmarkets.org/
http://www.scielo.br/scielo.php?pid=S1807-76922012005000007&script=sci_arttext
http://usa.chinadaily.com.cn/2010-11/24/content_11601369.htm
www.investopedia.com
http://www.bloomberg.com/news/2012-11-15/goldman-sachs-says-asian-bonddemand-surge-may-cause-bubble.htm
http://www.gwu.edu/~ibi/minerva/Fall1996/Antonio.de.Padua/Antonio.de.Padua.html
http://finance.indiamart.com/india_business_information/euro_issues.html
http://www.scmp.com/article/179477/zhenhai-plans-us200m-bond-issue (South China
Morning Post)
http://www.ftkmc.com/newsletter/Vol2-19-july25-2011.pdf
The Handbook of Fixed Income Securities by Fabozzi
The Eurobond Market Study by European Central Bank
Indian companies and International Bond Market by Dr. Prabina Rajib Associate
Professor, Vinod Gupta School of Management, IIT Kharaghpur
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