The Autostrada del Sole, which joins Italy’s north and south and was completed in 1964, was as much part of the country’s postwar revitalisation as Fiat 500 cars and film stars wearing Gucci loafers. Behind the company that built the toll road was a deal that transformed global finance.
On July 1, 1963, Autostrade had issued the world’s first eurobond. Despite its name, the bond was dollar-denominated and pitched at US currency investors operating across national borders.
“Capital at that time was not so accessible and the company wanted to reduce its reliance on the Italian state,” says Giovanni Castellucci, chief executive of Autostrade. “It was the first very big toll road anywhere and it was then copied. Now every country has an Autostrada del Sole. But ours was the first.”
Exactly 50 years later, European corporate bond markets could be on the verge of another significant shift. Today’s bond pioneers believe that weaknesses in the continent’s banking system and historically low interest rates will encourage companies to tap capital markets much more for finance and rely increasingly less on bank loans.
Traditional bank ties remain strong, especially in continental Europe. On some measures, emerging economies have experienced a bigger shift towards capital market funding of companies since 2008. But just as the launch of eurobonds – which were named long before the birth of the European single currency – kick-started the globalisation of corporate finance, the crises of the past six years could bring Europe’s markets closer to the depth and liquidity of those in the US.
“In five to 10 years, I think the European market will look broadly similar to the US market in terms of bank and bond percentages,” says Michael Ridley, vice-chairman of investment banking at JPMorgan, whose banking career began in 1978.
Eurobonds were created out of necessity – as well as changes in the 1960s in US tax rules that encouraged investors to keep dollars outside the country. But their pioneers consider Autostrade’s launch issue as part of a broader shift in capitalism in the decades after the second world war.
“It was a major step along the way to the globalisation of finance and foreign exchange markets,” says Stanislas Yassukovich, former deputy chairman of London’s stock exchange, who was involved in many of the early eurobond deals. “It was also a major step in the postwar recovery in Europe – and the rest of the world for that matter.” Chris Tuffey, head of investment grade capital markets and syndicate at Credit Suisse, adds: “It made the world a smaller place.”
The success of eurobonds cemented London’s position as Europe’s financial capital: SG Warburg, based in the City, topped the list of bankers to the Autostrade issue, which also included Deutsche Bank. Cross-border markets were given a further boost from the 1980s when the development of international swaps markets made it easier for companies to borrow in foreign currencies and for investors to borrow in low-interest countries to invest in higher-yielding assets.
Then, in 1999, came the launch of the euro, the continent’s boldest experiment yet in economic integration. “Once the euro came into being, it accelerated hugely the growth of the European corporate bond market,” says Chris Whitman, global risk syndicate head at Deutsche Bank.
The early years of this century saw a wave of issuance as European telecoms companies raised funds to buy 3G licences. “That was really the first time European markets had been aggressively peppered on a consistent basis by very large corporate deals,” recalls Bryan Pascoe, global head of debt capital markets at HSBC.
Although capital market aficionados have a strict definition of a eurobond – its legal form and tax-free status – the phrase has fallen out of use somewhat in recent years. Some original features, particularly the provision for the anonymity of investors, have gone. But cross-border issuance of corporate bonds has become ubiquitous. “Eurobonds largely replaced domestic markets in Europe – there was no point launching a bond in just one country when you can tap an international investor base at no extra cost,” says Chris O’Malley, whose book Bonds without borders will be published next year.
How the market develops will depend crucially on structural changes in the continent’s financial system, triggered by the crisis of the past few years. Not all are necessarily positive. “Eurobonds were created at a time when exchange and capital controls were being removed – when everything was being opened up,” says Mr Yassukovich. “Now the trend is completely the opposite. It is not an atmosphere in which finance can prosper.”
One threat is the financial transaction tax planned by 11 EU states, which would hit bond markets as well as equities. Although the final shape of the tax is still subject to much debate in Brussels, its opponents warn that the taxing of bond trading would reduce the liquidity of markets and increase issuance costs.
A less high-profile concern is that regulators have unintentionally dealt the market a blow by increasing the cost to banks of holding bonds on their books. The effect has been to reduce their role as “market makers” – increasing trading risks and of panic price reactions during times of stress.
“Banks’ trading desks historically had an important role as warehouses and providers of liquidity in the credit markets. While still relevant this has certainly been impacted by the tougher regulatory environment.” says Mr Pascoe.
Mr Tuffey from Credit Suisse says: “The move towards capital markets in Europe has been slower partly due to uncertainty over regulation but also [because of] the huge players out there defending parochialism. German and French banks, for example, have historically lent to local corporates at generous rates.”
Meanwhile, many smaller European companies remain wary of the extra transparency required under today’s more stringent rules. “It will be some time before midsized European companies overcome their disquiet about the regular reporting required by capital markets,” says Paul Watters, corporate credit strategist at Standard & Poor’s. “If you have a relationship with a bank, the detailed information that you provide remains private.”
Data on corporate bond issuance show a move this year towards companies funding themselves more in debt markets and relying less on bank loans. European corporates borrowed $377bn worth of debt from the capital market in the first half of 2013, the biggest ever and more than twice that in the first half of 2006, according to Dealogic. At the same time the volume of loans from syndicates of banks has fallen sharply.
The figures are volatile and not yet convincing evidence of a long-term shift. In recent weeks, global bond markets have hit a bout of turbulence, triggered by Ben Bernanke, the US Federal Reserve chairman, signalling a possible slowdown in US quantitative easing. QE was instrumental in driving demand for corporate debt as part of a global “hunt for yield”. Since Mr Bernanke’s May speech, prices have fallen, yields risen – and issuance dried up.
But bond markets have always had bouts of good times and bad times for companies to issue debt. “A little bit of stability and they will be piling back into the market,” Mr Whitman predicts.
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Encouraging the shift will be low interest rates and increased concerns about the stability of banks – which have encouraged companies to pay much more attention to their funding requirements – and it could quickly become firmly established if European economies saw stirrings of a revival in growth. “Companies have battened down the hatches and cut back on discretionary spending. We have not yet got to the point where there is material demand for new debt funding to support growth,” argues Mr Watters. “Our gut feeling is that it is a bit like pushing a snowball down a hill. It starts slowly but picks up speed over time.”
S&P argues that in coming years Europe could even have the opposite problem to a lack of demand – and there could be insufficient investor capacity in European bond markets to meet companies’ funding requirements, forcing them to tap dollar markets – just as Autostrade did in 1963. “The pressure valve in Europe has always been the liquidity available in the US dollar market,” says Mr Watters.
With government finances under severe pressure and banks continuing to struggle, European policy makers want to promote alternative forms of finance. The European Commission has launched initiatives to encourage capital market development, and Andrew Haldane, the Bank of England official responsible for financial stability, warned in parliamentary evidence last month that Europe had “too much of a banking monoculture and that is not good for financial sector resilience”.
“The US and Europe are on the same path towards greater and deeper capital markets but Europe just started later and is further behind,” says Monica Klingberg Insoll, a senior director at Fitch Ratings. “The market only started in 1999.”
Paving the possible way ahead has been the rapid development of corporate bond markets in the world’s emerging economies. During the past quarter, emerging-market companies obtained three times as much funding from the bond markets as from bank syndicates, the biggest gap in at least a decade – even though the same regulatory pressures affecting European banks have hit emerging-market banks.
“The trend of emerging-market corporates borrowing increasingly from the bond markets over their relationship banks has picked up noticeably in 2012, particularly in Asia,” says Shamaila Khan, portfolio manager at AllianceBernstein. “It is not just external debt that is growing, though. Local bond markets are getting bigger as well.”
In spite of their rapid growth, however, emerging economies’ bond issuance volumes remain small compared with Europe’s. Autostrade’s managers see potential for further expansion.
“We’re still on the same page as 50 years ago,” says Mr Castellucci. Using bonds, not bank loans, the group is keen to maintain its edge in motorway construction – although not all of its projects have the same cachet as the Autostrada del Sole. Mr Castellucci boasts: “We did the first privately financed toll road in the UK – the M6 around Birmingham.”
Additional reporting by Rachel Sanderson
Borrowing: Investors punish companies for their location
The launch of the euro was designed to bring the continent closer together, but in financial terms it has been growing further apart since the debt crisis as borrowing costs diverge sharply between the core and periphery, writes Michael Stothard
In bank loans to small companies, the difference in average Spanish and German borrowing costs has never been higher, according to European Central Bank data, despite recent market improvements. In the bond market, there is a similar problem.
Companies based in the periphery are forced by the markets to pay more than their rivals in the core, leading to complaints that they are being punished by investors purely for their location and regardless of the strength of their business.
Even big multinationals, with a limited amount of business in their home market or Greece or Spain, complain of having to pay more at time of stress, as many investors dump whole geographies from their portfolios.
“It is sometimes easier for fund managers to say that they are not exposed to credits in the eurozone periphery than it is to say that they are buying one or two companies that they have faith in,” says a strategist at a global asset manager.
For this reason, some companies have thought about trying to game the system. Telefónica, the Spanish telecoms company, said it was looking to issue a bond via its German unit in a bid to tap into the lower borrowing costs in the core.
The spread between yields on Spanish sovereign 10-year debt and the German equivalent has narrowed since last year after Mario Draghi, European Central Bank president, pledged to prevent a break-up of the eurozone.
But Germany can still borrow 10-year debt at 1.7 per cent compared with 4.8 per cent for Spain.
The difference in borrowing costs between core and periphery is reflected in the level of debt issuance as well.
Companies based in France and Germany were able to borrow €102bn of ultra-cheap debt from the markets in the first half of this year, while companies based in Italy and Spain borrowed just €31bn at higher rates, according to data from Dealogic.
In July Mr Draghi warned: “If we want to get out of this crisis, we have to repair this financial fragmentation.”
Letter in response to this column:
Caution is advisable on eurobonds / From Mr A. Edward Gottesman