UNIVERSITY COLLEGE LONDON

LEGAL ASPECTS OF INTERNATIONAL FINANCE

Professor Graham Penn
Professor Philip Rawlings

EUROBONDS - INTRODUCTION

The issue of eurobonds began in the late 1950s and early 1960s and developed using many techniques from the term and syndicated loan markets. For example, many terms in the bond subscription and underwriting agreements are derived from similar terms in loan documents. There are also parallels between the group of managers and the lead manager in a bond issue, and the syndicate banks and the agent in a loan syndicate; and in both cases the economic rationale of risk spreading across a syndicate is important. There are, however, a number of crucial differences between a syndicated loan and a eurobond issue which can be best appreciated once the structure used to issue eurobonds is fully understood.

Eurobonds are usually issued by multinational corporations whose names are well recognised or by governments or government instrumentalities from developed countries; unlike in the market for term and syndicated loans, relatively few government issuers from developing countries have had success in the eurobond market. The issuers coming to the eurobond markets have traditionally had such profiles and high credit ratings that very few eurobond issues are secured, although this is changing with the development of securitisation, which we considered earlier in this course. Another exception is where for tax or reasons of securities regulation an off-shore subsidiary of a substantial corporation is used, and the latter provides a guarantee of the subsidiary's obligations to holders of the eurobonds.

Issuers of eurobonds moved from term and syndicated loans to the issue of eurobonds for several reasons. The original issuers were such good credits that they realised they could raise funds more cheaply by issuing bonds directly to investors, than through loans from banks. At the same time, competition between banks for syndicated loans was so great that banks found that offering alternative financing through a bond issue gave them more flexibility and that it was more profitable to take large fees for managing, underwriting and selling the eurobonds than keeping loan assets on their books for the period of a syndicated loan. The investment banks quickly developed their marketing and distributing techniques so as to sell on all bonds they agreed to underwrite and/or sell, so were rarely required to allocate any capital against the bonds they underwrote. The capital requirement (ie the amount of capital required to be held by a bank or financial institution to protect it against the risk of default on a financial asset such as a loan or bond) is still lower for holdings of bonds than for term loans, reflecting the belief that bonds are more liquid assets than loans. In fact, bonds are structured to ensure easy transferability and simplified trading processes.

Investors in (or purchasers of) eurobonds are a varied group. They range from institutional investors and banks to individuals, the latter often generically described as "Belgian dentists". Banks have been particular investors in floating rate notes, which are identical to bonds but have floating rate rather than fixed rate interest, which banks require to protect themselves against their own floating rate obligations in the inter-bank market. If these floating rate notes are perpetual and subordinated, they may be issued as a portion of bank capital in satisfaction of capital adequacy requirements in many countries.

A eurobond is, typically, a fixed interest security usually with a face value of between US$1,000/10,000. It is a document which specifies the entity borrowing the funds (the issuer of the bond), the amount of principal (or the face value) borrowed and the rate and intervals for the payment of interest. It also sets out the terms of repayment of principal, the covenants of the issuer (e.g.