EURO-CURRENCY MARKET

Workshop at PDIMTR
On
11TH of March 2010
WHAT IS EURO-CURRENCY MARKET?

• It is a market for Borrowing and Lending of

currency at the center outside the country in
which the currency is issued.

• It is different than the Foreign Exchange

Market, wherein the currency is bought and
sold.
WHAT IS EURO-CURRENCY MARKET?
• This is a Capital Market:
– Dollar deposited in London is called as Euro-Dollar deposit
– Sterling deposit in Germany is called as Euro-Sterling deposit
– Euro loan extended in Japan is called as Euro-Euro loan

• Centers for Euro-Currencies:

– London
– Few other in Europe
– Singapore (also called as Asian Dollar Market)
– Hongkong
 Features of Euro-Currency Market

1. Types of transactions
2. Control of the country of issue of the currency
3. Huge amounts of transactions
4. Highly competitive Market
5. Floating rates of interest based on LIBOR
6. Dominance of Dollar denominated transactions
7. Four different segments
Features of Euro-Currency Market

• Types of Transactions:
1. Japanese Exporter, earning USD, keeps these
USD in London Bank (say AMEX)as Deposit.
2. AMEX bank may use such deposits for lending
to a French Importer.
3. Indian exporter, earning Japanese Yen, keeps
these Yen in Korea as Deposit
4. Nigerian Importer avails loan in INR from Russia
to import machinery from India.
Features of Euro-Currency Market
• No Direct Control of the country which issued the currency:
– Utility of the currency that is being bought and sold
is entirely outside the control of the country of its
issue.
• But Indirect control is possible:
– As the settlement always takes place in the country
in which the currency is issued, indirect control is
possible.

• Because of this Euro-Currencies are also referred to

as Offshore Currencies.
 Euro-Currency Market
• Bankers and the Public form the participants
of the Euro-Currency Market and the two
types of transactions take place:

1. One bank with the other

2. One bank with Public

Features of Euro-Currency Market
• Huge amounts of Transactions:

– Generally they are in only millions of USD

– This has lead to Syndication of loans, where large

numbers of banks participate in the lending
operations

– It also consists of pool of large number of short

term deposits, which provides the biggest single
source of funds for commercial banks
Features of Euro-Currency Market
• Highly Competitive Market:

– There are no entry barriers. There is free access to

the new institutions in the market

– The lending rates are low and deposit rate are high,
thus allowing a wafer thin margin for operations

– Consumers, i.e. investors and borrowers derive

advantage out of this situation
Features of Euro-Currency Market
• Concept of Floating Rate of Interest:

– The rate of interest in the market is linked to the

Base Rate usually LIBOR, i.e. London Inter-Bank
Offered Rate

– The rate of interest on advances and deposits is

reviewed periodically and amended according to
changed circumstances, if any in LIBOR
Features of Euro-Currency Market
• Dominance of Dollar in the market:

– Dollar is a leading currency traded in the market

(about 90% to 95% market share)

– However other currencies are now emerging thus

reducing the role of dollar somewhat (about 80%
market share)
• Euro
• Japanese Yen
• Pound Sterling
 Features of Euro-Currency Market

Euro-Currency Market Segments:

There are four predominant market segments as follows:
1. Euro-credit markets:
where international group of banks engage in lending for
medium and long term
2. Euro-bond market:
where banks raise funds on behalf of international borrowers
by issuing bonds
3. Euro-currency (deposit) market:
where banks accept deposits, mostly for short term
4. Euro-notes market:
where Corporates raise funds

The segmentation is not watertight and different segments overlap each other.
 Factors favouring the Growth of Euro-Currency
Market
• The following five countries are responsible
for the growth of the Euro-Currency Market:
– China (fear that its Fx in USD would be blocked)
– USA (indeed blocked identifiable Fx in USD in1950,
federal Reserve Act, regulation ‘Q’ and ‘M’; control
and restrictions on borrowing funds in US in 1965,
and introduction of interest equalization tax in 1963)
– Korea (War broke out in 1950)
– Russia (erstwhile USSR){because of their banking
presence in Paris and London}
– UK (policy of not granting sterling loan outside
sterling area in 1957)
 China / Korea / Russia
• Since 1949, China feared that its dollar earnings
would be blocked by USA.
• So China shifted its dollar earnings to Paris in the
Russian banks
• Korean war broke in 1950
• USA indeed blocked Chinese identifiable dollar
deposits in USA
• Russian banks in Paris and London started disguising
their balances by placing them in western European
banks rather than in N.Y.
• So communist countries had dollar claim on the
western European banks and western European
banks had similar claim on USA
 UK
• British Government in 1957, decided not to
grant sterling pound loans outside sterling
area.
• During the same period, however, Western
European banks were permitted to foreign
currency deposits (say bank in London will
accept dollar deposit)
• So the banks in London offered dollar loans
to their non-sterling area customers.
 USA: Federal Reserve Act: Regulation ‘Q’

• This act was about restriction on payment of interest on

dollar deposits as well as other currency deposits.
• No interest was payable on deposits having maturity of 30
days or less. There were restrictions and ceilings on interest
payments on deposits having maturity above 30 days.
• Therefore the dollar deposits of Non Resident US citizens got
shifted to Europe as the banks in Europe offered higher rates
of interest on dollar deposits (as well as other currency deposits)
• Foreign (for US) investors also shifted their dollar deposits
from US to centers outside US, mostly to banks in London
• Banks London used these deposits for lending to its
customers in non-sterling areas
• Thus London got the prominence in borrowing and lending
Euro-dollar.
USA: Federal Reserve Act: Regulation ‘M’

• This act was about reserve requirement of the

banks on their deposits
• The act required US banks to block more money
in reserves, than European banks
• US banking regulation was not very tight then
(and it is not so even now)
• American banks found it beneficial to move the
deposits of Non Resident US citizens as well as
those of resident citizens to banks in Europe.
 USA: Controls and Restrictions
• In 1965 the controls and Restrictions were placed
on borrowing in USD for investments abroad. They
were voluntary.

• In 1968 these controls and Restrictions were made

mandatory

• So the borrowers from US sought loans from

outside US or in other words they were driven to
Euro Markets
 USA: Interest Equalization Tax
• To discourage flow of dollar outside US, US
introduced interest equalization tax in1963
payable by residents of US on their earnings
on foreign securities

• To avoid this tax lenders lent through Euro-

Currency Markets
 Interest Rates in Euro-Currency
Maket
• LIBOR:
– The banks (called as reference banks)in London charge different rates of interest
on their lending
– These rate at 11.00 AM London times, are averaged and rounded off at nearest
0.1250
– These are calculated for 1 month, 3 month or 6 month period
• LIBID:
– This is the interest rate paid by the banks in London on the deposits kept with
them.
– They are generally 0.25% or 0.125% lower than LIBOR
• LIMEAN: It is average of LIBOR and LIBID
• Prime Rate: of USA
• SIBOR: Singapore LUXIBOR: Luxembourg
• MIBOR: Mumbai BIBOR: Bahrain
 Segment 1: Euro-Credit Markets
1. Tenure: Medium and Long Term Loans [up to 10--15
years 10% of loans, 5—8 years 85% of loans, 1– 5 years
5% of loans] provided by group of banks.
2. Amount: It is a wholesale sector of the international
capital market.
3. Security: Loans are provided without any primary or
collateral security. Credit rating is the essence of lending
4. Type of loan: a) Revolving [like cash credit]
b)Term Credit
5. Interest Rate: Generally 1% above the reference rate,
rolled over every six moths
6. Currency: Generally USD, but can be any other currency,
as required by the borrower and ability of the lender.
 Segment 1: Euro-Credit Markets
Syndication of Loan:
– Managing banks, as desired by the borrower
– Lead bank, generally who takes the largest share of
lending
– Agent bank, as required to take interest of the banks
in syndication and comply with the procedure
– Common assessment of the borrower and his
country
– Common documentation
– In very few cases co-financing with IMF or IBRD is
possible
 Segment 2: Euro-Bonds
• Euro-Bonds are unsecured securities
• They are therefore issued by borrowers of high
financial standing
• When they are issued by government
corporation or local bodies, they are guaranteed
by the government of the country concerned
• Euro-Bond is outside the regulation of a single
country. The investors are spread worldwide
• However foreign bonds are issued in only one
country and are subject to the regulation of the
country of issue.
 Segment 2: Euro-Bonds
• Selling of EB is through syndicates of the
banks
• Lead manager advises about size, terms and
timing of the issue
• Entire issue is underwritten
• Lead manager’s fees, underwriting
commission and selling commission is
somewhere between 2% and 2.5% of the
value of the issue
 Segment 2: Euro-Bonds
• Lead manager allocates the bonds to all
members of the selling group at face value
less their commission
• Thereafter every member is on his own
• They can sell to investors at whatever price
they can obtain
• Thus no two investors in the Euro-Bond
market need pay the same price for the
newly issued bonds
 Segment 2: Euro-Bonds
• Features of Euro-Bonds:
– Most Euro-Bonds are bearer securities
– Most bonds are denominated in USD 10,000
– Average maturity of the Euro-Bond is 5 to 6 years
– In some cases maturity extends to 15 years
• Types of Euro-Bonds:
– Straight or Fixed Rate Bonds
– Convertible Bonds
– Currency Option Bonds
– Floating Rate Notes
 Straight or Fixed Rate Bonds
1. These are fixed interest bearing securities
2. Interest is normally payable yearly
3. Year is considered of 360 days
4. Maturities range from 3 years to 25 years
5. Right of redemption before maturity may be
there or may not be there
6. If the right of redemption is there then
redemption is done by offering an
agio(premium)
 Convertible Bonds

1. These are fixed interest bearing securities

2. Investor has an option to convert bonds into
equity shares of the borrowing company
3. The conversion is done at the stipulated price and
during the stipulated period
4. Conversion price is normally kept higher than the
market price
 Convertible Bonds
5. The rate of interest is lower than the rate of
interest on comparable straight bond.
6. Sometimes the bonds are issued in a currency other
than the currency of the share. This provides an
opportunity to diversify the currency risk as these
bonds are issued with fixed exchange rate of
conversion
7. Bonds with warrants: warrant is part of the bond but
is detachable and traded separately, when the
conversion takes place. The investor can keep the
bond and trade the warrant for shares.
 Currency Option Bonds
• They are similar to straight bonds
• Generally issued in one currency and option
to take interest and principal in another
currency.
• Exchange Rate is either fixed (generally not)
or is spot rate prevailing in the market three
business days before the due date of
payment of interest and principal
 Floating Rate Notes
• FRN is similar to straight bonds with respect to
maturity and denomination
• Rate of interest however varies and is based on LIBOR
+ 1/8%, ¼%,1.5%........
• Rate of interest is adjusted every six months
• Minimum interest rate clause may be included
• ‘drop lock’ clause may also be included, which means
if minimum interest rate happens to be paid then it is
locked for the remaining period of the bond.
• Generally it is found that banks issue and invest in
FRNs
 Segment 3: Euro-Currency Deposits
1. Euro-bonds represent the funds amassed by
the bank on behalf of international borrower;
Euro-currency deposits represent the funds
accepted by the bank themselves.
2. The Euro-currency market consists of all
deposits of currencies placed with the banks
outside their home currency.
3. The deposits are accepted in Euro-currencies,
as well as currency cocktails (SDR, ECU etc.)
 Segment 3: Euro-Currency Deposits
4. The deposits are placed at call (overnight, two
days or seven days notice) for USD, Sterling
pounds, Canadian dollars and Japanese Yen;
and of two days in any other currencies
5. Time deposits are accepted for periods of 1,3,6
and 12 months for all currencies
6. USD and Sterling pound can be placed for a
period of five years
7. Minimum size of deposit is USD50,000 or its
equivalent
 Segment 3: Euro-Currency Deposits
Certificate of Deposit
1. It is negotiable instrument
2. They are bearer instrument and can be traded
in the secondary market
3. Period: 1 year (1 month through 12 months)
4. Minimum amount: USD50,000
5. Currencies: USD, Sterling Pound, Yen
6. Interest Rate: 1/8 % below LIBOR
7. Tranche CD: carries different rates of interest
for each tranche
8. Discount CD: they are issued at discount
 Segment 4: Euro-Notes Market
1. This market constitutes the instruments of
borrowing issued by the corporates in the Euro-
currency market
2. The instruments issue may be underwritten or may
not be underwritten
3. The borrowers directly approach the lenders
without the intermediation of the banks or financial
institution.
4. Instruments are of the following categories:
1. Commercial Paper
2. Note issuance Facilities
3. Medium Term Notes
 Commercial Paper
1. It is a promissory note with maturity less than
a year, generally the period varies between 90
days to 180 days
2. Generally issue is not underwritten
3. Amount: USD 100,000 or equivalent
4. Issued on ‘Discount to Yield ‘ basis, but interest
rate works out lesser than that is paid on bank
borrowing and higher than that is paid by the
bank on deposits
5. They are unsecured instrument
 Note Issuance Facilities (NIF)
1. Borrowers place short term notes of 3 months
to 6 months maturity directly with the
investors
2. The notes are rolled over on maturity
3. The banks underwrite at the time of issue as
well as when the notes are rolled over
4. With slight variation they are also known as:
1. Revolving underwriting facility (RUF)
2. Standby Note Issuance Facility (SNIF)
3. Note Purchase Facility (NPF)
 Medium Term Notes
1. MTN represents Long Term, Non Underwritten
and fixed interest rate source of raising finance.
2. It can be comparable with Euro-bonds with a
difference that Eurobonds issue is underwritten,
where as MYN issue is not underwritten.
3. Their maturity is somewhere between short
term CPs(less than one year) and long term Euro
bonds(more than five years)
4. They are privately placed and have great
flexibility
 Euro-Issues
• Access to Euro Equity Market is through the
following two ways:
1. Foreign Currency Convertible Bonds
2. Depository Receipts
(FCCB has already been explained)
• Depository Receipts:
1. Global Depository receipts
2. American depository Receipts
 Global Depository Receipt (GDR)
• Shares of the issuing company are issued in the name
of an international bank, located in foreign country
and is called as ‘Depository’
• The physical possession of the shares issued is with
the ‘Custodian’, in the issuing country
• Based on the shares issued to depository, depository
issues GDR in USD
• GDR is a negotiable instrument
• GDR is a bearer instrument and traded in
international market, either through ‘stock exchange’
mechanism or on ‘Over The Counter’ basis
 Global Depository Receipt (GDR)
• The settlements are done through international clearing
systems like ‘Euro-clear’ (Brussels) or CEDEL (London)
• GDR is denominated in US dollars, that represents shares
issued in local currency
• Issuing company pays the dividend to the depository in
local currency
• Depository converts this local currency into USD at the
ruling exchange rate and distribute it among the GDR
holders pro rata
• Exchange risk is borne by the investor
• Voting rights are only with the depository and are
regulated by the agreement between issuing company
and the depository
 American Depository Receipts

• They are similar to GDR, but issued in USA.

Issues in Foreign Domestic Market
• When bonds (or equities) are issued in only
one foreign domestic capital market, they
are known as:
– Yankee Bonds, if issued in US domestic market
– Bulldog bonds, if issued in UK domestic market
– Samurai Bonds, if issued in Japanese domestic
market
• Reliance industry, ICICI, Infosys Technologies
etc. tap the foreign markets
Thank you