The Role of Eurodollar Bond Issuance Essay

Published: 2019-11-23 08:22:24
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Category: Currency

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Eurodollar bonds are U.S. dollars held in banks outside the United States by a non US organization. They pay interest and principal in Eurodollars. These bonds are not registered with the Securities and Exchange Commission. Due to fewer regulatory restrictions and costs in the Euromarkets, Eurodollar bonds can be sold at lower than U.S. interest rates. Eurodollar bonds are one of the more common Eurocurrency bonds because of the international importance of the dollar.

The Eurodollar market is one of the worlds primary international capital markets, and companies use Eurodollars to settle international transactions, to invest excess cash, to make short-term loans, and finance imports and exports. The development of the Eurodollar market was mainly due to the restrictions of the US regulations on international lending and investments in the 1960s. Similarly, when the German monetary authority restricted non-residents from issuing Deutsche mark bonds in the 1970s, the euro-DM market which had developed outside Germany grew rapidly.

One of the biggest reasons of the popularity of Eurodollar market is that Eurodollar deposits outside of the United States, the banks holding these deposits do not have to adhere to the Federal Reserves reserve requirements, and the Securities and Exchange Commission does not regulate Eurodollar securities. Other reason is the fundamental factors associated with the size of an economy and the growing influence of that economy in international trade, investment and financial transactions. Therefore, following the strengthening of the real factors, market forces would dominate and, sooner or later, the government would be forced to abandon the restrictions on international use of the home currency

Many banks and corporations find the lack of regulation attractive because it lowers costs, increases flexibility, and allows for creative structuring of financial instruments. This is why some U.S. companies raise money in the Eurodollar markets when U.S. markets are unfavorable. Sometimes American companies even create two-tranche IPOs, where one tranche trades on U.S. exchanges and the other trades on a European exchange. Other Eurodollar securities, such as Eurodollar bonds, pay investors in U.S. dollars but do not have to comply with SEC regulations.

In 1981, the Chicago Mercantile Exchange began trading Eurodollar futures, which were the first futures contracts that did not require delivery of an underlying instrument but were instead settled in cash. The most important regulation that has stimulated the development of the Euro-dollar market has been regulation Q, under which the Federal Reserve has fixed maximum interest rates that member banks could pay on time deposits. Whenever these ceilings became effective, Euro-dollar deposits, paying a higher interest rate, became more attractive than U.S. deposits, and the Euro-dollar market expanded. U.S. banks then borrowed from the Euro-dollar market to replace the withdrawn time deposits.

PROS

* Eurodollar bonds would be a decisive step towards a necessary medium term fiscal union and a first step towards a longer term political union. * They could reduce and even stop the present series of self-fulfilling attacks to fiscally vulnerable Member States and contagion to other Member States with less fiscal vulnerability. * They could, eventually, bring back financial stability to the euro area, given that joint guaranties or liabilities could convince markets that its Member States are really serious about achieving a proper fiscal union and a stable euro.

* They could reduce the cost of debt of most euro area Member States and eventually of all of them through the much larger size, depth, liquidity and diversification of such a market which could reach the same status than the US Treasury bond market. * Lower cost of debt and very large attraction to large government and private investors that need to diversify their investments beyond US dollars could help the euro area Member States to achieve earlier sustainable debt levels, faster recovery of economic activity and higher economic growth potential by returning faster to more normal levels of public investment.

CONS

* A Eurodollar bond, jointly guaranteed by euro area Member States, contains an implicit insurance for all participating Member States and some of them may have an incentive to issue too much debt to profit from such an implicit guarantee (when they could only issue too little debt before the existence of the Eurodollar bonds) creating a moral hazard issue and its consequent rejection by the most fiscally responsible Member States. * Some AAA rated Member States, such as Germany, may have temporarily to pay a slightly higher interest rate on its debt, given the inclusion in the jointly guaranty of other Member States with lower ratings. * The same Member States rightly claim that Eurodollar bonds require their issuance to achieve a very high harmonization of fiscal policies by all euro area Member States.

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