Eurobonds as Refugees From Tax Men Turn 50 in $4 Trillion Market

Half a century ago, a London bond deal for an Italian highway operator, denominated in U.S. dollars and arranged by a U.K. bank founded by a Jew fleeing Germany spawned a $4 trillion-a-year global market.

Autostrade SpA, the manager of Italy’s freeway network, borrowed $15 million on July 1, 1963, through a new kind of international debt security, dubbed a Eurobond. Financiers led by Siegmund Warburg, founder of S.G. Warburg & Co., created the debenture so its interest payments were untaxed and in so doing gained access to pools of stagnant American dollars in Europe.

On the eve of its 50th anniversary and a celebratory black-tie dinner in London’s Savoy Hotel today, the market for Eurobonds and the larger derivatives markets that have grown up alongside it face new controls and taxes from cash-strapped governments after the worst financial crisis since the Great Depression forced five European nations to seek international bailouts. The market’s founding fathers say escaping similar rules was the key to its initial success.

“The market was riven with bureaucracy and rules and stamp duties and everything to make our lives difficult,” said Peter Spira, 83, who joined Warburg in 1957 as a newly trained chartered accountant and worked on the Autostrade deal. “We fought a long battle and we eventually won.”

Tax Loophole

It all started with bankers exploiting a quirk in the tax code dating from the 19th century that allowed financial transactions originating in the U.K. between foreign counterparties to go untaxed, said Stanislas Yassukovich, who traded the Autostrade bonds at White Weld & Co. White Weld was acquired by Merrill Lynch & Co. while the separate European business later became part of the firm now known as Credit Suisse Group AG.

The new securities they dreamed up to take advantage of the loophole allowed borrowers and bankers access to a pile of cash called Eurodollars because they were held outside of the U.S., and which were left idle for tax, regulatory or political reasons.

From those beginnings the market has helped hasten European integration and promoted London as a global financial center. Borrowers from Paris-based hotel operator Accor SA to the Republic of Zambia have raised funds using Eurobonds.

Issuance has risen steadily since the turn of the century, peaking at about $4.5 trillion in 2009 from $1.4 trillion in 2000, according to data compiled by Bloomberg. Sales this year are set to match the $4 trillion sold in 2012, the data show.

First Swap

Growth began in earnest with the development of the international swaps market in 1981 by the World Bank. The derivatives gave investors the ability to use interest rates in one currency to subsidize lower rates in another as well as give borrowers the choice of fixed or floating rates that can reduce financing costs. The swap-driven deals became bigger and bigger as the diversity of borrowers in different currencies increased the appetites of global investors.

Swaps allowed borrowers to raise debt where it was cheapest and pay in the currency of their choosing. In the first deal, the World Bank needed funds in Swiss francs and Deutsche marks but wasn’t able to access those markets. Instead, it borrowed dollars while Armonk, New York-based International Business Machines Corp. took out a loan in francs and marks. The two borrowers then swapped the liabilities, essentially exchanging cash flows.

“Clearly the development of the swaps market was extremely important for the bond market,” Rene Karsenti, who worked on the first public currency swap as a junior executive at the World Bank and is now president of the International Capital Market Association, or ICMA, said in a telephone interview. “Swaps delinked the currency, the interest rate, the credit rating of a transaction from the needs of the borrower.”

Transaction Tax

The interest-rate swap market, which grew to about $29.4 trillion in notional amount in June 1998, passed the $100 trillion mark in December 2003 and reached $370 trillion in December 2012, according to the Bank for International Settlements in Basel, Switzerland.

Europe is now considering a financial tax that would apply to bond trading, while in the U.S., measures designed to crack down on tax evaders holding money offshore may force U.S. institutions to levy a withholding tax on some transactions, according to Chris O’Malley, a senior adviser to ICMA. The self-regulatory organization’s members range from securities dealers and brokers, to banks, issuers and investors.

Cheaper Rates

“The most important attribute of Eurobonds, by a mile, is that they’re free of withholding tax,” said O’Malley, the author of the provisionally titled book “Bonds Without Borders,” to be published by John Wiley & Sons in April. “If that changes you can whistle goodbye to the world’s biggest market. If you’re going to buy a cross-border issue, the key is that you don’t want to be taxed twice. Double taxation is a total deal killer.”

Investors in London would be less likely to buy bonds issued by Munich-based Siemens AG if, for example, tax were payable to both the German and U.K. authorities, he said.

Without Eurobonds, issuers would have to turn to domestic or regional markets, which would be more expensive, said O’Malley.

“I guess we’d go back to Bulldogs and Kangaroos and Rembrandts and Matadors,” O’Malley said, referring to securities sold by foreign companies in the U.K., Australia, the Netherlands and Spain. “Effectively, there are no domestic bond markets in Europe now. They’ve all been subsumed under the Eurobond market.”

Regulation Hurdles

Before 1963, international bonds denominated in dollars had to be registered with the U.S. Securities & Exchange Commission, according to Yassukovich. They were underwritten by U.S. banks even though as much as 75 percent of the debentures were sold to investors in Europe, according to Ian Kerr’s “A History of the Eurobond Market.”

Warburg, a German Jew who set up S.G. Warburg in London in 1946, together with his colleagues saw that a bond in dollars sold and traded outside the U.S. could be cheaper to issue and generate fees for European financial institutions. Warburg’s family, who “may rank as the oldest, continuously active banking family in the world,” trace their ancestry to the 16th century, according to Ron Chernow’s “The Warburgs.” They were forced to flee Nazi Germany and sold their stakes in M. M. Warburg & Co., one of the largest private banks in Germany, to regime-approved purchasers in 1938.

Governor Carli

Warburg turned to Bank of Italy Governor Guido Carli for help in finding a borrower and in January 1963 signed up Rome-based Autostrade. A team led by Ian Fraser, who was named the head of the U.K.’s City Panel on Takeovers and Mergers in 1969, took six months to find ways around the thicket of regulations.

The London Stock Exchange, the Bank of England, the Inland Revenue and the Stamp Office all made their job harder, with exchange controls and taxation among their main issues, according to Kathleen Burk, Professor Emerita of modern & contemporary history at University College London.

Central banks in Europe also had to consent to the bonds being distributed within their borders, as well as the coupons and principal being paid in dollars.

Just 17 days after the Autostrade deal, President John F. Kennedy announced a new law for the Interest Equalization Tax that gave American businesses a reason to borrow abroad and to keep those dollars outside the U.S. American multinationals received another incentive for Eurobonds when President Lyndon B. Johnson asked in 1965 and obliged by law in 1968 companies to fund foreign investments with money raised abroad to stem a flow of dollars out of the country.


“The bombshell, the thing that really kicked it all off, was the Interest Equalization Tax,” said Yassukovich. “That totally killed the market in New York for international bonds.”

About $4.8 billion of Eurobonds were issued from 1963 through 1967, and the amount rose to $17.5 billion in the five years through 1972, according to Kerr. Some $47 billion was sold in the next five years, with the amount surging to $119 billion from 1978 through 1982.

Stanley Ross, 82, who in 1950 began a five-decade career in financial markets starting at Strauss Turnbull & Co., one of the brokers of the Autostrade issue, recalls how the firm’s equity business was “gradually pushed aside by the sheer volume” of Eurobonds. “The market grew without any regulation,” said Ross, who co-founded the Association of International Bond Dealers in 1969 and was known for wearing a monocle and mutton-chop sideburns.

Financial Crisis

The market was largely self-regulated by organizations such as the AIBD, a predecessor to the ICMA, until the 2008 financial crisis prompted policy makers to demand greater scrutiny. The 17-nation euro zone suffered through almost two consecutive years of economic contraction and the sovereign debt crisis led Greece, Ireland, Portugal, Spain and Cyprus to seek bailouts.

The proposed financial transaction tax, which the European Commission estimates could raise 30 billion euros ($40 billion) to 35 billion euros a year, would mean a levy of $10,000 on a $10 million trade.

The U.K. has mounted a legal challenge and Luxembourg, where Citigroup Inc. estimates assets held by banks are 22 times the nation’s gross domestic product, may do the same.

“The moral to me of all of that story is that markets will migrate to wherever they see the optimum location to provide a service to their clients,” said John Stancliffe, who was born in 1932, worked at White Weld in London from 1955 to 1979 and traded the Autostrade transaction. The financial transactions tax “is absolute insanity,” he said.

Champagne Celebration

The U.S. enacted in 2010 the Foreign Account Tax Compliance Act, which may also discourage bond investors if they risk being slapped with withholding tax, according to O’Malley at ICMA.

Belgian dentists, shorthand for wealthy individuals, were attracted to the debt’s untaxed coupon payments and their anonymity. The person holding the bond could claim the payments.

“We did virtually nothing with U.K. counterparties,” said Yassukovich, the former White Weld executive. “We traded almost entirely between the famous Belgian dentist in Belgium and, say, a Latin American client or whatever.”

Buyers of Eurobonds range from wealthy individuals in places such as Switzerland and Singapore investing via private banks, to funds run by New York-based BlackRock Inc., and Pacific Investment Management Co. in Newport Beach and the rest of the world’s biggest money managers.

The $15 million deal Fraser and Spira cobbled together has been succeeded by thousands of bonds each year. Top-rated sovereigns, state agencies and corporate borrowers now issue into the same market as Ukrainian chicken farmers and Greek suppliers of refrigeration equipment.

“The business has changed,” said Ross, a bus conductor’s son who will be speaking at the Savoy tonight as the champagne corks pop to celebrate the market’s half-century. “What I don’t know is whether there are the same opportunities available anymore.”

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