| A survey by Finance of the likely implications for treasurers of the euro will be an increasing use of a wide range of treasury instruments, notably options, as well as increasing recourse to highly engineered products. |
I n tandem, there will also be increased availability, and usage of traditional 'plain vanilla'
products,such as euro deposits and euro spot foreign exchange, at more competitive margins/prices than hitherto in the legacy currencies that the euro replaces, because of the rationalisation and expansion of the eleven domestic money markets into one.
Identified by the main third party providers of treasury services in the Irish market is a lengthy list of products, listed alphabetically in the table below.
These products indicate for corporate treasurers the areas where new knowledge should be developed, and financial risk management opportunities examined.
The euro has brought about a sea change in the effective market facing Irish corporates - the new, and ever deepening market, means that financial engineering and financial risk reduction possibilities now are opening up that hitherto would have been impractical.
The euro is in the process of opening up new derivatives, particularly in the options area, interest rate options particularly, that dramatically open up the interest rate risk hedging and risk management opportunities that exist.
An example was the difficulty of issuing corporate bonds. Prior to the introduction of the euro, the primary way of engaging in corporate bond issuance was through the US private placement market, with currency swapping to hedge the issue. 'This was expensive, as using interest rate swaps to convert fixed rate bond issues to floating rate exposed Irish issuers to fluctuations in a a swaps market dominated by a small number of large players. The cost of using swaptions to lock-in the spread over government bonds was too large to prove feasible', according to Damien Dunne, associate director of the Treasury & Institutional Desk of Bank of Ireland Group Treasury.
However now, the possibilities have improved on two counts. A deep and liquid euro corporate bond market beckons in the future, in parallel to the US private placement market, while options, for example swaptions, in euro now are available.
Many treasurers see a growth in securitised corporate debt issuance by Irish companies in the years ahead, particularly by those such as plcs who are strongly engaged in investor relations/debt rating relationships and processes.
Companies within Europe have generally been debt averse compared to US companies. While a typical debt to equity ratio for a European company is in the 20-30 range the average in the US is closer to 60.
European banks are increasinglyly anticipating a trend by clients to use the securitised markets as a source of funding, rather than their 'relationship banks' balance sheets.
The traditional approach, has tended to result in:
l an emphasis on short term funding
l low levels of leverage
l difficulties for smaller, perhaps undercapitalised, companies in raising finance.
In the US some 75-80 per cent of all corporate debt has been provided by the bond markets historically with the balance coming from the banking sector. In Europe these percentages, in most ocuntries, will be inverted. Accordingly, with
The prospect that the ration will notmalise 'trans Atlantic', Europe is facing an explosion in securitised corporate debt issuance, and this will drive the liquidity and general thrust towards securitisation in the future.
Thus, debt should developed in a quasi-equity way, with investors seeking higher returns than offered in the rock bottom euro cash markets through the use of derivatives, and an increased focus on equity risk.
But the euro is also expected by treasury providers to lead to increased use of plain vanilla products. The elimination of separate domestic treasury markets opens up increased advantages of centralising treasury operations for pan European companies, perhaps in a single, financial shared service location.
For example it is now possible to finance an Italian debt with funding from an existing CP programme in the lower-margin and more liquid French CP market (with no FX overhead), offering the pan-European treasurers a substantial advantage in costs and convenience.
On the foreign exchange with rates now fixed there increased efficiency for existing netting and pooling schemes. For example the euro allows a worthwhile balance of cash to be deposited overnight, whereas previously deposits were maintained in legacy currencies, which would have been swapped into a holding currency and netted before deposit. Thus, the forecast that the euro will produce a growth in traditional plain vanilla instruments as well. |
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| Article appeared in the April 1999 issue.
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