The Euro medium-term note (EMTN) market is 10 years old this year. In 1986, Euromoney quoted Brian Woolley, then head of capital markets at Citibank International, saying: "One day the MTN will take over the world." Woolley is now a managing director at Citi. "I was 10 years ahead of my time," he says. "I was absolutely right. MTNs are now the predominant way of issuing international debt."
The EMTN market has just grown bigger than its parent, the US MTN market. Last month EMTN outstandings passed half a trillion dollars, according to The MTN Desk, Euromoney's new database of MTN programmes and issues. Over the past 10 years, there have been more than 10,000 deals in 32 currencies from 500 issuers. The EMTN is taking over the international bond markets too - outstanding deals launched off MTN programmes now represent 45% of Eurobond issues compared with 14% in 1991.
"Soon all fixed-income debt will be done off a single debt issuance programme," says Bruce Cairnduff, head of MTNs at Sumitomo Finance. "Issuers won't need anything else." In other words the MTN market will one day become the international debt market.
Cost, speed and flexibility
But this outcome is not widely appreciated. One EMTN trader at a top-tier US house insists that only 10 people at his bank understand what an MTN is. "And probably only three of them can see where it's going," he adds.
There are three basic reasons for the success of the market: cost, speed and flexibility. These underpin the market's rise and they ensure its continued growth and survival. How far can it go? "How high is the sky?" responds Tony Wilson, head of MTNs at Daiwa Europe. "In theory, the potential aggregate growth of outstandings off debt shelf facilities is as great as the size of the Eurobond market [currently just under $2 trillion in outstandings]. Every active borrower in the world should have one."
The costs of setting up a programme and issuing debt off it are falling all the time. Issuers used to be advised that it was worth the initial expense of putting a programme in place only if they planned more than five deals. But that figure has dropped substantially. The estimated upfront costs of an EMTN programme are $131,500. The estimated total cost of a stand-alone Eurobond, including the printing and legal costs associated with the prospectus, is about $100,000. Similar deals issued with EMTN documentation incur only small one-time costs. Issuers thus save money after two deals, and the benefits increase with use.
Programmes save time and money. Pricing supplements for vanilla MTN deals are typically two pages long. Abbey National's are usually only one page. "Terms and conditions can be ready less than two hours after issue," says Daiwa's Wilson. "An investor rang this morning with a request. We approached a small group of issuers and half an hour later we got back to the investor with a list of possible trades. Ten minutes later, he'd chosen one. We waited for the swap to be tied up. Bang, all done in about one hour. Settlement is in three days and one of those is a dollar holiday. And this happens all the time."
The ease and economy of the documentation process is only half of the story. The raison d'être of the modern MTN market is the flexibility and variety of issues that may be done with this documentation.
Traditional MTN issues - pre-placed, non-syndicated tranches tailored to the individual requirements of a small group of institutional investors - are now only one aspect of the market. Public, syndicated issuance in 1995 was $96 billion, 69% higher than 1994.
By contrast with the growth in MTNs, outstandings in the Euro commercial paper (ECP) market have stayed flat over the past two years at about $85 billion, despite the growing demand for short-dated paper. The explanation is that more EMTNs are being issued with maturities of less than one year, cutting into the traditional CP domain.
Even the syndicated loan market stands to lose ground. There has been a change in emphasis by the current drivers of the MTN market - Japanese institutional investors. Traditionally in the life companies in Tokyo, the loan department and the securities desk (which buys MTNs) have competed for the same credit. Dai-Ichi Life, one of the largest life companies, has just merged these two departments and will be looking at credits regardless of instrument. MTNs are the cheapest and simplest way of buying a credit and Dai-Ichi is rationalizing its approach to them. It is likely that others will follow.
There is no reason why all these markets could not be tapped with one form of documentation. Furthermore, the MTN is providing more options such as subordinated and perpetual debt and, in particular, an ever-increasing range of currencies. In 1991, MTN tranches were issued in eight currencies. This month sees the 32nd EMTN currency with the IFC's Polish zloty public issue lead-managed by JP Morgan.
The Czech koruna, Indonesian rupiah and Estonian kroon sectors have all been opened in the past year, and the South African rand has proved a particular success with 20 issues worth over $1.25 billion. Last month Mexican bank Nacional Financiera launched a rand Eurobond off an EMTN programme - the first time an emerging market credit has issued in an emerging market currency other than its own.
It is important that MTN programmes are arranged with maximum flexibility. Some programmes were initially set up to handle only a limited range of currencies and maturities (between one and 10 years); some issuers were unable to issue subordinated debt; on other programmes investors could buy paper only through one of the appointed dealers; and some banks even forgot to include themselves as dealers. Worst of all, sometimes yen issues were off-limits. "If you're not involved in yen, you're not in the MTN market at the moment," says Matt Carter, vice-president and head of EMTNs at CS First Boston. These sorts of mistakes result in lengthy and expensive redrafting.
"As long as a debt shelf facility incorporates all the bells and whistles," says Wilson of Daiwa, "I can't think of an instrument that can't be done off it."
The ever-decreasing costs of documentation and increasing liberalization suggest that the move from specialist issuance to more flexible and standard documentation will continue. The European Investment Bank (EIB), traditionally a user of domestic MTN markets with 10 domestic facilities, has just decided on a multi-currency programme. "An issuer like ourselves simply cannot afford not to have an EMTN programme," says René Karsenti, director-general of finance at the EIB. "It is the natural evolution of the market."
A key barrier to globalization of debt markets is integration of the US market with the Euromarket. Global MTN programmes do exist, but their cost and complexity are significant. Jeff Salzman, head of debt capital markets at Morgan Stanley, notes that "the SEC registration fees, disclosure requirements and legal costs incurred are enough to dissuade all but the most active borrowers such as Federal Home Loan Banks, Freddie Mac and Fannie Mae from creating truly global programmes". Big Euromarket issuers, such as Abbey National and Beta Finance, still have separate programmes for the two markets.
Global programmes
The convergence of different instruments under a single form of documentation is a major trend in the MTN market. However, this does not mean that the public and private markets will necessarily grow closer. Talk at recent market conferences has centred on whether the differences between syndicated Eurobonds and "traditional MTNs" (smaller deals more akin to private placements) have blurred. Kyran McStay, head of MTNs at Salomon Brothers International, explains the confusion: "There are two separate levels - one is documentation and the other is process of issuance. Documentation has evolved to provide a common platform for public and private deals. However, the public and private markets will continue to have distinct issuing processes. If anything, there is a trend to more variety of issuance."
In terms of documentation, there may be no difference between a Eurobond and an EMTN. A Eurobond is an EMTN if it has been issued off an EMTN programme. In terms of process of issue, there is no difference between a stand-alone Eurobond and a syndicated EMTN tranche - except that the latter saves time and money. A bank's syndicate desk will still be responsible for the deal. Investors won't care, or probably even know, about the documentation differences.
Investors have good reason to be as comfortable with syndicated EMTNs as they are with stand-alone Eurobonds. Robert Gray, chairman of the market practices committee of the International Primary Markets Association (IPMA), explains that earlier problems have been ironed out: "Investors assume that there is no difference between traditional Eurobonds and syndicated EMTNs, and so expect the same level of due diligence and consequent protection. We have attempted to get an important message across to issuers: that MTN programmes are not a mechanism to bypass traditional market standards. A special working group was formed in 1992 and issued recommendations to ensure there was no short cut. It was a complete success. The two instruments are now effectively the same thing."
Another issue that worries some EMTN investors has been the existence of a liquidity premium. However, it is ridiculous to compare the liquidity of a huge syndicated deal to a specially-tailored private placement. The connection between the two lies solely in the fact that they are covered by the same umbrella documentation. An investor who requests a unique structure because he sees a play others have missed will not expect active secondary market trading. His very motivation is that nobody else is interested. "The liquidity premium is a totally bogus problem," argues the head of one trading desk. "If anything it's the other way around. Because you are giving people what they want, you can charge a structuring premium."
Equally, investors have different expectations of liquidity for different types of public issues. One trader notes "...a world of difference between a $1 billion subordinated global targeted at institutional investors and a Luxembourg franc issue for a household name like Unilever targeted at the Belgian dentist retail market. You are unlikely ever to see the Unilever paper again." Says Benoît Debroise, funding manager at Banque Nationale de Paris (BNP): "Liquidity is far less of an issue today. We have seen since 1994 that even large Eurobonds can become illiquid very quickly." McStay at Salomon says that increased transparency and dealer rivalry "have greatly improved the competitiveness of secondary trading".
There remain some obstacles to the progress of the EMTN market. "There are two huge structural difficulties in the market: national government or central bank restrictions, and stock exchange regulations," says Jeff Werner, treasurer at General Electric Capital Corporation. "That is why development has been slower than we had hoped over the last five or six years."
Everyone has his own favourite anomaly. Many MTN specialists point to the fact that non-sovereigns cannot yet issue in pesetas, though synthetic deals are in demand. Others mention the Bundesbank's rules which prevent financial institutions from issuing Deutschmarks in maturities of less than two years. Non-German dealers also have to arrange any Deutschmark issues through a German subsidiary. French authorities make issuing francs very complex and require that franc deals are listed on the Paris Bourse.
Werner cites the obstacles imposed by the Bank of England: "I find it silly that we can't do deals over five years or with denominations of less than £100,000 off an MTN programme."
Things are changing, if only slowly. On February 14, the Bank of England advised the British Bankers' Association that, as a result of market pressure, sterling regulations will be relaxed. Notes with maturities over five years will be allowed for the first time if they are listed on approved stock exchanges. Sovereigns and quoted companies will be allowed to issue unlisted sterling notes.
"It is ridiculous to have these currency regulations in the market," says Peter Yngwe, treasurer of Swedish Export Credit. "It is the end-users that are paying for these inefficiencies and it is a sign that something is wrong."
IPMA's market practices committee may be able to help. It is setting up a new MTN sub-committee. Even if there is little chance of directly influencing central banks, it is a step forward in giving market practitioners an official and combined lobbying force. "We could be a very effective voice in encouraging liberalization," says Gray. "We want to help address any and all inefficiencies in the market. IPMA's position is to move market issues forward as quickly as possible. We see no reason, for example, why technology should not enable anyone in the market to get their hands on documentation. We are very much in favour of standardized pricing supplements and there is already some headway being made."
There are few major borrowers left to come to the EMTN market with the recent arrival of Sallie Mae and the imminent EIB programme. The Republic of Italy remains one notable exception. Corporates, second-tier banks and emerging market credits have also started to sign programmes. Particularly noteworthy is the recent arrival of non-Japanese Asian issuers, heralded by a string of Korean banks. Significant for the status of the EMTN is a new tendency for debut issuers in the Euromarket to start with a debt-issuance programme rather than a benchmark Eurobond.
