The international money and bond markets – a borrower's eye view
What do the Euromoney markets look like from the other side? Here Mr Clements, deputy treasurer of ICI, explains first how the group fits fund raising on the international markets into its financing activities. He goes on to outline the market’s importance to ICI, both now and in the future, and then to talk more specifically about the advantages and disadvantages of the market from the borrower's point of view.
By A. W. Clements, Deputy Treasurer, ICI Limited
Some indication of the scale of problems involved in financing a group the size of ICI can be judged from the ICI annual report for 1971. In the ten years 1962 to 1971 nearly £2,000 million was spent on new assets, new investments and additional working capital. Of this just over £1,200 million came from internal operations – cash generation – and nearly £800 million was obtained 'from outside' in the form of new equity, loans, and contributions from minorities. Of the externally derived £800 million over £500 million was in the form of loans, and of this nearly £170 million was borrowed on the international market. In 1971 alone, of about £300 million of total finance required in the year, over one-half was obtained externally, and in fact £134 million consisted of new loans. The effect of all this has been to increase the group's gearing very substantially – loans as a percentage of funds invested have increased from 8 per cent at the end of 1961 to over 32 per cent at the end of 1971.
But how does all this come about? Are these figures merely the summation of a number of separate and only loosely coordinated plans, or is there a clear-cut group financing policy, and indeed, philosophy? The answer of course is the latter, otherwise chaos would prevail and financial disaster threaten.
At any one point in time we look forward through the next three years in detail, and, when deciding on our plans, use more general projections for the years beyond that.
Thus, during the planning phase in 1971, detailed cash forecasts for the years 1972, 1973 and 1974 were discussed, and finally put together. These embodied the capital programmes agreed by board committees, which are responsible for the UK divisions and the overseas subsidiaries, as well as financing plans based on the cash projections available. But all of this work was subject to a final approval after a global look at the totality. At this stage it was vital that the finance function should be in a position to say whether or not the overall programme could be financed, and, if there was a need for some contraction somewhere, where it ought to take place and how. In order to be able to do this it was, in practice, necessary to break the programme down into three sections.
First, there was the overseas part of the group (excluding Europe), where by and large the programme was financed by cash flow plus local borrowings. In so far as a contribution was seen to be necessary from ICI in the UK, it was merely a question of deciding whether or not to use borrowings on the international market, or sterling funds.
Second, there was Europe, and to an increasing extent nowadays the United States, where again it was necessary to arrive at the contributions needed from the centre after taking into account local cash flows and borrowings, and here it was the international market virtually on its own which had to fill the gap.
Finally, there was the UK part of the group, including all the inflows from the overseas companies. That part, of course, is a residual, throwing up questions of utilisation of short-term facilities and, at times, of long term funding operations as well. When the three sections were put together it was possible to look at balance sheet projections, and profit and loss accounts, in order to take a view of the gearing resulting from all these financing plans, and as a result, to present a financial view to the main board.
It will be seen that the international capital market, as a source of funds, figured significantly in at least two of the stages in this process, but primarily as a source of overseas borrowings required to finance part of the group's overseas capital expenditure. This is an inevitable result of UK exchange control, and it cannot be denied that our first operations on that market were dictated more by the necessity of obeying the Treasury than by deliberate choice. In fact, before the Eurobond market had become an established fact, the ICI group had been borrowing institutional dollars in New York in order to finance its non-sterling area expenditures. In the past we would have been forced to borrow on the international market even if we had had sterling flowing out of our coffers, because of exchange control, and, even after the full effect of the EEC entry inspired relaxations can be seen, it may still be necessary for us to do the same to some extent. But to an ever increasing degree these days we find that the international capital market is one of the sources we consider for the financing of deficits within the group generally. We no longer look upon it as a source only to be used to finance operations in Europe and the rest of the non-sterling area. The extent to which we have had to rely on it recently to obtain funds for sudden expansion in the United States has merely confirmed, in our minds, its vital role, along with the UK and US markets, in the financing of the group as a whole. In fact, as will be seen later, in some ways it is more important than the other two.
Attractions of the international capital market
The reasons for this are not difficult to state. In the first place there is the sheer size of the market. The figures are well documented elsewhere – suffice it to say that it must be of significance to an international company that corporate bond issues on the Euromarkets in 1971 amounted to over two and a half times those floated in the UK. It is also worth noting that in recent years companies in Germany, France, the Netherlands, Belgium and Switzerland have raised less finance via bond issues on their own markets than companies have obtained on the international market. Another way of looking at this is to attempt to estimate the approximate amounts which a company like ICI might expect to be able to raise on the various capital markets, should it feel it necessary to do so. Experience in recent years in the UK, and in particular the unsecured loan stock operations since 1965, would seem to indicate that on average something like £20/£30 million per annum in the form of long term loans would not be regarded as more than ICI's fair share of a market which has, in the past ten years, itself averaged less than £350 million per annum. But recent years have also shown us that at least the same amount can be obtained on the international market, where although issues may be smaller than in the UK, it is possible to float more than one in the same year.
Here, undoubtedly, the fact that issues can be denominated in a number of different currencies – dollars, DMks, Swiss Francs, Guilders, French Francs, EUAs, ECUs, and optional currencies – is a great help, because to a large extent it creates markets within a market. But this is not all – the international market is pre-eminent as a source of medium term funds – say five to ten year money, at fixed or floating rates. On no other market that I know of can one expect to raise over $200 million in one operation, and quickly. Until very recently the UK has hardly had a medium term market at all and US bankers freely admit that good corporate borrowers can obtain much more medium term money, more easily and with less restrictions, on the Euromarkets than in the US. Finally, when dealing with the size of markets, one must not forget the national markets in Europe, the United States and elsewhere, as a source of funds for the group subsidiaries located there. These can be important, but the amounts raised are of course strictly related to the capital expenditures in those territories and this inevitably tends to reduce their significance in the financing of an international group's programme.
The long term end of the market – the Eurobond market – exhibits in the most marked way that freedom and absence of restrictions which attracts us
But undoubtedly of more importance than the size of the international market is the fact that it is the only major source of long and medium term funds available to the group for investment on a global basis. Funds raised on that market can be invested wherever the central authority in the group wants to invest them. In the case of other major sources of external funds the same is by no means true. Thus until now capital raised in the UK has been available not only for UK investment as a general rule, and similarly since the introduction of IET and the US guidelines etc., the US market, as far as we have been concerned, has been a source only for our US expansion. But Euromarket funds can be used in Europe, the USA, Japan and the rest of the non-sterling area – and even the UK. That market provides the flexibility and mobility in financing which all company treasurers seek and it provides it to a greater extent than any other. Indeed one might almost say that while the UK and US markets have become sources of local pools of finance, the international market has developed into the one real global source available to the major companies.
Any suggestion that this situation is likely to continue for long presupposes that the IC group will continue to borrow heavily, and also that the exchange controls in various places which have helped to create the present state of affairs will not change materially. As for the former, the current state of the chemical industry implies a lower rate of growth than in the recent past, and therefore less borrowing. However the upturn will come and current capacity will be fully employed, and again there will be targets implying high growth rates. While all financial men would like to see all expansion plans met from internal sources, this is in most cases something of a pipe dream, and any attempt to achieve high growth rates on the basis of rates of return even 50 per cent higher than those of today must result in a new dependence on the capital markets. This also gives the answer to the exchange control point. We have seen in the recent UK budget the first of the relaxations consequent upon this country entering the EEC, but the greater freedom to use sterling for direct investment is unlikely, in our case at any rate, to lessen our dependence on the international market. The figures quoted above of the amounts we might expect to raise on the different markets remain true, and relaxation of controls merely calls for greater efficiency in picking the right market at the right time, and greater expertise in utilising the new flexibility made available.
The long term end of the market – the Eurobond market – exhibits in the most marked way that freedom and absence of restrictions which attracts us. We find it particularly convenient to be able to decide (with our advisers) that the market is 'booming' and that it is therefore right to proceed at top speed with an issue which will involve despatching telexes to underwriters and sellers within 48 hours or so. But this is only possible because the market itself is not hedged around with rules and regulations and because we are able, by using the right financing vehicle, to involve ourselves in the minimum of fuss with stock exchanges, auditors, exchange control authorities and revenue departments. This facility if properly employed certainly makes for minimisation of cost. Of course we believe that major UK companies ought to be given triple-A rating along with our US rivals, and we have sufficient confidence in the UK and European fraternity of lead managers to believe that this will become a reality before long! Costs of issue themselves, while higher than in the much older markets of the UK and the USA, cannot really be regarded as out of line when one takes into account the different back-up for the market, and in particular, the lack of institutional support. We like also the relatively simple list of conditions – short enough to be printed – albeit in small type, on the reverse of the bond!
The redemption provisions may seem a little strange at first to those accustomed to English practice, but they have their raison d'étre in a much narrower secondary market, and since the introduction of a trustee for the bondholders many of the possible difficulties which we thought we could foresee in the early days have been ironed out. The facility for early repayment in the event of taxation difficulties (withholding tax on the interest) is useful, if not essential, and so is the ability to buy in bonds in the market and include them in the sinking fund instalments. The negative pledge rarely gives rise to serious problems, since it is restricted in practice to bond issues, or even international bond issues. It is also of advantage to us, having used in the first instance an offshore borrowing vehicle, to be able to switch the obligation should the need arise either to ICI or to some other wholly-owned subsidiary in the group.
But undoubtedly the most important aspect of the market to us is the great diversity of readily negotiable borrowing instruments available on it. The fact that one can consider, before choosing, straight bonds, convertibles, and warrant attached loans, plus a whole range of currency denominations from dollars through most of the EEC currencies to more complex arrangements such as EUAs, ECUs and optional or reference constructions, plus a range of final maturities from five years to 20 years, plus fixed or floating coupons, gives the company treasurer hope that, even in the darkest days, something can be found to whet the investors appetite. As has been said recently, the market is not only one of the three largest capital markets in the world, it also has the greatest variety of borrowing vehicles, and as such must surely continue to rank high in any company's shopping list.
Turning to points of criticism, it will not surprise anyone who followed the market in 1971 to find an ICI man mentioning first instability – and here, of course, I am referring primarily to the Eurodollar bond market. As is well known by now, towards the end of February 1971 ICI International announced a $30 million issue with a coupon of 8¼ per cent, but within a few days, because of congestion in the market, had to increase the coupon to 8½ per cent. By the time the date for fixing the issue price and signing the agreements arrived it was clear that response on the part of the public was poor, and rather than change the terms in some way again, it was decided to withdraw the offering. It is difficult, from the vantage point of the borrower, to pinpoint precisely what is wrong, and how it might be corrected. Clearly at times nervousness in the market is a reflection of currency scares, but at other times indigestion, culminating in chronic constipation, seems to result simply from an uncoordinated build up of too many issues. Obviously to some extent this is caused by the fact that the market is not regulated, but it does seem to us that at times the code of sealed lips, which seems to prevent even underwriters and co-managers from issuing warnings about impending massive issues, goes a little far.
Undoubtedly the most important aspect of the market to us is the great diversity of readily negotiable borrowing instruments available on it
But I suspect that the root cause of the problem is the fact that at the end of the day the market depends largely on individuals rather than institutions, and that only when managers and co-managers of Eurobond issues have been able to create and build up the sort of institutional support which an unsecured loan stock in the UK might call forth, will matters improve. This in turn however must wait on very considerable changes in law and regulation, particularly in Europe, and the more the Eurobond market comes under attack the less likely it is that it will happen. Fortunately the other sectors of the market – Swiss francs, DMks, Guilders, etc – are well regulated, and there one avoids the uncertainty caused by instability – though at the cost of having to queue!
This is not the only area where we would like to see changes and improvements. The size of the issues seems smaller and smaller as years go by, each with its own inflation rate. In 1967 we raised $30 million on the Eurobond market – in 1971 $30 million was still a sizeable issue, and though we have since raised $50 million in one operation, as soon as something upsets the market even a little, issues revert to quite small dimensions. And on the other sectors the figures are even smaller. Maturities too we feel, could be lengthened out and here we have tried hard and achieved some success, with final maturities of 20 years in our recent Eurodollar and DMk issues. We hope the trend will continue. As regards underwriting, it used to be held that the prevalent system, which falls somewhere between UK risk underwriting and US incentive underwriting, gives the borrower the best of all worlds. Our experience however has not quite lived up to that, and one can but hope that developments will take place in time so that when an issue is in trouble the underwriters can still be persuaded to take large enough fair shares to keep the issue alive. Similarly with the fundamental nature of Eurobond issues – they are neither public offerings, nor placings, in the UK sense, and many of our worries would be removed if genuine placings were possible. I realise that they are in the medium term field; perhaps they will emerge in the long term area when more institutional backing is available – or is there a real challenge for the banks here?
It may seem somewhat strange that among the disadvantages of the Eurobond market, I have not mentioned exchange risks. In our case, however, it is not a case of having to use the market, and therefore having to live with the exchange risks involved. We try to build up a portfolio of currency borrowings to match our portfolio of currency assets, and in any case the lower interest rate on the strong currency loans, when compared with sterling borrowings, goes a long way to even out the risk.
I have also not mentioned the equity aspect of the market at all. Frankly, in spite of all the talk to the effect that this must and will be the next great growth sector in the market, we have seen few promising signs which might tempt us in. We have not made use of convertibles or warrant issues so far, largely because the occasion has not materialised and also because of the five-year no-conversion rule imposed by the Bank of England. As for the pure equity aspect, we are quoted widely overseas, but this does not seem to be sufficient to create an equity market of depth and quality. In addition, we find it a little difficult to see how we, for example, could move beyond the convertible concept to a true international equity in, say, a special and highly profitable international division, bearing in mind not only our general undertaking but also the interests of our existing stockholders, who, having nursed new ventures through their teething troubles, are entitled to some of the action themselves.
Other criticisms of the long term market, which really amount to a list of problems, such as the relatively poor secondary market, the necessity of including many relatively weak banks in selling groups, and the clearing facilities, are best left to the experts. The other aspect which is a worrying one, namely the future of the market, I will touch on at the end after I have said just a few words about the medium and short term markets.
There can be no real criticism of the medium term market – chiefly, as far as we are concerned, bank syndicated five year plus loans – on grounds of size or speed of setting up a loan as our experience last year in raising a large sum of dollars to finance part of the cost of Atlas Chemical Industries testifies. If we have any complaints they are that we find the loan agreements somewhat lengthy, reflecting no doubt a somewhat too prevalent US influence; that the fluctuating interest rates tied to the inter-bank rates tend to force one into mathematical contortions in order to avoid driving up the rate against oneself; and that a negative pledge in a bank borrowing creates real problems for a giant company which cannot hope to control every small activity everywhere. These points will be instantly recognised by those who have heard them before, and they are not so serious as to detract from the real usefulness of the market to us.
The short-term market is of course a subject in itself. We have used it in a number of ways at different times, both for borrowings and for deposits. Suffice it to say that we have found the multi-currency type of facility most helpful, that the ability to borrow on the market has stood us in good stead in a number of places when we have not been able to cover currency exposures by more normal forward transactions, and that the market now plays a significant role in our short term money management within the group. It is, however, more than unfortunate that the extent to which it has been used to oil the wheels of currency speculation has driven the authorities to erect a series of barriers – the five year rule in the UK, French controls, the German bar depots, and so on – which has made full use of the market by a group like ours more difficult.
This last point leads me straight in to my summary and conclusion, which relates to the future of the market. There must be doubts about the long term future of the Eurodollar market, not only because of the controls which currently are being imposed from various directions, but also because a change over to a US surplus and a strong dollar must mean a drying up of its principal source. However, presumably other currencies would take the place of the US dollar and we would still have a Eurocurrency market. Even so, it is significant that fears of future non availability of the dollar find their way into the clauses of medium term borrowings, where the banks expect to be able to demand repayment, or higher interest rates in the event of changes in the law resulting in shortage of dollar deposits, minimum reserves, and so on. It seems to us that sometimes these clauses are weighted in favour of the banks, and at the least there ought to be alternatives available, such as a switch to other currencies, or even to other banks!
Fortunately, the medium term market is so large now – some estimates put it as big as $10 billion – that it has its own in-built survival mechanism, and as long as there is a Eurocurrency pool of some description, it will have its sources. It is when one looks at the long-term market that one tends to have the greatest doubts. A wholesale relaxation of US controls could result in a tendency for the market to return to New York, and if at the same time UK exchange controls were also being dismantled, we might well see a move towards London as well.
Why should multinational companies be concerned at this? Surely an international capital market is all that is required, and its precise location is immaterial? While there is some truth in this, it would be a pity in many ways to see the Eurobond market diminish in size and importance – Eurobond issues have many attractive features compared with institutional loans or bond issues in New York. In addition, when the market as it is now is compared with the narrow and very traditional national markets of Europe (always excepting London, of course) it does hold out the promise of forming the basis of a truly European capital market. One can but hope that this is true, and that Eurobond managers and co-managers will be able to fend off the challenge of New York and London. To a major company operating on a global basis the market, in spite of all its imperfections, affords that flexibility and mobility which are so vital in its financing operations, and one cannot be confident that a return to a more truly national location would carry with it quite the same degree of freedom. Perhaps a general recognition of that possibility will spell not only survival, but also continued growth, for the international money and capital markets in their present form.