When Eurocommercial paper was ‘the most invidious’ thing in capital markets

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By:
Mark Baker
Published on:

The early pages of Euromoney often saw odd storms blow up, apparently out of nowhere – and one of the oddest was the short but sharp squall over Eurocommercial paper (ECP).

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The impeccably named Ninian Freebooter, described as a Canadian banker, was writing in February 1972 as commercial paper had made the leap from the US and Canadian domestic markets and into the Euromarket. Freebooter didn’t believe that this was a truly new market and he wasn’t altogether sure that those involved in it were particularly capable to boot.

All this came about some 18 months after Michael von Clemm was writing in Euromoney about the very first ECP deals – for TRW, Alcoa and American Standard. At the time, von Clemm was lecturing at Harvard University. As he clarified for our readers, ECP had more in common with the finance paper issued through investment banks in the US than with the promissory notes that tended to be issued directly to investors.

The diatribe that Freebooter launched against the emerging asset class was of a ferocity rarely seen. “Of all the less-than-wholesome occurrences in the international capital and money markets during the past few years,” he wrote, “the most invidious has been the establishment of Eurocommercial Paper.”

A strong start, but there was more to come. First, the whole market was a misnomer.

“There is little ‘Euro’ about it,” he wrote. What was being “peddled in London by merchant banks” was nothing more than US corporate promissory notes. He also noted that “a newly-arrived New York brokerage firm” had got in on the act, a reference to the arriviste Goldman Sachs.

Respectability

Next up was the product’s “apparent respectability”.

While conceding that issuers in the months since the market began had been of reasonable standing, he said that they were not always “what Americans are so fond of referring to as ‘Triple A’.” And the people involved, such as the Schroder Bank and White Weld, were excellent merchant bankers, “but are they good enough to run a new type of market given that all the experience of dealing in commercial paper is domiciled in the US and Canada?”

Would anyone be able to claim respectability for the asset class when its issuers numbered in the hundreds instead of a dozen, Freebooter asked. “When everybody is so relaxed that ‘Single B’ paper starts to circulate or another Penn Central crops up?”

That reference was to a topic that regularly featured in Euromoney in the early 1970s, the bankruptcy of the Penn Central Transportation Company in June 1970. The firm’s collapse under losses of hundreds of millions of dollars was the largest failure in US history at the time, and – remarkably – remained so until Enron in 2001.


An attempt to malign a new credit instrument by associating it with [names like Penn Central] was indeed unfair 
 - Michael Magdol, J Henry Schroder Banking Corporation

Freebooter was clearly still smarting from that event: “One can anticipate the readers in London moaning, ‘Oh, not that same old gripe about Penn Central commercial paper again!’ – but for those of us who were persuaded by our dealer ‘friends’ to buy the stuff there cannot be a too frequent repetition of the moral of the Penn Central story.”

At least the US had a rating agency for CP – a subsidiary of Dun & Bradstreet. “One hardly ever meets Europeans who even know such a service exists,” Freebooter marvelled.

Putting aside the bitterness, Freebooter’s fundamental charge was that the concept of ECP was bogus – and the prospect of a large amount of promissory notes “floating around the world” ought to “cause one to tremble”. CP had some purpose in the US market, where commercial banks were restricted by law to lending no more than about 10% of their capital to one borrower.

On this basis, General Motors Acceptance Corporation (GMAC), the largest issuer of CP and borrowing as much as $3 billion at the time, could not function if it only had access to commercial banks since its borrowings were more than could be supplied by the biggest 400 banks in the US combined.

Freebooter argued that there was no comparable case outside the US, given the absence of similar limits.

Market failure

Then there was the question of what might happen in the event of a failure of the market. Freebooter noted that in the US market banks would provide back-up lines of credit. More than half of US CP was also directly placed by banks with their own clients. The rest was “dealer paper”, sold to brokers like Goldman and then offloaded as quickly as possible. This less attractive market was the structural model for ECP, said Freebooter.

Not surprisingly, the following month saw responses from Michael Magdol of J Henry Schroder Banking Corporation and Robert Kock from the London office of Goldman Sachs.

“An attempt to malign a new credit instrument by associating it with [names like Penn Central] was indeed unfair,” argued Magdol.

Further, the market was not misnamed. US companies were required to finance their offshore operations in the offshore markets and all the issuers of ECP so far had done precisely that. They were borrowing Eurodollars from non-US and non-Canadian sources.

Magdol also disliked Freebooter’s suggestion that ECP served only to satisfy the “greed” of issuer and investor. He argued that financial services existed to create credit instruments that accommodate both parties, which seemed to him “to be a distinct advantage rather than something to be commented upon in a critical manner”.

Kock at Goldman noted that his firm had been dealing in CP since 1869 and that the US market had now grown to more than $30 billion, smaller only than US treasury bills and certificates of deposit. The great diversification of investors gave it stability and it was against this background that the ECP market was being established.

Kock predicted that it would not be long until European companies began to use the market too. And while dealers were indeed important actors in ECP, this would promote an active secondary market – which, he argued, would help issuers and investors alike.