The Eurobond’s 50th birthday has lessons for governments about how not to regulate finance

The Eurobond’s 50th birthday has lessons for governments about how not to regulate finance

Jul 6th 2013 |From the print edition

FIFTY years ago this week Autostrade, an Italian motorway operator, issued a $15m bond. The first Eurobond was less a piece of clever financial engineering than an elaborate tax dodge. The idea dreamed up by London bankers was to capture some of the dollars that were sloshing around Europe (hence the name Eurodollars) because of America’s Regulation Q, which limited the interest rates paid on deposit accounts. Autostrade was chosen as the first issuer because it had the right to pay interest (in the form of coupons) without deducting Italian tax. The bond was issued in Schiphol airport in Amsterdam to avoid British stamp duty. The coupons were payable in Luxembourg to avoid British income tax.The new market’s growth was boosted when President John Kennedy imposed a tax to discourage Americans from investing in foreign securities. International companies that wanted to borrow in dollars turned instead to the Eurobond market. Investors, such as the archetypal Belgian dentist, were looking for a safe home for their capital and a shelter from Europe’s high taxes. Over the next four decades the market grew exponentially, hitting its first $1 billion year in 1966 and reaching a peak issue of $4.5 trillion in 2009.

With some encouragement from the Bank of England, London became the centre of this new market. The effect was to revive a financial centre that had been suffering from the country’s economic troubles and the decline of the British empire, with its associated sterling area. The Eurobond market created lucrative work for the City’s accountants, lawyers and merchant banks, and it attracted foreign banks to set up branches in London.

This was the dingy, decaying city’s first step towards becoming the cosmopolitan capital of global finance that it is today. When exchange rates were allowed to float in the early 1970s London established itself as a currency-trading centre. More complex products like derivatives gravitated to it, too. Although Britain likes to lecture the world’s tax havens on their need for transparency and reform, its own financial sector owes its modern success to the country’s willingness to host an opaque, tax-evading capital market.

Capital punishment

The Eurobond market was the first big modern international capital market; in time it was followed by large cross-border markets in currencies and equities. Governments in continental Europe have always treated these with suspicion. To them, markets are made up of speculators who like to interfere in the smooth running of economies; when a government’s policies are unconvincing, they drive currencies down and bond yields up. One reason why the European Union’s leaders were so keen on the creation of the single currency was their frustration with the devaluations that dogged the old Exchange Rate Mechanism.

In recent years the wrath of European leaders has turned to the bond markets and the rise in the cost of government borrowing in some peripheral euro-zone countries. The politicians’ response has been to put in place or propose a raft of regulations and taxes, from restrictions on short-selling (betting on falling prices) and limits on bankers’ pay to taxes on financial transactions, in an attempt to curb the power of the dreaded markets.

Europe’s governments should, instead, heed the lesson of the Eurobond’s success: that elaborate rules will neither lower the borrowing costs of businesses nor persuade investors to forget their worries about the creditworthiness of governments, for money will always find a way round them. If trading becomes too expensive in Europe, volumes will shift elsewhere; and if regulations become too onerous the business will move to a more welcoming jurisdiction. Just as the American authorities handed a gift to London in the 1960s, the Europeans are now helping to ensure the eventual triumph of financial centres in Singapore and Hong Kong.