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At a lunch for financial gurus in snowy Davos yesterday, one topic generated plenty of heat: rivalry between New York and London to act as a global centre of finance. Since it emerged London hosts more initial public offerings than its US rival, American officials have been scratching their heads about whether they could – or should – stop this eastwards drift.
The IPO trend has grabbed attention but another thought provoking statistic has emerged which market watchers would do well to note. The International Capital Markets Association says some 49 per cent of new international bond issues last year were euro-denominated; nearly twice the proportion conducted in dollars. So 45 per cent of the outstanding $10,000bn-odd international bond sector is now euro-denominated – making the euro the dominant currency for this market.
To be fair, this does not tell a complete tale. “International bonds” are cross-border issues, or those securities once known as euro bonds, until the euro was launched in 1999 and the nomenclature became confusing. But there are actually more so-called “domestic” bonds in the world, or those denominated in the same currency as the country of the issuer. Global outstanding domestic sovereign issuance, for example, totals some $14,000bn; of which almost a third is denominated in euros and dollars respectively.
What makes the trend in international bonds interesting is that it represents the area where issuers and investors have most choice. Traditionally, they plumped for the dollar: in 2002, more than half of international bonds were denominated in the greenback. Now the euro is king.
Why? ICMA diplomatically blames the trend on relative interest rates. Most notably, European rates have generally been lower than American rates and far more stable this decade. That makes the currency attractive for issuers, including the large pool of American companies who use the international bond market.
However, I suspect the trend also reveals a more subtle point about relative investor attitudes towards the euro and dollar. After all, when the euro was launched in 1999, there was a welter of speculation about whether the single currency would last. Indeed, as recently as two years ago, some hedge funds in New York were devising strategies to bet that some members would eventually exit the euro (gambits which usually involved taking positions in Greek or Italian credit default swaps.)
Such speculation has not entirely gone away. But it has certainly died down. After all, the economies of Italy and Germany are improving, and even Greece is looking better on the fiscal front (or more adept at juggling the numbers.) At the same time, some asset managers have become more uneasy about putting all their eggs in the dollar basket.
This shift should not be over-dramatized. I am certainly not suggesting the dollar is about to lose its role as pre-eminent global currency; nor that the US is about to be displaced as the site of the world’s largest and most liquid capital market. But central banks mutter about diversifying their assets. As the ICMA data show, issuers and investors increasingly try to hedge their bets by using the euro as well. And as financial institutions worldwide become more comfortable buying euro-denominated bonds, the market becomes more liquid and sophisticated – and thus attracts more activity. A virtuous circle.
All this should be distinctly gratifying for the masters of the euro; in 1999 who would have dared guess the dollar would ever be displaced from the eurobond world? But there is a fly in the ointment, at least for anyone in Frankfurt or Paris. These days a very large proportion of trade and issuance of euro-denominated bonds occurs not in the euro region but in London.
That picture is unsurprising for international bonds, given London was the cradle of the old-fashioned eurobond market. More noteworthy is that a sizeable chunk of domestic euro bond activity occurs in London too. ICMA has its headquarters there, and so does the European Primary Dealers Association – for dealers making markets in domestic euro-denominated government bonds.
This helps explain why the City is growing in financial stature worldwide. Nor is it something New York can easily fight. The trend is not driven by regulation alone. If the ICMA data have a moral, it is that the tectonic plates of the financial system do shift, sometimes in unexpected ways. There is still plenty to play for and for financial titans in Davos to discuss.