INVASION OF THE EUROPEAN CAPITAL MARKET BY US FIRMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600010038-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 12
• Document Creation Date: December 22, 2016
• Document Release Date: October 1, 2009
• Sequence Number: 38
• Publication Date: July 1, 1968
• Content Type: IM

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Cift~orrL~~'~? G8-89
Confidential
.QmclSEk
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
INTERNATIONAL FINANCE SERIES NO. 4
Invasion of the European Capital Market
by US Firms
Confidential
ER IM 68-89
July 1968
copy N!
60
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WARNING
This document contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP 1
I Etcludrrd from eulomelic
downgrading end
d.douiflenton
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CONFIDENTIAL
CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
July 19 6 8
INTELLIGENCE MEMORANDUM
Invasion of the European Capital Market
by US Firms
Summary
A large expansion in the Eurobond market this
year has permitted US companies to carry out most
of their European investment plans despite US
restrictions on capital movements to Europe. New
issues in the Eurobond market totaled $1.5 billion
in the first half of 1968, an increase of 62 percent
over the same period in 1967. US firms accounted for
all of the increase, and their share of the market
rose from 30 percent in all of 1967 to 81 percent
in the first half of 1968. Some smaller European
borrowers have been squeezed out of this market by
the heavy competition from large U3 companies who
can pay higher, interest rates and offer more attrac-
tive terms.
Some US companies had been concerned that the
US prohibition on transferring dollars for direct
investment in Europe might prevent them from meet-
ing their investment plans in Europe this year.
However, the Eurobond market has proved extremely
resilient and has absorbed all new issues with
frequent oversubscriptions. The market's volume
probably will exceed $2 billion for 1968 as a
whole.
Although the development of the Eurobond market
has had no direct effect on the US balance-of-pay-
ments program, it has offered US firms an attractive
Note: This memorandum was produced solely by CIA.
It was prepared by the office of Economic Research.
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alternative to transfers of funds from the United
States and has permitted them to adapt to the pro-
gram with a minimum of complaint. The surge of
Eurobond borrowing has also demonstrated the confi-
dence of Europeans in the long-term strength of the
dollar and their continuing willingness to hold
relatively illiquid dollar-denominated securities.
Moreover, Europe's growing market for dollar funds
represents a rising private demand for dollar
balances -- which results in dollars being kept
out of central bank reserves, where they would
constitute direct claims against the US gold stock.
From the European point of view, the strength
and flexibility of the Eurobond market has tended
to ease problems of domestic monetary and fiscal
policy. Few US firms have had to compete for funds
in the thin national capital markets. Central banks
have thus been able to avoid rising domestic interest
rates or the inflationary monetary policies that
would have been necessary to keep interest rates
from rising.
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Background
1. With the announcement by President Johnson
on 1 January 1968 of the new US balance-of-payments
restrictions, US firms were virtually prohibited
from transferring dollar funds out of the United
States to finance investment in continental Western
.Europe. `I?iley have, however, been able to maintain
investment plans by turning to European markets as
a source of capital financing.
2. The European capital markets -- markets for
long-term funds -- have two major institutional
elements: (1) a domestic capital market in each
of the principal Western European countries, in
which debt or equity securities are issued in local
currency and traded domestically; (2) a large and
growing international market -- the so-called
"Eurobond" market -- in which securities denominated
in one or more currencies are issued, quoted, and
traded in several national centers simultaneously.
The Eurobond market is the most dynamic segment of
the Western European capital market and it is the seg-
ment which US firms have invaded most heavily.
3. The Eurobond market became important in the
early 1960's, particularly after 1963, when the US
Interest Equalization Tax (IET),* which effectively
closed the hitherto prominent New York market to
new foreign issues, stimulated a shift of foreign
borrowing to centers outside the United States.
The Eurobond market subsequently grew rapidly.
Demand for funds came both from US companies and
from foreign companies and governments. The supply
of funds -- mainly US dollars -- came from both
Europeans and others, many of whom had previously
invested in the New York capital market.
* The intent of the IET was to tax US citizens'
investments in foreign securities at rates that
would equalize interest rates prevailing in New
York and the (nominally higher) rates abroad. In
order to attract US investors, foreigners would
thus be forced to offer higher rates in New York
to cimpensate lenders for the tax. This, in turn,
removed the incentive for foreigners to borrow in
the hitherto lower-cost US capital market.
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No single financial center outside New York has the
combination of technical facilities and access to
funds in very large amounts to handle a significant
portion of the international capital market. The
increased resort to Eurobond financing, which mar-
shalls the facilities of many centers, was thus a
logical outgrowth of the eclipse of New York in
this field. The annual volume of new issues in
the Eurobond market during the 1963-67 period is
shown in the following tabulation:
Amount
Year (Million US $)
1963 346
1964 800 (est.)
1965 1,079
1966 1,429
1967 1,878
4. Eurobonds are debt securities with long-
term maturities. Thus, they differ from Eurodollars
(or other Eurocurrencies), which are bank balances
traded or loaned by banks at short or medium term.
Because of lower taxes and convenient issuing regu-
lations, Luxembourg is the principal country of
issue for Eurobonds. They are usually denominated
in US dollars, not only because US dollars are widely
held and used extensively to finance international
transactions, but also because a large portion of
the market is taken up by American issuers. Although
these bonds can be traded anywhere in the world,
London and Zurich are the p _-:-ncipal markets.
5. The specific form of a Eurobond issue de-
pends on the ingenuity of the borrower and the
underwriting syndicate in making the issue attractive
to prospective investors. For example, to offer a
hedge against currency devaluation, an issue may be
made redeemable in one or more currencies. The
currency in which a bond is denominated may be
specified at the time of issue or a range of options
may be left to the holder's choice at the time of
interest payment or repayments of principal. Bonds
may be issued to the bearer rather than to a named
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individual, in order to satisfy the investors'
desire to avoid taxes. Eurobonds may be secured
or unsecured, and some are convertible into common
stock of the issuing corporation.
6. Eurobonds have been issued by American,
European, and Japanese firms as well as central
and local governments of various countries. The
principal buyers -- banks and other financial
institutions -- have been attracted by the quality
of the issuers, fixed returns, and comparatively
high yields. Eurobonds are blue chip securities,
and they attract investors rather than speculators.
New issues are underwritten by syndicates of the
largest and most prestigious commercial banks and
investment banking houses in the Free World.
Recent Developments
7. Severe US restrictions on capital outflows
to Western Europe have stimulated unusually large
security sales by American firms in the Eurobond
market. In the first half of 1968, Eurobond sales
by all borrowers totaled $1.5 billion -- a 62 per-
cent increase over new issues during the same period
in 1967. The share of US firms in total new issues
has risen from 30 percent of the $1,.9 billion total
in 1967 to 81 percent for the first half of this
year. US firms have accounted for all of the large
increase in Eurobond sales so far this year and
have, in addition, taken some of the funds that
otherwise would have gone to European borrowers.
8. Most Eurobond issues in X968 have been
dollar-denominated, convertible into common stock
after specified future dates. These convertibles,
almost exclusively American, have proven very
attractive, and all have been heavily oversubscribed.
In contrast, the more traditional straight-debt
securities preferred by European issuers have not
been as well received by investors. Although
dollar-denominated bonds have predominated, some
issues have been in Deutsche Marks or a Deutsche
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Mark/Sterling option, French Francs, or European
Units of Account.*
9. Eurobond interest rates this year have been
generally stable. They gained fractionally during
the first half of March, reflecting some movement
out of securities and into gold, but quickly fell
back when the gold crisis abated after 17 March.
During June, they began rising once again, this
time reflecting the increasing tightness in all
dollar markets as a result of restrictive monetary
policies in the United States and somewhat reduced
dollar outflows from the United States. Rates are
now slightly higher than 7 percent on straight debt
issues, about one percentage point above comparable
levels in 1967; on convertible issues the rate is
about 5 percent, unchanged from a year ago. These
rates are only fractionally higher -- less than 0.5
percent -- than comparable domestic long-term
corporate bond yields in the United States.
10. The large-scale entry of US firms into the
Eurobond market has squeezed out some of the
smaller European borrowers. The larger American
companies are able to pay higher interest rates
than most European firms or even central and local
governments, and they have greater flexibility in
offering attractive terms -- such as the much-
coveted option for convertibility into common
stock. Many American companies probably could, if
necessary, pay rates up to 10 percent -- a rat.:
that would exclude most other Eurobond issuers,
* The "Unit of Account" is equal to the gold value
of one US dollar, and bends using it offer investors
the option of buying the bonds and receiving payment
in the Unit of Account equivalent of any of 17 major
currencies. This financing technique was first
offered by a syndicate headed by Belgian bankers
early in the 1960's. It is designed to give the
investor a multiple protection against currency
devaluations by permitting him to demand principal
and interest payments in what he considers to be
the strongest currency at the time the payments fall
due.
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11. The non-American borrowers who have been
squeezed out of the Eurobond market this year have
been forced to find alternative sources of capital
funds. The non-American borrowers who remain in the
market are comparable in size, power, and prestige
to their American competitors. For example, ENI
(the state-owned Italian energy firm) and KLM (Royal
Dutch Airlines) are now in the process of placing
new issues totaling $75 million.
12. In the face of heavy US competition, some
non-US borrowers have turned to national capital
markets as a source of funds. Borrowing in the
West German market has become increasingly common,
especially since the liquidity of that market has
been vastly increased by heavy inflows of funds
seeking a safe, strong-currency haven during the
sterling, dollar/gold, and French franc crises of
this year. The governments of Quebec, Kobe, and
Mexico all have tapped this market in recent months.
Interest rates and borrowing costs in Germany now
are equal to or lower than those in the Eurobond
market, and the German market has been able to
handle them in stride. The Swiss market also has
experienced an increase in activity, but it remains
a relatively high-cost, low-volume market for
foreign borrowers.
13. The buyers' side of the market has changed
very little. Banks and financial institutions
remain the principal purchasers. Since mid-1967,
disruptions of normal international financial
flows have caused very large international move-
ments of liquid funds, and some of these funds
found a haven in Eurobond investments, although
the exact amounts are unknown. There is little
evidence that holders of liquid dollar balances
in the United States have transferred large
amounts to Europe for reinvestment in Eurobonds.
Present interest rate differentials offer little
or no incentive for making such transfers.
Outlook
14. With new issues of Eurobonds continuing to
be announced and planned, observers foresee only
one possible check on the growth of the market: a
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"glut" of American issues similar to the oversupply
of bonds generated by Japanese firms in the much
smaller market existing a few years ago. US
corporations have borrowed more than twice as much
in the Eurobond market during the first half of 1965
(over $1 billion) as during all of 1967. Normally,
a "summer lull" in new issues takes place during
July and August, but this year offers no such pros-
pect. Indeed, Texaco has announced the summsr-
season placement of the market's largest single
issue to date -- $75 million.
15. Even with the decreased number of non-American
issues, the market's absorptive capacity continues
to surprise even seasoned observers. Activity re-
mains feverish, and oversubscriptions are common.
At the beginning of this year, bankers and financial
writers were pessimistic about the market's capacity
to take up the $1 billion of new American issues then
projected for 1968 as a whole. By midyear, the market
had easily absorbed a total volume of $1.5 billion.
Predictions that new issues will top $2 billion for
the year now appear not only reasonable but also
well within the market's capacity.
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