Long term borrowing global financial markets lenders and borrowers financial

"For us at the World Bank, the last 10 years have been equivalent to the financial industrial revolution. In the 1980s, we never issued a Eurobond. Moreover, 1980 was the same as 1970, only bigger. The 1990 programme bears no similarity at all - today we are borrowing in 20 different currencies, by means of interest rates, currency swaps, reverse currencies, zero coupons, and perpetual. The 1980s have exploded."

(Don Roth, treasurer at the World Bank quoted in Capital Markets: "The New Order" - A Supplement to EURO MONEY, May 1991)

The above quote dramatically underscores the phenomenal changes that have swept financial markets around the world during the 1980s and the 1990s. The "financial revolution" has been characterized by both a tremendous quantitative expansion and an unprecedented qualitative transformation in the institutions, instruments, and regulatory structures.

Global financial markets are a quite recent phenomenon. Before 1980, national markets were largely isolated from each other and financial intermediaries in each country operated principally in that country. In London, the foreign exchange market, the Eurocurrency and Eurobond markets were the only markets, which were truly global in their operations.

Financial markets facilitate transfer of resources from the lenders to the borrowers, the former attempting to maximize the return on their savings, while the latter looking to minimize their borrowing costs. A well-organized financial market is able to achieve an optimal allocation of surplus funds. Healthy financial markets also offer the savers a wide range of instruments enabling them to diversify their portfolios.

Two forces have driven globalization of financial markets during the eighties. The difference between savings and investment within individual countries has been increasing tremendously, and is reflected in their current account balances. This has necessitated massive cross-border financial flows. For instance, during the mid-seventies, the massive surpluses of the OPEC countries had to be fed back into the economies of oil importing nations. In the mid-eighties, the large current account deficits of the US were financed primarily from the growing surpluses in Japan and Germany. In the mid-nineties, developing countries experienced huge current account deficits and have had to resort to international financial markets to bridge the gap between their incomes and expenditures, as the volume of aid from official bilateral and multilateral sources has fallen far short of their perceived needs.

The other prime motive is the increasing preference over international diversification of their asset portfolios on the part of investors. This would result into gross cross-border financial flows though the net flows would be zero. Several investigators have established that significant risk reduction is possible via global diversification of portfolios.

These demand-side forces by themselves would not have sufficed to give rise to the enormous growth in cross-border financial transactions if they had not been accompanied by liberalization and integration of financial markets.

Financial markets have turned out to be highly innovative by responding rapidly to changing investors' preferences and complex needs of the borrowers, by designing new instruments and highly flexible risk management products.

The funding avenues potentially open to a borrower in the global capital markets can be categorized as follows:

These are bank loans, which carry floating rate of interest. Syndicate Credits are arranged by one or more lead managers (or banks) with a number of other banks participating in the loan. The basic theme is exposed to a number of variations.

Medium Term Notes were initially conceived as instruments to fill the maturity gap between short-term money market instruments like commercial paper and long-term instruments like bonds. Subsequently these evolved into very flexible borrowing instruments for well-rated issuers, particularly in their "Euro" version, viz. Euro-Medium Term Notes (EMTNs).

The basic structure under this is based on the Note Issuance Facility (NIF). It was introduced in 1980s. These instruments were only popular for a while. Later the introduction of risk based capital adequacy norms made them unattractive for banks.

These are short-term borrowing instruments comprising of commercial paper, certificates of deposit and bankers' acceptances among others.

In addition to these, export related credit mechanisms such as buyers' and suppliers' credits, general-purpose lines of credit, and forfeiting are other sources of medium-to-long-term funding.

Another innovation to have emerged during the last decade or so is 'Project Finance'. Despite the fact that it uses one or more of the funding instruments, its innovation lies in the way the financing package is set, including the rights and obligations of the parties involved; allocation of various operating and financial risks to those who are best equipped to bear them; and incorporation of various guarantees. Project Finance has been designed to finance single large projects such as the Euro tunnel. It is applied to infrastructure development and other projects (e.g. building prisons). By now, it has become a highly specialized field.

Like in the case of banking and money markets, most of the funding instruments also have their "domestic" and "offshore" segments. The main differentiating dimension is regulatory requirements, which in turn influence the disclosure, accounting, and rating discipline a potential borrower must subject itself to. The legal framework governing the rights and obligations of the borrower and the lender also differs. Within the domestic segment, funding avenues such as private placements are available, which have less stringent requirements and therefore are easier to access.

The designation of an instrument such as bond varies according to the segment tapped and the nationality of the issuer. When a non-resident company issues a dollar- denominated bond in the US capital market, it is termed as 'Foreign Dollar Bond'. A dollar bond issued outside the US may be considered as a 'Eurodollar Bond' or more generally known as an "international" dollar bond. Foreign and international bonds taken together are referred to as 'External Bonds'.

Borrowers often access a currency-market segment, which offers ease of access, cheaper all-in cost or some other attractive feature, and then use swaps to reconfigure their liabilities in terms of currency and interest-rate basis.

Long Term Borrowing