With European fund managers under pressure to increase their returns in the low yielding eurozone, the smarter investor is looking at the MTN market for opportunities to enhance yield.
But has the credit market developed sufficiently to meet investors' needs?
IT IS STILL EARLY DAYS, but there is evidence that the smarter investor and the adaptable issuer could help fulfil the potential of the single European market using the natural benefits inherent in Euro-MTNs.
The investor base can still largely be broken down by the investor's goals - and those vary widely. Tax avoidance has always been one area appealing to a certain type of investor in the European markets.
But, as Eugene Yurist, head of international funding at Landesbank Baden Württemberg, says, the days of outright tax avoidance have passed. "The old story about the Belgian dentist and the German insurance agent meeting in Luxembourg doesn't exist any more. Regulatory crackdowns and low yields mean there is little incentive to go to such lengths and retail investors have found themselves to be better off in equities."
A group of investors remains that use MTNs to undertake tax arbitrage and opportunities to reduce tax burdens - German investors. Broadly speaking, zero per cent capital gains tax and 60% income tax is a powerful incentive to take advantage of the former. For instance, German investors can buy discount bonds and, depending on the maturity and the amount of discounting, they can be taxed on lower coupons only.
Investors are able to take advantage of the tax treatment of currency plays by, say, buying a yen bond with semi-annual investment payments in yen that pay back the money in yen at maturity. The cashflows from the payments are then used in the forward market to hedge them back.
But retail and smaller investors are very much at the margin in the eurozone MTN market - it is the institutional market which the leading investors are seeking to attract.
"The big change since monetary union has been the broader investor audience in Europe," says Frank Czichowski, head of international funding at KfW. "We have been intensively marketing our euro-denominated product throughout Europe and the investor base has become even more international."
According to Daniel Cogoi, global head of MTNs at Paribas, the market is very much driven by price. "One of the big changes since monetary union is that the ability to issue different currencies off a programme is not so much an issue any more.
"Investors can buy paper from any European issuer and they have lost the ability to differentiate in price between different currencies. The investor has a lot of options, and the more the market develops, the more options they have," says Cogoi.
Top European funds are beginning to commit huge amounts of funds to the European credit markets.
"Now we are seeing the big pension and mutual funds in Europe moving in many cases billions of euro from government to credit markets, clever Euro-MTN marketing can see the product stand side by side the bond market for investor acceptance," says Kevin Regan, managing director of fixed income distribution at Warburg Dillon Read.
While investors are not specifically looking at the MTN markets per se, how and where they are going to buy their paper is interesting.
Says one European investment banker: "The big Italian, German and French funds are becoming increasingly precise about optimising their portfolios, not just taking 5% of every big corporate deal going.
"There will be a different skew on the relationship between the MTN market and the bond markets as a whole and a different skew on the perceptions of liquidity. This, ultimately, will affect borrowers."
Many life assurance companies, for example, guarantee returns on certain policies. In a falling interest rate environment, they are now scrabbling for instruments that yield enough to cover their promises.
"I would estimate that more than 25% of demand for structured MTN product is insurance-based demand," says Marc Falconer, vice-president of Euro-MTN trading, private placement and structured bonds, at Salomon Smith Barney.
WITH RELATIVELY LOW interest rates, the emergence of the European corporate market and funds beginning to diversify away from government bonds, there are more issuers from which to choose.
"The European market is becoming a homogenous credit market like the US and we will see an increasing willingness to go down the credit curve for yield," says Falconer.
"We have seen that, and investors are beefing their research, but most investors are still incredibly ratings driven, to the point that while they may buy a triple-B issue, they will not yet buy a triple-B issue as a credit play - namely, on the expectation that it will be upgraded. Ratings agencies are extremely powerful and we rarely see investors ignoring their ratings."
Even among higher rated issues, European investors seem to regard ratings agencies as king and there may be a reluctance to look behind credits. The slew of bank issuers that came to Europe from the US in 1996 and 1997 has all but petered out.
Bruce Foster, vice-president of money and capital markets at Household International, has been disappointed by the reception of the market to his A2/A rated Household Finance Corporation, which has a $10bn Euro-MTN programme with $4bn outstanding.
"It's progressing, and I'm optimistic in the long term, but there seems to be a lack of supply of credit analysts looking across Europe and they are overwhelmed by the barrage of issuance. There is still work to be done as far as credit goes across Europe," he says.
Some assert that the type of investor is changing. "Yes we are adopting the US model. There is a build up of mutual and pension fund money and money market funds," says one banker.
The advent of money funds is an important development, but opinions vary about their effects on the Euro-MTN market.
Many institutional money funds have already set up funds that are growing rapidly, reaching the $2bn to $6bn-plus range. These may drive the short end of the Euro-MTN market.
Even if perceptions have overtaken the reality when it comes to the impact of the euro on Europe's credit markets, they are becoming deeper and broader - and the Euro-MTN market is likely to be swept along with the changes.