The use of structured debt in the Euro-MTN market has never fully recovered from the shock of 1994, when investors took some stinging losses on complex derivatives-linked notes.
But the structured trade has always been part of the European MTN market's development. And, with rates low in most major economies, the need for yield is encouraging investors to look for incremental pick-up.
Are Euro-MTN structures becoming more commoditised? Is the European market destined to become ever more similar to its US counterpart?
And how will the Euro-MTN market fit into the development of a more sophisticated credit market in Europe?
IF INVESTORS MISS the fancy names that used to be allocated to structured trades, they certainly do not miss the complexities that used to muddle the MTN structured market.
Keeping things simple - at least relatively so - seems to have become an underlying theme in the MTN market of late. Just a handful of structures tend to predominate at any one time, with numerous little nuances and twists added on to tailor to individual needs. But derivatives appear almost to have disappeared.
Structured private placements have, from time to time, fallen victim to the vicissitudes in the general market, and to fashion - most notably following the US rate rises in 1994 when structured debt caused some huge losses for investors.
"In 1993/1994 structured notes were around two-thirds of the business we did," says John Delaney, executive director of MTN trading at Goldman Sachs. "Then the world changed and that figure went down as low as 15%. The market has evolved."
It certainly has. "High-yield semi-public transactions disappeared with the blow-up in emerging markets last year," he adds.
However, there remains a solid demand for structured notes - reflecting the low yields available to investors in the developed markets and the need to enhance returns.
But, Delaney says: "It's not unlike 1993 when the stockmarkets were high and investors were looking for incremental pick-up on low yields."
Then there was a proliferation of structures such as "corridor floaters", which were founded on perceptions that US interest rates would rise.
And many of the structures that came with the run-up to EMU have also disappeared with the single currency. Convergence plays are now limited to the peripheral countries of Europe and to those betting that the single currency conditions will be met at any particular time.
There are several new (or at least almost new) structures that have become increasingly popular over the past year, and each fit broadly with the demands of certain types of investors.
Structured Euro-MTNs linked to constant maturity swaps (CMS) have been a particular feature. A yield curve play, these structures are simply fixed/floating notes.
A typical deal will have a maturity of 15 years and pay a fixed
coupon for the first four years with the remaining coupons being
derived from the CMS minus a spread. They will often contain a
floor on the floating leg and principal is usually
protected. The theory behind these relatively simple structures is that the long end of the yield curve in the underlying market will steepen over time.
Richard Tynan, director of Euro-MTNs at Lehman Brothers, sees healthy demand for such structures from insurance companies - particularly Japanese companies which promised high returns in times when interest rates were high and are now faced with challenging interest rate curve environments.
Mediterranean insurance companies - "with memories of short term rates with 10% handles on them", in the words of one banker - have also been keen participants.
Equity linked notes, and more recently reverse convertibles, are being increasingly used to boost returns. Equity linked notes usually carry a zero coupon and a minimum guaranteed return, plus an uncertain upside linked to certain equity prices.
"For reverse convertibles the opposite is true. The bonds carry a higher than usual coupon but the redemption can be lower than par, so that there is no minimum guaranteed return," says Henry Nevstad, senior associate director at Deutsche Bank.
"The bet in the two different cases is that with straight equity linked notes, investors take the view that equities will rise, as opposed to the view that they won't fall in the case of reverse convertibles."
There was a big wave of interest earlier in the year for notes linked to the Euro Overnight Index (EONIA) for investors wanting exposure to the overnight lending rate as a proxy for doing overnight repurchase agreements. These were predominantly two year notes. "One fund manager put Eu1bn into EONIA trades in April/May", says Gavin Eddy, executive director at Warburg Dillon Read.
Another structure that has been used frequently in the UK has been annuity hedging for pensions funds in sterling.
Elsewhere in the sterling market, there have been convergence plays and interest in the anomalies in the sterling yield curve as against the euro curve.
There is always a role for the issuer to play in supporting its structured deals and most regular borrowers are aware of the dangers that can arise when structured debt is not supported.
"Any frequent issuer in the structured market where there is no secondary market should provide a bid cheaper than the asset swap desk. That'll help people do more structured deals," suggests Eugene Yurist, head of international funding, at Landesbank Baden-Württemberg.
ISSUERS CAN ALSO fight shy of certain types of structures that are available. "We don't do all the structures in the market," says Frank Czichowski, first vice president and head of capital markets at KfW.
"We consider the associated risks, particularly to our reputation. If a swap is involved we look at processing risk, calculations of counterparty risk and we don't currently do any equity or credit-linked structures."
Japanese investors dominate the demand for lightly structured private placements and equity-linked Nikkei knock in structures, power reverse dual currency deals and Bermudan trades still feature.
"Japanese investors prefer more commoditised structures, such as callable structures to boost yield. For instance a 10 year issue with a call after one year and quarterly thereafter," says Delaney at Goldman Sachs.
With the structured market evolving rapidly in Europe, questions have been raised as to whether it is inevitable that the Euro-MTN market will come to resemble its ancestral home: the US.
With a single currency and a maturing and more proactive investor base, can the market avoid becoming entirely commoditised?
Taken to its limits more savvy investors could take the option of or buying a bond and getting a derivative or option attached to it rather than buying a structured Euro-MTN - which is often the way that it is done in the US. This would almost certainly herald the decline of European structured MTN markets.
Already, the advent of money market funds and the drive by investment bankers for league table prominence is having an effect. Will there be more short term business - of one year maturities - that is viewed from a league table angle by dealers using the short end of the market to improve their position?
"In the US, huge chunks of one year issues get done and sold to money market funds. I hope Europe won't become like that as it's a bit of a mug's game," says one US investment banker.
MOST PLAYERS THINK Europe will avoid that route, at least for the meantime. It may take a long time for the market to become like the US.
"Swaps pricing on structured trades should become more transparent over time," says Merrill Lynch associate, Mike Bransford, "but that may take a while."
Those who believe the Euro-MTN market is doomed to become increasingly like its US counterpart may be wrong, in the view of some bankers, because of the state of rates in Europe.
Even with rates likely to increase, absolute yields remain low - which means that the structured market is set to stay in Europe for some time.
Olivier Jalouneix, director at Morgan Stanley Dean Witter, provides another reason why the European model will not simply ape that of the US.
"The US market trades differently. There MTNs trade at a slight liquidity premium to public issues, which is the way it should be, but the Euro-MTN market will not necessarily get there immediately," he says.
"A number of issuers in Europe still post their Euro-MTN levels well behind their public deal levels and focus on structured trades. The presence of a healthy structured market will make the move towards the US MTN market a slower process."
European players believe that there is room for both models - for the structured trades which have been a key part of the European market's development, and for a more sophisticated pricing system akin to that in the US.
The key point, however, is the development of the credit market for Euro-MTNs as part of the broadening of the European debt capital market.
"With time we will have the opportunity to grow the private market for longer maturity trades, for example, to provide corporates with more funding in those areas," says Jalouneix.
"In contrast to the US you do not see a lot of private euro-denominated Euro-MTN issuance for corporates in 10 years and longer."
However, the nature of structured trades changes all the time. "The rate of product innovation has sped up and the premium for good new products is high, but the time span where you can earn pioneer profits is shorter," says Yurist at LBW.
"As an issuer one has to the look at the market and invest in valuation technology and make speedy responses to investor inquiry. As the life cycle of products shortens, whoever is the first borrower to issue a particular structure has the chance to do the next four to five deals."