Extendible commercial note (ECN) programmes could be the future for short-term debt. A product that can offer do-it-yourself liquidity to issuers could prove vital to a successful funding strategy at a time when disintermediation and consolidation dominate the market. American dealers are confident that ECNs can offer this on both sides of the Atlantic. Chris Kersey, head of global money market origination, at Goldman Sachs, estimates there will be close to 50 issuers of ECNs in America by 2000. He even suggests there will be issuance in the European market by the close of 1999. One ECN issuer says: "Its definitely growing. This is the way of the future. Investors will be providing the back-up rather than the banks." When awarding top-grade ratings, agencies require liquidity backup for CP programmes. Historically, banks provided this facility to issuers, but in the American market a shift is taking place. Due to consolidation in their industry, American banks are pulling out of providing this facility to borrowers. The extendible commercial note programme is one answer to issuer needs for easy access to cash. The first issuers of this product, in Autumn 1998, were Texaco, Hershey Foods and Disney. Ten corporates have extendible commercial note facilities rated in the American market and nine have issued off their programmes. The idea is steadily spreading in America. In excess of $3 billion-worth of extendible notes have been sold to investors since 1998. Cargill is a recent convert to the product. Its $1 billion programme kicked off on April 9, this year. Andy Reul, North American funding manager at Cargill, thinks the product is the most innovative one to hit the market in a decade. He says: "Through extendible notes we see the potential to expand our investor base, further penetrating into money market funds." The ECN product was devised by Goldman Sachs. It behaves in the same way as ordinary CP with the usual maturity of notes being 90 days. However, at issuance, the note has a built-in option, held by the issuer, enabling them to extend the maturity for up to 390 days from the original issuance date. Investors appear to be in a win/win situation. To date, no issuer has opted to extend. The buyer therefore receives a high premium and a good rate of interest for taking on a relatively small risk in the likelihood that the notes will mature on the date initially agreed. All issuers of this product in the American market are investment-grade corporates. But there is also strong economic incentive for the borrower not to extend the note. Any extension after 90 days triggers a repricing of the security into Libor and ratings-driven pricing, which would be significantly higher than normal CP rates. One borrower says: "We have to educate investors so that they realise that the likelihood of us ever extending the note is virtually nil. We would only ever extend in circumstances where the CP market effectively closed down to us for some reason." Kersey, at Goldman Sachs, believes there are benefits across the board with this type of facility. He says: "Everybody wins with ECNs. The issuer gets access to a new source of contingent liquidity in the form of money market investors, the commercial banks don't have to provide issuers with unprofitable backstop liquidity facilities and investors get an enhanced yield with no added credit risk." Kersey explains that ECN programmes will not replace CP programmes, but says they are a complementary product and make the CP market more efficient. The product suffered, in its early stages, when it should have grown the most. This was largely due to the crisis in the fourth quarter of 1998. Also, there was hesitancy on the part of borrowers and investors to accept a new product. There has been a substantial marketing effort to make this product work in America. Some initial trades have been subsidised by underwriters selling it flat or at a loss, since it is in their best interest to make it work. Hunter Brown, vice-president, JP Morgan, is confident the product will be successful, but says: "The market for ECNs is still in a very early stage. There is a learning curve for both issuers and investors." Some European CP dealers are less enthusiastic about the new product and do not believe conditions are right in the European market yet. However, John Delaney, executive director, Goldman Sachs, London, is confident. He says: "The European market is obviously smaller and less sophisticated than the US market, but ECNs will come to Europe. Especially with Emu, the trend is towards a more homogeneous market. Undoubtedly we will see issuance in the European market." It appears that two trends have encouraged the product's growth in America. Consolidation has left banks with reduced capacity. They are also reluctant to provide liquidity services because these services give sub-marginal returns. So, issuers have been forced to go directly to the money markets to look for greater liquidity. Similar trends are already being seen in the European market. Andy Reul, at Cargill, believes this product will develop globally. He says: "We will assess the acceptance of extendible commercial notes in the US market and may consider issuing the product in Europe at a later date."
August 11, 2000
