What Are Eurobonds and How Do You Invest in Them?
The Benefits and Drawbacks of Eurobonds
Imagine that a U.S.-based company wants to expand into India’s market and needs to raise capital to build some physical retail locations. Since the building costs will be incurred in Indian rupees, and the company may not have a credit history in India, it may decide to issue a rupee-denominated bond in the United States. The company benefits from lower borrowing costs while U.S. investors benefit from unique diversification.
These so-called Eurobonds have become increasingly popular with the rise in globalization. In this article, we will look at eurobonds, their benefits and drawbacks, and how international investors can invest in them.
What Are Eurobonds?
In 1963, Autostrade, an Italian motorway network, issued 60,000 15-year bearer bonds with face value of $250 U.S. dollars and a 5.5 percent annual coupon. The company chose to issue the bonds in U.S. dollars instead of Italian lira to avoid the Interest Equalization Tax in the United States. The bonds became the world’s first eurobonds since they were issued in Italy and denominated in U.S. dollars rather than Italian lira.
Eurobonds, or external bonds, are international bonds that are denominated in a currency other than that of the issuer. Despite their name, eurobonds aren’t necessarily denominated in euros and can take many different forms. Euroyen and Eurodollar bonds, for example, are denominated in Japanese yen and U.S. dollars, respectively. Most eurobonds are bearer bonds that are electronically traded through clearing houses, like Euroclear and Clearstream.
Many eurobonds have unique nicknames that are commonly used among traders and investors. For example, the term Samurai bond refers to Japanese yen-denominated eurobonds, while the term Bulldog bond refers to British pound-denominated eurobonds.
It’s important to note that eurobonds aren’t synonymous with foreign bonds. Foreign bonds are bonds that are issued by foreign borrowers in a country’s domestic capital market and denominated in their currency. However, foreign bonds are underwritten by a domestic banking syndicate in accordance with domestic securities laws while eurobonds do not involve pre-offering registration or disclosure requirements (hence their bearer bond nature).
It’s also important to note that the term Eurobond – with a capital “E” – refers to an unrelated proposal for joint bonds issued by Eurozone countries. As a jointly issued bond, Eurobonds would help lower borrowing costs for weaker members of the Eurozone, such as Italy or Spain.
Benefits and Drawbacks
The most attractive benefit of a eurobond, compared to a foreign bond, are the reduced regulatory requirements and greater flexibility. Eurobond disclosures are governed by market practices rather than an official agency, which enables issuers to avoid regulatory paperwork, reduce costs, and ultimately issue the bonds more quickly. Issuers also have the flexibility of issuing bonds in the country and currency of their choice.
For investors, eurobonds offer lower par values and aren’t subject to automatic withholding taxes like many foreign bonds. The bearer bond nature of eurobonds means that companies don’t have to disclose interest payments to tax authorities, which means that it’s up to individuals to declare the income. Competition is also much greater in the eurobond market than the foreign bond market, which translates to more competitive pricing and liquidity.
The primary drawback of eurobonds is that they’re not regulated by domestic regulators, which could increase their risks. Investors must also handle calculating and withholding taxes on their own rather than having them automatically withheld or reported to tax authorities. And finally, investors must also factor in any foreign exchange risks associated with the issues, which can be volatile when dealing with emerging or frontier markets.
How to Invest in Eurobonds
Eurobonds can be purchased in the same way as most other bonds through global stock exchanges. Currently, the Luxembourg Stock Exchange and the London Stock Exchange are the two biggest hubs for investing in eurobonds, but there are many issues around the world.
Investors looking into these bonds should be sure to conduct due diligence to ensure that they are comfortable with the terms and risks associated with the bonds. These bonds should also be included as part of a diversified portfolio to mitigate risks stemming from any single country, currency, or asset class. It’s a good idea to consult with a financial advisor or broker before purchasing eurobonds to fully understand these unique risk factors.