Financial Cold War. James A. Fok
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Midland attracted reduced the fall in the country's foreign exchange reserves from $56 million to $6 million.37 As with most financial innovations, other banks quickly copied what Midland was doing.
In the wake of the Suez crisis, sterling was hit with renewed distress, prompting the Chancellor of the Exchequer to impose new foreign exchange controls in the third quarter of 1957. The use of sterling to finance foreign trade between third parties was banned and refinance credits in sterling were outlawed. Prevented from using their sterling deposit bases for international lending, resourceful British banks began to use their dollar deposits.
Meanwhile, US multinational companies were making large investments to expand their overseas operations. Though US balance of payments deficits had been modest from 1950 to 1957, from 1958 to 1962 US deficits reached levels of between $2.5 billion and $3.8 billion.38 In 1961, the Federal Reserve began expressing concerns that the growing Eurodollar market may ‘constitute a danger to stability’,39 but by that time the Bank of England had grasped the importance of this market in developing international trade and to restoring the City of London's role as a leading international financial centre. By 1963, the Bank for International Settlements (BIS) estimated the size of the Eurocurrency market to be $12.4 billion, of which three-quarters was in US dollars. This large base of offshore dollar deposits soon became the target of bankers helping corporations to raise funds via bond issues.
The Coupon Express
In the post-war years, New York had been the principal financial centre where borrowers went in search of investment. The first international bond issue after WW2 was by the World Bank in the New York-based foreign dollar bond market (or, as it came to be known, the ‘Yankee’ market). This was largely a public sector market, with issuers including governments, government agencies and municipalities. Issues were required to comply with the 1933 Securities Act and be registered with the Securities and Exchange Commission (SEC). Regulations also required that a US investment bank acted as lead manager on the issue and that there be a US domestic underwriting syndicate. Many US public pension funds were not permitted to buy these foreign securities and US insurance companies were restricted on the amount they could hold, so these issues were increasingly bought by European investors through discretionary private banking accounts with Swiss or Benelux banks, or via London brokers. Towards the end of the 1950s, three-quarters of these issues were being bought by European investors.
It was galling to the European intermediaries that, although they were handling much of the distribution, US underwriters were earning most of the new issue fees. European distributors therefore began to look for a way to handle the entire new issue process by themselves.
At the time, Switzerland would have seemed the natural home for what would become the massive Eurobond market, since most of the early issues of US foreign dollar bonds were placed there. Switzerland itself had a sizeable market for foreign bonds issued in Swiss francs, which had started in 1947 and, by 1963, had the equivalent of around $790 million outstanding – slightly larger than the amount owed by European borrowers in the New York market.40 White, Weld & Co., a New York-based firm that was one of the most prominent players in the foreign dollar bond market, formed a close relationship with Crédit Suisse and based its European activities in Zurich. So, what led the market to come to be centred on London?
As with most such decisions in international finance, it ultimately came down to questions of regulation and tax. Switzerland imposed a 35 percent withholding tax on interest paid on domestic issues to non-residents, but foreign issues were exempt from this. What weighed far more against Switzerland though was the tax authorities’ refusal to exempt bond trading from Swiss stamp taxes, and a Swiss Federal issue tax of 1.2 percent that made it unattractive for Swiss banks to underwrite and manage issues in Switzerland themselves.
For tax reasons, US banks initially flocked to set up operations in Paris. Morgan Guaranty and Morgan Stanley together had set up Morgan et Cie there to underwrite new issues. Merrill Lynch based their first European headquarters in the French capital, as did Dillon Read. However, a number of European countries grew concerned at the rapidly expanding pool of stateless Eurodollars and took steps to limit its growth. In the early 1960s, France, along with Switzerland, Germany and Italy, prohibited interest payments on foreign deposits.
London had been a far-from-obvious candidate for becoming host to this foreign securities market. An executive with SG Warburg at the time recalled that ‘London was a pretty miserable place to be, beset with post-war gloom, exchange controls and the narrow parochial attitude of the City’.41 However, because of the concentration of banks in London holding Eurodollar deposits, the British authorities began to see an opportunity for the City to ‘fill a vacant role in Europe in mobilising foreign capital for world economic development’.42 That Britain still operated exchange controls that had created a highly regulated onshore domestic economy may in fact have helped create common ground between City firms and the British regulators in pursuing business in this offshore currency market. Stanislas Yassukovitch, then an executive at White Weld and who would go on to be appointed CEO of the European Banking Company and Deputy Chairman of the London Stock Exchange, among other prominent positions, pointed out:
Paradoxically it was because there was exchange control. As a result of the Exchange Control Act, the Bank [of England ] could allow traffic in foreign currency securities on its capital market, and activity in foreign currencies, because it was completely isolated from the management of the domestic currency mass.43
For the first Eurobond issue out of London to take place, however, there was a myriad of legal, regulatory and tax issues to overcome. The firm that led the way on this was SG Warburg.
SG Warburg had been founded in London in 1936 by Siegmund Warburg, a scion of the German-Jewish banking dynasty who had fled from Hamburg to Britain after Hitler had come to power. The company was originally named New Trading Company, or ‘Nutraco’, and began by financing the growth of small businesses and offering corporate finance advice. In its early years, it comprised a small group of German-Jewish émigrés, whose leading members were known as the ‘Uncles’. The company's internal language was German and, in the German tradition, the Uncles were extremely formal, addressing each other by their last names even after decades of close acquaintance. SG Warburg was not among the leading City firms, but in 1956 acquired a small merchant bank, Seligman Brothers, through which it became an Accepting House recognised by the Bank of England and gradually made a name for itself over the following decade.
SG Warburg was not a major distributor of Yankee bonds, but Siegmund Warburg was familiar with the market through his family's relationship with the US investment bank Kuhn, Loeb & Co. His cousins Paul and Felix Warburg were both senior partners at the New York firm and Siegmund himself served as a partner and Executive Director of Kuhn Loeb from 1953 until 1964. As far back as 1958, Warburg had bemoaned the fact that American underwriters were receiving the lion's share of fees on Yankee issues, notwithstanding the fact that most of the distribution was carried out by European banks. In the early 1960s, he and his partners set out to overcome the barriers to launching a Eurobond out of London. The borrower that served as the test case with the British authorities was the builder and owner of Italy's motorway network, Autostrade.44
The reason why Autostrade was chosen traces back to its relationship with the Italian public holding company Istituto per la Ricostruzione Industriale (IRI). IRI had been set up in the 1930s to rescue and restructure companies