In the early and mid-1980s, the major difference between MTNs and corporate bonds was in their primary method of distribution: Typically, agents placed MTNs in relatively small amounts continuously or intermittently, while underwriters placed large, discrete amounts of corporate bonds. This strict classification no longer applies, however. A growing number of MTN offerings have the characteristics of traditional corporate bonds, and regional dealers now sell a significant percentage of MTNs. Thus, as the MTN market has matured, it has become harder to define the securities and to describe their mode of distribution.
Principal Transactions
One important change in the distribution process is that a larger share of MTNs are now sold on a principal basis, rather than on an agented basis. In a principal transaction, the MTN dealer purchases an MTN for its own account and later resells it to investors. In a “riskless principal” transaction, when the dealer buys the MTN, it has already lined up an investor that has agreed to the terms of the resale. Riskless principal transactions often involve structured MTNs. In other principal transactions, dealers underwrite MTNs when they have not lined up investors but expect to do so easily and quickly.
Large, Discrete Offerings
Corporations now more often sell MTNs that are nearly indistinguishable from corporate bond offerings. These MTN offerings typically have large face amounts of $100 million or more, the typical size of corporate bond offerings. They are sold on an underwritten basis, and they often have relatively long maturities of ten or thirty years. Furthermore, announcements of such offerings appear along with announcements of corporate bond offerings in financial publications.
Despite the similarities to corporate bonds, these large, discrete, underwritten securities technically are MTNs because they are issued from MTN shelf registrations. To most investors, this technical difference is largely irrelevant because the securities have the essential features of corporate bonds. As a result, the securities reportedly do not command a yield premium relative to the yield on corporate bonds.
As large, discrete offerings of MTNs have become more common, the distinction between MTNs and corporate bonds has blurred. As a result, the arguments for financing with MTNs have become more compelling. By setting up an MTN program, a corporation does not give up the advantages of issuing large, underwritten securities that typically would be accomplished with a corporate bond offering. However, unlike a shelf registration for corporate bonds, an MTN program gives the corporation the flexibility to issue in small amounts continuously and to participate more actively in structured transactions.
Distribution through Regional Dealers
Through the mid-1980s, the major New York investment banks distributed nearly all MTNs to investors. As the market has matured, regional dealers have placed an increasing volume of MTNs. According to market estimates, placements through regional dealers now account for 5 to 15 percent of MTN issuance volume. In these placements, regional dealers receive information about issuers’ offering rate schedules from MTN agents. In turn, the regional dealers communicate this information to their investor clients. When an investor buys an MTN through a regional dealer, the regional dealer receives a selling concession from the MTN agent. Placements through regional dealers improve efficiency in the market by broadening the investor base for MTNs.
Many regional dealers have contacts with smaller institutional investors, such as small banks, municipalities, and individuals with high net worth, that represent a relatively stable source of funding.
Euro-MTNs
MTNs have become a major source of financing in international financial markets, particularly in the Euro-market. Like Euro-bonds, Euro-MTNs are not subject to national regulations, such as registration requirements. Although Euro-MTNs and Euro-bonds can be sold throughout the world, the major underwriters and dealers are located in London, where most offerings are distributed.
Although the first Euro-MTN program was established in 1986, the market represented a minor source of financing throughout the 1980s. In the 1990s, the Euro-MTN market grew at a phenomenal rate, with outstandings increasing into the hundreds of billions. New borrowers account for most of this growth, as a majority of the 190 entities that have established Euro-MTN programs did so in the late 1990s. As in the U.S. market, flexibility is the driving force behind the rapid growth of the Euro-MTN market. Under a single documentation framework, an issuer with a EuroMTN program has great flexibility in the size, currency denomination, and structure of offerings.
Furthermore, reverse inquiry gives issuers of Euro-MTNs the opportunity to reduce funding costs by responding to investor preferences.
The characteristics of Euro-MTNs are similar, but not identical, to MTNs issued in the U.S. market. In both markets, most MTNs are issued with investment-grade credit ratings, but the ratings on Euro-MTNs tend to be higher. In 1999, for example, 68 percent of Euro-MTNs had Aaa or Aa ratings, compared with 13 percent of U.S. corporate MTNs. In both markets, most offerings have maturities of one to five years. However, offerings with maturities longer than ten years account for a smaller percentage of the Euromarket than of the U.S. market. In both markets, dealers have committed to provide liquidity in the secondary market, but by most accounts the Euro-market is less liquid.
In many ways, the Euro-MTN market is more diverse than the U.S. market. For example, the range of currency denominations of Euro-MTNs is broader, as would be expected. The Euro-market also accommodates a broader cross-section of borrowers, both in terms of the country of origin and the type of borrower, which includes sovereign countries, supranational institutions, financial institutions, and industrial companies. Similarly, Euro-MTNs have a more diverse investor base, but the market is not as deep as the U.S. market.
In several respects, the evolution of the Euro-MTN market has paralleled that of the U.S. market. Two of the more important developments have been the growth of structured Euro-MTNs and the emergence of large, discrete offerings.
Structured transactions represent 50 percent to 60 percent of EURO-MTN issues, compared with 20 percent to 30 percent in the U.S. market. In the Euro-MTN market, many of the structured transactions involve a currency swap in which the borrower issues an MTN that pays interest and principal in one currency and simultaneously agrees to a swap contract that transforms required cash flows to another currency. Most structured Euro-MTNs arise from investor demand for debt instruments that are otherwise unavailable in the public markets. To be able to respond to investor driven structured transactions, issuers typically build flexibility into their Euro-MTN programs. Most programs allow for issuance of MTNs with unusual interest payments in a broad spectrum of currencies and with a variety of options.
Large, discrete offerings of Euro-MTNs first appeared in 1991. They are similar to Euro-bonds in that they are underwritten and are often syndicated using the fixed-price reoffering method. As a result of this development, the distinction between Eurobonds and Euro-MTNs has blurred, just as the distinctions between corporate bonds and MTNs has blurred in the U.S. market.
The easing of regulatory restrictions by foreign central banks has played an important role in the growth of the Euro-MTN market. For example, over the past decade, MTNs denominated in deutsche marks have emerged as a major sector in the Euro-market as a result of regulatory changes made by the Bundesbank in August 1992. Under the previous rules, foreign borrowers could only issue debt denominated in deutsche marks through German subsidiaries or other German financial firms, and maturities could not be shorter than two years. Debt denominated in deutsche marks also had to be listed on a German exchange, and these offerings were subject to German law, clearing, and payment procedures. These rules effectively precluded issuers from establishing multicurrency Euro-MTN programs with a deutsche mark option.
In the August 1992 deregulation, the Bundesbank removed the minimum maturity requirement on debt denominated in deutsche marks issued by foreign nonbanks, and it eliminated or simplified issuance procedures for all issuers. Although the new rules require that a “German bank” act as an arranger or dealer, the definition is broad enough to include German branches and subsidiaries of foreign banks. The arranger is required to notify the Bundesbank monthly of the volume and frequency of issues denominated in deutsche marks. Other central banks have instituted similar liberalizations that may result in rapid growth of MTNs denominated in other currencies, such as the Swiss franc and the French franc.
Outlook For The MTN Market
Few innovations in finance have been as successful as the medium-term note. Its success derives from its remarkable adaptability to the needs of both borrowers and investors. The success can be measured by the number of borrowers, the diversity of note structures, and the amount of outstanding MTNs, all of which have increased dramatically over the past decade.
The adoption of SEC Rule 415 in 1982 was the key event that removed the regulatory impediments to continuous offerings of corporate notes. Other regulatory changes, such as SEC Rule 144A and liberalizations by European central banks, have been instrumental in the development of new sectors in the MTN market. As a result of these regulatory changes, financial markets have become more efficient. In 1992, the SEC eased restrictions on the types of securities eligible for shelf registration. As a result of this ruling, asset-backed MTNs emerge as the next major growth sector in the public MTN market.
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