Bond Issues in European Units of Account

Jean O. M. van der Mensbrugghe

UBLIC ISSUES of bonds expressed in European units of account, P which amounted to the equivalent of US$5 million in each of the years 1961 and 1962, totaled $48 million in 1963. In April 1964, another bond issue in units of account equivalent to $10 million was launched by seven municipalities of Greater Copenhagen. All these issues, which were sponsored by Belgian banks and were offered on most European capital markets, provided a limited exchange guarantee; they were subscribed without hesitation by the general public, but became the subject of controversy among government officials, bankers, and brokers. Some European central banks, particularly the Swiss National Bank, have been reported as strongly opposed to issues in European units of account.1 In order to facilitate an appraisal of the issues in European units of account and the contro- versies to which they have given rise, it has seemed appropriate to describe the origin of these issues, to examine the conditions under which the unit of account varied in the first seven bond issues, and to outline the terms of the issues.

Origins

A number of international public institutions and treaties have included provisions for units of account. Since its inception, in May 1930, the Bank for International Settlements, in accordance with Article 5 of its statutes, has drawn up its balance sheet in units of account, with a gold weight of 0.29032258 gram of fine gold a unit, which corresponds to the value of the Swiss franc before its devaluation in 1936.2 The agreement for the establishment of a

* Mr. van der Mensbrugghe, economist in the IMF Institute, is a graduate of the University of Louvain. He was formerly on the staff of the Royal Institute for International Affairs, Brussels. He has published "Les Unions Economiques: Re*alisa- tions et Perspectives" (Brussels, 1950), as well as several articles. 1 See The Economist, November 23, 1963, pp. 791-92, and January 11, 1964, p. 128. 2 See Eleanor Lansing Dulles, The Bank for International Settlements at Work (New York, 1932), pp. 581-95, and the comments by Miss Dulles, op. cit., pp. 29-31 and 487-89. 446

©International Monetary Fund. Not for Redistribution BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT 447 European Payments Union (EPU), which was signed in Paris on September 19, 1950, stipulated in Article 26 that the accounts of the Union "shall be kept ... in terms of a unit of account of 0.88867088 grammes of fine gold" which is equivalent to one U.S. dollar. A similar provision was included in the European Monetary Agreement,3 which was signed in Paris on August 5, 1955 and which came into force after the dissolution of the European Payments Union in De- cember 1958. The treaties signed in Rome on March 25, 1957, establishing the European Economic Community (EEC)4 and the Euro- pean Community for Atomic Energy,5 also provided for a unit of account, which was in fact the same as that of the EPU. The statutes of the European Investment Bank, which were annexed to the treaty establishing the EEC, stipulated that the capital of the Bank should amount to 1 billion units of account, the value of one unit being 0.88867088 gram of fine gold.6 The wide use of units of account in international public agreements has led some private bankers and experts to wonder whether such a device should be extended to international private contracts. In particular, Professor Robert Triffin in 1957 wrote that "a first step in this direction [monetary integration in Europe] might be to legalize the use of exchange guarantees in terms of the EPU unit, in the writing of private as well as public contracts. This could aid greatly in the revival of capital markets, now paralyzed by exchange fears and risks."7 Three years later, in 1960, Triffin wrote, in similar fash- ion: "The first [step toward monetary integration in Europe] would be to authorize and encourage the use of the European unit of account in all international, and even national, capital transactions through- out the Community's [EEC] territory. This would contribute to the revival of the capital markets still paralyzed or handicapped today by fears of exchange rate instability." 8 The launching of bond issues in European units of account is not only an adaptation to capital transactions of a technique used in international public institutions; it also accords with the development of foreign issues in European capital markets. Until 1963, the frag- mentation of European capital markets, the high interest rates pre- vailing on most of those markets, and various restrictive controls led

3 Article 24. 4 Article 209. 5 Article 181. (i Article 4, par. 1. 7 Robert Triffin, Europe and the Money Muddle (New Haven, Connecticut. 1957), p. 291. 8 Robert Triffin, Gold and the Dollar Crisis (New Haven, Connecticut, 1960), p. 142.

©International Monetary Fund. Not for Redistribution 448 INTERNATIONAL MONETARY FUND STAFF PAPERS a number of European Governments, international institutions, and enterprises to float bond issues on the New York capital market.9 There have been numerous reports that these issues were subscribed to a sizable extent by European investors. This interest of European investors in dollar bonds has led, since 1957, to the flotation by Euro- pean Governments or enterprises of loans expressed in U.S. dollars on European capital markets; such issues on the London capital market were particularly important in 1963 and January-February 1964.10 In addition, since 1957, multiple currency loans—the principle of which is actually much older—have been issued in European capital markets; these loans have been expressed in U.S. dollars, but the payment of interest and amortization could be made in a number of European currencies as well as in U.S. dollars, the fixed rate between these currencies and the dollar being determined on the basis of existing parities at the time of issue. Loans in European units of account are a variant of multiple currency loans.11

European Unit of Account In the seven issues considered in this paper, the initial value of the unit of account in which the bonds were expressed was defined as being the same as the value of the unit of account used in the EPU.12 It was linked to the currencies13 of the 17 member countries of the former EPU in terms of the par values agreed between such countries and the International Monetary Fund or, if there were no such agreement, on the basis of domestic legal definitions of the currency in terms of gold or of another currency defined by its gold contents;14 this is the reason why it is called a European unit of account. The prospectuses of the issues listed the values of the 17 currencies in terms of the European unit of account. 9 See Jean 0. M. van der Mensbrugghe, "Foreign Issues in Europe," Staff Papers, Vol. XI (1964), pp. 327-35. 10 See The Economist, January 18, 1964, p. 235. A loan expressed in Swiss francs was also issued in 1963 in London. 11 For differences between multiple currency loans and loans in European units of account, see Fernand Collin, The Formation of a European Capital Market and Other Lectures (Brussels, 1964), pp. 27-28. 12 See above, p. 447. 13 Austrian schillings, Belgian francs, Danish kroner, deutsche mark, French francs, Greek drachmas, Icelandic kronur, Irish pounds, Italian lire, Luxembourg francs, Netherlands guilders, Norwegian kroner, pounds sterling, Portuguese escudos, Swedish kronor, Swiss francs, and Turkish liras. 14 Par values for all the currencies, except the Swiss franc, of the member countries of the former EPU have been agreed with the Fund. Switzerland is not a member of the Fund. The gold content of the Swiss franc is defined in the Federal Coinage Law of December 17,1952.

©International Monetary Fund. Not for Redistribution BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT 449 The value of the unit of account could be changed only under very strict conditions. The basic principle was that the unit of account could be modified only by a change in the value of all the 17 currencies to which it was linked. If, during a given period, the parities of all but one of these currencies were changed, the value of the unit of account remained unchanged. Similarly, failing a modification of all the 17 currencies, the unit of account would remain unchanged if there were a modification in the value of the U.S. dollar, to which it was originally equal, or in the price of gold. The absence of a direct link between changes in the unit of account on the one hand, and in the price of gold on the other, indicated that the bonds in European units of account could not be considered as legally including a gold clause; such a clause is forbidden in private contracts by law or by judicial decision in a number of European countries.15 The conditions under which the unit of account would be modified, following a change in the 17 currencies to which it was linked, gradu- ally became more precise. In the first bond issue (February 1961), it was stipulated that, if all the 17 currencies were devalued or revalued by the same percentage, the unit of account would be devalued or revalued by the same percentage; but if the 17 currencies should undergo differentiated changes in value, the value of the unit of account would follow the value of the currency which had devalued the least since the time of issue. The second (May 1962) and third (January 1963) issues provided that, if the 17 currencies were all revalued or devalued, but not by the same percentage, the unit of account would be revalued or devalued in accordance with the currency which had changed the least since the time of issue; however, it would remain unchanged if the percentage of devaluation of the currency (or currencies) which were devalued the least was equal to the percentage of revaluation of the curency (or currencies) which revalued the least. In the fourth issue (July 1963), it was repeated that, if there were a uniform change in the 17 currencies to which it was linked, the unit of account would change by the same percentage as all the currencies; or if there were a general change in the same direction but by different rates, the unit of account would change by the same percentage as that one of the 17 currencies which had changed the least from the original parity. The conditions under which the unit of account would vary if some currencies were devalued while all others were revalued (or vice versa) were, however, quite different from 15 See Arthur Nussbaum, Money in the Law, National and International: A Comparative Study in the Borderline of Law and Economics (Brooklyn, N.Y.. 1950), pp. 280-99 and 414-45.

©International Monetary Fund. Not for Redistribution 450 INTERNATIONAL MONETARY FUND STAFF PAPERS those set out in the three previous issues. In this fourth issue, the unit of account was to vary only if at least two thirds of the 17 currencies were devalued (or revalued) while all others were revalued (or devalued), and its variation would be the same as that of the currency which changed the least from its original parity among the larger of the two groups of currencies. Thus, if less than two thirds of the 17 currencies were devalued (or revalued) while all others were revalued (or devalued), the unit of account would remain unchanged. The fifth (October 1963), sixth (November 1963), and seventh (April 1964) issues included similar rules. The only addition to the conditions incorporated in the fourth issue was a provision that, in calculating whether at least two thirds of the 17 currencies had changed in the same direction, no account was to be taken of a possible future merger of some of the 17 currencies. The first three issues did not indicate the dates on which the gold content of the unit of account, and the ratio between that unit and the 17 currencies to which it was linked, were to be modified. It can, however, be surmised that the gold content of the unit of account was to be modified when a change in the parity of the 17 currencies became effective. The ratio between the unit of account and the 17 currencies was to remain unchanged if all the currencies changed uni- formly; however, it was to be modified if there were a differentiated change, and this modification was, presumably, to be effected as soon as the differentiation became effective. Subsequent modifications in the unit of account were to take place if the 17 currencies were again changed. The fourth, fifth, sixth, and seventh issues provided that, in the event of a differentiated change in the 17 currencies, the ratio between the unit of account and the currencies was to be modified de facto as soon as the appropriate proportion of the currencies was modified. However, it was provided that any such modification in the unit of account would be followed by an interim period of two years (called "transition period" in the fourth issue and "adjustment period" in the fifth, sixth, and seventh issues); during this period, the unit of account might change, following a change in only some of the 17 currencies, and also a new definition of the unit of account and of the ratio between that unit and the 17 currencies to which it was linked might be given. After those two years, any further change in the unit of account was again to be determined exclusively by changes in the value of the 17 currencies. During a transition or adjustment period, the unit of account might be modified if a further change in one or some of the 17 currencies affected the calculations on the basis of which it was originally modi-

©International Monetary Fund. Not for Redistribution BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT 451 fied when there was a change in the 17 currencies.16 For instance, if at any given date 16 of the 17 currencies were devalued by 10 per cent and the remaining one by 5 per cent, the unit of account would be devalued by 5 per cent; but if during the next two years the currency which had been devalued by 5 per cent was further devalued by 5 per cent, while other currencies remained unchanged, the unit of account would also be devalued by a further 5 per cent, without initiating a new transition period. Again, if originally 13 of the 17 currencies (i.e., more than two thirds) were devalued by 20 per cent, while 4 of them were revalued by 10 per cent, the unit of account would be devalued by 20 per cent; but if, during the transition period that followed this devaluation, 2 of the 13 currencies which had devalued by 20 per cent were revalued by 15 per cent (of the original rate), the unit of account would also be revalued by 15 per cent of that rate and would thus be only 5 per cent below its original value.

Payment of Subscriptions

Four of the seven bond issues considered here (the second, third, sixth, and seventh) prescribed that subscription payments could be made in all the 17 currencies of the member countries of the EPU. For this purpose, the currencies were not linked to the unit of account as such, but to the quotation of one of them on the exchange markets17 at the time of payment: the Swiss franc in the second and third issues, and the deutsche mark in the sixth issue. Subscriptions in Swiss francs to the second and third issues and in deutsche mark to the sixth and seventh issues were to be effected on the basis of the gold parity of these currencies at the time of payment. For the other issues, the number of currencies in which subscription payments could be made was restricted to a few of the 17 currencies to which the unit of account was linked. In the first issue, payments could be made in Belgian francs, French francs, Luxembourg francs, Nether- lands guilders, pounds sterling, or Swiss francs. When the fourth issue was launched, it was specified that payments could be made in deutsche mark, Italian lire, Netherlands guilders, pounds sterling, or Swiss francs on the basis of the gold parity of these currencies. The

16 This rule was spelled out only in the fourth issue, but it presumably was in force also in the fifth, sixth, and seventh issues. It is explained by some exam- ples in Collin, op. cit., pp. 63-65. 17 The official market or, when transactions in securities could not be effected on the official exchange market, the free market.

©International Monetary Fund. Not for Redistribution 452 INTERNATIONAL MONETARY FUND STAFF PAPERS fifth issue was to be subscribed in deutsche mark at a rate of DM 4 for each unit of account, or in Netherlands guilders or in pounds sterling on the basis of the average quotations of these currencies in terms of deutsche mark on the Frankfurt exchange market two days before the closing of the subscription lists. No reasons were officially given for restricting the number of currencies in which subscription payments were to be made. It may be surmised that the restriction was imposed partly for administrative reasons and partly to take account of the fact that in some countries residents were not authorized to subscribe to foreign bond issues.

Payments of Interest and Amortization

Under the terms of all the issues but the fifth, the currency in which interest on the bonds was to be paid and amortization effected (always nominally at par) might be chosen freely by the bondholder from among the 17 currencies to which the unit of account was linked. This choice had to be notified before payments fell due;18 if it were not made within the time limit indicated, the banks that sponsored the issue or—in the fourth, sixth, and seventh issues—the bank through which all operations pertaining to the bonds were carried out, were to determine the currency in which the interest and amortization payments would be made. In all cases, the payments in the currency chosen were to be made on the basis of the gold parity of these currencies. In the fifth issue it was stipulated that the payments of interest and amortization would be due in units of account, but made in one of the 17 currencies. This currency would be chosen, by agreement between the issuing company and the bank through which all operations pertaining to the bonds were carried out, from among those of the 17 currencies which were internationally traded and of which the actual market value was higher than its definition in terms of gold, or at least as close to that definition as possible. The market value was to be determined on the basis of the average exchange rate applicable to capital transactions between the currency chosen and a currency freely convertible into gold, 14 days before the payments fell due, on an exchange market chosen in common agreement. If the currency chosen were subject to restrictions which would limit its use, the issuing company and the bank acting as trustee would be

18 One month in advance for the first issue; 6 days for the third issue; and 14 days for the fourth, sixth, and seventh issues.

©International Monetary Fund. Not for Redistribution BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT 453 free to determine the currency to be used for the servicing and amortization of the bonds.

Other Characteristics of the Issues

The names of the companies that issued bonds expressed in units of account, the dates and amounts of the issues, the interest rates, the issue prices, and the maximum maturities are summarized in Table 1.

TABLE 1. BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT

Amount Issued Interest Maximum (million Rates Issue Maturity Date of units of (per cent Price (number of Issuing Company Issue account) per annum ) (per cent ) years)

1. Sociedade An6nima Concessionaria da Refinagao de Petroleos em Portugal (SACOR, Feb. Portugal) 1961 5 5% 99 17 2. Sociedade An6nima Concessionaria da Refinagao de Petroleos em Portugal (SACOR, May Portugal) 1962 5 5M 99 16 3. Norges Kommunalbank Jan. (Norway) 1963 12 sy 99 20 4. Imatran Voima July Osakeyhtio (Finland) 1963 5 6 97 15 5. Cassa per il Mezzogiorno Oct. (Italy)' 1963 18 VA 99M 15 6. Banco de Fomento Nov. Nacional (Portugal)2 1963 13 5^ 97^ 15 7. Seven municipalities of Greater Copenhagen Apr. 5 (Denmark) 1964 10 5 8/ 98 20

1 Bonds for 2 million units of account were privately placed with an interest rate of 5J£ per cent and a maturity of 2, 3, 4; and 5 years. The conditions indicated in the table pertain to the remainder of the issue. 2 Bonds for 3 million units of account were privately placed with an interest rate of 5^ per cent and a maturity of 3, 4, and 5 years. The conditions indicated in the table pertain to the remainder of the issue.

©International Monetary Fund. Not for Redistribution 454 INTERNATIONAL MONETARY FUND STAFF PAPERS The companies that issued the bonds are either nationalized companies or private companies in which the Government is the main shareholder. In all issues except those of the SACOR and that of the municipalities of Copenhagen, the Government has guaranteed the payment of interest and amortization of the bonds. In all seven issues, the monetary authorities have guaranteed that they would not place any restrictions on the transfer of interest and amortization payments. The issues were all sponsored by Belgian banks, which headed syndicates including banks and other financial institutions in Europe and the United States.19 Only the first issue was offered through the intermediacy of Swiss banks, and the absence of such banks in the underwriting of subsequent issues may well have been due to the reluctance with which the Swiss monetary authorities regarded issues expressed in units of account. It has been reported that the French and Italian authorities refused to authorize the first issue in units of account in their territory.20 Apparently they subsequently reversed their attitude, because Italian banks since the second issue and French banks since the fifth issue have participated in underwriting syndicates. It has also been mentioned that the Netherlands authorities allowed domestic banks to underwrite the first issue, provided that the placement of the bonds in their country remained private.21 Since the second issue, British banks have taken part in all underwriting syndicates. The effective yields on the bonds varied between some 5.6 per cent and 6.2 per cent, and the costs to the borrowers were further increased by underwriting fees. Actually, the interest rates paid on bonds in units of account have been higher than the rates on ordinary foreign bond issues in Switzerland and the Netherlands, and approximately the same as the rates on domestic bond issues in Belgium, France, the United Kingdom, and the Federal Republic of Germany. The rates have, however, been somewhat lower than those that could actually be obtained by the issuing companies on their domestic capital markets, where they might also have been prevented from borrowing either by a relative scarcity of domestic funds—as in Finland and Norway—or by unfavorable local conditions—as in Italy in 1963, or in Portugal. But any comparison between rates of interest on new

19 Only the fifth and sixth issues were distributed to financial agencies in the United States. Since the issues were not registered with the Securities and Exchange Commission, these agencies could not offer the bonds publicly. 20F. Collin and A. Leeman, "De eerste Internationale lening in rekenmunt," Economisch-Statistische Berichten, June 21, 1961, p. 619. 21 Loc. cit.

©International Monetary Fund. Not for Redistribution BOND ISSUES IN EUROPEAN UNITS OF ACCOUNT 455 bond issues on the capital markets of the countries in which the issuing companies were domiciled and the rates on bond issues in units of account is subject to uncertainty, because the bonds in units of account have been expressly exempted from all taxes in the countries of the issuing companies, while private bond issues in these countries have not been exempted. When account is taken of the tax privileges, the effective yields on the bonds in units of account may possibly be higher than the yields on domestic issues in the country of the issuing company. The addition of a limited exchange guarantee to these bond issues does not seem to have resulted, thus far, in a notable reduction of the costs of borrowing for the issuing companies, but it may well have allowed the companies to gain access to foreign capital markets which otherwise would have been closed to them. In this way, the seven issues of bonds in units of account have contributed —although to a small extent—to the increase in foreign bond issues on European capital markets. Actually, subscriptions to issues in units of account were taken up easily, and the bonds have been traded above par on a number of European Stock Exchanges. All seven issues are traded on the Luxem- bourg Stock Exchange, where, in contrast to exchanges in most other countries, there is no stamp duty on the transfer of securities.22 The first, second, and seventh issues are quoted on the Brussels Stock Exchange, the third on the Amsterdam Stock Exchange, and the first on the Zurich Stock Exchange.

Emissions en unites de compte europeennes

Resume Depuis 1961, une nouvelle formule d'emissions etrangeres s'est developpee en Europe: celle d'obligations en unites de compte europeennes. Les emissions publiques de telles obligations, qui ont lieu sur divers marches de capitaux sous Fegide d'un syndicat preside par des banques beiges, se sont elevees, de fevrier 1961 a avril 1964, a un total de 68 millions de dollars. Apres avoir rappele brievement Torigine des emissions en unites de compte europeennes, Tarticle examine com-

22 Loc cit. See also The United States Balance of Payments, Hearings Before the Joint Economic Committee of the Congress of the United States (88th Con- gress, First Session, July 8 and 9, 1963), Part I: Current Problems and Pol- ides, p. 143.

©International Monetary Fund. Not for Redistribution 456 INTERNATIONAL MONETARY FUND STAFF PAPERS ment les diverges emissions ont defini Tunite de compte et determine les conditions auxquelles Funite de compte pouvait etre modifiee. Les regies presidant au choix des monnaies a utiliser pour le paiement des souscriptions et interets et pour le remboursement sont egale- ment decrites. Les caracteristiques "classiques" des emissions sont enfin rappelees. De cet examen il parait resulter que les rendements reels des obligations en unites de compte sont vraisemblablement plus eleves que les rendements d'obligations nationales dans les pays emetteurs. Le principal avantage d'emissions en unites de compte parait avoir ete de donner a des societes un acces a des marches de capitaux etrangers quails n'auraient probablement pas eu sans le recours a la formule des unites de compte.

Emisiones en unidades de cuenta europeas

Resumen A partir de 1961 se ha desarrollado en Europa una nueva formula para las emisiones extranjeras: las obligaciones en unidades de cuenta europeas. Las emisiones publicas de tales obligaciones, las cuales se efectuan en varios mercados monetarios bajo la egida de un sindi- cato encabezado por bancos belgas, se elevaron entre febrero de 1961 y abril de 1964 a un total de US$68 millones. Despues de hacer memoria brevemente del origen de las emisiones en unidades de cuenta europeas, el articulo examina la forma en que las varias emisiones ban defmido la unidad de cuenta y determinado las condiciones bajo las cuales podria modificarse. Se describen asimismo las reglas para la seleccion de las monedas que ban de utilizarse para el pago de las subscripciones e intereses, y para los reembolsos. Por ultimo, se resenan las caracteristicas "clasicas" de las emisiones. De este examen se desprende que los rendimientos reales de las emisiones en monedas de cuenta son probablemente mas elevados que los obtenidos de obligaciones nacionales en los paises emisores. La principal ventaja de la emision en unidades de cuenta parece haber sido la de permitir a las companias acceso a los mercados de capital extranjeros' opor- tunidad que es muy posible no hubiesen tenido de no haber recurrido a la formula de la unidad de cuenta.