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4.6.1.6 Domestic and international equity

Once they get to a certain size, companies have the choice of diversifying their sources of external finance by accessing the capital market. We have already noted that the largest firms can issue bonds and raise funds in the syndicated loans market, but before they can access these markets it is more than likely that they have become publicly listed on their domestic stock exchanges and raised equity finance through the issue of shares (or stock as it is known in the United States). The next step maybe to consider a listing in a foreign market - known as a Euroequity issue. However, most firms are not known well enough overseas to attract foreign investors so they may first try a Eurobond issue where the market is for professional investors and if this is a success they may progress to a cross-listing of their shares on another stock exchange.

There has been a substantial growth in the cross-listing of shares during the 1990s and the US market has been a popular destination for such listings. In particular, European and Asian companies are keen to seek out US investors by listing not only in their home market but also in the United States. The main rationale is that a foreign listing provides the company with access to a more liquid capital market and a cheaper source of funding. There is also substantial prestige associated with obtaining a foreign listing on a major international stock market like the London and New York exchanges. Firms also seek to cross-list to diversify their source of funding and to tap new investor segments - such as various institutional investors that may not be prevalent in home markets. A cross-listing of equity in another market may also establish a secondary market for shares used to acquire other firms in the host market and such shares can also be used to compensate local management and employees in foreign subsidiaries.

4.6.1.7 Securities underwriting, fund management services, risk management and information management services

In addition to the financial services already mentioned, international banks also provide a variety of sophisticated services that complement traditional credit and debt finance facilities. These services are numerous but they can be broadly grouped into three main categories: guarantees; foreign exchangeand interest raterelated transactions; securities underwriting and fund management services (the main features of such services have been illustrated in Section 3.5.2).

4.6.1.8 Foreign exchange transactions and trade finance

Firms involved in international trading activity can rely on the banking system to

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provide various forms of trade finance that help facilitate the import and export of goods. The three main types of trade finance relate to the provision of letters of credit, forfeiting and countertrade.

Letters of credit

A letter of credit is a legal banking agreement that allows importers to offer secure terms to exporters. Letters of credit have been used for centuries in international trading transactions. The letter of credit from a bank guarantees to the seller that if various documents are presented, the bank will pay the seller the amount due. It is simply an undertaking given by the issuing bank on behalf of the buyer to pay a seller a specific amount of money on presentation of specified documents representing the supply of goods within certain time limits. These documents must conform to terms and conditions set out in the letter of credit and documents must be presented at a specified place.

Such an agreement offers security to the seller as an assurance of payment from an international bank, on the condition that the terms of the letter of credit are complied with. In addition, a seller can also raise extra finance using the letter of credit as collateral if necessary.

The attraction from the buyer's perspective is that they do not have to pay cash up front to a foreign country before receiving the documents of title to the goods purchased. This is obviously helpful when the buyer is unfamiliar with suppliers j overseas. In addition, a letter of credit protects the buyer's interests as the bank will only pay the supplier if specific documents are presented. Payment will be given if these documents comply with the terms and conditions set out in the letter of credit. The buyer can also include safeguards into the letter of credit such as inspection of the goods, quality control and set production and delivery times. Table 4.2 sets out the main features of a standard letter of credit agreement.

An irrevocable letter of credit provides a guarantee by the issuing bank in the event that all terms and conditions are met by the buyer. A revocable letter of credit, in contrast, can be cancelled or altered by the buyer after it has been issued by the buyer's bank.

Forfaiting

In a forfaiting transaction, the exporter agrees to surrender the rights to claim for payment of goods or services delivered to an importer under a contract of sale, in return for a cash payment from a forfaiting bank. The forfaiting bank takes over the exporter's debt and assumes the full risk of payment by the importer. The

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goods. This type of activity is usually more prevalent in countries that limit FDI and are subject to greater political risk.

4.6.2 New' credit products and securitisation

The growing corporate emphasis on capital market financing is also driving the development of a wider range of 'new' credit products . For instance, corporate debt is widely traded in the United States, either as bonds, syndicated loans or securitised assets - loans that are bundled together and sold as a security in the market. In the United States a broad array of loans are being securitised, including corporate loans, mortgages, credit card receivables, computer leases, and so on. The growth in credit derivatives business has also helped boost the market for tradable corporate credit products. Credit derivatives are tradable instruments that can be used to manage credit risk - the likelihood of default. The growth of such business means that nowadays around 50 per cent of all credits to US firms are tradable. This contrasts with the situation in Europe, where less than 20 per cent of credits are tradable.

While the European corporate bond market is under-developed compared with that in the United States, analysts predict that it will grow rapidly over the next five years. As companies seek to use a range of debt products it is most likely that many will choose tradable debt financing from the onset with high - yield corporate debt being the fastest growing segment.

As developments in these segments of the credit product market enhance liquidity this should facilitate the securitisation trend. While Europe has witnessed some high-profile bank loan securitisations (mainly in the form of Collateralised Debt Obligations, CDOs3) it is expected that the restructuring of banks' and large companies' balance sheets will continue at a faster pace, thus boosting the securitisation trend. Traditionally the bulk of loan securitisations in Europe were related to bank mortgage loans or top-end AAA corporate loans. Triple AAA loans are those of the highest credit quality assigned by the credit rating agencies; loans rated below BBB are regarded as high-yield or 'junk' issues. The growth of a deeper and more liquid market for corporate credit will therefore help the securitisation of lower-grade credits. Securitisation in Europe has traditionally been limited by the lack of quoted companies, poor disclosure standards and various other factors. Nevertheless, it seems likely that these obstacles will be overcome by the development of viable vehicles for securitising smaller credit issues and the growing investor demand for such products.

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The securitisation trend in both the United States and Europe is also likely to be reinforced further by e-issuance and e-trading platforms that will extend beyond the primary equity markets and fixed income trading already undertaken by many global as well as investment banks. At present, a handful of firms are attempting to develop online standards for a wide range of government and corporate bond secondary markets. In the United States firms such as TradeWeb and Deal Composer are developing such services, as are their European counterparts - such as EuroMTS.

In addition to a wider range of tradable credit products, many companies will also seek to use more tax efficient means of asset financing to fund their business including leasing and factoring/forfaiting. Traditionally, this type of business in the United States has been provided by specialist firms - such as GE Capital, whereas in Europe the main asset finance firms are owned by large banks. As more companies aggressively manage their balance sheets and identify the tax and other accounting advantages associated with alternative asset financing structures they are likely to increasingly require specialist services in this area. While businesses such as aircraft and computer leasing have been around for some time it is envisaged that a wider array of superspecialist asset finance firms may emerge, or may be developed by global banks, to deal with the financing needs of specific industries or market segments. Various European global banks have suggested that they may re-direct their asset finance business towards the medium-sized corporate sector to complement their traditional lending business.

Overall, global credit markets are expected to witness major changes over the next few years. Following the US model, Europe is likely to experience rapid growth in the corporate bond, syndicated lending, credit derivatives and loan securitisation business. Much more of this activity will relate to non-investment-grade or 'middlemarket' company businesses, many of which have modest international activities. In addition, traditional bank credit will also be substituted with asset finance that better matches corporate client needs and risk profiles.

3 CDOs are securitisations of packages of corporate bonds, loans and credit default swaps. They typically comprise of between 50 and 150 underlying securities, so the spread of risk or 'granularity' is less than, for example, mortgage securitisations. Balance sheet CDOs are created by banks from assets already on their books, although banks increasingly acquire assets in the market to create a CDO, sometimes to meet the requirements of a particular investor. The risk of default is