On July 1, 1963, Autostrade, the operator of Italy’s national system of motorways, issued the world’s first eurobond. The eurobond is credited with many fine things from the rebirth of London as Europe’s financial center to one of the major steps in postwar recovery in Europe. To a capital market aficionado, it has a strict legal form and tax-free status. And the eurobond began life as a tax arbitrage tool for Europeans seeking a safe home for their capital. But first, what is a eurobond?

Definition of Eurobonds

A eurobond is an international bond that is denominated in a currency that is not native to the country where it was issued. For example, Autostrade, an Italian company, issued a $15 million bond denominated in U.S. dollars. That’s it. It’s that simple.

How Eurobonds Offered Tax Arbitrage and Why They Were First Offered

In the 1960s there were a lot of middle-class people in Europe, but there were not that many low-risk places where they could place their savings and expect a safe return.Regulation Q in the U.S. discouraged Europeans from placing money in their deposit accounts because this portion of the Glass-Steagall Act limited the interest rates paid on deposits.

Also contributing to the birth of the eurobond was a new tax in the U.S. that discouraged Americans from investing in foreign securities. The Interest Equalization Tax of 1963 levied up to a 15% tax on the price of a bond purchased by a bondholder. Yes, 15%! The goal of the tax was to decrease capital account outflows and to increase investment in the US. However, with fewer dollars flowing into investments in Europe, European companies needed dollars to fund their projects.

Thus was born the eurobond.

The first eurobond served as the blueprint for the rest. Autostrade’s eurobond was designed by London bankers, it was issued in Schipol airport in Amsterdam to avoid British stamp taxes, and the bond coupons were payable in Luxeumbourg to avoid British income tax. This effectively allowed a German doctor to invest his capital in a bond that was sheltered from tax while grew it in a Luxembourg bank.

This product’s success speaks for itself. In 1966 the market grew to $1 billion, and it reached its peak of $4.5 trillion in 2009.

The Future

The future of the European eurobond is uncertain. London, Hong Kong, and Singaporean bankers have been very successful at creating and underwriting eurobonds, and the Asian countries will likely continue to be successful for sometime. The big risk is that European governments are moving towards implementing a transaction tax on bond trading in Europe, which could be the beginning of the end of European eurobond finance.