European bonds glimmer on far shore across broad ocean of SEC regulation

Allen Webb is puzzled and a little bit miffed.

A fixed-income analyst for the Retirement Systems of Alabama in Montgomery, Mr. Webb said back in the summer that he was looking to invest a sliver of the $24 billion fund in European corporate bonds.

But, at the end of October, he still was waiting to pull the trigger.

“Some European paper being issued is shut out to U.S. investors,” says Mr. Webb, who’s no neophyte at investing overseas. Along with $10.3 billion in domestic fixed-income, he and Julie Barranco, assistant director, manage the fund’s European government bond portfolio, which has fluctuated between $185 million and $325 million this year.

European buyers get first crack. The Securities and Exchange Commission requires U.S. investors to wait more than a month before buying into some of the deals, many of which have been attractively priced.

European corporations should love to have U.S. pension funds buying their offerings, Mr. Webb says.

Not so, others respond, pointing to the SEC’s 40 day “seasoning period” as the culprit. For a foreign bond to comply with SEC regulations, companies must pay extra fees and open their books to Washington regulators. Registered U.S. investors such as pension funds and their money managers are free to buy the paper after the bond is fully subscribed or sold and the waiting period has elapsed.

The rule was written 66 years ago to protect U.S. investors. Now, some say, it works to protect buyers in Europe from U.S. competition.

Buying European corporates would have been a first for the Alabama Retirement Systems, where officials were thinking about diversifying the portfolio and finding more yield. Mr. Webb — like plenty of others –believed the corporate bond market would explode in 1999 with the advent of the euro.

The market has boomed, with $235 billion issued through June vs. $140 billion in the first six months last year, according to Capital Data Ltd. in New York

“The boom’s happening, but not for U.S. investors,” says Mr. Webb.

good for europe

European investors are “getting the benefit” of the seasoning period, says Michael Maquet, a director with Merrill Lynch & Co. Inc. in New York.

Only 28% of the corporate bonds this year were geared to U.S. investors and comply with the SEC’s Rule 144A, reports Lehman Brothers International Europe in London.

“Bonds can be issued in a global format, but that means complete reporting to the SEC,” Mr. Maquet says.

Demand abroad is more than enough to soak up the tide of issues. And insiders point to the tax benefit European owners of the bonds receive: The bonds are typically “non-bearer” and issued with less paperwork than 144A issues, so their ownership cannot be easily traced.

U.S. investors and fund managers point to one deal in particular, July’s $6.25 billion issue by Tecnost SpA, to illustrate their frustration. Tecnost, the holding company controlled by Olivetti SpA that Olivetti used to finance its hostile takeover of Telecom Italia SpA, was off limits to U.S. investors. The deal was “one of the cheapest investment-grade telecoms in Europe,” says Chris Wilson, vice president and portfolio manager with Alliance Capital Ltd.

“Our U.S. domiciled clients had to wait” the 40-day period for Tecnost to become seasoned, says Mr. Wilson, who directly manages $1.6 billion in global bonds, the bulk of which is for European clients. He’s part of a team that runs $7 billion in global bonds for Alliance in London.

And the waiting period costs. “When Tecnost seasoned, it tightened by 10 basis points” because of demand from U.S. money managers, he says. “There is no trick getting around this. There’s no trick getting it into U.S. accounts.”

Mr. Wilson notes the seasoning rule blocked him from buying a dozen issues this year when they first came to market. Alliance’s U.S. clients’ portfolios have “lost maybe 25 to 30 basis points this year” because of the forced delay.

seasoning slipping?

Over the next few years, the seasoning rule will have less of an effect on U.S. investors, he predicts. Mr. Wilson says buying European corporates is not “a problem if you have an offshore fund, but if you’re a state pension board, that’s a problem.”

Not all brokers and managers see the SEC’s enforced waiting period as a problem. Louise Purtle, euro credit product manager with Deutsche Bank Securities Inc. in New York, has a seasoning calendar that tracks when the deals are likely to become available to U.S. investors.

She is pleased with the market’s growth. A $1 billion issue was common at the beginning of the year, where now $4.5 billion issues come to the market regularly, she adds.

Another problem is that investors are looking for pure European plays. Corporate issues in euros by U.S. corporations such as Ford Motor Co., just don’t give the pension fund the yield — or the exposure to European companies — it’s looking for, he says.

Still, some European companies looking for U.S. investors are tailoring their issues to SEC rules, says Mr. Maquet at Merrill Lynch. He points to a recent issue by Germany’s Dresdner Bank AG as one example.

Yet it’s far more common for European companies offering junk bonds to comply with the SEC regulations, sources say, and they are less-than-plentiful in Europe. More than 70% of European corporates are rated AA or higher, according to Lehman Brothers in London.

In the end, the European corporate bond market is not as sophisticated as the one here. Managers can’t pull up information at a touch, for instance. “It’s not as easy to get a list of the top 50 issues and where they’re trading,” says Laura Zimmerman, senior vice president, portfolio strategist, global bond portfolios, with Payden & Rygel in Los Angeles.

Too, credit spreads have been tighter in Europe than in the United States this year, Ms. Zimmerman says. “People will take a 90-basis-point higher yield” by investing in U.S. corporate paper, she says.

Her $4 billion global bond portfolio is proof. At the beginning of the year, she thought she would have 50% in European corporate and sovereign paper. But, by the end of the year, that percentage is likely to be only 25% to 30%. “That reflects relative value, not issuance,” she stresses. “U.S. and U.K. holdings are cheap.”