Financial Cold War - James A. Fok

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of the office, Julius Strauss found the young Stanley Ross reading a translation of Marcel Proust's À la Recherche du Temps Perdu. Impressed with this display of intellect, Strauss promoted him to the equity trading department. From there, he was appointed to trade the Autostrade issue and was, therefore, one of the first people to trade the Eurobond market. He joined Kidder Peabody in 1967 and there oversaw the rapidly expanding trading in Eurobonds.

      Although London was establishing itself as the home of secondary trading in Eurobonds, in 1967 New York remained the centre where they were settled. The settlement process was still highly manual, and the rapid expansion in the volume of trades had created a logjam. Each night, the clerks would send a telex to the firm's bank in New York listing the bonds it should receive and deliver on its traders' behalf. Kidder Peabody's New York bank Schroder would report payments that it had made on its behalf against bonds received. The problem was that there never seemed to be any corresponding reports for cash received when the traders had sold bonds. At a time of rising interest rates, Kidder Peabody's overdraft costs were skyrocketing, eating up all the trading profits.

      Ross flew to New York to find out what was happening. His bank sent him down to the vaults where the bond certificates were held. There, he was handed a tatty folder containing all his firm's settlement instructions. When he opened the file, hundreds of delivery instructions flew up in the air and fluttered to the floor. Schroder had simply cut up all the telexes and acted on the instructions to receive bonds but left the delivery strips in the folder. There were all the profits!

      Traders weren't the only ones afflicted by the paperwork crisis, however. The market was unregulated and unscrupulous banks would frequently exploit the inefficiencies in the settlement infrastructure. The Belgian dentist and his ilk, who represented around 90 percent of market demand, sometimes wouldn't see their bonds for up to two years after paying for them. When they were finally delivered, it would often be without the intervening coupon payments. If this situation were allowed to continue, it would eventually kill the market.

      The logjam in New York only affected US dollar-denominated Eurobonds. Luxembourg, which had long historic, linguistic and commercial ties to its neighbours, had emerged as an offshore banking centre within Europe. By the late 1960s, Luxembourg banks had developed a thriving business in bond settlements and might have seemed poised to capture more business from New York. However, operations there too were paper-based and involved the transportation of bond certificates between various banks in armoured vehicles, which was a costly process prone to settlement errors. A greater problem in Luxembourg though was its paucity of fine dining venues.

      The closing lunch was something of a ritual in the Eurobond market in those days. The closing of a Eurobond issue required the physical handover of the bond certificates by the borrower, once it had confirmation that the lead manager had paid over the issue proceeds. This would usually involve a small ceremony, followed by a gourmet lunch. French tax law precluded Paris as a venue for closings, while stamp taxes ruled out London. In the search for an alternative, one banker approached the head of Morgan Guaranty's securities department in Belgium to see if Morgan might be able to host closings in Brussels. The city possessed the requisite standard of cuisine and had good transport links with major European cities. Thus, in 1965, Morgan Guaranty began to host closings in Brussels.

      Stanley Ross was an enthusiastic early adopter of this service and Kidder Peabody became the first major trading firm to insist that anyone wanting to deal with it would have to become a member of Euroclear. The ICSD quickly became a significant profit centre for Morgan, since it paid little interest on the large and stable amounts of cash held in its clients' cash accounts and was able to invest this cash to reap substantial income.

      Concerned that Euroclear would give Morgan Guaranty key insights into its competitors' activities, a group of Luxembourg and foreign banks established Cedel in Luxembourg in September 1970. Bitter competition and rivalry between Euroclear and Cedel would serve to drive down settlement fees further, much to the benefit of customers.

      To allay the competitive concerns, Morgan Guaranty sold Euroclear to its users in 1972, though it continued to profit from providing credit to Euroclear's customers until Euroclear set up its own bank in 2000. Cedel was fully acquired by Deutsche Börse in 2002 and is now known as Clearstream.