Development of Equity-Linked Securities Market in Europe: Drivers Behind the Growth

By Agnese Aboltina, Janis Skutelis / Tutor: Ph.D. Joel Reneby / Stockholm School of Economics, 20 December 2001

This thesis tries to determine the factors that have driven and hindered the rise in volumes of convertible securities market historically and furthermore to distinguish convertibles as an asset class different from bonds and equity, while detecting the main benefits and drawbacks for investors and issuers.

Executive Summary

This thesis examines development of equity-linked securities market in Europe, volumes of which have increased significantly only during the last decade. The area of this study has enjoyed little academic attention that makes this paper more valuable.

The following aims had been set for this study:

• To determine what factors have driven and hindered the rise in volumes of convertible securities market historically.
• To distinguish convertibles as an asset class different from bonds and equity, while detecting the main benefits and drawbacks for investors and issuers. Both quantitative study focusing on drivers covering period of 1987-2001 and a qualitative study detecting market participants and market development issues has been performed. Below is the summary of findings during both approaches.

Conclusion

Regression results

• Equity volatility has a positive relationship with CB issue volumes: the higher the volatility, the higher the CB issuance volumes. This is believed to be the main driver, as it also represents the core profit driver for convertible arbitrage funds, the main investor group.
• Interest rate level has a negative relationship with CB issue volumes: the lower the interest rates in the market, the more CBs are issued.
• No relationship between equity market returns and CB issue volumes was found. It can be explained by the variety of investors buying CBs at both upturn and downturn of equity market.

Findings from qualitative study

• Other significant CBs market drivers are: mergers & acquisitions activity, bigger focus on shareholder value resulting in sell-off of non-core equities, demand side growth facilitated by larger risk adjusted returns, supply side growth encouraged by cheaper funding in terms of lower coupon payments, and other significant forces like increasing competition among investment banks and more favourable regulations.
• Convertible and exchangeable bonds have many distinguished benefits compared to debt and equity suggesting to perceive them as a new asset class. However, market participants have to be aware of the various drawbacks to fully benefit from investment in CBs.