International Currencies and Capital Allocation

Using a new security-level dataset covering $32 trillion in global investment positions, this paper establishes that the currency a bond is denominated in – not the nationality of its issuer – is the dominant predictor of who holds it, and that this home-currency bias leaves most firms borrowing only at home while a small number of large foreign-currency issuers capture nearly all foreign bond capital. The data are Morningstar’s complete position-level holdings of open-end mutual funds and exchange-traded funds domiciled in over 50 countries, filtered to the 23 countries (14 of them inside the euro area, leaving 10 effective country units) where Morningstar’s coverage of fixed-income assets under management is at least a quarter of what the Investment Company Institute reports. Four facts follow. First, home-currency bias is strong and is identified within firm: comparing an investor country’s share of two bonds issued by the same parent but denominated differently, and controlling for maturity and coupon, Canadian funds hold a share of a Canadian-dollar bond about 90 percentage points larger than of a non-Canadian-dollar bond from the same issuer, with similarly large and precisely estimated coefficients for every other country (Table 2, p. 12). Running home-country and home-currency indicators side by side, the currency coefficient and R-squared are roughly twice those on country alone, and adding currency collapses the country coefficient while barely moving the currency one – so, at least for corporate bonds, the classic home-country bias documented since French and Poterba (1991) is largely confounded by home-currency bias (Table 4, pp. 14-15). Second, home-currency bias travels with a stark allocation of capital across firms: in each country a small number of large firms issue in foreign currency and borrow from foreigners, while most firms issue only in local currency and are held almost entirely by domestic investors. Probit estimates using Compustat, Worldscope and SDC data show that bigger firms are significantly more likely to issue in foreign currency on all four size proxies used (Table 5, p. 17). That this is not simply about which firms foreigners find unappealing is shown by the fact that the same local-currency-only firms do receive foreign equity investment (Figure 9b, p. 20). Third, the United States is the exception: a significant mass of medium-sized US firms issues only in dollars yet receives substantial foreign financing, which the authors read as the global taste for dollar debt effectively opening the capital account for local-currency US borrowers – a pattern found for no other country in the data (Section 4, pp. 16, 19-20). Fourth, in the time series the dollar’s role is recent rather than permanent: the dollar denominated 41 percent of global cross-border corporate debt holdings in the data in 2005 and the euro 38 percent, shares that were largely stable until 2008, after which the euro’s fell to 22 percent and the dollar’s rose to 63 percent (Introduction, p. 2; Section 5, pp. 21-22). The paper is explicit about its scope: the dataset contains quantities but not prices, so it cannot assess borrowing costs or quantify the value of the dollar’s privilege; it covers bond finance only and excludes bank lending; the analysis is of corporate rather than sovereign bonds; and the authors deliberately establish the four facts without identifying the mechanisms behind them, offering hedging costs, market segmentation by currency and fixed issuance costs as candidate explanations for future work to formalize.

Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens

Because global firms raise capital through subsidiaries incorporated in tax havens, official residency-based statistics attribute those securities to the haven rather than to the parent’s country; this paper matches the universe of traded securities to their ultimate parents and restates bilateral investment positions, finding developed-market financing of large emerging market firms to be dramatically larger than reported and China’s net creditor position to be roughly half its official size. The scale of the problem is set by two numbers: the corporate sector globally raises 7 percent of its equity and 9 percent of its bond financing through foreign subsidiaries located in tax havens, and CPIS records $3.9 trillion of foreign portfolio investment in the Cayman Islands in 2017 against a Cayman GDP of $5 billion. The method has three steps. First, combining seven commercial data sources, the authors map each issuer of the 26 million stocks and bonds in CUSIP Global Services’ master file to a single ultimate parent, reallocating more than 90 percent of the corporate bonds and equities issued in each of Bermuda, Curacao, the Cayman Islands, the Channel Islands, Luxembourg, Macau, Panama and the British Virgin Islands. Second, merging that mapping with Morningstar security-level holdings of 61,000 funds reporting over 11 million positions worth $32 trillion as of December 2017, they build “reallocation matrices” giving, for each investor country, asset class and year, the share of residency-based holdings in each country that belongs to each other country on a nationality basis. Third, they apply those matrices to two public residency-based datasets – the US Treasury’s TIC and the IMF’s CPIS – for nine developed investor economies with adequate fund coverage. Two patterns dominate the redrawn map. Bond positions in the BRICS are far larger: US corporate bond holdings in the BRICS rise from $19 billion to $126 billion, a 560 percent increase, and euro-area holdings from $152 billion to $389 billion, because emerging market corporates issue through haven affiliates partly to spare foreign bondholders withholding taxes that are 15 percent in Brazil and 20 percent in Russia but zero in the British Virgin Islands, the Cayman Islands, Luxembourg and the Netherlands. Equity exposure to China is far larger still: US holdings rise from about $150 billion to almost $700 billion, the euro area’s from under $100 billion to over $300 billion, overwhelmingly reflecting Variable Interest Entities listed in the Cayman Islands. Because foreign claims on VIEs enter China’s accounts as intercompany positions valued without reference to listed share prices, China’s reported net creditor position of $2.1 trillion at end-2018 is overstated by $1.1 trillion. The paper is careful about what it does and does not establish. Its central identifying assumption is that reallocation matrices built from fund holdings are representative of all security investment, which it tests against US insurance-company and Norwegian sovereign-wealth-fund holdings, obtaining best-fit slopes of 0.98 to 1.00 with R-squared of 0.95 to 0.98. On China’s accounts it states that it has “corresponded with China’s statisticians and have no reason to believe their treatment of these FDI positions is inconsistent with official guidelines” – the claim is one of mismeasurement relative to market value, not of misreporting. And it insists there is no single correct restatement: alongside the baseline it offers full-nationality, guarantor-based and sales-based alternatives, since “the most appropriate concept in accounting for these positions will depend on the question at hand.”

Brent Neiman | Macro Paper Warehouse

International Currencies and Capital Allocation

Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens