Luke Heath Milsom, Vladimir Pachetka, Isabelle Rolland, Dariusz Wojciek
Exports of financial services decline with geographic distance at a rate similar to that of international trade in goods (eg, Portes and Rey (2005)). This is surprising because there are no transportation costs involved. The consensus is that distance is a proxy for informational friction. We show how sharing across borders can help overcome information barriers to trade in financial services. We enlarge the underwriting industry as international syndicates reduce information asymmetry between issuers and investors located in different countries.
International links between financial institutions is a major feature of the integration of global financial markets. Recent contributions have highlighted its positive effects on international trade in goods (Caballero et al (2018), Claessens and Van Horen (2021)). Surprisingly little is known about the empirical impact of international linkages on international trade in financial services. We set out to bridge this knowledge gap.
Geographical patterns of international equity transactions are strongly influenced by information frictions, which represent barriers that investors face in accessing and interpreting price-relevant information, particularly soft information, about foreign issuers (Sarkissian and Schill (2004), Portes and Rey (2005)). However, information frictions can be mitigated by financial and reputable intermediaries, including venture capitalists, equity research analysts, accountants, auditors, law firms, and stock underwriting firms among others (Dunbar (2000), Pollock et al. (2004), Ljungqvist et al (2009), Jeon and Lijon (2011)). We focus on the role of securities guarantee networks, which play an important role in enabling companies to access global capital markets.
Cross-border syndication plays an important role in the global equity issuance activity. When companies issue equity securities domestically or abroad, the offering can be subscribed by a single underwriter or what is called an underwriting syndicate, which is a group of financial institutions temporarily formed to sell the new securities to investors. The purpose of underwriting syndicates goes far beyond sharing risk among underwriters. In fact, one of their main purposes is the production of information. Undertakers participating in a union collectively have a higher potential for collecting and disseminating information than any individual union member. Thus, the links formed through international underwriting syndicates facilitate the flow of information across borders and limit information friction between issuers and investors located in different countries.
In a recent Bank of England staff working paper (Milsom et al (2023)), we argue that through this channel co-links enhance exports of equity underwriting services, providing supporting evidence using gravity equations consistent with the theory. We build a comprehensive two-country panel dataset of trade flows by aggregating transaction-level data on underwriting-related revenue streams from the Dealogic Equity Capital Market database. Our dataset covers 122 countries of origin and 145 countries of destination for the period 2000-15.
Exploiting the associative structure to measure the flow of information resulting from associative links
We build a scale of newly formed “Core Links” that act as proxies for the flow of information between business partners. To do this, we exploit the structure of underwriting syndicates. The principal underwriter is primarily responsible for due diligence, while other syndicate members primarily sell securities to investors within their networks. In other words, the information is mainly obtained by the major insurance companies. Therefore, the flow of information between trading partners is stronger when the guarantor in the importing (exporting) or exporting country is the main guarantor. We refer to these sharing links as “basic syndication links”. While information can still be expected to flow between trading partners when underwriters in both countries are non-principal underwriters, the information content of new partnership relationships should be lower. We refer to these union ties as “marginal union ties.” The question we ask is whether newly formed relationships increase the flow of underwriting services between business partners? Therefore, our explanatory variables measure the number of newly connected bank binaries per pair of countries in each year.
Recognize the impact of newly formed unions on exports
We estimate the gravity equations and find that a 1% increase in new core joint links increases exports by 0.243%. In other words, a doubling of the change in the density of primary links is associated with an increase in exports of 24.3%. According to their lower informational content, new peripheral partnerships have less impact on exports. The effect of a 1% increase in new core interconnections on exports is about seven times greater than that of new peripheral interconnections.
Our aim is to isolate the causal effect of unions on exports through information production (display side effects). The identification of this causal effect is compromised by reverse causation, in which underwriters from export markets create new linkages in import markets in anticipation of an increase in exports due to demand shocks in the importing country (demand side effects). To rule out reverse causation, we develop an effective variable approach that focuses on exogenous supply-side shocks. Specifically, we measure shifts in the interest of the exporting country’s insurers in each importing country as an export destination unrelated to changes in the demand-side outlook in the importing country itself. When they are used, the effect of new primary links is slightly smaller: a doubling of the change in the density of primary links is associated with a 22.1% increase in exports.
Borrowing reduces information friction between issuers and investors
We present more evidence that unions promote exports by mitigating information friction. First, we show that the new core co-links are more important when the importing (exporting) country is more risky. The impact of new core interconnections on exports is greater when the destination country scores worse on the International Country Risk Index, has a worse sovereign credit rating as measured by Moody’s, and performs worse in terms of resolving insolvencies as per the World Bank report. business surveys. Second, we show that new underlying co-links are also important for more information-sensitive transactions, that is, initial public offerings rather than subsequent offerings and convertible debt.
In conclusion, cross-border sharing is a critical mode of supply in the financial services trade, particularly when informational frictions between trading partners are intense. The ability of a country’s insurers to form international syndicate ties is a critical, yet little researched, determinant of a country’s export potential.
Luke Heath Milsom works in the University of Oxford’s Department of Economics, Vladimir Bachetka works in the University of Leeds Business School, University of Leeds, Isabelle Rowland works in the Bank’s Macro Financial Risk department and Dariush Wojciek works in the School of Geography and Environment, University of Oxford.
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