Since 1988, the costs of clearing and settlement of MTNs have decreased substantially as a computer-based system of book-entry recordkeeping has supplanted physical certificates. When an MTN is issued under the book-entry system, an agent bank for the issuer uses a computer link with The Depository Trust Company (DTC) to enter the descriptive information and settlement details of the transaction. The sales agent receives a copy of the computer record from DTC, and the investor receives a trade confirmation from the sales agent and periodic ownership statements from the custodian bank, in lieu of physical certificates. Secondary market trades are likewise recorded with computer entries. Under the book-entry system, an issuer makes one wire transfer to DTC that covers all interest payments on each interest payment date. This payment process contrasts with the process for physical certificates in which issuers make separate payments to each investor. Similarly, under the book-entry system, when the MTN matures, the issuer makes only one funds transfer to DTC. In the late 90's, the DTC book-entry process costs $4 for each issuance, and each participant in a transaction pays between $1.29 and $1.54 for subsequent deliveries in the primary and secondary markets. Besides reducing the direct cost of issuance, the book-entry system also lowers the likelihood of delayed delivery because of logistical problems and reduces the chances of failed trades arising from paperwork errors. Book entry has become the preferred method of clearing and settlement in the MTN market. According to DTC, issuance of book-entry MTNs rose from $600 million in 1988 to over $1 trillion. In the 1980s, SEC disclosure requirements associated with public offerings discouraged foreign corporations from issuing MTNs in the U.S. public market. For foreign corporations, the most burdensome requirement is that financial statements conform to U.S. generally accepted accounting principles. Most foreign issuers would have to incur considerable legal and accounting expenses to meet this requirement, and many would have to disclose more information about their operations than is required in their home markets. The expense of registering securities and satisfying ongoing reporting requirements has also deterred foreign entities from borrowing in the U.S. market. Foreign issuers could avoid the costs of a public offering by selling MTNs in the U.S. private placement market. However, yields on most private placements included an illiquidity premium resulting from regulatory restrictions on trading. The adoption of SEC Rule 144A in April 1990 effectively created an alternative market in which foreign corporations could gain access to U.S. investors without having to satisfy the disclosure requirements for public offerings. Rule 144A allows institutional investors to trade private placements among themselves with few restrictions. To protect less sophisticated investors, the SEC requires that 144A securities be sold only to "qualified institutional buyers," which own and invest in a minimum of $100 million in securities. This definition is broad enough to include most of the institutions that buy MTNs, such as banks and bank trust departments, insurance companies, pension funds, mutual funds, investment advisers, and state and local governments. A foreign issuer of a 144A security must provide, upon demand by a security holder or potential purchaser, a brief description of the business and financial statements for the three most recent fiscal years, which can be in the accounting format used in the issuer's home country. Privately placed MTNs are an example of a security that may be eligible for resale under Rule 144A. Since the adoption of Rule 144A, issuance of MTNs by foreign corporations in the U.S. private market has increased markedly. In general, MTNs issued by foreign corporations under Rule 144A have similar characteristics to those sold by U.S. corporations in the public market. Both typically are dollar denominated and investment grade, with standard covenants. The adoption of SEC Rule 415 in 1982 was the key event that removed the regulatory impediments to continuous offerings of corporate notes. Other regulatory changes, such as SEC Rule 144A and liberalizations by European central banks, have been instrumental in the development of new sectors in the MTN market. As a result of these regulatory changes, financial markets have become more efficient. In 1992, the SEC eased restrictions on the types of securities eligible for shelf registration. As a result of this ruling, asset-backed MTNs emerge as the next major growth sector in the public MTN market.
There is perhaps no other investment that is as popular as MTN Private Trading Programs, yet so hard to understand due to its privatization. Here's a peek at the private world of MTNs.
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