Eurocurrency Market

Key takeaways

• The eurocurrency market is the market for currency deposits held outside the currency’s home country (for example, U.S. dollars held outside the U.S., called eurodollars).
• It developed to provide a funding and lending channel outside domestic regulation, often resulting in higher deposit rates and lower loan rates than domestic markets.
• Major participants include banks, multinational corporations, mutual funds, and hedge funds.
• The market carries higher regulatory and liquidity risks because deposits lack the protections and reserve requirements of domestic banking systems.

What is the eurocurrency market?

The eurocurrency market consists of deposits and loans denominated in a given currency but held or issued outside that currency’s domestic banking system. It is a wholesale money market used to place and borrow large sums in foreign jurisdictions, often to avoid domestic regulatory, tax, or interest-rate constraints.

Note: “Eurocurrency” does not refer to the euro (the EU currency). The term originated with eurodollars (U.S. dollars held outside the United States) and applies to any currency traded offshore.

History and development

The market grew after World War II, when large dollar flows to Europe (partly tied to reconstruction efforts) created demand for dollar deposits outside the U.S. London became an early center for these markets. Over time, other currencies (yen, pound, etc.) developed similar offshore markets wherever there was demand to trade that currency outside its home jurisdiction.

How it works

• Deposits and loans in the eurocurrency market are typically large and short-term. Common maturities range from overnight up to 12 months.
• Because eurocurrency accounts are held outside national jurisdictions, they generally aren’t covered by domestic deposit insurance and are not subject to the same reserve requirements.
• Reduced regulation and reserve obligations often allow higher rates for depositors and lower borrowing costs for lenders compared with domestic markets.
• Transactions are usually between banks and large institutional participants; minimum transaction sizes are large (historically often $25 million or more).

Major types of eurocurrency markets

• Eurodollar: The largest and most influential segment—U.S. dollars deposited outside the United States. Eurodollars can be held in a wide range of financial centers (London, Singapore, Caribbean jurisdictions, etc.). Trading often occurs among U.S. institutions as well.
• Euroyen: Offshore markets for Japanese yen, which expanded notably in the 1980s and 1990s as international demand for yen funding grew.
• Eurobond market: While not a deposit market, eurobonds allow borrowers (governments, corporations, financial institutions) to issue debt denominated in a currency different from their home currency and place it in international markets. The first widely noted eurobond issuance occurred in 1963.

Advantages

• Greater competitiveness: Offshore markets can offer borrowers lower borrowing costs and depositors higher returns than some domestic markets.
• Flexibility: Enables firms and governments to access funding in foreign currencies and to diversify funding sources internationally.
• Size and liquidity: These markets can handle very large transactions and attract global liquidity.

Risks and limitations

• Regulatory and protection gaps: Offshore deposits usually lack domestic deposit insurance and may not be subject to home-country prudential regulations.
• Liquidity risk: In stressed conditions, the market can be vulnerable to runs or sudden withdrawals.
• Counterparty and settlement risk: Large wholesale exposures increase the importance of counterparty creditworthiness and reliable settlement arrangements.
• Exchange-rate risk: Participants borrowing or lending in non-domestic currencies face currency risk unless hedged.

Brief FAQs

Q: Is the eurocurrency market tied to Europe?
A: No. It began in Europe but refers broadly to offshore markets for any currency.

Q: What is legal tender?
A: Legal tender is money that a country’s law recognizes as the valid medium for settling debts and transactions within its borders.

Q: Are eurobonds the same as “euro bonds”?
A: Eurobonds are bonds issued in an international market and denominated in a currency different from the issuer’s home currency. “Euro bond” (two words) sometimes refers specifically to bonds denominated in euros and issued within the eurozone.

Conclusion

The eurocurrency market is a major global wholesale funding arena that enables large-scale, cross-border deposits and loans in currencies outside their home jurisdictions. It provides competitive pricing and liquidity benefits but carries heightened regulatory, liquidity, and counterparty risks that participants must manage.