By Daniel Archibald | CFA
When most investors think about investing internationally, the investments that usually come to mind are the big U.S. stocks such as Apple, Amazon or Bank of America. Exposure to foreign stocks like these are likely to have a home in the portfolio of a well-diversified, Australian portfolio. These stocks are traded on onshore markets in the U.S. - the NY Stock Exchange and the NASDAQ. That is, even though they are foreign stocks in the eyes of a non-U.S. Investor, the stocks trade in the currency of their home market.
An offshore market is one in which their is no real home country, or where the securities are traded in currencies other than that of the local jurisdiction. Most of the world's largest stock markets are onshore, with only a handful of smaller, specialist exchanges offering equity in offshore markets (e.g. 'The International Stock Exchange'). Other than stock markets, the main types of onshore capital markets are:
- Money market
- Bond market
- Derivatives and commodity markets
These stand-alone markets are generally interbank or institutional. In some countries, the marketplace can be a mix of different underlying markets. This is the case in Australia where the ASX (Note: Australian Securities Exchange NOT Australian Stock Exchange) offers an onshore market for stocks, bonds and derivatives to institutional and retail investors. Bonds, derivatives and commodities in Australia are also traded on over-the-counter equivalents, which are markets mainly reserved for banks, super funds and other large institutions (both domestic and foreign). All the securities in these onshore market places are priced in $A and based on Australian interest rates. These exchanges allow domestic and foreign participants to ability to issue and trade in securities under domestic regulations.
Most all developed and developing countries have well-established onshore markets. Domestic, and usually foreign, investors can access these markets to raise capital, invest or speculate. As is the case in Australia, onshore markets in any jurisdiction will have securities traded in regulated currencies, under regulations of the home country.
But what if you didn't like the restrictions placed on trading by the home country. What if you wanted to raise debt and issue bonds in Japanese Yen, but wanted to avoid regulations that would likely increase your borrowing rate. Offshore markets fill this void. The most common type of offshore capital markets are:
- FX market - the real offshore market, with the biggest trading centre in London
- Eurocurrency market - 'euro' in this case does not refer to the Euro currency, but simply to the fact that offshore markets grew mainly in Europe. This market is equivalent to onshore money markets (short term deposits and bills)
- Eurobond market - this market is equivalent to onshore bond markets
- Commodities market - the London Metals Exchange (LME) is effectively an offshore market for commodities as most contracts are priced in $U
As highlighted, traditional home of most offshore markets is London and Europe.
Overall, for the offshore market to work, there needs to be a level of trust between participants, owing to their unregulated nature. Thus, offshore markets tend to only include banks, large investors and large institutions. Also, the majority of offshore market trades are in $US, such as eurodollar deposits traded in the eurocurrency market or eurodollar bonds traded in the eurobond market. Euroeuro, euroyen and eurosterling securities are also common.
With the rise of China, the importance of the $US is likely to diminish. London and Europe are still likely to be the main offshore trading hubs, but Hong Kong, Singapore and Sydney are also likely to grow in importance. And as currency restrictions are lifted and the Chinese renminbi begins to freely float, euroyuan deposits and bonds are also likely to become common place on offshore markets. It may be wishful thinking, but perhaps the markets could also replace the euro-prefix, so as to stop unnecessary confusion with the euro currency...