Medium Term Notes (MTNs)

 Creation of the MTN

1. Issuer Decision: Typically, a corporation or financial institution decides to issue an MTN to raise capital for medium-term needs. This decision is often influenced by the issuer's funding strategy, market conditions, and capital structure.
2. Structuring the MTN: The issuer, often in consultation with financial advisors and underwriters, structures the MTN. This involves deciding the total amount, currency, maturity period (usually 1-10 years), interest rate mechanism (fixed or floating), and repayment structure.
3. Credit Rating Assessment: A credit rating agency assesses the issuer's creditworthiness, assigning a rating that impacts investor perception and pricing of the MTN.
4. Documentation and Legal Compliance: Issuers prepare a detailed prospectus, outlining the terms of the MTN, risks involved, and legal disclosures. Compliance with regulatory requirements is critical.
5. Global Note Creation: For ease of transaction, a global note representing the entire issuance is created and registered with a common depository like Euroclear or Clearstream.

Primary Market Dynamics

1. Underwriting Process: Investment banks or underwriters are engaged to market the MTNs to potential investors. They play a crucial role in setting the initial price based on market demand, issuer's credit rating, and prevailing interest rates.
2. Marketing and Book Building: The underwriters conduct roadshows to gauge investor interest. They build a book of orders, adjusting the pricing based on demand.
3. Pricing and Sale: The final price is set, and the MTNs are sold to institutional investors like pension funds, insurance companies, and asset managers. The global note facilitates this process.
4. Settlement: The sale proceeds are transferred to the issuer, and the investors receive their MTN holdings, recorded in the global note system.

Secondary Market Transactions

1. Trading: MTNs are traded over-the-counter (OTC) in the secondary market. Brokers and dealers facilitate transactions between buyers and sellers.
2. Euroclear/Clearstream (or other) Role: These clearinghouses manage the global note, updating ownership records as trades occur. They ensure the secure and efficient transfer of securities.
3. Price Fluctuations: In the secondary market, MTN prices fluctuate based on interest rate movements, changes in the issuer's credit rating, and overall market demand.

Maturity of the MTN

1. Approaching Maturity: As the maturity date nears, the issuer prepares to repay the principal amount to the MTN holders.
2. Repayment: On the maturity date, the issuer repays the principal amount to the current holders of the MTN. This is facilitated through the clearing system (Euroclear/Clearstream).
3. Closure of Global Note: Upon full repayment, the global note is closed, and the MTN is removed from the system.

Professional Resources and Best Practices

• Legal and Financial Advisory: Issuers often engage legal and financial advisors to ensure compliance with regulations, proper documentation, and effective market strategies.
• Market Research: Continuous market research is essential to understand investor appetite, interest rate trends, and credit market dynamics.
• Risk Management: Issuers and investors alike must manage credit risk, interest rate risk, and liquidity risk associated with MTNs.
• Regulatory Compliance: Adherence to securities regulations and guidelines is critical throughout the MTN lifecycle.

Conclusion

The MTN market is a sophisticated and dynamic segment of the financial industry, requiring careful coordination among issuers, underwriters, investors, and clearing systems. From the initial decision to issue an MTN to its final maturity, each stage involves intricate processes and professional expertise to ensure successful execution and compliance with regulatory standards.

The Role of the Intermediary Bank

The role of an intermediary bank in the process of issuing a Medium Term Note (MTN) is multifaceted and crucial, especially when dealing with leading banks that are the issuers of these instruments. Here's an in-depth look at the intermediary's functions:

1. Liaison and Negotiation:

• Bridge Between Issuer and Investors: The intermediary acts as a bridge between the issuing bank and potential investors. They facilitate communication and negotiations, ensuring that the needs and expectations of both parties are addressed.
• Credit Lines: The intermediary bank can establish a credit line for the issuer. This credit line provides the issuer with the necessary liquidity to support the MTN issuance
• Credit Enhancement: The intermediary can arrange for credit enhancement measures to improve the issuer's creditworthiness. This might include securing guarantees, letters of credit, or insurance policies from third parties.
• Collateral Arrangement: Arranging collateral to back the MTN issuance is another strategy. This could involve earmarking certain assets or revenues of the issuer as security for the MTNs.
• Negotiating Terms: The intermediary negotiates the terms of the MTN issuance on behalf of investors. This includes the interest rate, maturity period, covenants, and other key terms.

2. Market Analysis and Pricing:

• Assessing Market Conditions: Intermediaries analyze current market conditions, including interest rates, investor demand, and economic indicators, to advise on the timing and pricing of the MTN issuance.
• Pricing Strategy: They help in developing a pricing strategy that aligns with the issuer's objectives while being attractive to investors.

3. Structuring the Deal:

• Deal Structuring: The intermediary advises on the optimal structure of the MTN, considering the issuer's financial position and market conditions. This includes deciding on the maturity, coupon rate, and whether the rate is fixed or floating.
• Documentation and Compliance: Ensuring that all necessary documentation is in place and complies with regulatory standards is a critical role of the intermediary.

4. Distribution Network:

• Investor Outreach: Utilizing their network, intermediaries reach out to potential investors, which can include institutional investors, fund managers, and other banks.
• Book Building: They are often involved in the book-building process, collecting and managing orders from investors.

5. Risk Assessment:

• Credit Risk Analysis: Intermediaries conduct a thorough analysis of the issuer's credit risk, providing insights to investors and aiding in the risk assessment process.
• Due Diligence: They perform due diligence to ensure the credibility and financial stability of the issuer.

6. Regulatory Compliance and Legal Oversight:

• Compliance: Ensuring that the MTN issuance complies with relevant local and international regulations is a key role of the intermediary.
• Legal Framework: They oversee the legal aspects of the issuance, including the drafting of agreements and ensuring adherence to securities laws.

7. Settlement and Facilitation:

• Coordination of Settlement: Post-issuance, the intermediary coordinates the settlement process between the issuer and investors.
• Facilitation of Transactions: They facilitate the transaction process, ensuring smooth transfer of funds and issuance of MTNs.

8. Post-Issuance Services:

• Market Making: In some cases, intermediaries provide market-making services, offering liquidity for the MTN in the secondary market.
• Investor Relations: They may assist in maintaining ongoing relations with investors, providing updates and information post-issuance.

Conclusion

The intermediary bank plays a pivotal role in the MTN issuance process, especially when dealing with leading banks. Their expertise in market analysis, deal structuring, distribution, risk assessment, and regulatory compliance is invaluable. They ensure that the MTN issuance is executed efficiently, meets the objectives of the issuing bank, and aligns with investor interests. Their involvement is critical in bridging the gap between complex financial instruments and the diverse needs of the financial market participants.

Margins of Bank MTNs

A Bank-MTN (bank medium-term note) is a debt instrument that is issued by a bank and backed by its assets, such as loans, mortgages, or securities. A Bank-MtN typically matures in 2 to 5 years and pays a fixed or variable interest rate to investors. A Bank-MTN issue is usually arranged by the issuing bank itself or by another bank that acts as a dealer or an underwriter for the issuer. The bank that arranges the Bank-MTN issue charges a margin or a fee for its services, which is deducted from the proceeds of the Bank-Mtn issue. The margin is usually expressed as a percentage of the face value or the principal amount of the Bank-MTN.

Primary Market

The margin for a new Bank-MTN issue in the primary market depends on various factors, such as the credit rating of the issuing bank, the maturity and currency of the Bank-MTN, the market conditions and demand for the Bank-MtN, and the negotiation between the issuer and the arranger. The margin may also vary depending on whether the Bank-MTN issue is underwritten or placed by the arranger. Underwriting means that the arranger guarantees to buy all or a portion of the Bank-MTN issue from the issuer and then sell it to investors at a higher price. Placing means that the arranger acts as an agent for the issuer and tries to find investors who are willing to buy the Bank-MTN issue at a specified price. Underwriting involves more risk for the arranger, so they usually charge a higher margin than placing.

To illustrate how margins are calculated by banks, let us look at an example of a new Bank-MTN issue by Deutsche Bank, one of the largest banks in Germany and Europe. According to its annual report, Deutsche Bank issued EUR 12 billion worth of Bank-Mtns in 2022, with maturities ranging from 2 to 5 years and interest rates ranging from 0.25% to 1.75%. Assuming that these Bank-Mtns were underwritten by another bank at a margin of 0.5% of their face value, then the bank would pay Deutsche Bank EUR 11.94 billion (EUR 12 billion minus 0.5% of EUR 12 billion) for these Bank-Mtns and then sell them to investors at their face value of EUR 12 billion, earning EUR 60 million (0.5% of EUR 12 billion) as its fee.

Secondary Market

The margin for trading a Bank-MTN in the secondary market is the difference between the bid and ask prices of the Bank-MTN. The bid price is the highest price that a buyer is willing to pay for a Bank-MTN, and the ask price is the lowest price that a seller is willing to accept for a Bank-MTN. The margin reflects the liquidity and volatility of the Bank-MTN, as well as the supply and demand for it. The margin may also vary depending on whether the Bank-MTN is traded over-the-counter (OTC) or on an exchange. OTC trading means that buyers and sellers negotiate directly with each other or through intermediaries, such as brokers or dealers. Exchange trading means that buyers and sellers use a centralized platform that matches orders and executes trades. Exchange trading usually offers more transparency and standardization, so it may have lower margins than OTC trading.

To illustrate how margins are calculated in the secondary market, let us look at an example of trading a Bank-MTN issued by Deutsche Bank on an exchange. According to its quarterly results, Deutsche Bank had EUR 55 billion worth of outstanding Bank-Mtns as of June 2023, with maturities ranging from 2023 to 2027 and interest rates ranging from 0% to 2%. Assuming that one of these Bank-Mtns had a face value of EUR 100,000, a maturity date of December 2025, and an interest rate of 1%, then its price would depend on its yield-to-maturity (YTM), which is the annualized return that an investor would earn if they bought the Bank-MTN at its current price and held it until its maturity date. The YTM is inversely related to the price of the Bank-Mtn: if the YTM goes up, then the price goes down, and vice versa. For example, if the YTM of this Bank-Mtn was 0.75%, then its price would be EUR 102,564, which is calculated by discounting its future cash flows (interest payments and principal repayment) by its YTM using this formula:

where C is the annual coupon payment (EUR 1,000), F is the face value (EUR 100,000), YTM is expressed as a decimal (0.0075), and n is the number of years until maturity (2.5).

If this Bank-Mtn was traded on an exchange, then its bid and ask prices would be determined by the market forces of supply and demand. For example, if the bid price was EUR 102,500 and the ask price was EUR 102,600, then the margin would be EUR 100, which is the difference between the bid and ask prices. The margin would represent the profit that a dealer or a broker would make by buying the Bank-MTN at the bid price and selling it at the ask price. The margin would also reflect the liquidity and volatility of the Bank-MTN: if the Bank-MTN was highly liquid and stable, then the margin would be low, and if the Bank-Mtn was illiquid and volatile, then the margin would be high.

Purchase Procedure

1. Initial Deposit into the Client's Account at IFB

The first step: the client deposits the required funds into their account at International Financial Bank (IFB) after opening the necessary account(s) and fulfilling all compliance requirements.

2. Due Diligence and Compliance Process

The bank conducts due diligence and compliance checks on both the client and the seller/issuer of the MTN

3. Engagement of a Transaction Intermediary (If Applicable)

An intermediary may be engaged to help structure the deal, ensuring favorable terms for both the client and the issuer.

4. Escrow Account Setup (If Required)

An escrow agreement is established to ensure that the funds and the financial instruments are protected during the transaction.

5. Signing of the Purchase Agreement

This stage now requires a deeper understanding of the contractual terms, particularly concerning the volume, tranches and timing of the financial instruments.

• Volume: The total face value of the MTN to be transacted must be explicitly defined in the contract. For MTNs, these are typically issued in denominations of $10 million or more up to several billion, but the volume can vary depending on the structure of the deal.
• Tranches: If the MTN is being issued in multiple tranches (batches), this must be clearly outlined in the purchase agreement. Tranches help manage the risk and timing of the transaction. 
• Tranche size: The contract should detail the size of each tranche (e.g., $500 million per tranche).
• Delivery schedule: The timeline for the issuance of each tranche should be set, which could be monthly, quarterly, or as negotiated.
• Conditions for tranche release: The agreement should specify any conditions or milestones (e.g., successful KYC and due diligence) that must be met before subsequent tranches are released.

These elements ensure that the transaction is staggered to manage risk and liquidity, particularly in large-volume deals.

6. MTN Transaction Process

This step is critical for understanding the transfer of the MTN and the payment mechanics. It includes details about the infrastructure and systems used to complete the transaction.

A. Verification of the MTN
The bank ensures that the MTN is genuine, valid, and can be delivered. This involves verifying:
- The issuing institution’s credibility.
- The legal enforceability and negotiability of the instrument.

B. Transfer of the MTN via a Central Securities Depository (CSD)
MTNs are typically held and transferred through a Central Securities Depository (CSD). CSDs provide a high level of security, transparency, and efficiency in the transfer of financial instruments. In this case, common CSDs include Euroclear, Clearstream, or the Depository Trust & Clearing Corporation (DTCC).

CSD Role: The CSD acts as an intermediary that facilitates the transfer of the MTN between the buyer and the seller. Once the purchase agreement is in place, the following steps occur:

• Delivery versus Payment (DvP): The MTN is delivered to the buyer (the client) only after the payment is made. The CSD ensures the synchronized transfer of the security and funds, reducing counterparty risk.
• Electronic transfer: The MTN is electronically transferred from the seller’s custody account to the buyer’s custody account at the CSD (e.g., Euroclear account).
• Confirmation: The CSD provides both parties with a transfer confirmation, ensuring that the security has changed ownership.

C. Payment through RTGS (Real-Time Gross Settlement)
Payment for the MTN purchase is typically processed through a Real-Time Gross Settlement (RTGS) system, which allows for immediate, final settlement of funds. RTGS systems are used for high-value transactions and are typically operated by central banks.

RTGS Features:

• Immediate settlement: Payments are settled on an individual, real-time basis, meaning funds are transferred instantly and cannot be reversed.
• Finality of payment: The funds transfer is irrevocable, providing security to both parties..
  
  The combination of CSD for security transfer and RTGS for payment provides a secure, real-time transaction environment, minimizing risks related to delayed settlements or counterparty defaults.

7. Final Funds Transfer

After the MTN or SBLC has been authenticated and transferred, the final payment is executed via RTGS, ensuring both immediate settlement and irrevocability.

8. Post-Transaction Safekeeping and Utilization

Once the MTN or SBLC has been transferred, the client must ensure proper custody and, for SBLCs, manage the instrument's utilization in accordance with its intended financial or trade strategy.

9. Regulatory Reporting and Taxation

Finally, the client needs to fulfill regulatory obligations and address any taxation implications resulting from the transaction.

Buy and Sell Medium Term Notes (MTNs) with Discount 

Purpose: 

Facilitates the trading of Medium Term Notes (MTNs), enabling clients to acquire or liquidate these debt instruments at a discount for strategic financial purposes. 

Key Features: 

• Seller provides valid MTNs issued by reputable corporations, financial institutions, or governments. 
• Buyers benefit from the discounted acquisition, typically 5–30% off the MTN face value, depending on maturity, issuer credit rating, and prevailing market conditions. 

Funding & Security: 

• Minimum Tranche Size: USD/EUR 500 million to be deposited with the facilitating financial institution. 
• The buyer’s bank must confirm the purchase of the discounted MTNs through a bank confirmation letter or similar financial instrument. 
• Settlement: Transactions are conducted via recognized clearing systems like Euroclear, Clearstream or DTC to ensure security and transparency. 

Fees: 

• Administrative Costs: 1.25% of the MTN face value to be deposited upfront in the client’s account with the facilitating financial institution to cover due diligence, legal fees, and administrative expenses. 

Compliance: 

• Both buyer and seller undergo complete Know Your Customer (KYC) and Anti-Money Laundering (AML) verification processes. 
• Supporting Documents: Mandatory submission of transaction contracts, MTN issuance documents, details of the issuing entity, and any relevant regulatory approvals. 

Additional Guidelines: 

• Due Diligence: Comprehensive evaluation of the MTN’s terms, including interest rates, maturity dates, and any embedded options or covenants. 
• Legal Framework: All transactions comply with international securities laws and regulations, as well as the guidelines set by regulatory authorities in the relevant jurisdictions. 
• Confidentiality: Parties may be required to sign Non-Disclosure Agreements (NDAs) to protect sensitive financial information throughout the transaction process. 
• Market Transparency: Adherence to standard market practices to promote fairness and efficiency in the trading of MTNs. 

By following these guidelines, clients can engage in the buying and selling of MTNs securely and efficiently, leveraging discounted opportunities for investment diversification or liquidity management while ensuring full compliance with legal and regulatory requirements.