Analyzing Euro Area Finance Dynamics

Sep 4, 2024

European Central Bank Project on International Finance

Introduction

  • Collaboration with the European Central Bank.
  • Focus on understanding financial relationships in Euro-Area countries.
  • Challenge due to intermediation through Luxembourg, Ireland, and the Netherlands.

Importance of Onshore-Offshore Financial Centers (OFCs)

  • OFCs obfuscate capital allocation and financial integration assessments.
  • Example with BMW:
    • BMW raises capital via bonds issued by a subsidiary in the Netherlands (BMW Finance NV) instead of directly in Germany.
    • Bonds likely held by Italian investors through funds in Luxembourg/Ireland.
  • Resulting flows:
    • Italy to Luxembourg, Luxembourg to Netherlands, etc.

Objectives of the Paper

  • Use new data and methods to clarify financial exposures of Euro-Area countries.
  • Show the importance of understanding intermediation structures affecting capital allocations.

Key Findings

  • More than half of assets recorded as owned by the Euro area do not belong to it.
  • Historical dynamics of financial integration are revised:
    • Decline in home bias only holds for bond markets after OFC adjustments.
  • Financial centers impact firms' access to foreign capital.
  • Ownership of funds in these financial centers is shifting from Switzerland to the UK.

Methodology Overview

Step 1:

  • Attribute holdings of Luxembourg and Ireland funds to ultimate owners using:
    • Securities Holding Statistics (SHS) from ECB.
    • Commercial data from Morningstar and Refinitiv.

Step 2:

  • Connect securities to ultimate corporate parents and nationality using algorithms from prior work.

Example Output

  • Adjusting Italian investments from €75 billion to €128 billion after accounting for both residency and nationality adjustments.
  • Significant increases in exposures to non-Euro area, especially China and the US.

Portfolio Decomposition

  • Three distinct components:
    1. Direct foreign portfolio holdings of Euro-Area investors.
    2. Indirect holdings through funds in Luxembourg and Ireland.
    3. Holdings of ROW investors through these funds.
  • Observed trends indicate a shift towards non-Euro-denominated assets as we move from portfolio 1 to 3.

Home Bias Analysis

  • Common measure for home bias displays large declines in Euro-Area post-euro introduction.
  • Adjustments reveal that Euro-Area home bias aligns more closely with the US when accounting for OFC activities.
  • Bond market home bias adjustments show a real decline, while equity adjustments suggest prior data overstated home bias declines.

ROW Investors in Financial Centers

  • New administrative data reveals significant UK investments in Luxembourg/Ireland funds.
  • UK acts on behalf of both its citizens and non-Europeans.
  • Funds reporting in British pounds are likely targeting British investors.

Conclusion

  • Findings provide new insights into global missing wealth, previously attributed to Switzerland, now shifted to the UK.
  • Research available for public use to inform policy and further study.
  • Contributions significant for theories of financial integration and allocation models.