Dealing with risk: Underwriting sovereign bond issues in London 1870-1914

Abstract

Using the records of several leading 19th century issuing houses, this paper analyses the transformation of underwriting practices in London's primary sovereign bond market from 1870 to 1914. It shows how underwriting risk developed from being a liability, which market intermediaries sought to avoid, to becoming a valuable financial commodity. The impetus for this development was increased competition in the loan business from the 1880s onwards, which weakened the negotiating position of issuing houses and forced them to shoulder an increasing share of the underwriting risk. Issuing houses had to find methods to deal with this risk, but they were initially hamstrung by public perception of underwriting as detrimental to the interests of ordinary investors. Firms began to adopt informal underwriting arrangements, with limited scope, but these only allowed for a relatively limited distribution of underwriting risk to third parties, the danger of which was exposed during the Baring crisis. Consequently formal underwriting syndicates were developed, allowing for a greater dissemination of underwriting risk. This meant that the risk associated with issuing loans could be broken down into sufficiently small tranches so that no underwriter had to shoulder a risk greater than what he desired. As a result underwriting risk came to be seen as a profitable investment opportunity, a financial commodity in its own right, and a means of patronage for issuing houses