The snowballing effect of Parmalat at the end of 2003 ushered in an inauspicious start to 2004 for investors in Italian debt capital markets. Coined 'Europe's Enron', the Parmalat scandal broke in December 2003 amid allegations of false accounting, financial manipulation, insider trading and financial fraud.

A number of Parmalat executives have been placed under arrest. Parmalat's gross debt is currently reported to be more than e14.3bn (£9.6bn), a multiple of the company's assets. The Securities and Exchange Commission (SEC) alleged that Parmalat "engaged in one of the largest and most brazen corporate financial frauds in history".

Then in mid-January, Finmatica, an Italian listed software company, withdrew a e55m (£37m) convertible bond issue after the deal was announced amid allegations of providing false corporate information, market manipulation and obstruction of market regulators. So, are the Italian debt capital markets headed for a meltdown?

While it may be some time before we understand the full effects of Parmalat, it would seem that the scandal has not affected the Italian debt capital markets in terms of volume. Italian issuers are still issuing significant amounts of debt.

Sources indicate that (without considering the dollar's slide against the euro) the total amount of Italian debt issued during January 2004 (£11.9bn) was more than double the volume issued during January 2003 (£5.5bn), although the picture is not so clear when comparing December 2003 (£2.4bn) to December 2002 (£5.3bn). Italian sovereigns (including local governments) issued the largest volumes of debt in Italy in January 2003 and 2004. Instead, Italian securitisation vehicles and banks issued the largest debt volumes in Italy in December 2002 and 2003.

However, Italian corporate debt issues, which one would expect to be most affected by the Parmalat scandal, showed a steady increase in volume in January 2004 (£2.2bn) compared to December 2003 (£528m). These amounts also represented an increase when comparing them, respectively, to January 2003 (£2.1bn) and December 2002 (£509.3m). Perhaps the striking fact is the amount of corporate debt that is being issued notwithstanding the Parmalat scandal.

The increase in total Italian corporate debt issued in January 2003 and 2004 was due to large issues by two Italian bluechip corporates. During January 2003, Olivetti International Finance issued a total of $3.6bn (£2bn) as fixed rate bonds. While during January 2004, Telecom Italia issued a total of $3.83bn (£2bn) in fixed rate notes. But even factoring out these large deals in both periods, the volume of corporate issues and the number of corporate issuers have increased.

In mid-January, the press reported that the primary bond market was quiet with few new issues planned. However, on 27 January 2004, Enel announced plans to issue a euro bond ranging between e500m (£335.5m) and e1bn (£671m) to retail investors, as well as a e1.5bn (£1bn) bond to institutional investors. The timing has not been set for the issue to retail investors. However, Enel's board resolved to issue the bond to institutional investors by 30 June, 2004.

On 6 February, 2004, San Paolo IMI, an Italian bank, increased the size of its euro bond issue by 20% because of overwhelming investor interest. In fact, by mid-February, issues by Italian banks had already exceeded the totals issued by Italian banks during the entire month of January. In addition, the Republic of Italy issued a $6.6bn (£3.5bn) bond on 10 February. Still, some issuers may have had cold feet. Il Sole 24 Ore reported that Autostrada's proposed e6.5bn (£4.4bn) bond to be issued to institutional investors at the end of January had been postponed, although financial sources indicate that the postponement was not related to the Parmalat scandal.

In December 2003, Fitch Ratings reported that approximately e14bn (£9.4bn) of Italian corporate bonds will mature in 2004, which may lead many Italian corporates to refinance their debt. Both Enel and Autostrada's proposed issues are refinancings. In light of the problems with Parmalat and Finmatica, however, Italian companies with good liquidity that plan to refinance their debt by issuing new debt may be placed under additional scrutiny.

Investors may be encouraged by the Italian Government's immediate response to the Parmalat scandal. On 23 December, Italy changed its bankruptcy protection regulation to protect Parmalat and its employees. A draft reform law to establish a new regulatory agency for the financial markets was approved by the Italian cabinet on 3 February, 2004. The draft law intends to divest the Bank of Italy of its power to supervise the corporate bond market and transfer it to a new regulator, provisionally called the Authority for the Protection of Savings, which would also have increased powers of enforceability (including the ability to impose criminal sanctions).

Powers currently held by Consob, the Italian stock market regulator, would also be transferred to the new agency. The proposed law would possibly impose strict liability for the solvency of the issuer on financial intermediaries that onsell securities issued outside of Italy (which would include bonds issued under a law other than Italian law, such as most euro bonds) to the public in Italy. Imposing strict liability on financial intermediaries as such would have very significant negative consequences for the euro bond market in Italy.

The Parmalat scandal appears to be the catalyst for reforms much the way Enron goaded the US legislature to push through the Sarbanes-Oxley Act.

The European Union (EU) is considering implementing US-style regulatory agencies and regulation for its member states. Frits Bolkestein, the EU's internal market commissioner, has indicated that auditing standard proposals to be made next month will resemble the standards established under the Sarbanes-Oxley Act and are currently being reviewed because of the Parmalat scandal. Based on Parmalat's problems, it is expected that a key proposal will require a group's auditor to take responsibility for the entire audit of the company and its subsidiaries.

It is not yet clear how Parmalat will affect the Italian debt capital markets either in economic or regulatory terms. However, Italian and European regulators seem to be taking the threat seriously. The Italian Government appears to be going to the root of the problem and revamping the regulatory system to give new oversight powers and stronger enforcement authority as needed in order to better protect investors. The EU is backing these proposals and will likely bolster them with proposals of their own.

Economically, the deal flow appears stable, although a few hiccups are expected along the way. How will the Italian debt capital markets look a few months from now? Only time will tell.

Max Aaron is a partner and Bon Joyce an associate in the Milan office of Allen & Overy.