Firms urged to prepare for eurozone break-up
- 10 August 2012
- From the section Business
As Olympic mania intensifies with the UK's increasing gold medal count, the crisis in the eurozone has quietly slipped out of the limelight.
European Central Bank president Mario Draghi's bond-buying plan, aimed at lowering borrowing costs, has appeased the markets for now in spite of being sketchy on details.
And as none of the troubled eurozone countries is planning bond auctions in August, the pressure is off.
The eurozone crisis it seems is officially on its summer break.
Time to prepare
But this summer lull is a mere illusion, according to law firms, which behind the scenes are beavering away feverishly on behalf of their clients to examine, and try to minimise, the consequences of the very worst-case scenario - a collapse of the euro, or the withdrawal from the European Monetary Union by a eurozone country.
Investors and companies doing business in the member states of the European Union remain concerned about the consequences of one, some or all of the eurozone countries returning to their old national currencies.
Companies and investors party to contracts that require payment in euros or are denominated in euros should re-structure the deals to ensure that they will not have to receive payments in a devalued currency, such as the Greek drachma or the Spain's peseta, according to law firms.
"If they have got business and contractual arrangements in a country deemed particularly at risk, or are involved in specific transactions with a counterparty based in one of the countries deemed at risk, then it could have a dramatic impact on cash flow if the payment is made in a different or devalued currency," warns Jim Rice who heads the Linklaters eurozone core group, which was set up to deal with the large volume of client inquiries on the issue.
Companies should ensure that the definition of euro within the contract refers to the currency of the eurozone, rather than the use of the euro as adopted by a specific country, Mr Rice says.
This means it may be harder for a firm to switch to a devalued currency in the event of a eurozone exit, he says.
It may also help if the governing law of the contract is an independent law, such as English law, he adds.
Indeed, he continues, it might be helpful if the place of performance of the contract is located outside any of the countries deemed to be at risk. This would mean that the contract is more likely to be honoured in the designated currency.
"There is little that you can do that is foolproof, but many clients are making some changes, or at least instigating a review as an exercise to determine what the extent of their risk is," Mr Rice says.
Ultimately, however, what is important in most contracts is not the colour of the currency, but rather whether the customer can pay at all, according to law firm DLA Piper.
Companies must make sure their customers will be able to pay in a currency and in an amount that is convertible on the markets to satisfy the payment in full, DLA Piper observes.
It suggests pragmatic redrafting of existing, as well as new, contracts, to address a potential eurozone collapse and thus reduce the most obvious risks to supply chains.
Financial firms such as banks also face greater risk in the event of a eurozone collapse, essentially due to their larger scale and the high level of individual transactions.
A recent report by Credit Suisse bank analysts, led by Carla Antunes da Silva, calculated that the biggest impact from a so-called Grexit, an exit of Greece from the Eurozone, on 11 European banks' investment banking departments would stem from counterparty losses on derivatives contracts and other counterparty credit risks.
The banks' losses, when added up, could total €9bn ($11bn, £7bn), the report says.
Much will depend however on the terms of any legislation passed in the exiting country. Such legislation is likely to include a new currency law and a capital controls law.
David Wakeling at Allen & Overy points out that even if contracts are amended, a country leaving the eurozone is likely to impose so-called exchange or capital controls to stem the flight of money from a currency set to be devalued.
In, say, a Grexit scenario, these controls could see the Greek government making it illegal for its banks to continue to pay its counterparties in euros.
A further complication for firms trying to prepare for a possible break-up of the eurozone is that it could happen in so many different ways.
There are three key scenarios:
- One of the weaker peripheral eurozone countries, such as Greece or Spain, leave the eurozone,
- a complete break-up of the eurozone,
- the stronger members of the eurozone, including Germany, leave to set up on their own.
Companies face a wide variety of possible toxic outcomes from a collapse of the eurozone, hence although they can do much to prepare they would undoubtedly also see some surprises.