On January 1 1999, the European Union will adopt a single currency. The euro will be substituted for national currencies. After a transitional period ending on January 1 2002, the old currency notes and coins will be withdrawn. This raises important legal issues that will be felt most keenly in London the EU's most important financial market and one where most international financial transactions are written under English law.
To get a flavour of what this aspect of economic and monetary union (Emu) means, consider a Deutschmark/yen currency swap. Replacing the Deutschmark with the euro will fundamentally alter what the parties contracted to exchange. Using the English law doctrine of frustration, one or other party might claim to be excused from continued performance if the change was to destroy the objective of the swap. Where the swap involves two participating currencies, the contract might even become pointless as each party had entered into it to exploit currency volatilities. Remove them and the contract is dead. How will each party react? That is the sort of uncertainty markets dread. By replacing major trading currencies, such as sterling and the Deutschmark, the euro will have far-reaching legal consequences for all markets. Bankers are pricing deals that will extend beyond 1999 to reflect the consequences of Emu. They need to be clear about the legal risks involved.
Issues like this prompted the formation of the City of London Joint Working Group on Emu Legislation through which the British Bankers' Association, the International Swaps and Derivatives Association and the International Primary Market Association among others form views on what Emu means in legal terms. Working alongside it has been the Financial Law Panel (FLP), the body established in 1993 under the auspices of the Bank of England and the Corporation of the City of London following the Hammersmith & Fulham swaps case. Its remit is to tackle legal problems that impede the workings of London's financial markets.
The continuity of contracts is a major issue. If the mere introduction of the euro were a legal excuse for one or other party to a contract to treat it as terminated, commercial mayhem would ensue. Everyone wants continuity but if the euro's introduction heralds disruption such that the financial consequences of a contract are distorted one or other party would suffer. Some argue that, unless the parties have made provision in the contract for their rights to be modified in such an event, member states should not intercede and redress the balance through national law. To do so might erode the unconditional acceptance of the euro which it must command if it is to succeed.
This view was presented last September by the Zentraler Kreditausschuss (representing various German banking federations). It argued for a general EU provision overriding general provisions of national law that would otherwise override contractual provisions agreed between the parties. The FLP argued against this, in favour of national flexibility following the euro's introduction. Neither side is right or wrong. But they illustrate that discussion of the euro's implications is highly theoretical. Bankers may find it boring but they need to pay attention.
Continuity of contracts has ramifications extending beyond the EU. The FLP, in its submission to a sub-committee of the House of Lords Select Committee on the European Commission (EC), gave the example of a German exporter contracting with a US importer under New York law for payment in Deutschmarks. Once the euro takes over, will the contract be upheld by New York law? "As a matter of principle, the answer should be affirmative ... under the laws of major financial jurisdictions," the FLP said. "However, a great deal of investigatory work needs to be done to ensure that this is in fact the case."
Drafting the relevant regulations has not been easy for the EC. For a start they have to meet both France and Germany's views. France wants the substitution of the euro for old currency to take place by way of a Big Bang on January 1 1999. That way no-one can contemplate the euro not working. Germany is not willing to abandon the Deutschmark until the euro is safely established. Both positions can be accommodated, as the FLP has argued, although no compromise is logically possible. After the euro's introduction, the national currencies cease to exist; they become units of it. By providing that debts denominated in a national currency can be discharged in euros at the fixed conversion rate, the regulations ensure that there is no benefit in the right to receive, say, Deutschmarks rather than euros. Speculation between "old" currency units and the euro is made pointless rather than prohibited.
Revised regulations adopted the FLP's drafting suggestions to remove references to "no exchange risk being considered to exist" and replace them with "given the absence of exchange risk ... legislative provisions shall be interpreted accordingly". This semantic difference is crucial. If there were an exchange risk between the euro and national currency units and banks within the EU were told to ignore it, they would be treated differently from banks outside the EU with assets and liabilities stated in similar terms but who had been instructed not to ignore such risks. This would cut across the Basle Accord and lead to inconsistencies of capital treatment.
Other problems have included the EC's original assumption that the Ecu would simply become the euro and then its assumption that the Ecu would cease to exist when the euro was introduced. Neither is advisable. An agreement to borrow Ecu100 million and repay 100 million euros involves a risk of fluctuation since the euro will be fixed to reflect the economic performance of participating member states only. The euro will be harder than the Ecu would have been, so imposing an obligation on the borrower to repay at a premium. "The Ecu is not a currency," the FLP said in its submission to the Select Committee, "and the rules of law which apply when a state changes its currency for another might have no application... if two [US] banks enter into a swap contract under which one agrees to pay in US dollars, and the other in Ecu denominations, and the contract is governed by New York law, why should a New York court order the Ecu payer to make payments in euros simply because legislation passed in the EU required this?"