Is the UK watched from the sidelines on January 1, around ?14 billion in euro notes and ?50 billion in coins were distributed across the 12 eurozone member countries. If and when the UK finally decides to join the party, the far-reaching changes facing UK banks will not be limited to operational and compliance matters. UK entry will redefine the UK banking marketplace, raising new strategic challenges and threats for the institutions concerned.
Instead of watching and waiting, UK banks need to plan ahead. As Lynne Guyton, a senior manager at management consultants Accenture points out, the euro will continue to be an important driver in the evolution of Europe’s capital markets. From a strategic perspective, banks need to be taking these into account. Guyton says: “Treasury services post-EMU will be principally driven by the polarization of currency risks between the world’s two major currency blocs – the US dollar and the euro.”
In the post-entry environment, says Guyton, UK banks may well find themselves at a disadvantage to their competitors in first-wave countries, as they lack the practical experience gained from working within the EMU. She continues: “Shareholders will expect banks to deliver performance in line with the best European benchmarks. As a result of this pressure, and others such as regulation and intensifying competition, UK banks will need to look at pursuing different types of strategic alliances – ones based around capabilities rather than traditional consolidation-based M&A.”
Another important change in the operating environment will be the continuing erosion of constraints on cross-border securities investment, says Guyton. “As the ‘domestic’ currency bloc open to UK investment managers extends throughout Europe, investors will move to diversify their holdings across the continent, improving the allocation of investment resources to the best opportunities. By the same token, continental European investors will move into the UK.”
From a legal perspective, the euro’s arrival poses a range of issues for financial sector companies. The changeover is an enormous logistical exercise, involving more than 300 million people in 12 countries, and there are some reservations about the levels of preparedness. Geoffrey Yeowart, a partner at Lovells and a member of the Bank of England’s City Euro Group and HM Treasury’s Euro Business Advisory Group, explains: “The wholesale financial markets are generally well prepared since they have been using the euro since its introduction in January 1999. Retail banking systems are also expected to be ready on time, as are most large companies and public administrations at national level. However, the state of preparedness among small and medium-size businesses is mixed. Concern has been expressed that many of them, as well as some local authorities in remoter areas, may have underestimated what is involved and left their preparations too late.”
When the euro was introduced in January 1999 it did not itself alter the denomination of existing contracts. Where a contract stipulated a particular currency unit for payment, payment continued to be made in that currency unit until December 31 2001, unless the parties agreed otherwise, or unless the amount was payable by crediting the payee’s account. However, as Lovell’s Yeowart says: “The position changes fundamentally on January 1 this year. Legacy currency units will cease to exist. From then on, all non-cash payments must be made and received in euro only.”
The unit of account in which all monetary obligations are expressed was open to voluntary redenomination at any time before January 1 2002 from an obsolete currency unit to the euro. If they were not redenominated before that date, all contracts and other legal instruments in existence at that point would be automatically read as if references to legacy currency units are to the euro at the fixed conversion rate. This fundamental principle, known as the “read as euro” principle, is set to assume central importance in the coming months.
Parties to syndicated loans in a legacy currency were expected to choose to redenominate them to euro on the last rollover date under the loan agreement last year. The British Bankers’ Association (BBA), says Yeowart, ceased to publish legacy currency Libor after December 31 last year designating euro BBA Libor as the successor rate. Where an amount would otherwise become due for payment in a legacy currency on or after January 1, the equivalent euro amount should have been paid, using the payer’s standard settlement instruction (SSI) for euro where available.
Corporate issuers of debt and other debt securities in legacy currency were slow to voluntarily redenominate their securities to the euro.
This is a significant point: according to Yeowart, Euroclear identified 9,632 securities (of which 5,404 are international and 4,228 domestic) that were still denominated in legacy currency in the middle of last month. This raises the question, he says, as to whether issuers will need to redenominate formally on January 1 2002, or whether they will simply be able to rely on the “read as euro” principle: “The European Commission has suggested that formal redenomination is not essential. However, it may be desirable to redenominate and renominalize in order to avoid having holdings stated in awkward decimal figures. If it is planned to adopt euro market conventions on such matters as rate fixings, or the method of counting days for interest calculations, the terms of the securities will have to be changed as well.”
Yeowart advises that this should not normally be done unilaterally where the terms of the issue are governed by English law, unless the issuer has an express right to do so, particularly if this would have an economic effect on holders.
Other important areas for consideration include whether interest will be calculated on the amount of the bond read as euro, or on the original amount in its legacy currency unit, with the amount of interest calculated being converted to euro. “The Commission has recommended the first approach as most consistent with the ‘read as euro’ principle” says Yeowart “but it will be left to national law to determine which method should be followed. This is expected to be followed in Germany, Italy, the Netherlands and Austria, but not Belgium and Greece.
“The Euroclear and Clearstream systems have opted for the second approach, so as to avoid any possible change to present calculation terms for bonds. The difference between the results of the two approaches will be small.”
Contracts may well be affected by the disappearance of benchmarks, indices or pricing sources linked to a national currency unit. Some participating member states (including Germany and France) have already introduced domestic legislation to designate successor price sources. So, for example, Frankfurt inter-bank offered rate (Fibor), Paris inter-bank offered rate (Pibor) and Amsterdam inter-bank offered rate (Aibor) have now been replaced by euro inter-bank offered rate (Euribor). The International Swaps&Derivatives Association (ISDA) is publishing its own revised price sources update.
Yeowart concludes: “A contract governed by English law which failed to identify a replacement price source might be unenforceable for uncertainty. The English courts are expected to lean towards implying a term that the nearest comparable successor rate (if readily ascertainable) should be adopted – in the absence of a contrary intention of the parties. This may not be easy to do all in cases, but trade associations have done much useful work in identifying affected benchmark rates and ensuring that designated replacement rates are provided.”
