Preparing for a worst-case euro scenario
Firms are reorganizing to limit the damage in the event of European monetary breakup
There is now a very real risk that the euro-zone single currency will break up. Depending on who one asks, the odds of survival vary, as do the number of countries that might leave. The major banks and multinationals have responded and are already putting contingency plans into action. In Spain, the leading companies on the stock exchange are trying to come up with an answer to a question that is in itself a matter of life and death: if we leave the euro, what will happen to our shares and assets, our bank accounts, and our results?
The contingency plans being thought through around Europe range from creating a new currency for Germany and its satellites to selective expulsion of countries considered too great a risk or too great a burden to bear, right through to the dismantling of the euro, as well as the creation of a two-tier euro. Any of these options would have enormous implications at the commercial, fiscal, and financial level for companies, as well as putting their credibility on the line.
Among the sectors most concerned with finding a solution quickly are tourism, financial services and exports. Companies such as IAG, the owner of Iberia and British Airways, as well as Barclays, have already announced contingency plans for their Spanish operations. ING, the Dutch bank, has announced it is reducing its exposure in Spain by 6.2 billion euros.
Among the companies that have already taken measures regarding their operations in Greece are US giant Procter & Gamble; insurers Lloyds; TUI Travel and Thomas Cook, the UK’s two largest tour operators; Crédit Agricole and HSBC; and Heineken. The Swiss banks, worried about their funds, are on what one expert has called “maximum alert” about the future of the euro zone, and many companies have set up special teams to put together contingency plans and assess their options.
“A lot of Spanish firms have already been looking at the possible scenarios for several months now,” says Sara Baliña of Analistas Financieros Internacionales (AFI). “This is neither new nor surprising. It is a responsible and straightforward way of responding to the current situation we face — although the risk of Spain leaving the euro is still relatively low, at below 20 percent,” she says.
Juan Iranzo, the director general of the Instituto de Estudios Económicos (IEE), believes, for the moment, that Spain will not be leaving the euro. “But companies still have to face the possibility, and take measures. If I were them, I would try to get my money out of Spain, to sell shares before any devaluation, and to have as much capital in foreign currency as possible.”
If the peseta were to be reintroduced, and immediately devalued, the government would have to guarantee the continued supply, through imports, of important materials, and at current prices. In other words, it would have to control prices as it used to in the days of the military dictatorship, as happened with gasoline, for example. This is not exactly a reassuring scenario. AFI has drawn up several such contingency plans at the request of companies on the stock exchange. None of them is so far willing to discuss the plans.
Consultants Ernst & Young already have a team of 10 people at its Madrid office working on such plans. The team is headed by Asís Velilla, in charge of financial instruments. Velilla says the clients drawing up contingency plans for their Spanish operations foresee a situation where Portugal, Italy, Greece, Ireland and Spain leave the euro zone at the same time, and the subsequent establishment of a two-tier euro.
The fear of what might happen to Spain as the euro crisis has worsened over the last four years can be outlined in the following manner. The multinationals with operations in this country were the first to begin worrying about their investments in the event of a euro exit. Next came the companies with foreign investment funds (above all those in the United States), and with seats on the boards of Spanish companies; now the alarm has spread to Spanish companies. “What they want to try to put together is an assessment of the risks they face so they can take this to the board, and depending on their accounts, take the necessary measures,” says Velilla, adding: “Let’s not forget that any breakup of the euro zone would create opportunities to buy competitors at a low price.”
Spain’s high net worth individuals are also trying to put together emergency plans to protect their money should things go wrong. Juan Esquer, a partner at GBS Finanzas, says many wealthy people have already opened accounts in Luxembourg, Germany and France, or in non-euro states such as the UK and Switzerland, or in other cases have moved their money to the United States. Up until May this year, some 163 billion euros had been taken out of the country. “But this is creating a growing problem of compliance: the banks are asking questions about the origin of all this cash, and often this is not easy to prove,” says Esquer.
Consultancy firms and other financial specialists have been working on contingency plans for at least the last year in the event of a breakup of one sort or another of the euro. These plans have begun to leak out, and are causing major headaches for the boards of many companies. “Just dealing with the legal niceties is a headache of unprecedented proportions,” says a lawyer working at one of Spain’s biggest companies.
Despite the best efforts of people such as Eurogroup President Jean-Claude Juncker to calm the markets by saying that a Greek exit of the euro would be “manageable,” and experts such as Claudio Ortea, head of investments at Lombard Odier, who says the question is not “if, but when,” the Treaty of Lisbon does not include instructions on how to dismantle the euro. Before that could happen in any organized way, the treaty would need to be changed. However complicated that might be, the experts agree that any country that wanted to leave the euro would need to introduce legislation guaranteeing that contracts drawn up in euros would be valid. Neither is it easy to assess whether these contracts would be backed by the euro or by the new currency. The reality is most likely that they would be open to interpretation, depending on factors such as the laws of the country in question, where the assets were held, and where payments were being made.
For example, if Greece were to leave the euro, it would first have to leave the EU, and then make a formal request to rejoin, but without being part of the single currency. “The euro zone was put together along the lines of a lobster trap: easy to get in, but very difficult to get out,” says Simon James, a partner at British law firm Clifford Chance.
We have come a long way from the initial murmurings about a euro breakup, with loud denials from Brussels and Berlin, to the point where there is now open talk on how best this might be brought about. British consultants Capital Economics last month won the Wolfson Economics Prize with a piece of work entitled, Leaving the euro: A practical guide. As its name suggests, it details with chilling precision how countries would bring about a euro exit, and what the likely immediate consequences would be.
The authors suggest that countries leaving the euro set up a new currency with one-to-one parity with the euro from the first day of their exit and that all salaries, prices, loans, and deposits be immediately denominated in relation to parity. They add that the euro continue to be used for small transactions for no more than six months. The country that leaves the euro zone would immediately have to announce a plan to control inflation overseen by an independent institution, ban the indexing of salaries, and issue inflation-linked bonds. To avoid capital flight, the capital markets would have to be closed. In other words, it would be a series of measures very similar to those introduced in Argentina a decade ago, during the so-called corralito, which saw thousands lose their savings overnight.
This is the scenario that faces Greece — should it jump, or be pushed, out of the euro? But what about Spain? “The same measure would pretty much apply here as well,” says Jonathan Loynes, the chief economist for Europe at Capital Economics, and one of the authors of the study.
“The Lisbon Treaty allows for measures to restrict the free movement of capital for reasons of public order,” says Íñigo Berricano, managing director of law firm Linklaters. “Therefore, if we reach this point, which I don’t think we will, the Spanish government would have to set exchange control mechanisms to prevent capital flight. Such measures would have to be set up before any exit.”
And on the other side of the Atlantic? Firms such as JP Morgan Chase, Goldman Sachs, Morgan Stanley, Citigroup and Bank of America have been covering their backs against a possible euro breakup, renegotiating their contracts with European clients and at the same time using forms of non-payment insurance, such as credit default swaps (CDS), to reduce their exposure to those countries in biggest difficulty.
Behind the scenes, efforts are underway to make sure that if Spain or Greece do leave the euro, the banks do not get paid their money back in devalued pesetas or drachmas. For the moment, the banks are exposed to around 4.4 billion euros in Ireland, Italy, Portugal, Greece and Spain, along with some 20 billion euros in the case of JP Morgan. “These are relatively small amounts of money, and so the speed with which they have reduced their debt balances in the periphery countries,” says the director of a major Swiss bank based in Spain.
Soledad Pellón, an analyst at IG Markets, adds: “Nobody wants to be paid in a devalued currency, that is simply losing money.”
In the final analysis, says Douglas J. Elliott, the former vice president of JP Morgan, there are three likely outcomes of this nightmare scenario: “The gradual resolution of the problems in the euro zone (10 percent chance); that things get worse before they get better (65 percent chance); and that the whole euro project simply collapses (25 percent chance).”
“In the event of a total collapse, Greece would very likely be forced by its circumstances to leave the euro, as would other countries. Europe would fall into a deeper recession, the US economy would slow down further, and countries like China would see a sharp downturn. The only real winner in all this, if it were to happen between now and November, would be Mitt Romney, given that a worsening US economy would probably propel him into the White House,” adds Elliott.
Wall Street gets nervous
Wall Street sees the likelihood of Spain or Italy leaving the euro as remote, but does not rule out either of the two countries having to ask for a bailout, as Portugal and Ireland have. In the case of Greece, there are two clear, and opposing, views. On the one hand there is Citigroup, which is now talking about a 90-percent probability of an exit; and on the other, there is Goldman Sachs, which rules out Greece leaving the euro, and says the single currency will recover.
The Greek elections in June were something of an opportunity for the big banks to fine-tune their contingency plans. Special teams were set up in New York, London, and other financial centers to find a way to respond quickly and effectively, and avoid the mistakes made after Lehman Brothers collapsed.
Whatever happens with Greece, the US banks have already been taking steps over the last two years to deal with instability in Europe by reducing their exposure. This in part explains why the euro has weakened: firms have switched from euros to dollars.
Even the threat of a small country like Greece leaving the euro is enough to make many nervous on Wall Street. Allianz has highlighted the financial and legal problems of changing contracts drawn up in one currency. Procter & Gamble has already announced it is taking measures. JP Morgan Chase, the biggest bank in the United States in terms of assets, is the first major bank to talk about contingency plans for bonds issued by euro-zone economies. Its London office says the “possibility of a member abandoning the euro is no longer zero” and that it has taken the necessary steps. According to a survey of its clients, 30 percent believe Greece will leave this year, and five percent believe that another, larger economy could follow suit. “If this happens, we will be ready to separate assets very quickly.”
For the moment, few companies are willing to talk publicly about their contingency plans in the event of the euro breaking up or undergoing some kind of major restructuring; about how to deal with the suspension of trading in certain types of bond, and on the emergency measures to be taken to control the movement of money. The same applies to the banks and the investment funds.
The financial sector normally has more time to deal with these kinds of situation, and it is normally institutions such as the Federal Reserve that force them to do so. Companies are taking longer to come to terms with the possibility of major change. Consultants such as Ernst & Young and KPMG accuse many large corporations of failing to get to grip with the issues, and suggest holding conferences and seminaries to instill an awareness of the gravity of the situation.
For the moment, Goldman Sachs and JP Morgan say it is still too early to be writing the euro’s obituary. So far nothing has happened in the capital markets that has taken us beyond the point of no return and any difficulties can easily be resolved. That is their way of saying that the European Central Bank still has time to address the issue.