accenture if country leaves euro

7/27/2019 Accenture if Country Leaves Euro

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The long odds whitepaper series

If a country leaves the Euro


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Setting the scene This occasional paper looks at a highly unlikely event

which would, if it came to pass, have a significant impact

upon investment banks. This paper is NOT a predication orforecast, it is an examination of the sorts of issues thatwould need to be addressed if the event under discussiontranspired.

We are not seeking to enter into a debate about thelikelihood of any event. For the purpose of this paper,the event described has occurred. The question we areconsidering is what is to be done as a result.

Key pointsThe euro was introduced in stages over a number of years;

the ejection of a member, if it occurs, may take place overthe space of a weekend.

Given the potential impact and challenges resulting froma country leaving the Eurozone, we believe organizationsshould begin to plan and prepare their response to such ascenario.

Potential implications includeBank balance sheets would once again come under

pressure as a wide range of assets were revalued.

Assets would need to be segregated into differing

currencies and accounts.

There would be a spike in trading activity, at the sametime tactical solutions to clearing and settlement in a newcurrency would have to be implemented.

Fear of inflation and further devaluations would drivedemand for euro denominated bank accounts.

Counter-party concerns would emerge as domestic banksof the countries affected face funding difficulties.

Increased collateral would be necessary for certainproducts and there would be a need to recalculate risk

exposures.

There would be a need to establish new reference databenchmarks.

New foreign exchange desks would be needed to handle

up to $58 billion in foreign exchange transactions likelyto be needed for Greece, Ireland and Portugal alone.

Increased corporate financing opportunities will emergeas corporations in countries leaving the euro would seek

to refinance, or hedge their FX exposure, an opportunityworth over $2,500 billion for Greece, Ireland and Portugal.

If a country leaves the EuroExecutive Summary

1 2011 Accenture


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3 2011 Accenture

If a country leaves the Euro

2009 Accenture - Organization Name - Contact1|2009 2

Clearly the irreversibility of the eurowas initially thought of as being

crucial to financial market credibility.And credibility was achieved, to the

immense benefit of the members ofthe Eurozone. The biggest benefit

accruing to those governmentswhere, because of a history ofinflation or comparatively smallfinancial markets, borrowing costs

had traditionally been high. Howeverthe idea that the lowering of debtservicing costs would be used bygovernments to consolidate finances

proved sadly misplaced. Instead lowerborrowing costs were used to prolongunsustainable fiscal policies to thepoint where the system itself has

become imperiled.

One of the most common refrainsfrom financiers is why the politiciansin the Eurozone do not simply let

a sovereign borrower default. Theanswer seems to be the politicalfear of just how far the ensuingdisaster and associated contagion

would spread. In particular there is adesire to support the balance sheetsof a wide range of Eurozone banks.If there is one lesson that has been

learnt from the Lehman Brotherscrisis, it is that financial marketsare far more interconnected thanhad been previously thought and no

plan, however detailed, is likely to beable to figure out fully the impact ofan economic shock. The view of anincreasing number of economists is

that the longer such a situation goeson without addressing the underlyingfactors that are causing the strain,

the more likely the result is going tobe sudden and shocking2. Quantifyingthe problem, it is useful to considerthat the three most troubled countries

(Greece, Portugal and Ireland)constitute 6% of the Eurozone GDPand 8% of the Eurozones sovereigndebt.

The euro was ratified under theMaastricht treaty of 1992, introducedon 1 January 1999 with notes andcoins implemented three years later.

So after an introductory period ofmore than seven years, a countrysexit of the Eurozone may take placeover a weekend. If a country were

to leave the euro, a short transitiontimeframe may be necessary as theremay be significant capital flight assoon as any plans are announced

(investors anticipating a significantdevaluation). A scenario could becomplete denial of any plans towithdrawal until the moment of

actual leaving. In this scenario, theneed for secrecy would mean there

could be no printing of bank notes orminting of coins before the event.

While there are any number ofpotential scenarios that mightcome about in the euro area, froma complete break-up, to a country

being ejected (or deciding to leave,which amounts to the same thing).We are going to briefly examine thescenario discussed most frequently:

a financially recalcitrant countrybeing asked to leave or departing asit refused to meet the requirementsenabling it to stay.

Just how plausible is abreakup of the Eurozone?

Germany 2652

Italy 2446

France 2176

Spain 848

Netherlands 499

Belgium 452

Greece 434

Austria 263

Ireland 196

Portugal 191

Smaller menbers 199

0

50

100

150

200

250

300

350

UK Germany France Italy

Spain 848

Portugal 191

Ireland 196

Greece 434

Eurozone Sovereign Debt (Billions of Euro)

Bank Exposure to Selected EU Countries

Euro exit would be traumatic;

countries would try to devalueassets as well as liabilities

and would want to respondto populist pressures to easeausterity plans

Just how plausible is it that a country would leave the Eurozone?For much of its first decade of existence, the answer was clear not at all plausible. The architects of the euro had meant it to beirreversible, to the point where a mechanism was designed wherebycountries can leave the European Union itself, yet not the euro.More recently the ECB has opined that, leaving the euro would betantamount to leaving the EU altogether1.

ource: IMF

ource: Citi, BIS


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2011 Accenture 5 2011 Accenture

f a country leaves the Euro If a country leaves the Euro

Immediate QuestionsClearly if a country were to abruptlyleave the euro, its domestic finances

are almost certain to be underextraordinary pressure. Governmentbudgets are likely to be strained andattempts at fiscal consolidation are

likely to have been severe and haverecently failed, most likely through acombination of a refusal of investorsto buy more debt, or social unrest, or

both3.

Thus the immediate aftermath of adeparture from the euro is going tosee a reversal of these policies and

rapid easing of austerity policieswith predictable falling of exchangerates. There are numerous examplesof countries departing from an

irreversible currency peg. Breakingsuch a pegging arrangement is simplya matter of declaring the link deadand letting the markets determine a

new exchange rate. Leaving the eurowould be much less straight-forward.

With no possibility of printing newnotes in anticipation of a withdrawalfrom the euro, one likely option

would be to create a new electroniccurrency (NEC). This would be a purelyelectronic currency, existing muchlike the euro did between 1999 and

2001. The most crucial question iswhich instruments should be shiftedto the NEC and which should remain

denominated in euros. This wouldbe a matter for considerable legalargument, but it seems reasonableto suppose all payments and salarieswould move to this new electronic

currency. Debt is more difficult,but given that the devaluation ofdebt was the reason to have theeuro in the first place, it seems a

reasonable assumption that all publicdebt, savings and private debt indomestic banks, as well as the assetsand liabilities held in branches of

domestically registered foreignbanks would be denominated in NEC.

f a country were ejectedrom the euro, it wouldeed to establish anlectronic currency, whileontinuing to use eurootes and coins

Implications forFinancial ServicesDomestic banks of a country thatexited the euro would obviously be inserious difficulties, with significantportions of their balance sheets

effectively devalued, although itmust be remembered that many oftheir liabilities would be similarlymarked down. How all of this would

be worked out is an unanswerablequestion and largely beyond the scopeof this paper. What can be said is thatgovernments would have to seek tokeep a payments system operating,

either through direct nationalizationof key banks, or a state guarantee ofcore parts of the banks.

For corporate borrowers, the degree

of financial integration that has takenplace over the past decade means adivision of assets and liabilities intorelatively safe euros and devalued

NEC leaving scope for a considerableconfusion and prolonged argument.Are loans with non domestic Eurozonebanks to be denominated in NEC

or continued on as euro loans? Wenow turn to at least some of themajor issues that would have to beconfronted in the event of a country

leaving the euro.

Implications for Investment Banks

The effects of adopting the NEC wouldbe felt across nearly all functions

of an investment bank. While thesewill clearly vary in significance,banks should prepare for both theimmediate impacts predominantly

covering increased trading activityand various tactical fixes and themedium term implications, requiringthem to reconfigure systems and

reference data, to implement strategicchanges to processes across the full

trade lifecycle, and to assess theirappetite to trade in the NEC.

Immediate Impacts

Bank Balance sheets would onceagain come under pressure. Thelesson from the 2008 credit crisis

was that financial markets severelypunished those in most trouble,but that all banks suffered to agreater or lesser extent. Exposure to

any potential euro crisis varies bygeography and by bank within thosegeographies.

Trading desks will see spike inactivity, notably through demand

to trade in and out of the NECfelt by FX desks and through theneed to refinance called bonds andexercised CDS contracts. Longer-

term, banks will need to developnew NEC-denominated products and

restructure desks if they want tosupport the NEC.

Cash Management & Paymentsteams will need to reconcilein-flight transactions (particularlythose part way through 3 day

settlement cycles, or the one daycycle which will come into forcefrom 1 January 2012) in the shortterm, before establishing new

models to process payments to localinstitutions. This would necessitateestablishing correspondent bankingmodels for NEC payments to local

institutions, requiring new Nostro

and Vostro accounts, and re-routingpayments to new euro-denominated

accounts for those companieswishing to continue to processpayments in euros. A tacticalsolution would be required untilthese new payments routes had

been established, similarly requiringtactical Confirmations and Clearing& Settlement processes to supportthese transactions.

Risk will need to re-calculateexposures to NEC-denominated

products, as well as credit exposuresto local institutions and to other

banks with significant exposureto the NEC. This will need to besupported by new calculationframeworks and models that support

the NEC and may also require othertrading and credit limits and issuessuch as living wills to be examinedfollowing this credit event.

Data Management reconfigurationwill be required to ensure thatreference data supports the NEC.Similar impacts will be felt across

Technology as the capabilityto support data, processes andcalculations in the NEC will mandatewidespread reconfiguration across

all systems. In many cases, this willresult in duplication of processes(both manual and automated), forexample through the need to issue

confirmations in a new currency.

Settlement Systems will have tobe reintroduced. A real time grosssettlement system, Target2, has forthe past two years been used in all

Eurozone countries for high valueinterbank payments, it is no longermulti-currency.

Finance will see both immediate

and long term impacts, through theneed to segregate assets betweenthe euro and NEC a complex taskthat will likely result in months, if

not years, of legal wrangling.

Withdrawal from the

euro could mean:Renewed pressure on banksbalance sheets

Spike in trading activity

Reconciliation oftransaction in process

Reevaluation of riskexposures

New reference data point

Asset Liability Management will

come under immediate pressure toallocate increasing capital to coverthe higher collateral requirementsassociated with more risky NEC-

denominated products, whichwill result in a spike in CollateralManagement processing. This will bechallenged by capital reserves falling

as NEC holdings devalue.

Research teams must be also beprepared to meet immediate andongoing demand for NEC-focused

analytics and reports, which willbe a challenge in the early days ofthe NEC but an important sourceof information in an uncertain

environment.


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Corporate Finance

Strategy

Onboarding

Clearing &Settlement(Strategic)

Confirmations(Strategic)

Asset LiabilityManagement

CollateralManagement

Research

Immediate ImpactLong Term Impact

Marginal Impact

Significant Impact

Regulatory

CashManagement& Payments(Strategic)

Finance

Client account management

Technology

Trading

Risk Management

DataManagement Cash

Management &Payments(Tactical)

Clearing &Settlement(Tactical)

Confirmations(Tactical)

Long-term Impacts

Following the adoption of short-term

tactical fixes, strategic solutions tocater for the NEC will be requiredacross the full trade lifecycle, notablyincluding Cash Management &

Payments, Clearing & Settlement andConfirmations.

There is a possibility that thedevaluation following introduction ofthe NEC would be inflationary. This

has three consequences:

- Surge in demand for foreign oreuro denominated banks accountsas citizens and businesses tried to

protect accumulated wealth, withconsequential impact upon nondomestic banks client onboardingsystems.

- Difficulty in domestic banks infunding, as savings fled to euro

denominated accounts, likely to bein non domestic banks. This wouldbe similar to the situation seen inLatin America during the 1970s

1990s where savings were held in USdollars, in US bank accounts, withconsumers only drawing cash intoan inflation prone currency as they

needed it.

- The NEC would have to circulatealongside euro notes and coins.

This is likely to result in a variantof Greshams law, with bad(electronic) money driving out good(non inflationary) paper currency.The result would be a preference to

pay in electronic currency resultingin a significant shift to electronic

payments. Cash payments accountfor approximately 70% of financial

transactions across Europe. Thisfigure rises to 90% in Italy. It is likelythat those countries that mightleave the Eurozone all have a greater

number of cash transactions thanthe Eurozone average.

Onboarding teams will face anincreased workload through the need

to establish new accounts, which willinclude following Know Your Clientprocedures establishing new clients

into new NEC-denominated productsas they become available. To supportthis however, banks must assess theirappetite, and client demand, to tradein the NEC and to trade with local

institutions a risk and opportunityassessment that will requireevaluation from Strategy teams.

Bond Debt - The introduction ofa NEC is almost certain to count

as a material change to a bondcontract, allowing for the bondto be called. Therefore the needto refinance bond debt could be

considerable. Bank for InternationalSettlements data indicates thatamounts of outstanding domestic andinternational bond and debt securities

in December 2010 was $586 billion inGreece; $1,474b in Ireland and $455bin Portugal.

Bank Debt While bank debt is

unlikely to be called in, there islikely to be a desire by Corporatesto align the currency of revenuesand debt payments. The latest Bank

for International Settlements datarecords external loans and depositsin banks in Greece were $115 billion($9b of which was to the non bank

sector), for Ireland the figure was$460b ($187b of which was to thenon bank sector) and Portugal $85b($19b of which was to the non bank

sector)4. At the very least, many

companies would seek to hedge their

new bank debt FX exposure.

Forex - An opportunity for regionalplayers to expand foreign exchangeoperations. Given that for smaller EU

states, total daily FX (spot, forwardand swaps) equates to between 4%and 12% of GDP, this implies forGreece average daily FX would be

approximately $24 billion, for Portugal$18b and for Ireland $16b.

Regulatory functions will alsoneed to comply with likely detailed

reporting requirements of holdings in,and exposure to, the NEC, especiallywhile the fear of contagion followingthe default exists. Regulators arefurther likely to stipulate banks to

conduct wider-ranging scenario stresstests to ensure they are prepared forthe risks of further defaults across theEurozone.

These implications will clearly varydepending on banks exposure to theNEC. There will be opportunities to takeadvantage of market dislocation but

on top of both rapidly implementingstrategic fixes, and implementingstrategic solutions over the longer term,banks must assess their appetite for the

NEC. This option will not be available inthe medium term to those banks withsignificant NEC exposures however, andthey will be especially hurt by devaluing

capital bases. Local banks will similarly

feel the impacts of this devaluationbut the most agile will be able totake advantage of the opportunities

presented by the creation of new localfinancial markets.

Withdrawal from the

euro could mean:

Establishment of newolutions for cash

management, clearing andettlement

Fear of inflation

Refinancing of bank andbond debt

Need to onboard significantnumbers of new accounts

Opportunities for FX

Ireland

Ireland could well be a special case. For

any country contemplating departurefrom the euro, the creation of a NewElectronic Currency is a leap intothe dark which is always a daunting

prospect. Uniquely, however, for Irelandthere is an exit from the euro availableto no other members rejoiningsterling. While for many people thiswould be politically upsetting, it has to

be set against the potential prospect ofyears of recession that may well ensue

as the Irish try to recapitalize theirfinancial system. Moreover it should

be remembered that the Irish Punt waslinked to sterling from 1922 to 1979.Political objections to British Banknotes could potentially be overcome

through the issuance of Irish banknotes,which like Scottish or Northern Irishnotes, are of different design, but carrythe same value.

In order to take this route, theIrish would need to declare thatthey were rejoining sterling belowthe prevailing / exchange rate.

Effectively, Ireland would create aNew Electronic Currency, devaluingtheir assets and liabilities and thensubsuming their NEC into sterling in

one swoop. Rejoining sterling wouldneatly answer the problem of how toinstill market credibility, allowing theIrish government and of course Irish

businesses, to obtain financing at non-penal or distressed interest rates.

For financial services firms, theadditional advantage of this path is

that adding the Irish into existingsterling structures would be easier,and less expensive, than establishinga new currency.Ireland has a unique exit

from the euro: they couldrejoin sterling, rapidlyregaining financial marketcredibility

Breakup of the Eurozone: IB Operating Model Impacts

ource: Accenture


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Recalculate exposures to NEC-denominated products

Re-evaluate credit exposures to local institutions

Assess exposure to banks with significant NEC holdings

Develop new calculation frameworks and models

Adopt new reporting frameworks

Re-examine trading and credit limits

Segregate assets between euroand NEC

Adopt new NEC models

Allocate capital to cover increasedcollateral requirements on NEC products

Allocate capital to cover for devaluedNEC holdings

Prepare contingency for clearing housesnot supporting NEC

Establish connection to new local

clearing houses

Process increased collateral requirementson NEC products due to higher riskassociated with NEC

Reconfigure reference data to support NEC

Assist corporations to align their liabilitieswith earnings

Assess risk appetite for NECproducts

Assess risk appetite for NECinstitutions

Evaluate client demand for NEC

Adopt separate reportingof risk exposure to NEC

Conduct wider-rangingscenario stress testing

Generate NEC-focused analyticsand reports, bothinternal andexternal

Onboard clientsonto new NECproducts

Develop capability toconfirm tradesprocessed throughnew routes

Strategy

Deliver Client Service

Onboarding

Research Trading

AssetLiability

Management

RiskManagement

Regulatory Te chno logy ResourceManagement

HumanResources

Finance

Corporate Finance

ConfirmationsCash

Management& Payments

DataManagement

Clearing &Settlement

CollateralManagement

Client account management Client strategy & analytics

Core Investment Bank

Corporate Core

Reconfigure systems to support and calculate exposures in NEC,including Front Office, Risk, Trade Processing, Settlement, Confirma-tions and Finance

Provide coverage for the increased workload associated with dupli-cated processes

Reconcile in-flight transactions, e.g.payments part way through 3 daysettlement cycles

Establish correspondent bankingmodels, requiring new Nostro and

Vostro accounts, for NEC payments tolocal companies

Route payments to new euro-denominated accounts for europayments to local companies

Evaluate client exposures toNEC, restructuring portfolios andre-hedging risk

Process new legal documentation

Execute increased FX trading

Refinance called bonds & CDS contracts

Re-hedge bank and client exposures

Structure / develop new NEC denominated products(Bonds, FX..)

Develop new pricing frameworks for NEC products, e.g.plotting new bond curves

Restructure desks to provide coverage for NEC

Limited Impact

Key

Marginal Impact

Significant Impact

Immediate ImpactsLong term impacts

Mapping the Effects of a withdrawal from the Euro


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2011 Accenture0

f a country leaves the Euro

Conclusion

ven if departing the Eurozone is still long odds, it has to now be considered as a possible

cenario. Given the potential impact and challenges resulting from a country leaving the

urozone, we believe investment banks should internally stress test such a scenario.

his paper makes no predictions about the likelihood of this long odds event, but it does look

t a number of the key challenges that would face financial services firms were a country to

e forced to leave the euro. These range from coping with the reaction of a naturally nervous

ublic to corporate refinancing, to the likely size of any foreign exchange markets that might

ventually emerge.

ReferencesAthanassiou, Phoebus; Withdrawal and Expulsion from the EU and EMU; ECB Legal Working Paper Dec 2009

Roberts, Richard; EMU Fuse or Split?; Lombard Street Research; Oct 2010

Mayer, Thomas; The politics of the euro Deutsche Bank Research; July 2011

BIS Quarterly Review: June 2011 Table 3A: External loans and deposits of banks in all currencies vis--vis all sectors

About AccentureAccenture is a global management consulting, technology services andoutsourcing company, with approximately 211,000 people serving clients i n

more than 120 countries. Combining unparalleled experience, comprehensivecapabilities across all industries and business functions, and extensiveresearch on the worlds most successful companies, Accenture collaborateswith clients to help them become high-performance businesses andgovernments. The company generated net revenues of US$21.6 billion for

the fiscal year ended Aug. 31, 2010. Its home page is www.accenture.com

AuthorsDean JaysonSenior ExecutiveDean.l.jayson@ accenture.com

+44 207 844 8295

James SprouleHead of UK ResearchJames.r.sproule@ accenture.com+44 207 844 3387

Oliver KnightOliver.h.knight@ accenture.com+44 203 335 2667

accenture if country leaves euro

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