Nomura report shakes up investors with the what-ifs of a euro break up.
With the sovereign debt crisis seemingly intensifying daily and with no clear answer as to what will ease the union’s pressures, the possibility of Eurozone fracturing increases. That’s what a recent Nomura note to investors concludes.
The note delves into some of the legal purgatories financial contracts could find themselves in if that happens. According to Nomura, recent events – from the almost meaningless government changes in Greece and Italy along with sky-rocketing yields on Italian and Spanish bonds – point to the very likely possibility that the Eurozone doesn’t survive; or if it survives, it could be missing a few parts. “This highlights the increasing risk of some limited form of Eurozone break-up, where one specific or a few smaller Eurozone countries exit, and the remaining Eurozone countries stay put and continue to use the Euro,” according to the note from Nomura’s Fixed Income Research team.
While the Eurozone can and quite possibility will avert such a break up, Nomura’s note is good reminder that treasuries should be having a conversation about what happens to the company’s financial contracts if a country breaks away from the euro.
From a legal perspective, Nomura writes, investors should be thinking about “redenomination risk” of financial instruments (bonds, loans, etc); that is a contract in euros suddenly turning into one of drachmas, etc. The bank offers several parameters to consider for this scenario, the first of which is the legal jurisdiction of an obligation. For instance, “if the obligation is governed by the local law of the country which is exiting the Eurozone, then that sovereign state is likely to be able to convert the currency of the obligation from EUR to new local currency (through some form of currency law).” However, “if the obligation is governed by foreign law, then the country which is exiting the Eurozone cannot by its domestic statute change a foreign law. If the currency is not explicit to the foreign contract, then it may be up to the courts to determine the implicit nexus of contract.”
Other aspects to think about are whether the exiting country is doing so lawfully or unlawfully. Or was it mutually agreed to or done so unilaterally, which also changes the legal environment. But perhaps the main issue for US MNCs is the part mentioned above regarding it being “up to the courts to determine.”
While there are internationally recognized rules for sticking to one’s obligations (lex monetae), Nomura points out that there are gray areas where jurisdictions might not be recognized. Lex monetae is the universally accepted law that says that each state exercises sovereign power over its own currency (and wouldn’t try to legislate over another country’s money). But if Greece, perhaps after slipping off the austerity trail, were to bow out (or get kicked out) of the Eurozone, would it recognize the laws from a Greek perspective or from a Eurozone (or English or New York) view? There’s nothing conclusive.
Again, it will be “up to the courts to decide,” something that usually sends shivers up any investor’s spine. Ask any MF Global customer about how they were feeling recently when their money for a time was in legal limbo. Click here to see Nomura’s note in full.