Ben Franklin said that by failing to prepare, you are preparing to fail. But when it comes to Europe, prepare for what?
Will the EU survive? Will the euro disappear? Will it just be Greece that drops out? Will the whole bloc crumble? Will we have four new-old currencies plus the euro? What are the legal ramifications? What happens to my commercial or financial contract if the counterparty changes from euro to, say, drachma? Will a switch be overnight? Will it drag out? How will a New York State court look at my euro-denominated obligation?
These are just a fraction of the questions that have cropped up as a result of the ongoing crisis in Europe. And trying to figure out any one of them can lead a person into a Rumsfeldian tangle:
“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.” So who knows?
Although the concern and chatter about a breakup and what to do about it has increased dramatically, the likelihood has abated somewhat – or, cooler heads are prevailing and the world is more comfortable with this actually happening. The general consensus is that there is a 20-30 percent chance that Greece leaves the European Monetary Union. A total break seems less likely. Intrade, the online prediction platform that allows users to predict outcomes of future events, puts the probability of “Any country currently using the Euro to announce their intention to drop it midnight ET 31 Dec 2012” at 35 percent, which is down from 50 percent just a week ago or so.
What we do know for a fact is that cash is leaving the Eurozone. This has been confirmed by members of the NeuGroup Peer Group universe, many of whom have been conducting deep dives into their portfolios and weeding out any exposures to European financial institutions. And just today, the Financial Times, reported that consumers are getting into the act: foreign-owned banks operating in the US have suffered their biggest six-month fall in deposits on record, in what most view as a flight to safety from European banks to domestic institutions.
We also know that smaller events are more likely, like a large-bank default and further sovereign downgrades. And we also know that conversations are taking place in boardrooms at MNCs as they try to get ahead of any disruption. As expected, most are taking a conservative approach; sprucing up their ISDAs and other collateral agreements, sticking to short-dated contracts and avoiding long-dated ones, setting triggers in the CDS market (and if tripped, retreat). Other suggestions have been to accelerate a move to collateralized trades; consider putting limits on counterparties by location and/or jurisdiction; make a list of key customers and analyze how the crisis will impact them if it gets worse. See other suggestions here.
The good news is treasurers have since the crisis been working diligently to shore-up balance sheets, plug holes and fill cracks. As has been noted, one of the best risk-mitigators is a strong balance sheet (see related story here).
So how will a New York State court look at my euro-denominated obligation? According to a note on the legal ramifications from the law firm Orrick, it will view the obligation through New York eyes. “Where a New York State court has jurisdiction over the debt obligation, in the first instance, the court will follow New York State law which provides that, generally, the parties to an obligation arising out of a transaction covering, in the aggregate, not less than $ 250,000 may agree that the laws of New York shall govern their rights and duties, whether or not such contract bears a “reasonable relationship” to New York State.” See the rest of the note here.