Client Seminar: End game in the
Eurozone?
slaughter and may
18 September 2012
Client Seminar: End game in the Eurozone?
Eurozone Crisis: End game in the Eurozone?
“Over the past four years, the EU has responded decisively to the economic and financial crisis.”
(EU Commission Communication on Banking Union, 12 September 2012)
The four eurozone crises
Economic
crisis
Political
crisis
Debt
crisis
Banking
crisis
Where are we now?
•
ECB’s 6 September 2012 announcement of “unlimited” Outright Monetary Transactions – secondary market
purchases of shorter-dated eurozone sovereign bonds:
−− purchases to be “sterilised”
−− for countries complying with “strict and effective conditionality” attached to an EFSF/ESM programme,
ideally with IMF involvement
−− pari passu ranking for ECB
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Client Seminar: End game in the Eurozone?
•
German Constitutional Court decision, 12 September 2012:
−− allows establishment of ESM and fiscal pact to proceed
−− requires Germany’s obligations to be interpreted as subject to a cap of EUR 190 billion
−− excludes the possibility of ESM borrowing from the ECB
Possible scenarios
•
Euro survives intact
•
One or more Member States exit from the eurozone
•
Euro breaks up
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Client Seminar: End game in the Eurozone?
Eurozone outlook: lost decade or breakup?
Ernst & Young Eurozone Forecast
Marie Diron, Oxford Economics
Deleveraging to take years
France: Sectoral indebtedness
Eurozone: government debt
% of GDP
% of GDP
100.0
180
160
90.0
140
80.0
120
Non-financial
business
Domestic
financial sector
100
70.0
80
60.0
60
50.0
Consumer
40
40.0
2000
20
2003
2006
2009
2012
2015
2018
2021
Source : Oxford Economics/Haver Analytics
1995
1997
1999
2001
2003
2005
2007
2009
2011
Source : Oxford Economics/Haver Analytics
Social costs of internal devaluation is high
Unemployment rate
%
25
Spain
20
Greece
15
Portugal
Eurozone
10
UK
5
0
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source : Oxford Economics
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Client Seminar: End game in the Eurozone?
What is needed to hold Eurozone together?
The Eurozone has ammunition to deal with crisis but needs to act swiftly:
•
ECB even more interventionist
−− September meeting outcome was very positive
•
More bailouts
−− ‘mini’ bailouts for Spain? Italy?
−− New bailout for Portugal?
−− Renegotiation for Greece
•
Move towards fiscal & banking union
•
Change in macro policy
Piecemeal policy action leading to Eurozone’s lost decade?
Eurozone GDP growth
% point difference from historical average (2.3% pa)
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
2010
2012
2014
2016
Source : Oxford Economics
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2018
2020
2022
Client Seminar: End game in the Eurozone?
Immediate consequences of a breakup – Exiting countries
•
Large devaluations of new currencies: +/- 50%?
•
Inflation to rise sharply
•
Interest rates to soar
•
Bank runs and capital controls
•
Risk aversion to lead to slump in share prices, foreign direct investment etc.
Immediate consequences of a breakup – Residual Eurozone
•
Movement of the euro vis-à-vis the US dollar, sterling etc?
•
Risk aversion to lead to slump in share prices, foreign direct investment etc.
•
Strains on banking sector
•
Steep weakening of export markets
Bank exposures to government debt
US$ billion, 2012Q1
Germany
France
UK
Spain
Italy
Japan
US
Row
Source : BIS
0
10
20
30
40
50
60
70
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Client Seminar: End game in the Eurozone?
With breakup risk rising, the longer weak growth prevails
‘best case’
breakup
scenario
Eurozone*: GDP
% year
6
Forecast
4
Baseline
2
0
-2
-4
-6
-8
Eurozone break-up
* Remaining 12 countries
-10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source : Oxford Economics/Haver Analytics
Breakup would send unemployment to yet new highs
Spain unemployment
Eurozone* unemployment
% of labour force
% of labour force
Eurozone break-up
16.0
29
12.0
24
10.0
6.0
4.0
2005
19
Baseline
Baseline
14
9
* Remaining 12 countries
2007
2009
2011
2013
Source : Oxford Economics/Haver Analytics
06
Eurozone break-up
34
14.0
8.0
39
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2015
4
2005
2007
2009
2011
2013
Source : Oxford Economics/Haver Analytics
2015
Client Seminar: End game in the Eurozone?
Case Study: Greek Exit from the Eurozone
•
May 2010 Bail-out by IMF and Eurozone
•
Austerity results in prolonged recession with 20% fall in GDP while unemployment increases to 24.4% (55%
for under 25s) (June 2012) with further increases expected
•
Political/social opposition blocks implementation of many structural reforms
•
July 2011 announcement of second Greek package including PSI
•
Protracted negotiations accompanied by increasing tensions between eurozone member states lead to
agreement on 21 February 2012 on a second bail-out
•
Orderly restructuring of privately held Greek bonds representing 74% reduction in NPV (but ECB stands aside)
New Government Formed to Renegotiate Bail-Out
•
New Democracy forms a government in coalition with PASOK and Democratic left after 17 June election
•
Mandate to re-negotiate Greece’s second EU/IMF bail- out
−− tax cuts
−− suspension of cuts in public sector employment
−− extension of timeframe for compliance
•
EU refuses to agree substantial concessions
Things Fall Apart
•
Attempts to implement agreed programme fail
•
Spain seeks enhanced conditions credit line from ESM to activate ECB bond purchases under Outright
Monetary Transactions programme
•
EU/IMF freeze further funding of Greece
•
Government unable to pay public sector workers
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Client Seminar: End game in the Eurozone?
•
Violent disorder on streets/army deployed in city centres
•
Government falls as PASOK/Democratic Left withdraw
•
New elections called leading to SYRIZA victory
From Default to Eurozone Exit
•
Tsipras seeks fundamental renegotiation of Greek programme involving cancellation of austerity measures and
debt forgiveness
•
Refusal by EU leads government to declare moratorium on non-IMF loans
•
Mass capital flight leads Greece to impose capital and exchange controls; suspends Schengen membership •
Greek exit agreed privately by Merkel and Hollande and announced at an emergency EU summit
•
EU adopts a regulation under Article 352 TFEU to give immediate effect to Greek exit
•
Buttressed by treaty amendment under simplified revision procedure to provide retrospective authority for
regulation in case of legal challenge
The Return of the Drachma
•
Banks close for one week after exit announced (with limited ability to make cash withdrawals)
•
Drachma introduced electronically. Euros may continue to circulate as cash at market rate of exchange.
Alternatively, Greece may overprint Euros as new drachma
•
Drachma initially loses 50%-60% of value against Euro
•
Greece seeks new IMF package to cover balance of payments deficit
•
Paris Club negotiations on sovereign debt forgiveness possible (no payments of principal due on private bonds
until 2023)
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Client Seminar: End game in the Eurozone?
Redenominating Existing Transactions
•
Greek legislation provides for redenomination of Greek law governed Euro debts, contracts and bank accounts
at 1:1 exchange rate
•
Foreign law governed contracts redenominated if contract closely connected with Greece
•
Non-Euro contracts not affected but subject to exchange controls
•
EU refuses to enforce Greek legislation owing to differences of view between member states … but does not
prohibit recognition either
Redenomination Risk for Existing Contracts
•
Greek courts will apply Greek law
•
UK and other EU member states likely to recognise redenomination of contracts governed by Greek law
•
Possible exception if redenomination is in breach of EU Treaties (e.g. if discriminatory) or if violates ECHR
•
Foreign law contracts will be redenominated if lex monetae is the monetary system of Greece
•
How do you identify the lex monetae where a contract requires payment in euros?
•
Will a “hard Euro” definition help? What other practical steps can I take?
•
If contract is governed by foreign law and lex monetae is not Greek contract will not be redenominated
•
Exchange controls will complicate picture
•
Possible claims under BITs
Exchange Control Risk
•
IMF/GATS provide international framework
•
Article 65(1)(b) TFEU allows exchange controls if “justified on grounds of public policy or public security”
•
Greek courts will enforce controls
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Client Seminar: End game in the Eurozone?
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An English court will recognise Greek exchange controls if:
(A) required to do so by EU law (e.g. regulation implementing Greek exit);
(B) transaction is subject to Greek law; or
(C) the contract is an “exchange contract” and Greek exchange controls are consistent with Article VIII 2(b) IMF
Agreement
•
UK/US courts take a narrow view on what constitutes an “exchange contract”. Other EU jurisdictions including
France and Germany take a broad approach.
Wider Impact of Greek Exit
•
Risk of exit by other periphery states
•
Deposit flight and renewed banking crisis
•
Second credit crunch: increased funding costs and contraction in availability of credit across EU
•
Eurozone recession will be longer and deeper – how will ECB respond?
•
Further recapitalisation of EU banks – who pays?
•
Will this lead to greater integration or a slow unravelling of the Eurozone?
Exit – Day 1 action points
•
Exit is announced…
•
How robust is your contingency plan?
•
Consider whether to test contingency plan with a “dry-run” and give thought to “Day 1” action points, e.g.:
1. Preliminary
−− communications (internal and external)
−− identify material exposures/arrangements which are likely to be affected (including intra-group
arrangements)
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SLAUGHTER AND MAY
Client Seminar: End game in the Eurozone?
−− obtain legal documentation
−− consider whether input from advisers is required (legal and/or financial)
•
Analyse key legal issues and risks
•
impact of new legislation, including local and EU legislation
•
scope of new monetary law and capital and exchange controls
•
guidance issued to markets (e.g. by ISDA)
•
Remedies
•
contractual termination rights and remedies
•
impact of redenomination and capital and exchange controls on remedies
•
notices and performance obligations
•
litigation strategy
2. Analyse key legal issues and risks
−− impact of new legislation, including local and EU legislation
−− scope of new monetary law and capital and exchange controls
−− guidance issued to markets (e.g. by ISDA)
3. Remedies
−− contractual termination rights and remedies
−− impact of redenomination and capital and exchange controls on remedies
−− notices and performance obligations
−− litigation strategy
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Client Seminar: End game in the Eurozone?
4. Insolvency
−− establish which legal framework/insolvency regime applies based on type of counterparty
−− proprietary or unsecured claim
−− consider notifying insolvency official to reserve rights/remedies
−− consider impact on termination, set-off, netting and collateral
−− consider impact of any moratorium (if applicable)
−− monitor insolvency process and take note of any deadlines/bar dates
5. Strategy
−− consider group strategy and next steps
−− consider applicable decision making-process
−− call board/committee meetings as required
−− consider paper trail
6. Other considerations
−− impact on operations, infrastructure and systems
−− regulatory overlay
Risk mitigation
•
Continue to monitor, update and stress-test contingency plan
•
Reduce exposure
•
Consider whether to amend existing contracts and update internal guidelines/policies for new contracts
•
Additional disclosures
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SLAUGHTER AND MAY
Client Seminar: End game in the Eurozone?
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Consider additional protections for new M&A deals
−− more targeted due diligence
−− more bespoke provisions to address completion/valuation risk
Potential areas of dispute
•
Contractual
•
Jurisdictional
•
Regulatory
•
“International”:
−− Bilateral Investment Treaties
−− Challenges to EU/national legislative measures…?
−− Insolvency
Remedies/DR issues
•
Jurisdictional considerations:
−− Commencement
−− Enforcement
•
Interim relief
•
Substantive relief:
−− Breach
−− Frustration
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Client Seminar: End game in the Eurozone?
What’s next?
•
Longer-term market reaction as the OMT programme is implemented?
•
Terms of Spanish and Cypriot bailouts to be confirmed
•
Ireland and Portugal to work towards regaining market access
•
Greek austerity package to be renegotiated/official sector debt forgiveness if exit is to be avoided
•
Further steps towards fiscal union (fiscal transfer, eurobills, eurobonds)?
•
Further steps towards banking union (bank resolution framework, single regulator and rule book)
•
More elections (Italy, Germany)
… and years of continuing uncertainty
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© Slaughter and May 2012
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