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Treaty with care
Written by Trevor Morton
A decade after the euro was welcomed in, there is very little to celebrate, and things are set to get worse before they get better. The impact on firms will only be managed if business leaders face the harsh realities. Trevor Morton outlines the risks
January 1st 2002 was a milestone in the evolution of the European Union. The euro, first introduced some three years earlier as an alternative medium for accounting and payment purposes, became reality. Overnight, it replaced sovereign currencies in the bank accounts of countless businesses and institutions as well as the pockets of some 300 million people. Years of planning and preparation resulted in a smooth transition; coins and notes were in circulation within days. As a traded and reserve currency, it is second only to the US dollar. But adolescence is proving to be an awkward time for the euro. It has the potential to fragment the EU and disrupt a very beneficial free trade zone. Like an errant teenager, its going off the rails has serious implications.
Ten years on, 32 million citizens and a grand total of 17 member states now make up the eurozone. But there is little or no reason to celebrate. Two years of prevarication by EU leaders has resulted in a failure to address the sovereign debt crisis that has put the region and elsewhere on the path to second, post-credit downturn. A default – orderly or otherwise, by Greece (and possibly other PIIGS countries – Portugal, Italy, Ireland and Spain) is creating unprecedented levels of uncertainty. Irrespective of the path the politicians choose, or are forced to follow, there will be severe ramifications. Economies not just in the eurozone but those supposedly a safe distance away, must brace themselves for the potential outcomes and the ensuing risks.
According to Yael Selfin, head of macro consulting at PricewaterhouseCoopers, growing market pressure and significant tranches of sovereign debt due for refinancing by early spring point at a “likely resolution to the current phase of the crisis around the first quarter of 2012”.
“Politicians have taken two years to face up to this moment, he says. “The resolution they agree to is likely to be implemented overnight in order to minimise market actions that can make it hard to implement.” Selfin goes on to outline four scenarios: monetary expansion by the European Central Bank (ECB) to inject significant liquidity into vulnerable economies and banks; an orderly default for the most indebted countries; a forced exit by Greece; and the formation of a new, smaller and tightly regulated currency block. He concedes that the latter would see its members prosper whilst those economies excluded would experience severe economic contraction.
“We expect these scenarios to have an impact well beyond the eurozone,” Selfin adds. “Countries such as the US and UK are likely to see falls in exports and banking sector problems whilst increased levels of capital inflows as investors look to place a larger portion of their portfolios into ‘safe haven’ markets. Other countries, like China, will have to deal with a decline in a significant portion of their exports.”
2011 saw numerous meetings of European leaders culminating in the 9th December summit. With saving the euro from collapse as its agenda, hopes were for a visible commitment from EU leaders to a clear strategy, however unpalatable. Angela Merkel, the German chancellor, and the principle underwriter of any viable salvage of the euro as we know it, naturally enough demanded tough new legally binding fiscal rules for the eurozone. Despite France’s support, any chance that the summit would be the turning point was scuppered when EU lawyers ruled any changes would be illegal if approved only by the club of 17 eurozone members. As if to further spoil the situation, UK prime minster, David Cameron, made clear his commitment to veto any such changes without the agreement of all 27 member states, whilst playing a card to make a case to protect the UK’s financial markets. With no clear outcomes from the summit, and ratings agencies rattling sabres in the background, the only ray of light was action on the 21st December in the form of the ECB issuance of super cheap money to over 500 banks. Of €489.2bn issuance, some may have ended up buying sovereign Spanish, Italian and possibly Greek debt.
The December action of ECB was the only good news for some time. It may have gone some way to sustain the confidence of the financial markets. But over time, it may appear as little more than a sticking-plaster. With no resolution in sight, the new year opened for business not only with the same lingering uncertainties but with confirmation, if it were needed, that the economies of the eurozone’s members are heading back into recession. The reality is things are set to get worse before they get better.
The risks arising from a eurozone meltdown, partial or worst-case, are not be confined to major multi-nationals. Few, if any, organisations will be immune. The organisations without a rigorous assessment could be caught unawares by events in what is now a very connected world.
Unlike the gradual and stage-managed introduction of the euro in 2002, the sudden redenomination of a PIIGS currency in 2012 could see events proceed at a very different pace. All organisations need to plan for this and, be able to respond appropriately.
According to Richard Anderson, managing director of Risk Services at Crowe Horwath Global Risk Consulting, the risks could be considerable. Firms need to create a degree of preparedness that is appropriate to their exposure. “First, a crisis management team that represents stakeholders from across the organisation is needed. IT, marketing, finance and operations must be involved. Representatives from operating companies on mainland Europe and elsewhere are essential. The agility of the entire organisation may be called upon; events may unfold in days, or it could drag on for months. Scenario planning should factor this in. Crisis management teams must think outside the box and move away from comfortable ‘group think’. Investigation of the ‘what-if?’ should be based not just on single risks but on possible sequences of events where risk and outcomes could be compounded.” Organisations may consider external risk management advice to facilitate initial risk assessments, then build and test contingency plans.
“At a minimum, re-pricing products and services at fixed conversion rates would be required. But how do you plan for a rapid devaluation of ‘new’ sovereign currencies, potential liquidity problems, and with it, the likelihood of currency controls?” Many other operational issues are coming to light including the need for multi-currency IT platforms, redenomination of collateral and deposits. Anderson points to the upside issues following a period of instability which could see more flexible and competitive labour markets return in Greece, Portugal, Spain and Ireland.
The LEGO Group, the world’s fourth-largest manufacturer of toys is one such that has the events in the eurozone on its radar and plans in place. Hans Læssøe, senior director, strategic risk management leads a cross functional team across the group. “We do not expect a complete meltdown of the euro as a currency. However, we are aware that such an event would have significant consequences for us given that we keep all our financial reporting on transactional level in euros. In the unlikely event of such a scenario, we would need to change currency, in our case to Danish kroner, in order to keep reporting valid.
So far, the provider of our enterprise resource planning platform has not confirmed that contingencies are in place to address such changes. We will probably have to develop a work-around for which we have identified a team of internal experts to define how any interim approach would work, should the need arise. We do foresee a highly likely reduction of the eurozone. We address the Greek market through a distributor with whom we trade in euros. We envisage continuing to do so without any major changes on our part. Trade in other PIIGS countries represents a small portion of our overall sales and as such is not a key risk to the LEGO Group.”
How would they respond to any downturns from the eurozone crisis? “At the LEGO Group, we systematically monitor the trend of consumer sales by price group, and are prepared to shift our marketing and campaign priorities to lower price-point sets if the need arises. We also foresee a potential consumer focus on slightly lower price-points given the current outlook across Europe.”
Whilst the Christmas and New Year holidays provided a welcome but temporary break in reporting of eurozone crisis, it has now returned with a vengeance. It’s tempting to postulate on the political drama, but the real imperative now for every organisation is to ensure effective and actionable plans are in place to address the impact. Political risk at the macro level has the potential to translate into an array of operational risks. Preparedness now is essential.