From the October 2011 issue of Treasury & Risk magazine

Breaking Up the Euro

Multinationals would be wise to prepare for the possibility that Europe’s single currency may undergo a transformation.

Many believe the likelihood of a euro breakup is somewhere between a significant possibility and a dead certainty. Domenico Lombardi of the Brookings Institution recently set the chances at 50-50. Jeff Wallace, managing partner at Greenwich Treasury Advisors, goes further: “It’s pretty close to 100% probability—the only question is when.” A breakup could take three forms, experts agree: a complete disintegration of the euro, in which all countries revert to a domestic currency; an orderly breakup in which weaker countries such as Greece, Portugal and Ireland can opt to exit the euro; or an exodus of stronger countries to create a new currency.

The second scenario is seen as most likely, although certain hurdles would need to be overcome.

“Currently, there is no mechanism for members to expel a country because of default or a formal mechanism for a country to leave the euro,” says Trevor Williams, chief economist of Lloyds Bank Corporate Markets. “But this does not mean that it cannot happen.”

Whichever way you look at it, the likelihood of Europe’s single currency undergoing a transformation has increased. The consequences would be immense: economic turmoil, an immediate devaluation of currencies coming out of the euro, shutting down the banking system for a couple of days in those countries—and possibly a banking crisis on the scale of the 2008 meltdown. “Europe is going to be facing a lot of economic troubles, and those troubles will affect the U.S. and the rest of the world,” Wallace says.

Few companies are prepared for that. Many expect the euro to survive, like Enrico Rao, group treasurer of Italian tourism company Alpitour. “We do not have a plan B and we do not think it is necessary to make one,” he says.

For those who think otherwise, here are some of Wallace’s suggestions for a contingency plan:

  • Get excess cash out of the PIIGS (Portugal, Italy, Ireland, Greece and Spain). With European banks and even U.S. banks at risk of contagion, Canadian banks are an attractive option.
  • Units located in the PIIGS should borrow in-country from local banks. If those countries exit the euro, what was a euro loan will become denominated in the local currency, which will devalue rapidly. Out-of-country borrowings may remain in euros, and the euro will appreciate vs. the legacy currency.
  • Look at foreign exchange counterparties carefully. Avoid dealing with banks in the PIIGS or indeed in Europe.
  • Be sure European finance teams can communicate with treasury at headquarters over the weekend, since that’s when the Latin American currency devaluations in the ’80s and ’90s were usually announced.

For a look at how companies are dealing with wild swings in foreign exchange rates, see Hedging in a Crisis.


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