The European sovereign debt crisis has created a cloud of uncertainty as businesses head into year-end, and many finance executives expect the situation to deteriorate further. A survey of 75 senior treasury officials, most from European companies, attending an IT2 user conference last month shows 54% expect the eurozone to break up in the next year. And according to Financial Executives International’s quarterly survey, 65% of U.S. finance chiefs expect Greece to default, as do 42% of European CFOs.
Companies that do business in Europe could face considerable fall-out if Greece or other countries exit from the 17-nation currency union. Companies could see assets and liabilities redenominated and possibly devalued and the creditworthiness of banks or other business partners called into question. Treasurers might find that hedges no longer make sense or might need to make fixes in accounting practices and treasury software.
Paul LaRock, a principal at consultancy Treasury Strategies, says many companies have already cut their exposure to the euro. “To the extent that large corporations were holding what they might perceive as excess deposits in the euro, I think many of them have solved that problem.”
Companies now face the complicated task of measuring their exposure to redenomination risk, LaRock says. Currently, companies operating in Europe may be doing business with other company units, vendors or suppliers in other European nations that also use the euro. “If one of those countries were to leave [the eurozone], suddenly you have a foreign exchange exposure that you didn’t have before,” says LaRock, who's pictured at right.
Companies are examining intercompany transactions, accounts payable and accounts receivable that involve customers or vendors across national borders, he says. “That way, if rumors were to turn to reality and one of the countries were to leave the eurozone, they now have an understanding of the exposure that’s at risk,” LaRock says. “Then you can come up with a mitigation strategy.”
Treasury Strategies recommends that once companies have a handle on their exposures, they do stress tests looking at three different scenarios: a single country exiting the euro zone, more than one country exiting, and a complete breakup of the currency union.
“It’s very unlikely the eurozone will split up,” LaRock says. “But if it did, the consequences are so large that you have to think about it.”
Counterparty risk casts a considerable shadow. If Greece were to default, companies are wary of the impact of the Greek sovereign debt held by Greek banks, but Krishnan Iyengar, vice president of global solutions at treasury software provider Reval, notes that banks in a number of European countries, including Belgium, France, Germany, Holland and Portugal, also hold considerable amounts of Greek sovereign debt. Investment companies, like those offering money-market funds, and insurance companies may also be exposed, he says.
Meanwhile, if Greece did return to using the drachma, treasuries that rely on treasury management systems or other software would have to ensure that their systems could accommodate the currency change. “From a financial technology perspective,” Iyengar says, “a new set of ISO codes would need to be captured in existing systems, new rates would need to be captured, new market data feeds would need to be configured and valuation systems need to be retrofitted with business logic that would say, from such and such a date use the euro rate and from this date use the drachma.”
Companies would also have accounting issues to deal with. “Typically corporate treasuries are applying hedge accounting to any Greek-denominated derivative contracts they have and the contracts are typically hedging either forecast revenues or forecast expenses,” Iyengar says. “If those revenues and expenses suddenly get redenominated but the derivatives contracts do not, there are certainly issues to consider.”
The IT2 survey indicates though, that treasurers feel prepared to deal with the changes that could be coming. Roughly three-quarters (74%) say their company has policies in place that would protect it from the fall-out of a eurozone breakup, and 79% say their company could make the necessary financial and operational changes within three months’ time.
For more on this topic, see Breaking Up the Euro.