Euro breakup could affect your business?

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Introduction

Unfortunately, for all the talk about a solution to the European debt situation in 2011, no satisfactory rescue plan is yet to emerge. As a result, fear over a euro break-up is guaranteed to be the main market story of 2012. We have received a fair few questions from clients as to what would happen to the euro, euro contracts and such in the event of a breakup.

The truth is that no one knows for sure exactly what will happen in the Eurozone in the next few months. However, we’ve pulled together this quick guide to help you understand the risks involved and, hopefully, ease any fears that you may have about a complete collapse being just around the corner.

What will cause the euro to break-up?

A litany of events could push the Eurozone closer to a break-up, with one or more member states leaving the single currency. For the most likely culprit you have to look at where these problems began; Greece.

It is almost certain that the Greeks will default on their debt, but this is not the problem. The problem is containing the risk of contagion from Greece to other economies. European leaders need to make sure that the mechanisms, funds and programs administered by the various economic bodies (the ECB, IMF, EFSF, ESM and others) are in position to deal with the situation should it emerge.

At the moment that is simply not the case. This has resulted in an increase in yields in peripheral debt, the rise of CDS (anti-default insurance) prices and continuing euro weakness.

Do we expect the euro to fall apart completely?

In the event ascribed above, no. The Greek problem is not large enough to drag the euro down with it. For that we would need another catalyst, probably in the form of Italy, to experience deep political problems and a bank falling apart that would combine to form a crisis without response.

At this point, combined with an expected recession in Europe, the interbank markets would freeze ‘a la Lehman Brothers’ and the world would tip into crisis. It’s important to note that we are not expecting this to happen, however, and affix a 10% probability to this scenario.

What would be the impact on UK businesses in the unlikely event that the euro collapses entirely?

This is difficult to say but we know of a few law firms who are exploring contract laws between European counterparties in the event that the euro ceases to exist, and a “New Drachma” is introduced for example.

Any re-introduced currencies (like the Drachma) would naturally depreciate versus the euro in the first instance. So, hypothetically, any contracts struck under Greek law would be resigned with an agreement that EUR 1 = 1 ‘New Drachma’.

However, a significant deprecation (likely to be double digit in % terms) in the value of the ‘New Drachma’ would unfold, as it became freely available on the markets.

To make sure that there is no disconnect between euro payments and new currency distributions, new terms may be needed with local suppliers. Companies may also need to “off-shore” cash so as to not fall under any governmental line in the event the state defaults and nationalises bank assets.

Conclusion

The Eurozone debt situation is a constantly evolving nightmare and while the European political classes will take the world to the edge of disaster before they put a solution together, we expect the situation will be clearer in a year’s time, and that in the end, the euro will remain as a trading instrument.

The apocalyptic scenarios are great for headlines and terrible for businesses, but we believe that the risks of these playing out in reality are minimal; a currency just doesn’t disappear overnight

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