Planning for a possible euro redenominationhas been a mantra of many central bankers and industry bodies over recent months. The reality is that such planning is intellectually stimulating, theoretically logical but operationally pretty useless.
Quite simply, until the mechanism for a redenomination is known, the planning becomes a checklist of what is possible, probable and problematic. In the end there are a list of decisions that would be needed in the fullness of time and a list of issues that wouldhave to be resolved. Unfortunately, most of them will demand court and other action.
In the securities world redenomination will depend on the applicable law of any loan agreement. If the law is that of the redenominating country, the process is easier. Equity nominal value redenomination should be simpler than principal debt, which may be subject, for instance, to English Law. On the payment side (settlement, income, corporate actions), much will depend on the legal contract of the payment. A euro could be loosely defined in many contracts as the currency of the EU, and this begs the question of whether such payments are subject to EU law or the law in the impacted country. The place of payment is also important. Most equities are paid locally to an agent. But do global custodians contract for such a nuance in their legal agreements or will any decision be transaction specific (based perhaps on the date of announcement or advice)? International debt often identifies the ICSDs as the location of payment, but it is unlikely that they will pay away other than in the currency they receive. The location of a transaction may change across the chain; an offshore (to the impacted country) open trade could be in legacy currency, but any covering of that trade with counterparties in the impacted country could well be subject to redenomination risk.
Operationally, redenomination would be a nightmare. It is unclear what would constitute an act of default. It is uncertain where claims could be enforced. It is unclear how cross defaults would operate. Guarantors would have to be examined. In the end, one task is to examine legal documentation and split potential issues between those governed by local law, international law and those that are unclear. A redemption and payment schedule of debt would also be valid to identify the timing of any possible credit incidents. And for equities, the wise person would abandon all their contractual policies and pay as received.
And just in caseorganizations have spare resources, they should also consider who will decide details on such issues as the new ISINs needed, the days in the year for interest computation, the rounding up and down rules, changes in payment locations and how they get hold of new currency and open new currency accounts.
And think through collateral, repos and swaps, for they would all be impacted. If my fears are right, there are going to be many disputes on interpretation of law. Assets will be frozen by the courts. A weekend will not be enough to resolve the issue. We should all be hoping that a solution is found. The economic consequences of any redenomination are horrific; the operational ones will be just as bad.