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© Allen & Overy ICM: FOA InfoNet: Potential impact of the break-up of the Euro Richard Tredgett and Damian Carolan 8 February 2012
© Allen & Overy Basics 1.There is no exit mechanism in the EU Treaty 2.We face a variety of possible scenarios: weak state exit, strong state exit, north/south split, complete dissolution, euro continues, euro does not continue 3.We can expect legislation, but cannot predict where or precisely what it will say 4.The primary concerns are that euro-denominated obligations become denominated in another currency and/or that exchange controls prevent parties from performing obligations. 5.The rules that follow are based on: 1.For redenomination and exchange controls, a weak state exit where you expect and want to receive euros 2.For complete dissolution, a complete dissolution
© Allen & Overy Simple Rules - Redenomination 1.If you have defined “Euro” to mean the lawful currency of the exiting state, you lose 2.If you have agreed to local jurisdiction, you lose 3.If you have agreed to foreign jurisdiction, but local law, you lose 4.If you have agreed to foreign jurisdiction and foreign law, you might win (but see rules 5 to 8) 5.If counterparty draws you into domestic proceedings, you may lose (Italian torpedo) 6.If the lex monetae is local law, you lose 7.If you need to enforce locally, you lose 8.If you need to prove in local insolvency, you lose 9.EU/foreign jurisdictions may impose a solution 10.Some contracts may have provided for specific consequences (eg., termination, payment in DEM) 11.Plumbing issues will need to be addressed (e.g. EURIBOR to ATHIBOR) 12.English courts are reluctant to find contracts frustrated
© Allen & Overy Simple Rules – Exchange Controls 1.If you have agreed to local jurisdiction, you lose 2.If you have agreed to foreign jurisdiction, but local law, you lose 3.If you have agreed to foreign jurisdiction and foreign law, you might win (but see rules 4 to 6) 4.If you need to enforce locally, you lose 5.If you need to prove in local insolvency, you lose 6.If the exchange controls are preserved by IMF Agreement Art VIII (2)(b), you may lose (see rules 7 and 9) 7.English and NY courts take a narrow view of scope of Article VIII (not bonds or loans) 8.Article VIII might not apply to existing contracts 9.If the exchange controls are introduced in breach of EU Treaty, there may be a conflict with IMF Agreement – Supremacy of EU Law 10.EU/foreign jurisdictions may impose a solution 11.English courts reluctant to find frustration, but consider illegality in place of performance (Ralli Bros)
© Allen & Overy Simple Rules – Complete Dissolution 1.There will have to be legislation at an EU level/treaty revision 2.Conversion rates will be set, but market exchange rates will quickly diverge 3.All the rules for redenomination and exchange controls will still apply
© Allen & Overy Applying the Rules to Specific Contracts Bonds ISDA Master Agreements: CDS Swaps FX Deposits Shares
© Allen & Overy Potential issues for the listed derivatives markets (1) The exchange / trading venue Primary interest to maintain an orderly market - contract terms that are and continue to be enforceable Seek to reflect the wider market rather than dictate it? Proper / orderly markets Robust arrangements for settlement and clearing Contract specifications: Forward looking Existing contracts
© Allen & Overy Potential issues for the listed derivatives markets (2) The clearing house Partially reliant on exchange for contract specifications Contractual positions Emergency powers? Rewriting existing contract terms where impacted? Acceptance of new positions for clearing Fungibility Settlement arrangements Any impact on enforceability Collateral Location; robustness of enforceability Eligibility criteria; denomination Value; haircuts Across the board increased margin / default fund requirements - based on market volatility / uncertainty?
© Allen & Overy Potential issues for the listed derivatives markets (3) The clearing member Facing the clearing house Understanding nature of emergency powers Impact on registered contracts? Impact on collateral requirements - absolute size and eligible collateral Liquidity pressure? Facing a client Terms - passing through exchange / clearing house action Client-facing exposures: contracts, collateral and settlement arrangements should be assessed in line with key principles
© Allen & Overy Discussion These are presentation slides only. The information within these slides does not constitute definitive advice and should not be used as the basis for giving definitive advice without checking the primary sources. Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's affiliated undertakings.
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