New laws in pipeline to make Euro watertight

Date: 22/02/1996

By Tim Jones

NEW draft legislation from the European Commission aims to ensure that the transition to the single currency will be irreversible.

Officials inside DGII, the Directorate-General responsible for economic and financial affairs, are working flat out to deliver so-called 'secondary' legislation by early April on three areas where the Maastricht Treaty is silent.

These will establish the legal status of the Euro from the moment a monetary union is created until banknotes and coins are introduced, and ensure the continuity of contracts as well as a one-for-one swap of Ecus for Euros.

The last time the Commission carried out such an exercise was in 1993, when regulations were adopted banning central banks from granting overdrafts to governments and stopping the practice of forcing banks to hold public debt.

The underlying purpose is to seal all the possible cracks that could spook the fickle financial markets or give the impression of the transition itself as a toe-in-the-water exercise.

“The financial markets want certainty,” says Graham Bishop, EU monetary expert at investment bank Salomon Brothers. “If politicians want to keep their currencies just in case the thing unravels, then we will know they are not to be trusted.”

This applies most clearly to defining the status of the Euro while it remains a nebulous currency without physical cash changing hands.

Market logic suggests that, despite this, it will become increasingly important during the transition period from January 1999 to July 2002, assuming the single currency plan goes ahead in accordance with the Maastricht timetable.

From January 1999, the European Central Bank will only operate in Euro, so the money markets are likely to swap over to it, followed by the banks and the government bond markets. Then, multinationals, which account for 10&percent; of cross-border trade in the EU, are likely to spot the cost-cutting benefits of using the Euro.

To provide these institutions with the certainty they need, the Commission will want to give true legal status to the Euro. Officials may even specify that it is the only genuine currency and that the national units are sub-denominations of it.

Continuity of contracts is equally vital to the markets.

Failure to have watertight legislation may encourage both borrowers and lenders to use monetary union as an excuse for renegotiating contracts for loans, bonds, financial derivatives or insurance policies.

Although the Maastricht Treaty says financial contracts will continue - since the value of the capital must be translated into Euro at the exchange rate fixed at the point of transition - it does not talk about the interest rate. This means that contracting parties may be tempted to renegotiate.

Borrowers who raised cash in a high interest rate currency may argue that, since their liabilities will be in the Euro from day one, they should pay interest at the lower rate, while lenders in low interest rate currencies may start to demand interest at the higher Euro rate.

This inherent conflict of interest could unleash a flood of litigation, Barclays Bank's EU specialist and former DGII official Malcolm Levitt warned in a recent report.

Without EU-level legislation, member states could come to different legal conclusions.

While these issues concern events three years away, the question of whether an existing Ecu can be exchanged at parity for a Euro is of immediate concern to the Ecu bond market, which now totals 115 billion ecu.

Uncertainty over this issue, despite the pledge of the December Madrid summit to carry out a one-for-one swap, continues to trouble the market.

Once the drafting is complete, the Commission will forward the proposals to the Council of Ministers, Parliament and the European Monetary Institute.

However, since some of the legal basis for ratification does not kick-in until the short-list for Euro membership is drawn up, final adoption may have to wait until 1998.