Against a backdrop of ongoing Eurozone volatility, companies are continuing to review their exposures in Europe, including the nature and extent of their Euro-related contracts, and are asking what measures they can put in place to protect their assets and limit cashflow threats.
A question that is often asked in this context is what impact a member state exiting the Eurozone would have on the payment obligations of counterparties located in that country and, in particular, whether these obligations would be redenominated from the Euro into the new national currency.
Core legal issues to be considered include the law governing the contract; the courts that have jurisdiction over claims under the contract; where payment is to be made; where the goods or assets are located; and whether a supplier or lender can enforce its rights in that country. Much will depend on the particular circumstances and the specific drafting of the relevant contractual provisions. However, if arrangements are not governed by the law of the exiting country or are not subject to the jurisdiction of that country’s courts or the place of payment is outside the exiting member state, and provided the definition of ‘Euro’ is appropriately drafted, these should be a degree of protection against redenomination.
Even if the currency of the contract is not redenominated, a Eurozone exit may still give rise to other practical concerns. For example, if exchange controls are introduced restricting payments out of the country, this could, depending on the circumstances, limit the ability of the counterparty to meet its payment obligations under the contract. In addition, enforcement against the counterparty would be likely to be complicated if its assets were located in the exiting member state.
As well as reviewing their exposure under existing contractual arrangements, businesses may wish to consider the terms on which they enter into new agreements or renew existing agreements, and whether any additional or revised provisions should be included to seek to limit the risks associated with a Eurozone exit. For more detail see our Q&A and risk matrix.
Direct Australian exposure to the more volatile Eurozone member countries is small, both in terms of funding by Australian financial institutions and Australian trading relationships with those countries. However, total Australian exposure to Eurozone and the indirect effect of the crisis means that Australia is not immune. Funding costs are on the rise, as the effect of volatility is felt in the international capital markets; capital and bank liquidity is being withdrawn from Australia as European investors and banks retreat to their home markets and Australia’s economy remains buoyant through the export of commodities to China and other growing Asian economies, growth which is directly influenced by any reduction in demand from Eurozone countries. Direct Canadian exposure to the Eurozone is similarly limited.
Most loans in Asia are denominated in either US Dollars or the local currency. Loans in Euros are relatively rare, and are generally limited to situations where there is a link to parties in the Eurozone (e.g. export credit financing where the supplier is based in the Eurozone and acquisition financing where the vendor or target is in the Eurozone). The leading European banks have generally retreated from Asia as the Eurozone crisis has intensified - reducing headcounts, closing non-core business lines, selling debt on the secondary market - and concentrated on advisory work in Asia and their core businesses in their home markets. In their absence, liquidity has reduced, but a combination of Chinese, Japanese and Australian banks have stepped in to fill the vacuum to some extent. Equity markets in Asia have been adversely affected by the Eurozone crisis, and there has been a marked reduction in M&A and IPO activity in the region. However, as with any downturn, there are opportunities for some, and certain Asian companies have purchased distressed assets in Europe at low prices.
In the UAE and elsewhere in the GCC the majority of financing arrangements are denominated in US Dollars or the domestic currency (which in many cases is pegged to the US Dollar). As a result, the direct impact of current Eurozone volatility has so far been limited. For the same reason, the repercussions arising from a member state exiting the Eurozone are unlikely to be severe. However, given their proximity to Europe, the GCC economies have extensive and long-standing ties with many European economies and the negative effects of the Eurozone crisis therefore continue to be felt in the region. Dollar liquidity has become tighter as the largest international banks, which used to be big regional players, refocus their business on their home markets and the contraction in dollar liquidity has also increased funding costs for regional corporates, which in turn has contributed to the slow down in the region’s own economic recovery. While it is likely that the wider economic consequences of the Eurozone crisis will continue to impact negatively upon the GCC economies in the months ahead, it is just as likely to accelerate a trend which is seeing these economies increasingly turn their focus on building economic ties with the newly emerging economies of Asia and Africa.
Lending in South Africa by South African and other financial institutions is most often denominated in South African Rand. Exchange control approvals are required for lending in any other currency whether locally or to foreign borrowers. When lending is conducted outside South Africa, it would typically be in US Dollars. Lending in Euros by South African lenders to South African borrowers is rare. Likewise, currency hedging against Euros by South African institutions is not core business.
Accordingly, from a lending perspective there does not seem to be an immediate concern amongst South African lenders as a result of the Eurozone crisis. Many will not have direct Euro exposure and many of their borrowers would also not have significant Euro exposure. As a result, the direct or indirect effects of the Eurozone crisis still seem distant. South Africa’s geographical location helps to isolated to some degree in that regard.
Any further negative effects would, however, be felt in international fundraising where some of our banks and major parastatals do have Euro denominated exposures under debt capital markets issuances.
Likewise, any institutions relying on European lenders to fund their business will be concerned should any of these effects give rise to liquidity constraints in relation to those existing or future borrowings.
The resulting inward focus will benefit South African businesses and lenders although larger scale capital intensive projects may likely suffer if European syndicate participants are not able or willing to fund their participations in multi-bank transactions.
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