This is undoubtedly one of the hottest weekend reads in finance.
Nomura’s Jens Nordvig has written a quietly piece titled Currency risk in a Eurozone break-up – Legal Aspects that for the first time, really looks at the implications of a Eurozone breakup, and what it means to investors who are owed money in Euros.
In other words, if a bank, or a company, or the government in say Greece announces tomorrow that it’s going back to the drachma, what do you get? Will you be paid in currency that’s worth toilet paper? Does the fact that you’re owed money in Euros still mean anything?
It’s complicated stuff, and is probably just the first of a mountain of literature that’s about to be published on the issue, and you’re advised to hunt down a copy.
We’ve seen one.
Here’s the basic summary. Note the use of the term “redenomination risk” right up top. Not something you see that often.:
Investors should consider three main parameters when evaluating redenomination
1) legal jurisdiction under which a given obligation belongs; 2) whether a break-up can happen in a multilaterally agreed fashion; and 3) the type of Eurozone break-up which is being considered, including whether the Euro would cease to exist.
In a scenario of a limited Eurozone break-up, where the Euro remains in existence for core Eurozone countries, the risk of redenomination is likely to be substantially higher for local law obligations in peripheral countries than for foreign law obligations. From this perspective, local law obligations should trade at a discount to similar foreign law obligations.
In a scenario of a full-blown Eurozone break-up, evaluating the redenomination risk is more complex, as even foreign law obligations would have to be redenominated in some form. In this case, redenomination could happen either into new national currencies (in accordance with the so-called Lex Monetae principle), or into a new European Currency Unit (ECU-2). This additional complexity in the full-blown break-up scenario leaves it harder to judge the appropriate relative risk premia on
local versus foreign law instruments.
The distinction between local and foreign law jurisdiction also becomes less important in situations involving insolvency. In those instances, the lower redenomination risk associated with foreign law obligations may be negated by higher haircuts. Hence, the legal jurisdiction therefore seems most relevant from a trading perspective in connection with high quality corporate credits which are
highly resilient to insolvency.
Bottom line: What matters is how the Euro breaks up (whether it’s a unilateral pullout of an agreed upon exit pact among everyone) and then whether the debt is a domestic debt governed by domestic law or an international debt, governed by law in either New York or London.
One other thing that makes this report remarkable. It’s the first time we’ve seen, anyway, this warning on a research report:
The following analysis of the risks and process associated with defaults in and/or secession from the Euro / Eurozone is not meant to constitute legal advice. The authors of this report are not acting in the capacity of an attorney. Readers of this report should consult their legal advisers as to any issues of law relating to the subject matter of this report
Meanwhile, this is just the latest in a new genre of post-apocalyptic Wall Street literature. See more here >
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