The Eurozone Crisis: Risk Planning For Asset Managers

Author:Mr Richard Frase

In recent months, the eurozone crisis has been continually in the news, including speculation as to whether one or more EU states may leave the eurozone.

In extreme form the crisis could result in some or all of the following "euro events" in respect of one or more of the weaker eurozone members (a potentially "exiting state"):

a dramatic loss of confidence in the ability of the exiting state to maintain its financial creditability; transfer of funds away from financial institutions in the exiting state by domestic as well as foreign depositors fund transfers accelerate into a run on the banks; imposition of exchange and capital controls by the exiting state to prevent an exodus of capital; the exiting state leaves the eurozone (unilaterally or by some form of agreement) and redenominated its euros into a new domestic currency; this is followed by significant inflation and devaluation of the redenominated currency against the euro; affected banks and other institutions default by on their obligations, triggering creditors' claims and leading in some to insolvency or nationalisation; (conceivably) the imposition of border controls by the exiting state to prevent a temporary population shift out of the exiting state; and considerable uncertainty as to the correct legal characterisation of the above events in international and EU law, spilling over into uncertainty as to their impact on existing legal rights and obligations affected by these euro events. The expectation is that these euro events will be focused in states most likely to leave the eurozone. But there could also be a spill over effect for other states and their institutions where they are exposed, or thought to be exposed, to the exiting state's default.

At this stage, we do not attempt to predict where or how any of these euro events may occur in the future. Rather, we set out a high level view of issues relevant to an asset manager, and which it will be prudent to plan for on a contingency basis, in the same way as for other major areas of identifiable risk.

Business Issues

Euro events could impact on an investment manager in a number of ways.

At the portfolio level:

Do its investments have exposure to a potentially exiting state? Does it hold sovereign bonds issued by the state, or other securities whose issuers are based in that state? If so has it properly considered their position against its clients' risk profiles and investment objectives? If any changes are needed to reflect these issues,...

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