The Euro Odyssey: An Epic Journey Or A Greek Tragedy In The Making?

Author:Mr Peter Green, Jeremy C. Jennings-Mares and Lewis Lee
Profession:Morrison & Foerster LLP

The future of the European single currency stands precariously balanced. While hoping for the best outcome, prudent financial planning requires businesses to at least consider once unthinkable thoughts about the possible withdrawal of one or more member states from the single currency or even its demise altogether. This possibility has recently become more than just fanciful, since the recent failed election of the new Greek government has called into question Greece's willingness and ability to adhere to the significant policy reforms and austerity measures required as conditions to the second bail-out1. Should Greece fail to install a government in the forthcoming re-election which will adhere to these measures, European authorities may refuse to pay the next bail-out payment, which in turn may result in Greece's accelerated exit from the single currency.

This update provides some background regarding the stringent bail-out conditions which Greece has been required to implement and the potential impact this may have on the future of the single currency.

Bail-out Conditions

The conditions attached to the second bail-out required not only the implementation of stringent austerity measures including significant cuts in public sector pay and broad-ranging increases in taxes and excise duties, but also the participation by Greece in a sovereign debt write down of approximately €100 billion, via an initiative known as private sector involvement ("PSI").


The PSI resulted in an exchange of outstanding Greek sovereign bonds for new, replacement bonds at a discount of 53.5% of their face value. The replacement bonds are made up of a combination of short-dated bonds issued by the European Financial Stability Facility ("EFSF") and English law-governed bonds issued by Greece, with longer term maturities ranging between 11 and 30 years in length. Such exchange was partly facilitated by the ability of the Greek government (by amending Greek law) to compel holders of existing Greek law sovereign bonds to accept the exchange through the activation of so-called collective action clauses ("CACs"), retroactively applied to the existing sovereign bonds. CACs are provisions which provide for a specified majority of bondholders to be able to change certain specified terms (including those which affect maturity and the repayment of principal and interest) of a particular bond. Although it was controversial for the CACs to have been applied retrospectively to change the terms of existing bonds, it is worth noting that the language used in the Greek CACs is viewed by the International Capital Market Association2 ("ICMA") to be broadly consistent with a new model CAC recently published by the Economic and Financial Committee ("EFC")3 Sub-Committee on EU Sovereign Debt Markets. The model CAC will be mandatory in all sovereign debt securities (with maturities exceeding 1 year) issued after 1 January 2013, but is not intended to be applied on a retroactive basis.

Credit Default Swaps

A significant knock-on effect of the employment of retroactive CACs was that this triggered credit events in respect of a substantial number of credit default swaps (and other credit-linked financial transactions) referencing such sovereign bonds. An ISDA Determinations Committee opined, in March 2012, that the use of CACs did constitute a credit event under the 2003 ISDA Credit Derivatives Definitions. This was on the basis that the definition of Restructuring Credit Event included a reduction in the rate of interest or amount of principal payable (a "haircut"). Since the activation of the retroactive CACs involved bondholders being forced to take a haircut, the ISDA Determinations Committee determined that a credit event had occurred. Accordingly, an auction was held to determine the recovery value of Greek sovereign bonds. This recovery value (which was ultimately determined to be 21.5% of each bond's face value) resulted in net payouts to protection buyers under relevant credit default swap contracts.


Whether or not the Greek populace will elect a government which will continue to implement the reforms demanded by the European authorities remains to be seen. However, with excessively high debt levels, the credit ratings of banks in some member states being downgraded across the board and sovereign yields on new sovereign debt remaining at unsustainably high levels in Greece and other European member state countries, the risk of financial contagion is real and growing. To that end, many commentators have called for the building of a 'firewall' in the form of a heavily-capitalised European Stability Mechanism, with resources of €500 billion in addition to the €200 billion already committed by the EFSF. It is questionable, however, whether this money will ever be made available by member states and even if it were, whether it would ever be disbursed, given the difficulties, for some nations in need of those funds, in meeting the stringent conditions likely to be attached to the use of those funds. Regrettably therefore, the risk of a withdrawal of one or more member states from the single currency has not dissipated at all since our previous client alert on this topic.

We have therefore set out again, our analysis of the legal effects of a possible fragmentation or indeed, complete dissolution, of the single currency on certain financial contracts and arrangements.

Impact on Financial Documentation

For the purpose of this briefing, we have concentrated on two possible scenarios – the withdrawal by one or more member states ("Departing Member State" or "DMS") from the single currency and subsequent redenomination of the Departing Member State's national currency (a "fragmentation"), or the complete dissolution of the single currency of the Eurozone ("dissolution").

A fragmentation, while resulting in a change of currency for the Departing Member State, would see the Euro continue to exist as the legal currency for the Member States remaining in the EMU. It is possible that fragmentation, as well as involving the redenomination of the relevant national currency, would necessitate the imposition of exchange controls and restrictions on the use of the single currency in order to help stabilise the new currency of the Departing Member State.

In contrast, a dissolution of the single currency (albeit a much less likely event) could result in all the countries that currently use the single currency having to revert to their former currencies or implement new versions of those currencies. From a practical viewpoint, it seems inconceivable that dissolution could happen without the implementation of one or more EU treaties which would establish provisions for effective currency redenominations in the participating Member States.

While it would be impracticable (if not impossible) to consider every possible legal and contractual ramification of a fragmentation or dissolution, this update aims to provide an overview of some of the main provisions which might be relevant to parties who have entered into Euro-denominated or Euro-linked financial contracts. Consideration is also given to the broader legal principles which may assist parties as they seek to determine their rights amid the inevitable confusion that would ensue if one of these events were to occur.

For those who are party to financial contracts (e.g., loans, derivatives or securities such as bonds), the first point of analysis will always be the detailed provisions of the financial contracts themselves. Discussed below are a number of key provisions which will be relevant to determining a party's rights in the event of either fragmentation or dissolution of the Euro.

Governing Law

When reviewing a financial contract to determine the currency of payment, it is important to consider the governing law of the contract because this is the law which is relevant for the purpose of construing the terms of the agreement reached between the parties.

English law will give effect firstly to the express provisions of the contract. Where the contract is silent or...

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