fs viewpoint                                   www.pwc.com/fsi           02              08          15                   ...
Understanding the crisis
Eurozone crisis                                                        The current eurozone debt crisis, while building   ...
Eurozone crisis                                                           In March 2012, The Economist reported,          ...
The roots of the crisis go                                                 Diverging competitiveness                      ...
The roots of the crisis go   Over-reliance on debt                                     The European banking sector is an i...
The resolution to the crisis                                    Imperfect unionwill be impeded by the fact                ...
Potential scenarios
Potential scenarios for the                                        Each scenario varies in its likelihood and             ...
Scenario 1                           Policy action                                                          •	 Crisis is i...
Scenario 2                    Policy action                                                   •	 Following the Greek prece...
Scenario 3                  Policy action                                   •	 Greece exits the eurozone by imposing tempo...
Scenario 4                Policy action                                                                        •	 A Franco...
Exit of a country from the   A country leaving the eurozone may need to do     •	 Decide how to deal with existing outstan...
Implications for US corporations
How does all this impact   Eurozone restructuring has the potential to        Thus, companies should be more fully prepare...
Potential actions required   We expect the euro crisis to have a broad and                             profound impact on ...
1 	 Business model1.                   Problem statement                  In setting long-term business strategy—what prod...
2. 	 Revenue2              Problem statement                  Corporate revenue and profit margins are based on uninterrup...
3.	Treasury 3                  Problem statement                  Treasury must be prepared for the significant and diffic...
4. 	 Legal4            Problem statement                  For many organizations, legal contracts are based on existing EU...
5. 	 Procurement and 5                      Problem statement                  Many global organizations, especially large...
6. 	 IT6         Problem statement                  Regardless of size, complexity, or industry, companies are becoming in...
7. 	 Finance 7                  Problem statement                  The Finance function is heavily exposed to eurozone cha...
8. 	 HR/people8                Problem statement                  For businesses operating in Europe, the HR function is k...
9. 	 Tax 9                  Problem statement                  Companies should understand the immediate tax consequences ...
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
Eurozone Crisis: Strategies for Risk Mitigation
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Eurozone Crisis: Strategies for Risk Mitigation


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Eurozone Crisis: Strategies for Risk Mitigation

  1. 1. fs viewpoint www.pwc.com/fsi 02 08 15 28May 2012 Understanding Potential Implications for What companies the crisis scenarios US corporations are doing now Breaking Up is Hard to Do: The Eurozone Crisis—Possible Implications and Contingency Planning for US Companies
  2. 2. Understanding the crisis
  3. 3. Eurozone crisis The current eurozone debt crisis, while building Reform momentum is growing as political up over time, was triggered in April 2010 when leaders face up to this moment after more Eurostat, the Europe Union (EU) statistical than two years of procrastination and wishful authority, revealed that Greece’s 2009 budget thinking. Arguably, some of the largest deficit was €32.3 billion, or 13.6% of its gross financing hurdles in the most at-risk countries domestic product (GDP). In 2009, Greece had have been overcome, with yields on both short- estimated its deficit for 2009 would come in at and long-term debt significantly lower than at 3.7% of GDP. The EU’s limit is 3%.¹ the end of 2011, and consumer and industrial confidence beginning to improve. Nevertheless, Global markets have since responded to the significant operational risks remain for US magnitude of sovereign debt in other eurozone firms operating in the eurozone. Contingency countries as investors question the ability of planning can help mitigate the risk, and the these countries to repay their debts.² strategies adopted by US firms will depend on Greece, Portugal, and Ireland have requested likely market conditions. In this publication, financial assistance from the European Central PwC will outline four possible scenarios for Bank (ECB), the European Commission (EC), the eurozone’s future that can help guide US and the International Monetary Fund (IMF) to corporate decision-making. finance debt repayment. There has also been a stream of European summits to resolve the crisis. Consumer and industrial confidence Consumer and Industrial Confidence Growing market pressure and significant 20 tranches of sovereign debt due for refinancing 10 hint at a possible resolution to the current 0 phase of the crisis. However, there is no silver -10 bullet—any solution will necessarily play out -20 over time, step by step, via fiscal austerity to pay -30 down debt. In addition, deep structural reforms -40 will be necessary to restore competitiveness and -50 boost long-term growth. 2000 - Jan 2001 - Jan 2002 - Jan 2003 - Jan 2004 - Jan 2005 - Jan 2006 - Jan 2007 - Jan 2008 - Jan 2009 - Jan 2010 - Jan 2011 - Jan 2012 - Jan1   harles Forelle, “EU Sees Wider Greek Deficit, Roiling Markets; C Bonds Fall as Investors View Bailout and Default as Givens,” The Wall Street Journal, April 23, 2010.2 The eurozone consists of the following 17 European Union member countries who have adopted the euro (European Monetary Union): the 11 original members—Austria, Belgium, Finland, France, Industrial confidence Consumer confidence Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, indicator, SA % balance indicator, SA % balance Spain—and Greece (from January 2001), Slovenia (from January Source: Haver Analytics 2007), Cyprus and Malta (from January 2008), Slovakia (from January 2009) and Estonia (from January 2011). Understanding the crisis 3
  4. 4. Eurozone crisis In March 2012, The Economist reported, Many forecasters question whether Greece’s “Cheered by the signs of recovery, and relieved partial default on its debt and additional that disaster has been avoided (particularly funding from the ECB and the IMF of €130 in Europe, which towards the end of last year billion is a long-term fix or simply a way to seemed on the brink of a calamity of Lehman- delay the inevitable. Even with this package, like magnitude), financial markets have been Greece’s debt is still expected to be 120% of climbing steadily higher.”¹ GDP in 2020 under what some consider to be optimistic economic and budget assumptions.³ While financial markets have recently started to move higher, GDP data reflected a different As soon as the ink was dry on the Greek bailout story—confirming that the region shrank agreement, market attention turned to debt by 0.3% in the last quarter of 2011 while issues in Italy, Spain, and Portugal, thereby household spending, exports, and imports all signaling a potential continuation of the crisis fell.² Some fear that the eurozone may slide and once again highlighting the historical into deeper recession. origins of the current dilemma. Percent change in real GDP since 2000 Share of EurozoneGDP Share of eurozone GDP Percent Change in Real GDP Since 2000 150 Greece, Ireland, and Portugal: 140 6.1% of eurozone GDP 130 Spain and Italy: 28.5% of eurozone GDP 120 110 Rest of eurozone: 100 65.4% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Greece Spain Portugal Germany Ireland Italy Source: Haver Analytics, IMF, and WEO Databases. Source: Haver Analytics and PwC analysis1   Can it be… the recovery?” The Economist, 17 March, 2012. “2   Eurozone crisis live: FTSE 100 posts biggest fall of 2012 - as it “ happened,” Guardian Unlimited, March 6, 2012. http://www.guardian.co.uk3   Greece: Request for Extended Arrangement Under the Extended “ Fund Facility,” IMF Country Report No. 12/57, March 2012.4 FS Viewpoint
  5. 5. The roots of the crisis go Diverging competitiveness This imbalance stemmed from the eurozone’s unique governance structure (partback to the inception of the Divergences in the competitive positions intergovernmental, part supranational) and current-account balances of eurozoneeuro in 1999 and two countries have been building up over the and macroeconomic policy framework (single monetary policy and devolvedunderlying problems that past decade. Countries such as Germany fiscal authorities). Additionally, there and the Netherlands gained in price/have gone unchecked: cost competitiveness while others such as was no mechanism for regulating wider Greece, Ireland, Portugal, and Spain lost macroeconomic imbalances. competitiveness.¹ Current account balance (US$ billion) Manufacturing unit labor cost index Current account balance (US$ billion) Manufacturing unit labor cost index 400 180 300 160 Q1 2000 = 100 200 140 100 120 0 100 -100 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -200 Greece Spain Portugal -300 Germany France Italy -400 Netherland 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: OECD Germany Netherland Portugal Greece Spain France Italy Source: IMF1   European Economy News,” April 2010, European Commission “ Economic and Financial Affairs. Available from http://ec.europa.eu/. Accessed April 10, 2012. Understanding the crisis 5
  6. 6. The roots of the crisis go Over-reliance on debt The European banking sector is an important channel of transmission of the crisis becauseback to the inception of The divergence trend has been supported banks have large holdings of eurozone by a complementary flow of credit from thethe euro in 1999 and two surplus countries to the deficit countries. This sovereign debt on their books. The ECB is leading the effort to ease this pressure with theunderlying problems that has caused a build up in public and private introduction of its credit facility for the bankinghave gone unchecked: debt, delayed a correction in competitiveness, and allowed the structural problems of the sector, the long-term refinancing operations eurozone to be largely hidden. Many countries (LTROs). are now struggling to repay this debt. Pubic debt and and deficit estimates (% of GDP)(% Public debt deficit estimates for 2011 for 2011 of GDP) High debt 180 Greece High debt Gov’t debt (% of GDP) High deficit Moderate deficit 160 140 Italy 120 Ireland Portugal Belgium100 France UK 80 Spain 60 -12 -9 -6 -3 0 3 Government deficit (% of GDP) 40 20 Moderate debt 0 Low debt High deficit Axes represent Maastricht limits Low deficit Source: IMF6 FS Viewpoint
  7. 7. The resolution to the crisis Imperfect unionwill be impeded by the fact The 17 members of the European Monetary Union remain sovereign nations. The following timeline outlines potential trigger events duringthat the eurozone is not a 2012 that may impact the timing and ultimate resolution of the crisis.political union. March Apr May June… Aug Sept Oct Nov DecRefinancing €14.4 bn €8 bn €9.5 bn €7.7 bn IMF review of Greek bond Greek bond Portuguese Greek bond Greek economy redemption/ redemption bond redemption (Nov) disbursement (May) redemption (Jun) (Aug) (Mar) €14.6 bn IMF IMF review of Review of Greek disbursement to Greek economy economy by the Portugal (Mar) (May) IMF (Aug) €5.5 bn Ireland bond redemption (Mar)Political meetings EU Council G20 Finance EU Council G20 Finance EU Council meeting minister and meeting minister and meeting (1-2/Mar) central banks’ (28-29/Jun) central banks’ (13-14/Dec) meeting (20/Apr) meeting (13-14/Sep) EU Council G20 Summit meeting (18-19/Jun) (18-19/Oct) IMF/World Bank Annual meeting (Oct)Elections First round US presidential of French elections (6/Nov) presidential elections (22/Apr) Greek elections Greek elections (6/May) (6/May) Greek events Understanding the crisis 7
  8. 8. Potential scenarios
  9. 9. Potential scenarios for the Each scenario varies in its likelihood and Projected Eurozone GDP growth under Projected eurozone GDP growth under four scenarios. four scenarios impact.eurozone in 2012. 4% The eurozone that emerges from the crisis 3%There are a number of ways in which the is likely to be very different to the one we 2% 1%eurozone crisis could play out depending on the know today, with 2012 being dominated by 0mix of policy responses over the next year or uncertainty and high volatility. -1% -2% -3%two. Presented below are four possible, though There is a wide range of potential outcomes. -4%not necessarily exhaustive, scenarios that -5% -6%represent a range of potential resolutions to the 2005 2006 2007 2008 2009 2010 2011 2012 2013crisis in 2012:Scenario 1: Scenario 1 Scenario 2Successive phases of monetary and fiscal Scenario 3 Scenario 4action hold the eurozone together at the cost of Source: PwC analysis.inflation.Scenario 2:Voluntary defaults for highly-indebtedsovereigns.Scenario 3:Greece exits the eurozone and a firewall is built Scenario description Projected GDP growth (percent)2around other economies. 2012 2013Scenario 4: Scenario 1: Successive phase of monetary and fiscal action hold 0.1 0.7 the eurozone together at the cost of inflation.A new currency union is formed by the strongereconomies.¹ Scenario 2: Voluntary defaults for highly-indebted sovereigns. -3.0 -1.5 Scenario 3: Greece exits the eurozone and a firewall is built -1.0 0.5 around other economies. Scenario 4: A new currency union is formed by the -1.5 0.6 stronger economies.1   What next for the eurozone - Possible scenarios for 2012.” “ Available from: www.pwc.co.uk. Updated scenarios published March 2012.2 Ibid. Potential scenarios 9
  10. 10. Scenario 1 Policy action • Crisis is initially contained by ECB bank financing and agreement on Greek debt haircut.Successive phases of • Greece fails to meet the conditions of the deal, triggering another round of ECBmonetary and fiscal action financing coupled with fiscal transfers to peripheral economies in exchange for austerity measures.hold the eurozone together • A looser monetary policy is adopted at the end of 2012 to help restore theat the cost of inflation. competitiveness of the peripheral economies. Short-term outcomes • No or low growth will put downward pressure on inflation, signalling a looser monetary policy in 2013. • “Internal appreciation” of Germany in relation to the periphery helps alleviate recessionary pressure in peripheral economies by improving their trade balances. • Improved credit conditions and confidence could support GDP growth of 2% in 2014, as the survival of the euro looks increasingly certain. Medium-term outcomes • Higher inflation should ease debt restructuring, and improve competitiveness of peripheral European economies. • ECB raises interest rates to bring down inflation in the medium-term and restore credibility. • Most eurozone countries will be running primary surpluses for many years, putting a drag on growth. Higher inflation in the core Eurozone countries could restore the relative competitiveness in the core eurozone countries could restore Higher inflation of the periphery. The policy response restores confidence and prevents the relative competitiveness of the periphery. a prolonged recession. 140 Consumer Price Index Eurozone 2012 2013 2014 2015 2016 130 Forecast GDP growth 0.1 0.7 2 1.5 1.5 2004=100 120 Inflation 1.5 3.0 3.5 3 2 110 100 2004 2006 2008 2010 2012 2014 2016 Spain Germany Source: Eurostat and PwC Analysis10 FS Viewpoint
  11. 11. Scenario 2 Policy action • Following the Greek precedent, other highly-indebted economies seek to restructure their debts.Voluntary defaults for • We assume a 50% default on Portuguese and Irish sovereign debt and a 25%highly-indebted sovereigns. default on Italian debt. • In parallel, we assume leaders agree to measures aimed at insulating the rest of the eurozone from a collapse in confidence. Short-term outcomes • We estimate that the restructuring will cause a private sector wealth loss of up to €800bn, including €100bn to banks. • Bank losses would be partially recapitalized by governments, the European Financial Stability Facility (EFSF), and the European Stability Mechanism (ESM), but lending would also need to be reduced. • We expect that this would precipitate a contractionary debt spiral dragging the eurozone into a deep and protracted recession. Medium-term outcomes • We expect that restructuring governments will be locked out of credit markets and require long-term support from the rest of the eurozone and other bilateral institutions. • Over time, these countries would have to reestablish credibility with investors. Bank losses could total over €100 billion, whichlosses could total over €100 billion, which could Bank could precipitate a contractionary ...such a credit contraction could lead to a debt spiral... contractionary debt spiral... precipitate a deep recession € 35,000 € 30,000 Eurozone 2012 2013 2014 2015 2016 € 25,000 GDP growth -3 -1.5 -0.5 1 2 € 20,000 Inflation 1 0 0 1 2 € 15,000 € 10,000 € 5,000 0 Italy Greece* France Germany Portugal UK Ireland Spain Source: EBA. *Data as at 30 Dec, 2010 Potential scenarios 11
  12. 12. Scenario 3 Policy action • Greece exits the eurozone by imposing temporary capital controls and redenominating all new and existing contracts in new drachma.Greece exits the eurozone • The eurozone commits to saving the euro and uses the ECB and EFSF to build aand a firewall is built firewall around other vulnerable economies.around other economies. Greece outcomes • We expect that the new drachma could depreciate by as much as 50%, constituting an implicit default on debt. • Inflation would soar, potentially averaging 10% in 2012. • The Greek economy would enter a severe recession as credit conditions and confidence deteriorate and further fiscal austerity is mandated in return for IMF funding. • In the medium term, the economy could recover—driven by exports spurred by a weaker currency and improved competitiveness. Rest of eurozone outcomes • We expect this would cause an 18-month recession in the eurozone as investors’ losses and shaken confidence lead to capital flight and deteriorating credit conditions. • But the Greek exit also would provide an impetus for other vulnerable countries to bring forward fiscal and structural reforms to “avoid the Greek fate,” improving longer-term growth prospects. Historical devaluations have led to tosharp contraction in Historical devaluations have led a a sharp The region would suffer an immediate but short-lived GDP lasting one to two years. to 2 years contraction in GDP lasting 1 recession and growth would resume after 18 months. GDP index (100 = year of devaluation) 2012 2013 2014 2015 2016 120 115 GDP Greece -5 -1.5 0 2.6 2.8 110 growth 105 Rest of -1 0.5 1 1.6 1.8 100 eurozone 95 90 Inflation Greece 10 8 8 6 6 85 80 Rest of 1.5 1.8 2 2 2 0 1 2 3 eurozone Sweden (1992) Thailand (1997) Indonesia (1997) Argentina (2001) Korea (1997) Source: IMF, PwC analysis12 FS Viewpoint
  13. 13. Scenario 4 Policy action • A Franco-German acknowledgement that the existing eurozone is unsustainable paves the way for a new, smaller, and more tightly regulated currency bloc.A new currency union is • The new bloc includes: Germany, France, the Netherlands, Finland, and some of theformed by the stronger stronger new member states.economies. • More stringent rules are set out for members on fiscal union and structural positions. “New euro” • New bloc benefits from an inflow of capital in the first year. bloc outcomes • However, transition costs and a loss of competitiveness as a result of the stronger currency would drag on growth in 2012. • The new euro exchange rate could be permanently higher by up to 15% compared to the exchange rate for major trading partners. Periphery outcomes • Economies that break away from the euro face challenges of depreciating exchange rates, soaring inflation, and falling output. • Future success will depend on their ability to rebuild credible fiscal and monetary institutions. Countries with weak economic fundamentals are most at Countries with weak economic fundamentals The new eurozone will experience a boost in domestic risk if the euro were to break up. are most at risk if the euro were to break up demand while the periphery contracts in 2012. Indicative scorecard of economic and fiscal fundamentals (selected eurozone countries) Greece 2012 2013 2014 2015 2016 Stronger fundamentals Portugal Ireland GDP New euro 0.3 2.5 2.5 2 2 Italy growth Spain Periphery -5 -2 0 2 3 Belgium France Inflation New euro -1 0 0 2 2 Germany Netherlands Periphery 10 8 7 5 3 Finland government debt Gross general (% of GDP) Budget deficit yields 10-year GDP growth Expected outlook Ratings Potential scenarios 13
  14. 14. Exit of a country from the A country leaving the eurozone may need to do • Decide how to deal with existing outstanding the following: euro-denominated debt, which wouldeurozone will have broad probably entail a major government and • Announce and immediately impose capitaland far-reaching impacts. controls. private-sector debt restructuring (i.e., default). • Impose immediate trade controls to limit • Recapitalize the insolvent banks to make up capital outflows. for losses from defaults. • Impose immediate border controls to prevent • Determine what to do with the non-bank a flight of cash. financial sector and the stock and bond • Implement a bank holiday to prevent a “run markets. on the bank.” • Determine how to handle commercial • Announce a new exchange rate (presumably contracts that are written and denominated not floating at the beginning, given capital in euros and now may be in the new and exchange controls) so that trade could currency. continue. • Convert all euro-denominated notes and coin to a new currency.14 FS Viewpoint
  15. 15. Implications for US corporations
  16. 16. How does all this impact Eurozone restructuring has the potential to Thus, companies should be more fully prepared create significant change and disruption to for a range of unpredictable outcomes. One wayUS corporations? the operations of many firms. These changes to accomplish this is to focus on the potential would potentially materialize when the broader consequences of the four scenarios outlined to economic and market environment create determine what actions would be required at conditions in which many companies cannot an organizational level based on likely market afford the direct and indirect costs to their conditions, such as a credit crunch or currency businesses of carrying out such changes. devaluation. Many of the specific actions required at the Based on this analysis, companies can organization level following a complete or proactively develop contingency plans to partial eurozone restructuring will be intrusive address the potential consequences of various to the processes, systems, and operations of potential eurozone scenarios and begin to take an organization and will have to be executed steps to help minimize the risks today. quickly and with minimal lead time for impact assessment and action planning.16 FS Viewpoint
  17. 17. Potential actions required We expect the euro crisis to have a broad and profound impact on US-based multinational companies in the following areas, among others: 1 Business model and structure 2 Revenue 3 Treasury 4 Legal 5 Procurement and supply contracts 6 IT 7 Finance 8 HR/people 9 Tax 10 Crisis/incident management Implications for US corporations 17
  18. 18. 1 Business model1. Problem statement In setting long-term business strategy—what products to make, what markets to target, where to source and manufacture, how to organize the company, where to raise and structure and deploy capital—companies have typically planned based on the assumption of a stable eurozone and regulatory environment with stable, moderate growth and the free flow of goods, capital and people. The current crisis has called many of these assumptions into question. As a result, many companies, particularly those with heavy business activities in Europe or significant European stakeholders, will need to question many of the fundamental assumptions that have formed the basis of their strategies, business models, and organizational structures. Critical questions • How might the various potential outcomes for the euro impact overall corporate strategy? • Where do we want to invest capital going forward? Which countries (inside and outside the eurozone) will present attractive investment opportunities going forward? • How will the crisis impact ability to effectively borrow and invest in the eurozone? • Could the break-up of the eurozone result in increased regulatory costs and additional friction in the flow of goods and services within the region? • Will the declining attractiveness of European markets increase the level of competition in other developed and developing markets? • How should companies best alter their European footprint under various potential outcomes? Key areas of exposure and impact • Significant declines in economic growth reduces the attractiveness of for corporations European markets. • Reduced growth and higher costs result in impairment of prior investments. • Constrained capital markets result in further challenges to fund European growth and investment. • Reduced growth and constrained credit weaken the supplier base and create significant operational risks.18 FS Viewpoint
  19. 19. 2. Revenue2 Problem statement Corporate revenue and profit margins are based on uninterrupted global demand and supply as well as free flows of capital, labor, and goods throughout the eurozone. Should these be disrupted by the crisis (e.g., through a collapse in sales, FX movements, or capital controls), the impact on revenues will be significant and could undermine the viability of businesses. Some countries may impose some form of currency controls in order to limit the shocks to their economies. Countries with strong currencies but small economies (e.g., Swiss franc) will also try to suppress the value of their currencies through the use of market mechanisms. Critical questions • Under what scenario and in what circumstances is revenue most at risk? How long can businesses survive with below-average sales in the eurozone? • Under what scenarios do eurozone countries become unattractive to sell to or produce in? • Can potential exposures be hedged? Have non-traditional/natural hedging strategies been considered? • Have alternative growth strategies been identified and reviewed? • Can the business still afford to serve clients in euros in the short—and medium—term? Do margins need recalculating and pricing pegged to a more “stable” currency? Key areas of exposure and impact • A collapse in sales could occur as a result of severe recession or unfavorable price for corporations and foreign exchange movements. • Liquidity shortages as a result of sales collapse and regulatory measures could limit cross-border transfers. • Revenue streams could be significantly impacted through sharp foreign exchange movements. Implications for US corporations 19
  20. 20. 3. Treasury 3 Problem statement Treasury must be prepared for the significant and difficult changes that would occur under each scenario. A credit squeeze is likely to result. Possible capital and foreign exchange controls may need to be invoked at short notice and eurozone hedging strategies may need to be disaggregated by country, with aspects no longer effective as new currencies are created. Additionally, treasury should understand which scenarios will cause covenants to be triggered and cash to be trapped, and set parameters for exchange rate appetites if volatility increases and new currencies are created. Critical questions • Is there an appropriate forum for discussing working capital and cash forecasting? Have counterparty risk policies and credit scoring processes been reviewed? Is the business appropriately hedged? • How is credit risk currently monitored? Should changes be made to better predict and/or react to declining credit? • How legally enforceable are netting arrangements to reduce exposure? • What cash can be moved to neutralize euro exposures, surplus repatriated? Facilities redenominated? • Will weaker eurozone banks be able to provide local funding? • What will become of local deposits, if banks are no longer functioning? • How might a company redirect/collect customer payments outside high risk countries? • Will cash pooling structures continue to be viable and efficient? • How might increasing currency volatility impact FX hedging programs? Key areas of exposure and impact • Diversity of funding arrangements, credit risk, trapped cash risk, off balance sheet for corporations contingencies triggered • Forecasted internal cash reserves, intercompany balances • Debt arrangements upon currency restriction events, covenant implications • Cross-border cash management structures and credit facility interaction • Working capital strain as customers take longer to pay, suppliers weaken without prompt payment, and foreign exchange rates change or become increasingly volatile • Enforceability of euro derivatives/country of bank counterparty • Volatility arising from ineffective hedging strategies or hedge accounting20 FS Viewpoint
  21. 21. 4. Legal4 Problem statement For many organizations, legal contracts are based on existing EU law and the premise of a stable single currency, governed by the ECB. Should any of the four scenarios occur, sales, supply, and employment contracts (among others) are likely to require review and some revision. In extreme circumstances, contracts may become unenforceable. The consequences will vary dependent on applicable governing law and jurisdiction. Payment obligations will be dependent on applicable exchange rates. This in turn could cause defaults to occur. The potential for associated disputes could also increase. Critical questions • Is the potential impact on key contracts fully understood? • In the event of changes to either the currency of payment or the reference/regulatory bodies, are the associated contractual obligations and flow down provisions clear? • Are the definitions within existing contracts still valid? • Have the potential commercial risks been considered, as well as how these risks can be avoided or mitigated? • Has the financial impact of employment contracts and packages been evaluated? • Is there a plan in place to identify and solve legal exposures? Key areas of exposure and impact • All key commercial contracts including supply contracts, sales contracts, joint- for corporations venture agreements, distribution agreements, and IP licensing arrangements • Payment arrangements and systems and support service agreements • Transfer pricing • Impact on cross default provision arising from contractual default • Currency hedging and treasury management • Referencing in all contracts (for example, euro-dependent provisions, reference to bodies such as ECB or eurozone, Material Adverse Change) • Employee terms and conditions (such as salary, bonus, and other remuneration) Implications for US corporations 21
  22. 22. 5. Procurement and 5 Problem statement Many global organizations, especially large consumer products companies, rely on sourcing raw materials, products and services needed for their operations from the supply contracts eurozone countries. They also supply clients across Europe from different EU and non- EU hubs. With the four scenarios in mind, the changes could result in the creation of European low-cost countries. For US Companies, these changes could imply: • Strategic sourcing decisions may need to be revisited with changes to price or availability conditions. • Supply models may need changes in pricing, logistics, invoicing, and transportion. • Alternate vendors may be needed or activities may need to be brought in-house if the vendors are unable to survive the outcome of the crisis. Critical questions • Will there be low-cost country opportunities created as a result of eurozone restructuring? • Are there supply-chain risks as a result of rising material costs for suppliers no longer in the eurozone? • Can the impacts of those moves be reliably modelled (e.g., on cost or profit margin)? • Can the impact of supply-side changes on key clients’ supply chains be anticipated? • Are there alternative sources of supply for critical products and services? Are rapid moves to an alternative supplier feasible? • Are multiple critical suppliers in the same situation (i.e., could an organization experience multiple vendor failures)? • How might a company redirect/collect customer payments outside high-risk countries? Key areas of exposure and impact • The cost of producing and operating could change dramatically as a result of sharp for corporations economic and foreign exchange movements. • Potential cost reduction opportunities may arise. • Supply continuity for critical raw materials and products may need to be monitored. • Supply chain reviews should be considered for the most price-sensitive products and services, resulting in potential service model changes. • Different cost and margin scenarios may need to be evaluated, and alternative suppliers may be needed if the impact is material. • Make/buy decisions may need to be revisited across a range of products, and new efficiencies should be realized.22 FS Viewpoint
  23. 23. 6. IT6 Problem statement Regardless of size, complexity, or industry, companies are becoming increasingly reliant on IT/IS systems—both within their own companies as well as with customers, suppliers, and vendors—to conduct business operations. This reliance will create challenges for organizations to: • Understand the impact that the different scenarios will have on the IT environment and the various interfaces between systems (both external and internal) • Ensure that internal systems can remain flexible and adaptable enough to meet the demands of new and changing regulations and market environments • Ensure that external vendors of hardware, software, and services have developed plans to deal with each potential scenario and are able to maintain continuity of operations • Implement potentially significant master and transaction data changes In addition to these challenges, organizations should gauge their readiness to exploit the opportunities presented (such as integration, renegotiation of support deals, and relocation). Critical questions • Which systems and business areas are most exposed to the changes set out in the scenarios? • Do company systems have the ability to be modified to handle new currencies? • Can company systems handle the redenomination of historical transactions? • Have systems and vendors critical for survival of the organization been identified? • Do external vendors have plans in place to ensure continuity of IT and communications infrastructure and services? • Are transactions and reporting set up to accommodate a high-inflation environment? Key areas of exposure and impact • Work required to amend existing applications and data for corporations • Lack of control over IT systems due to contractual or physical limitations in the ability to reconfigure • Inability of systems to cope with extreme changes in inflation and valuations, including the ability to forecast and restate past performance • Inability of outsourced service providers to maintain continuity of their systems and to provide agreed-upon services • Potential increase in capacity from institutions switching businesses to non- impacted countries • Collapse of IT service providers, or inability to honor contractual obligations around IT service provision Implications for US corporations 23
  24. 24. 7. Finance 7 Problem statement The Finance function is heavily exposed to eurozone challenges in terms of: • Accountability for planning, budgeting, and forecasting in very uncertain times by building scenarios and securing board agreement with them. • Managing increased costs (both of finance and the whole organization) and interpreting their impacts to the organization. • Keeping statutory reporting in line without major increases of effort. • Dealing with increased reporting requirements and new types of what-if analyses and complex simulations. Critical questions • Is your Finance operating model still relevant? • Is the sourcing strategy still optimal, does the restructuring provide opportunities to revisit shared-service locations and outsourcing contracts? • Would outsourcing transactional activity mitigate risk in volatile markets during eurozone restructuring? • How quickly could the organization exit outsourced or shared environments within unstable economies? • Can statutory and management reporting be produced with current resources and without compromising quality? • Is the function set up to deal with inflation, currencies leaving the eurozone, and the introduction of a significant number of new currencies? • Can costs arising from the changes described in the four scenarios be modeled reliably? • Is finance ready to take on a much bigger role in communicating these changes to the rest of your organization? • Do you understand the potential financial reporting impacts of each scenario, including matters like revenue recognition, asset impairment, and hedge accounting? Key areas of exposure and impact • Service agreements with outsourced providers for corporations • Continued availability of qualified staff • Continued robustness and adequacy of the control environment • Shared-service center (SSC) location, setup, and internal pricing • Enterprise resource planning (ERP) and reporting systems • Current data models • Accounting policy matters and financial reporting impacts24 FS Viewpoint
  25. 25. 8. HR/people8 Problem statement For businesses operating in Europe, the HR function is key to supporting the business strategy while adapting to the impact of economic and legislative change on staff operations. With differences in specific HR needs among countries likely to increase, HR functions should be equipped to deal with increasing complexity while managing limited resources. Resources will be stretched to balance both short-and long-term measures in dealing with rapid change while facing sustained pressure to cut costs. Critical questions • With sustained pressure on cost reduction, how will HR operating models and structures cope with differing demands across territories? • How will talent be retained in less stable countries while dealing with sustained financial pressure and rapid change? • Will businesses need restructuring in response to changes in the eurozone? How will the impact of this be addressed with respect to human resource operations? • Have you defined your duty of care and responsibility to your employees in the event of collective actions in which they are impacted? • Is your team clear on how you will communicate to employees in the event of collective actions which keep them from work? • Do business continuity plans consider the potential for civil unrest or even military conflict? Key areas of exposure and impact • Managing a mobile and global workforce could become increasingly complex, with for corporations less standardization across Europe in terms of tax and employment law. Businesses should be equipped to deal with the increased risks associated with these changes, including areas such as rewards and pensions. • Those operating in less stable European countries may find themselves struggling to retain talent as employees seek more secure environments. • Some companies will need to respond to changes in the eurozone by restructuring their businesses and contracting for high-risk operations. The implications for HR and people activity should be dealt with appropriately, for example when redeploying or making headcount reductions. Implications for US corporations 25
  26. 26. 9. Tax 9 Problem statement Companies should understand the immediate tax consequences arising from various scenarios regarding the future of the eurozone. It will be important for companies to weigh the tax efficiencies of their proposed mitigation strategies. Critical questions • Do the changes give rise to a new contract from an accounting perspective? This may result in the recognition of profit or losses for accounting purposes that could also be taxable or relievable. • Do the changes give rise to a new contract from a legal and tax perspective? Modification of an existing contract could potentially represent the termination of the original contract and the creation of a new contract. This could crystallize a taxing event (i.e., the changes could trigger a disposal for capital gains purposes). • Where the contracts are between related parties, then an additional question is whether an arm’s length fee should be paid to the counterparty as compensation for the change in terms. The tax treatment of this fee would need to be considered from both parties’ perspectives, and whether this payment would be taxable on one side and deductible on the other. • Will any losses be tax-deductible and can they be utilized or will they become “trapped?” How does this change the tax profile of the group? • What happens if any foreign exchange gains should arise (e.g., due to a smaller, stronger euro)? • What will be the impact on business if it cannot defer foreign exchange gains or losses under the tax matching rules, where the hedge becomes ineffective from a tax perspective? • Has taxation been factored into contingency plans such that they are as tax efficient as possible? Key areas of exposure and impact • Different scenarios may create losses; it is important to understand whether these for corporations are foreign-exchange losses or impairment losses and the deductibility of these for tax purposes. • Redenomination of foreign assets and liabilities may result in hedges becoming ineffective from a tax perspective. • If the changes cause new contracts, especially loans, to be brought into existence, this may impact existing agreements with the taxing authorities (e.g., withholding tax clearances may be affected). It may also affect other taxes (e.g., VAT if there is a change in value of the contract).26 FS Viewpoint