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Eurozone: How the City is bracing itself for the worst.

Within the large investment banks, special teams consisting of 10 to 30 people have been assembled in order to develop rescue kits designed to face all types of scenarios resulting from a breakup of the Eurozone.

Article also available in : English EN | français FR

At the beginning of December, the governor of the Bank of England, Mervyn King, had angered entrepreneurs after his highly pessimistic comments during the semi annual press conference on financial stability. They accused him of feeding the self fulfilling prophecy that has a significant impact in any crisis of confidence.

King called on banks to “increase their capital in order to face an extremely menacing context” and indicated that the Bank of England itself was preparing a rescue plan designed to face a breakup of the Eurozone.

“Contingency plan”: the new expression in fashion

The British fund manager Schroders indicated that it was monitoring its counterparties very closely and only took as collateral a restricted list of government bonds. It specified that it avoided the countries deemed too sensitive in the Eurozone and particularly the PIIGS (Portugal, Italy, Ireland, Greece and Spain).

The world leader in FX and government bond brokerage, ICAP, said that it had tested its systems to manage a potential collapse of the Eurozone and a return to national currencies

“Every firm present within our portfolio now has a rescue plan” confirmed Andrew Aylwin, an associate in the London based private equity fund, Lyceum Capital. “The process has accelerated during the past few months while the first plan has been formalized 6 months ago”.

On a much bigger scale, the world leader in FX and government bond brokerage, ICAP, said that it had tested its systems to manage a potential collapse of the Eurozone and a return to national currencies.

Jeremy Bell : « The rescue plans will not hamper the availability of liquidity to funds »

According to Jeremy Bell, business lawyer and associate at Ashurst in London, some firms are making sure that their euro deposits are in bank accounts located in strong Eurozone countries instead of accounts in weak (...)

Within the large investment banks, special teams consisting of 10 to 30 people have been assembled in order to develop rescue kits designed to face all types of scenarios resulting from a breakup of the Eurozone. The teams carry out live simulations over several consecutive days and pay equal attention to logistics (number of available persons in emergency cases) as to information technology.

Jeremy Bell, a business lawyer at Ashurst, tempers the situation. According to him, most of the firms are far from considering a rescue plan. Like almost half of the fund managers questioned by Bank of America – Merril Lynch in its last monthly research note, Jeremy Bell does not believe in a Eurozone break up. He concluded by saying that if the worst was to happen, the large firms will react quickly and adequately.

The main issue for private equity firms would be to manage the risk stemming from the new exchange rates that could be introduced.

“The main issue for private equity firms would be to manage the risk stemming from the new exchange rates that could be introduced. They will have to find a safe way to deal with it. For example if an investment target is set in euros, with a commitment from the investors in euros, there will no exchange rate issue. But if the target moves towards another currency such as the Greek drachma, problems will appear. The fund managers may have to seek investors for advice on the best way to manage a new exchange rate”.

The process in itself is simple but it is the various potential situations that are hard to manage. We are particularly referring to the famous worst case scenarios. “In the rescue plans that we have built up till now continues Andrew Aylwin, we have carried out anticipations over 12 months by predicting most of the terms, bank clauses…We monitor the situation on a monthly basis and we make sure that the balance sheets are in equilibrium in order to ensure that the financing of the acquisitions is maintained. The whole point is to continue delivering the best value to our clients with the best possible decisions in order for them to continue to invest in our firms. It is like a stress test in the sense that we calculate the unexpected in order to make sure that we remain robust while good performances are maintained”.

Is the setting up of those rescue plans a new roadblock to the activities of the financial industry? “The main cost will be linked to the advisory and legal expertise according to Jeremy Bell. But in a broader sense, I do not consider these rescue plans as factors that can cause a drop in the level of liquidity available for the activities of funds. I simply hope that they will not stop while things get back in order. Of course, it is not good for the economic recovery. But we can also imagine these funds benefitting from those opportunities by positioning themselves to acquire undervalued assets”.

Johann Harscoët , December 2011

Article also available in : English EN | français FR

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