Source: The Wall Street Journal
A key part of the world’s foreign-exchange trading infrastructure is bracing itself for the possibility of a breakup of the euro zone, the latest sign investor concerns about the Continent’s debt crisis are on the rise.
CLS Bank International, which operates a platform in which banks settle most of their currency trades, is running “stress tests” to prepare for the possible dissolution of the euro, according to people familiar with the situation.
Some of the 63 banks that co-own CLS are making similar plans. “We always plan for contingencies,” said a senior executive at one of the largest currency-dealing banks.
New York-based CLS is by far the biggest name in the currency market known to be making preparations for such a scenario. Analysts with Japanese bank Nomura Holdings said Friday that a euro breakup is a “very real risk,” while HSBC Holdings analysts told clients on Tuesday that it’s “not unimaginable” for countries to leave the euro zone.
Most European leaders and large banks considered the idea too sensitive to even discuss until a few weeks ago. They feared talking about the possibility of a euro breakup would be a self-fulfilling prophecy, scaring lenders away from European banks and companies and exacerbating an already precarious credit situation.
Financial institutions often game out different scenarios when they see a potential market-moving event on the horizon, but it doesn’t always mean they believe a particular outcome is likely, several market participants said. “Even during the 2008 crisis, people ran plausibility scenarios. In retrospect, many of the things they tested for didn’t happen,” said Fabian Eliasson, head of currency sales at Mizuho Corporate Bank. “As a worst-case scenario, it is in sound mind to run the tests, but I don’t think it will happen.”
In the past couple of months, the European debt crisis has taken a turn for the worse. A Greek default is widely viewed as likely, while Italian 10-year bond yields topped 7% last week, raising fears that the country—and its roughly €2 trillion ($2.7 trillion) bond market—could eventually need a bailout. Italian bond yields traded just below 7% on Tuesday, though yields were on the rise in countries once considered to be on relatively sound financial terms, including Belgium and France.
Late Tuesday in New York, the euro was at $1.3505, not far above a one-month low. However, the currency has defied expectations by several major Wall Street banks that it would sink to $1.25 as a result of the debt crisis.
A number of investors are pessimistic about the euro’s chances of remaining intact. In a Barclays Capital survey of almost 1,000 investors, nearly half expect at least one country to leave the euro—up from about one-quarter three months ago and just 1% in the bank’s second-quarter survey.
Most finger Greece as the likeliest to exit, though 5% of respondents expect all five of the most troubled economies—Greece plus Portugal, Ireland, Italy and Spain—to leave.
There is little agreement about what a euro breakup would mean.
Nomura advised investors to check the fine print of their euro-denominated bonds, to ascertain whether they would be converted into a revived local currency, like the Greek drachma, in the event of a breakup. “New” currencies could quickly plunge in value by as much as 50%, analysts say.
Mark McCormick, currency strategist at Brown Brothers Harriman, said the complications that would arise from a euro breakup are one of the strongest arguments against it happening.
“The costs and legal implications are factors that add up to why policy makers would avoid a breakup,” he said.
Others view a fractured euro as a problem for the financial world’s back offices.
CLS could withstand the stress of a country leaving the euro zone, people familiar with the matter said. However, one of the people added that getting new European currencies up and running in the system would take “at least a year.”