Media Briefing Note: On the brink of change? Businesses should prepare for significant legal implications of a "Grexit", says Hogan Lovells
30 June 2015
If a Member State were to leave the eurozone, the trading and financial landscape of Europe could change dramatically, with little or no advance warning. There is no established legal framework for withdrawal of a Member State from the euro, fuelling much uncertainty. With the very real and imminent threat of Greece leaving the Eurozone upon us, Hogan Lovells' Constitutional Change Taskforce explores some of the key concerns facing businesses in the case of a "Grexit":
- Currency and debt redenomination may lead to a rapid devaluation of the replacement currency
- It is very likely that Capital controls would need to be imposed by Greece to protect it against further capital flight
- Enforcement against contracting parties may be challenging, given the expected increase in case volume and protective measures likely to be introduced by Greece
- Certain businesses in Greece may face potential insolvency
- If the central bank of Greece meets credit needs by printing money, inflation is likely.
Businesses are likely to face significant disruption and wide-ranging consequences, such as:
- Systems, reporting and processing issues;
- Consequences in respect of existing contractual arrangements, including contracts of employment, and contracting strategy
- An impact on certain loan agreements, bonds and derivative contracts;
- Trading issues with both suppliers and customers, and supply chain disruption;
- Intra-group issues in respect of parent or subsidiary companies domiciled in Greece
- Reduced financial strength of joint venture partners; and
- Increased transaction risks in M&A transactions and reduced deal certainty.
The Financial Institutions sector in particular is likely to face challenges, with concerns primarily around availability of banking services and capital markets.
Commenting on the potential impact for the international payments sector, Emily Reid, partner and Head of Hogan Lovells' global payment practice, said:
"Modern economies are dependent on international and national payment systems. Any capital controls to restrict access to deposits will potentially impact day-to-day consumer transactions made through the major card schemes as well as business to business and international payments. Payment Schemes will want to control any settlement risk and possible contagion.
"The fact that Greece is a Eurozone country creates added complexity. If there is a sudden exit from the Euro how will day-to-day payments be managed? Issuing a new currency would necessarily take time and this may be an area where digital cash or virtual currency could play a role."
Elaborating on digital currency, financial institutions partner Roger Tym said:
"In the midst of the current tumult in Greece, various options are being reported as solutions to the challenges the crisis is creating in the payments sector, including the potential for the Greek government to introduce a "parallel e-currency" based on deposit receipts or a flight to virtual currencies. Indeed, Bitcoin buys have jumped about 300% in the past few weeks and the Greek bitcoin-like cryptocurrency, Hellascoin, has seen a surge in value since the beginning of June.
"An exit from the euro would be likely to result in a weaker Greek replacement currency so investments in internationally traded virtual currency may be being seen as a way of combatting the expected devaluation of deposits. Virtual currency technology has also been heralded as a useful tool for the Greek government to employ to make payments while a new 'drachma' is being printed and issued.
"Despite the opportunities presented by these potential options, they do come with a health warning - the merits of any proposed solution needs to be fully understood to avoid jumping from the current Greek melting-pot into the fire. For virtual currencies, investors should recognise that the regulatory structures underpinning them differ from a traditional fiat currency, being a creature of contract rather than issued by a central bank, so are not covered by government compensation schemes - as well as assess the historic volatility of the chosen virtual currency. The specific terms of capital controls prevailing at the relevant time may also impact the ability to transfer value into a virtual currency.
"The Greek government's use of virtual currency as a tool in the context of introducing a new currency would also require careful management of associated risks, recognising the need to link it to the value of underlying deposits and to the new fiat currency on transition - so it may be that e-money would be a more suitable transition vehicle than a true "virtual" currency."
From a debt capital markets perspective, James Doyle, Head of Hogan Lovells' international debt capital markets group, added:
"The possibility of a Greek exit from the eurozone raises a number of difficult questions about how euro denominated bonds issued by the Greek state or private Greek companies would be treated. Leaving aside the question of capital controls, the spectre of redenomination is a risk that investors will have to consider again. Even where the terms of the debt instruments are not governed by Greek law, issues around enforcement of the terms of bonds will be key factors in determining the likely strategy going forward as will the interaction between a Greek sovereign default and events of default under other non-sovereign debt instruments.
"Contingency planning will also need to take into account the impact that Grexit will have on derivatives instruments that parties have entered into with Greek counterparties or which relate to debt issued by Greek entities."
Michael Thomas, financial institutions partner, said of the impact on clearing houses:
"Significant events such as the Greek crisis are closely monitored by clearing houses, as they can have widespread impacts on the financial markets, which increase the risk of defaults by firms that clearing houses will need to deal with. Clearing houses will therefore need to ensure that they have taken action to minimise their exposures to losses or operational difficulties that may arise as a consequence of a Greek default.
"This may include ensuring that: they do not clear any Greek-listed securities that are the subject of suspension orders; monitoring any potential impacts of the Greek situation on the value or accessibility of collateral they are holding; monitoring the impact of the current market turbulence on the validity of their stress testing models used to assess the adequacy of their collateral and default fund arrangements; and close monitoring of any clearing members with significant exposures to Greece, in order to be able to act promptly in the event of a default."
Stephen Foster, partner in Hogan Lovells Business, Restructuring and Insolvency team, considering the potential impact of capital controls, said:
"Despite the imposition in Greece of capital controls which should reduce the risk of capital flight from the Greek banks, the Greek banks are largely dependent on the emergency liquidity assistance (ELA) provided by the ECB. At present, the ELA limit for the Greek banks is being maintained at €89bn; however, there is a concern that the ECB may ask for additional collateral from the Greek banks to support the existing ELA funding, and may withdraw the ELA completely if Greece defaults on the €3.5bn payment due to the ECB on 20 July 2015. Either scenario may push one or more of the Greek banks into unsustainable financial difficulties, resulting in the need for bank resolution."
Partner Joe Bannister added:
"Bank resolvability has been the subject of many discussions and much regulation globally since the financial downturn in 2008. Many of the principles in the paper issued by the Financial Stability Board (FSB) entitled "Key Attributes of Effective Resolution Regimes for Financial Institutions" have been reflected in Europe in the Bank Recovery and Resolution Directive (2014/59/EU) (BRRD).
"The BRRD, which became effective on 2 July 2014, sets out a framework for the recovery and resolution of certain defined financial institutions, and envisages that national authorities in each member state will be given tools and powers to assist in the resolution of national and cross-border bank failures. Member States were required to transpose and publish implementing legislation by 31 December 2014, with an effective date of 1 January 2015 for all parts of the BRRD other than provisions relating to bail-in; Member States have until 1 January 2016 to implement the bail-in provisions.
"Although Greece has not formally brought in legislation implementing the BRRD, it does already have domestic legislation in place which is similar in many respects and should give the Greek resolution authorities power to resolve, if necessary, the Greek banks. The Single Resolution Mechanism applies to all Member States within the Eurozone (including – for the moment - Greece) and gives the ECB power to step into the shoes of the national resolution authorities. It also establishes a Single Resolution Fund which can be used to assist in the costs of any resolution. Unfortunately, it is not due to come into force until 1 January 2016, meaning the Greek resolution authorities are going to have to face the issues without the support of the SRF."
The current Greek crisis, which looks likely to be averted by the on-going negotiations, highlights a need for foreign investors to be aware of the protections which might be afforded to them by investment treaties which a country has entered into. Investment treaties typically contain an offer to arbitrate which means that foreign investors can bring a claim directly against a State before an international arbitral tribunal without the involvement of the domestic courts.
Elaborating on the impacts of capital controls for investment treaties, Markus Burgstaller, London litigation partner said:
"Not all measures adopted by a country which might cause harm to foreign investors will breach the terms of an investment treaty. Investment treaties typically protect foreign investors against certain types of governmental conduct, including the expropriation of their investments without compensation, as well as discriminatory or arbitrary conduct. In implementing the changes which it has agreed with other members of the Eurozone, it will be important for Greece to take care to structure them to avoid claims arising. For example, Greece should ensure that measures which it enacts do not favour domestic investors over foreign investors as this could amount to a breach of Greece's obligations under the investment treaties which it has entered into.
"Foreign investors may already be protected by investment treaties which Greece is a party to; whether this is the case will depend on the investment structure which foreign investors have utilised. However, by acting now foreign investors who are not already protected by investment treaties may be able to restructure their investments to provide protection if any future measures adopted by Greece do breach investment treaties."
From an EU constitutional law perspective, Nicolas Pourbaix, counsel in Hogan Lovells' Brussels office, explained:
"One of the key issues that the EU institutions, Greece and the other Member States will have to grapple with if (a form of) Grexit becomes unavoidable is how, from an EU constitutional law point of view, they can make it happen. The difficult starting point is that there is no procedure in the EU Treaties enabling a Member State to exit the European Monetary Union. This is not an oversight – the monetary union process was intended to be irreversible. How then could Greece leave the monetary union? There are effectively three ways that EU lawyers are exploring.
"One would involve Greece exiting the EU as a whole and negotiating its re-entry except for the monetary union. The second would make use of a mechanism leading to the other Member States suspending Greece's participation in the monetary union, but where that mechanism was designed for different purposes. And the last one would require all Member States, including Greece itself, unanimously to agree to a common course of action to exclude Greece from the monetary union.
"However, all three routes have in common that they are complex, lengthy, legally uncertain and politically sensitive. In light of this, one hopes that political will will triumph in the end and that a negotiated solution will be acceptable. What it does mean for business, though, is prolonged uncertainty both as to the shape and timing of any outcome, reinforcing the need for contingency plans.
For more, please visit Hogan Lovells' Eurozone microsite: http://www.hoganlovells.com/eurozone/.