An American view on how to prepare for the single European currency

 

Ralph J. Mehnert-Meland

 

I. INTRODUCTION

The first reaction when asked to write about the American view on the single EU currency is a question: "What view?" The developments toward monetary union in the European Union are still being overlooked in the United States. With the exception of the hype surrounding the ratification of the Maastricht Treaty, the information provided and available on the subject is scarce. This may become a problem! US-entities may not be sufficiently prepared for the ecu and the many advantages it will offer.

Many of the questions associated with the conversion of existing national currencies into the ecu, as discussed in other parts of this issue, will also apply to non-EU parties dealing with entities in the EU. An American company selling goods to a German manufacturer for Deutschemarks, for example, must consider the fact that, by the end of this decade, the Deutschemark will cease to exist and payment will be made in ecus.

The conversion will have significant advantages for and pose specific challenges to businesses in the United States. There are two main reasons for the latter. First, US-entities may face a challenge if the current trend to ignore these dramatic changes continues. Second, the large foreign exchange and related markets (for products such as spot and forward contracts, futures, options and derivatives) located in the United States must soon adapt their product palettes for the vastly changed post-conversion global foreign exchange structure.

This article discusses these special advantages and challenges. The first part outlines the main problems of the current multi-currency system. The second part

discusses the advantages of the abolition of existing currencies and their substitution by the ecu. The third part introduces issues related to the conversion and the fourth outlines steps to prepare for the ecu.

 
II. PROBLEMS AND COSTS OF THE CURRENT SYSTEM

The two main disadvantages for US-businesses (except the financial industry) of the present multi-currency system in the EU are foreign exchange transaction costs and costs associated with exchange rate uncertainty.
 

Foreign Exchange Transaction Costs

A company from the United States transacting business in the EU very likely deals with an existing EU currency. In the past, US-entities were almost always able to insist on the US-dollar as currency of contract. This has changed and existing national currencies (such as mark, pound and French franc) are often chosen. As a result, US-businesses are confronted more and more often with foreign exchange transactions.

The staggering costs associated with the transactions are divided into two groups:

1. Direct external and financial expenses in the form of fees and commissions, charges for certain foreign exchange products and the bid/offer differential; and

2. Indirect internal expenses in the form of personnel and other resources necessary for the administration of foreign exchange.

These costs directly affect the bottom line of any US-entity transacting business in an EU-currency. They also represent opportunity costs as they require corporations to use resources which could be used better or more profitably in other areas.
 

Exchange Rate Uncertainty

The second type of costs are those related to the exchange rate uncertainty inherent in any multi-currency system. For transactions between EU-parties, this uncertainty has been somewhat alleviated with the exchange rate mechanisms of the European Monetary System. Parties from the United States and other non-EU countries, however, still must account for the exchange rate uncertainty between their currencies (for example the dollar) and the currency of contract. This is especially the case if the currency is one that fluctuates more extensively, such as Italian lira, Spanish peseta and Portuguese escudo.

Such uncertainty can, of course, be decreased with hedging transactions (such as currency futures, options and forward transactions). These transactions, how-ever, carry direct costs (banking commission, fees and charges) and indirect costs (in-house administration and management resources).
 

III. ADVANTAGES OF THE CONVERSION INTO THE ECU

There is no doubt that the replacement of 12+ currencies by the ecu will generally result in savings for any business, including US-entities. This effect may be less significant for parties with business in only one EU-currency payable or receivable as they still need to exchange that into the home currency. In these cases, it is unimportant whether that currency is an existing currency or the ecu - the need to exchange will remain. In addition, the entities will still be subject to fluctuations between the ecu and their home currency.

One clear advantage for US-business will, however, be the ability to use the ecu instead of an existing weaker currency (such as lira, peseta and escudo) or a currency lacking an established trading market (such as Danish krona, Belgian franc and Irish punt). The ecu very likely will be rather stable toward other currencies, such as dollar and yen. With its introduction, a US-business could avoid using a currency that is less stable or does not have an established market.

The main cost advantage for US-entities transacting business in several EU-currencies are the savings in the administration of foreign exchange transactions. The decrease in foreign exchange management will simplify and facilitate business transactions. Hedging and related costs, on the other hand, would probably not be decreased as US-entities would still need to exchange ecus into dollars or vice versa.
 

IV. CONVERSION ISSUES

The conversion from a multi-currency to a one-currency system in the EU will, without doubt, have many advantages for US-businesses. It also will pose a number of challenges and raise issues which such entities must resolve to take advantage of the ecu. None of these challenges and issues are significant and - with the sufficient amount of information and preparation - can easily be addressed and solved.
 

Pre-Conversion Contractual Relations

An important question for US-entities is the procedure for contracts with transactions in an EU currency that will be abolished and substituted prior to the expiration or termination of the contract.

This issue will be solved by appropriate legislation at the EU or national government level for all EU-parties to an agreement. A different scenario, however, arises for contracts between parties of which at least one is not an EU-entity. In such a case, the parties should contractually provide for the redenomination of the contract in the ecu or a third currency, such as yen or dollar.
 

Technical Issues

Some technical issues related to the introduction of the ecu and the contemporaneous abolition of currencies will directly affect US-entities. They include the conversion of existing account balances in to-be-abolished currencies and the exchange of coins and notes held in the United States.

For example, US-entities maintain foreign currency accounts with banks in the United States and may possess coins or notes. The banks in the United States must convert the "book money" and establish mechanisms to collect and exchange the physical tender in co-operation with the appropriate authorities in the EU.
 

Foreign Exchange Markets

The conversion will have significant direct consequences for foreign exchange markets dealing in the existing national currencies, namely in German marks, French francs and British pounds. This especially applies in the United States, the location of the world's largest foreign exchange and related markets at which to-be-abolished currencies are traded on the spot and forward contracts and as options and futures. It also includes, of course, foreign currency derivatives.
 

Potential Shock to the Markets:

The first effect will be the confusion which will inevitably result from the conversion. The abolition and substitution of mark, franc and pound, three of the most used currencies in international commerce and investment, will very likely result in uncertainty and temporarily affect these markets.
 

Discontinuance and Introduction of Products:

In addition, all existing products in these currencies will become obsolete. This will require new products in ecus - spot ecu trading facilities at a minimum - to replace the redundant products and to ensure that the supply and demand for ecus will function properly. US-exchanges already offering ecu products (FINEX, CME, CBOT, PHLX and PBOT) must expand their ecu trading facilities and make any necessary changes to existing products.
 

Employment:

The abolition of products will also consolidate employment in these areas. The trading in products for one currency requires less personnel than that for twelve currencies, even though the volume of transactions may be the same or higher.
 

Intermediate Issues for Forward, Options and Future Contracts:

The new ecu will create intermediate technical problems for futures, options and forward contracts in to-be-abolished currencies bought or sold before the conversion and due or exercisable after the conversion.

 
Issues for Banks and Financial Institutions

Banks, financial institutions and entities involved in foreign exchange transactions will be most directly affected by the conversion process. They will bear the main burden in terms of manpower and direct expenses resulting from the abolition of the national currencies and the introduction of the ecu.

These entities will serve as the catalyst in the exchange process and will be at the forefront of the logistics to distribute the new currency and collect the old currencies. They will directly have to deal with the technical conversion of deposits and credits and the actual distribution of the new coins and bills. This process will undoubtedly put a significant strain on their resources. Although this issue will affect US-banks and financial institutions to a lesser degree than their EU-counterparts, will be important to involve all affected entities, including those in the US, in the planning process far in advance of the actual conversion date.

US-banks must then adequately prepare for the conversion and allocate the appropriate resources.
 

Accounting Issues

The substitution will affect accounting practices and procedures in the United States. As the solution to these issues solely depends on the national accounting rules and practices, the appropriate authorities in the United States must establish clear rules and guidelines.
 

V. HOW A US-ENTITY SHOULD PREPARE

The conversion into the ecu will have significant advantages for US-entities. These advantages will by far outweigh any challenges or issues provided that the entities address the issues and prepare far in advance to successfully adapt to the new system.
 

Information

The most important requirement is to keep informed about the events leading to the introduction of the ecu. Any "surprise" resulting from the conversion will lead to unwanted disruptions in business and operations. Good sources for information include the media in general, banks and other financial institutions, accounting firms, brokers and the legal profession.

At this time, this is a major problem in the United States. The interest in this subject is very limited. The view on the monetary developments in the European Union has not changed. US-entities still do not actively research and prepare for the ecu and the abolition of existing currencies. The short-term nature of this approach may backfire. At the time of the conversion, US-entities may be insufficiently prepared and may lack the information and skills necessary to successfully adapt their businesses.

One of the problems is, of course, the lack of easily accessible information on this subject. The ecu only receives very limited exposure in the applicable media and information sources. Its potential impact on US-entities has not been evaluated. Part of this problem is the lack of immediacy as the conversion "still is years away, if it happens at all" in the mind of many individuals.

 
Preparation

The second most important factor is the degree of preparation by businesses and individuals. The conversion cannot be accomplished in any business by waiting until the last minute - preferably the day before the conversion date - to gather the necessary information and implement the new procedures. This will be impossible from a technical standpoint (re-programming computer programs and changing bank accounts, for example), as well as the manpower and administration which would be required for such an overnight action.
 

Adjustment of Existing and Interim Contracts

As discussed above, an important step during the time before the actual conversion will be the adjustment of existing or new contracts to a potentially different monetary situation. This process may require significant amounts of time and resources and should be initiated by the affected US-entities as soon as possible.
 

Development of Infrastructure

US-businesses should also establish the necessary external infrastructure. This includes communications with banks, accountants and attorneys for the establishment of bank relations in the new currency, conversion of assets, accounting changes resulting from the re-denomination of assets and liabilities, and the general legal requirements associated with the conversion.
 

Treatment of the Existing Ecu

A limited number of US-entities already use private ecus in a variety of transactions. These businesses should treat and use the existing ecu as a normal foreign currency and should regard it as a training ground for the single currency. This will give them a distinct advantage at the time of conversion.

 

13-6-1994