The most recent important decisions for the preparation of the monetary union were taken by the Madrid European Council in December 1995 and the subsequent Summits in Dublin in December 1996 and Amsterdam in June 1997. The sequence and timetable of the main steps to be taken for the introduction of the euro, the changeover scenario, were decided in Madrid. The changeover scenario was the key significant decision in order to allow the practical preparations for the introduction of the euro, both in the public and in the private sector to be launched. In addition to that, the legal framework was agreed in Dublin and finalised in Amsterdam. The adoption of the legal framework provided clarity and certainty concerning the status of the euro as the currency of the participating Member States from 1 January 1999 as well as the organisation of the transition period between 1.1.1999 and 1.1.2002.
The changeover scenario is based on three major stages, with the key date being 1 January 1999 when parities will be irrevocably fixed. Right from this date monetary policy will be conducted in euro, governments of participating countries will issue national debt securities denominated in euro and thus a key part of the financial activities will be carried out in euro. Indeed, to manage liquidity and participate in the ESCB’s open market operations it will be necessary to operate in euro. Financial institutions, payment systems and clearing systems will have to be able to operate in euro to undertake transactions involving government debt. Capital markets are therefore key players in the whole operation.
The legal framework for the introduction of the euro has been defined
in two Council Regulations. The first confirms that the euro will be the
currency of participating countries from 1 January 1999 and ensures legally
enforceable equivalence between the euro and national currency units while
they co-exist. The second ensures legal certainty in the run-up to the
start of monetary union and covers continuity of contracts, the ono-to-one
conversion between the ECU and the euro and rounding rules.
2. Changes in the capital markets
The major change in the capital markets will result in the creation of the second largest bond market after the US. A significant difference is that in the euro bond market, different national central governments will continue to be sovereign issuers. In due course, depending on the ultimate number of participating countries, it could become the single largest market for fixed income securities. The full benefits of EMU will materialise if the future euro capital market is as unfragmented, liquid, efficient as possible. A number of factors support the emergence of an integrated EMU wide capital market, in particular the elimination of the exchange rate risk between participating currencies, the development of efficient cross-border payment systems (TARGET and the EBA Clearing System), and the intensified competition between financial intermediaries resulting from a single monetary policy. However, unless the market takes action to define and implement a common euro-area wide approach the market in euro will be divided by the current different national practices, conventions and standards. Most or perhaps all market participants could operate in such an environment, but a euro market with different national features would not be as efficient as a more homogeneous market.
To extract the greatest gains from the introduction of the euro with
the least disruptive adjustments it is necessary to identify issues that
require a common technical approach and those which can be left unchanged.
The start of stage three of EMU offers the possibility of creating a euro
securities market as broad, liquid and transparent as possible by defining
a set of common rules, applied in all participating countries of the euro-area,
governing various aspects of market operations. In an ideal world, harmonisation
might occur in one big bang. However, practical and political constraints
make such an approach problematic. The changeover process in the capital
markets has to be managed with the aim of minimising the efficiency cost.
Harmonisation of legal and administrative issues is a responsibility of
the authorities, but most of the decisions to be taken for the introduction
of the euro in the capital markets are the responsibility of the markets
2.1 How to step up preparations in the capital markets?
The magnitude and complexity of the changeover calls for places where information can be effectively pooled and interested parties can confront their ideas on potential problems and their solutions. The Commission established in July 1996 a Consultative Group on the impact of the introduction of the euro on capital markets chaired by Mr. Alberto Giovannini.
The aim of the group was to identify and discuss potential technical problems associated with the introduction of the euro and identify technical solutions. The work of the group aimed at improving consistency among solutions defined by different financial industries and different Member States, thus contributing to building up a consensus in the market place on issues where a common/harmonised approach is necessary or at least desirable. The results should also identify issues on which additional guidance, whatever legal or not, from the public authorities is required. The consultative group has an informal status and a flexible composition aiming at providing a fora for free exchange of views. Members of the group are from different Member States and from different types of financial activities so as to facilitate the exchange of views between different practices and interests. The group has permanent membership with the objective of gathering together individuals with expertise on capital markets and the process of monetary union and a variable membership with the objective of bringing to each meeting market specialists on the topics to be discussed at the meeting.
The starting point for the work of the group was the conditions and rules applicable for the changeover to the euro established by the legal framework. Market participants also shared the view that the introduction of the euro forces the abandonment of institutional arrangements in the market place and the introduction of new, often uniform techniques and/or institutions. In most cases this presents and opportunity to adopt the most advanced technologies thereby improving the efficiency of capital markets to a large extent.
The group has discussed the impact of the introduction of the euro in foreign exchange and money markets, fixed income and equity markets. The work concentrated on the practical aspects rather than on strategic or more analytical issues. The reason for that is the urgency to define technical solutions to make sure that capital markets can work in euro as from the beginning of January 1999.
On the basis of the work done by the consultative group, the Commission published a Communication which reflects the Commission understanding of the conclusions of the consultative group. It is focused on technical and other issues that will have a direct impact on the functioning of the capital markets after the introduction of the euro. The Communication sets out recommendations in particular on redenomination of the bond and equity markets, and on the market conventions that should be applied to the new euro bond market. These are issues on which market participants expect clear answers now to be able to proceed with the preparations.
The Communication is not a complete review of all the issues related
to the changeover of capital markets. It is a reflection of the current
state of knowledge and consensus. Other issues remain to be examined, aiming
at developing best practices and at reaching consensus at the European
level wherever it is necessary.
2.2 Main conclusions
Market rules and conventions
The existence of different conventions for similar types of euro denominated instruments would result in additional confusion and increased cash flow matching problems and reconciliation errors. Harmonisation of euro market conventions is desirable, as it would promote liquidity and transparency in the new markets and prevent confusion and disputes for euro trading and settlement. The existence of agreed harmonised conventions provides certainty to firms and settlement facilities to implement their systems requirements. Although parties to a financial contract may always specify their own terms, agreed harmonised conventions would provide a basis for standard practice. The recommendations given in the Communication concern basically the bond market and they are fully compatible with the ones put forward by the European Monetary Institute for the money market. The Communication proposes:
1) actual/actual for day counts for interest rates calculations. Actual/actual is the most accurate means of measuring accrued interest on bonds. Moreover the use of actual/actual would provide consistency with the approach adopted by the US Treasury bond market;
2) on business days there should be a standard definition. The convention for euro bond business days and the TARGET operating days should be identical and the number of non-business days should be kept to a minimum;
3)a common standard would be best for settlement dates. The less disruptive solution would be to retain the current standard settlement date for internationally traded cross-border transactions, T plus three business day cycle. However, the introduction of real time gross settlement systems and the desirability to reduce settlement risk will progressively lead to a reduction of settlement cycles;
4) the choice of coupon frequency (annual or semi-annual) should be left open since either of the two practices have advantages for specific types of investors or operations. Semi-annual coupons reduce the credit exposure of investors to issuers, while annual coupons involve lower administrative costs.
The major European and International market associations in the banking and financial sector published a joint statement recommending harmonised market conventions for the euro money, foreign exchange and bond markets. These recommendations are in line with the ones given in the Commission Communication and they have been endorsed by the Commission and supported by the EMI Council. Now, it is important that issuers ensure the use of common standards for euro-denominated bond issues, and in particular for benchmark government bonds.
Redenomination of outstanding debt
Redenomination of the existing debt would enhance both liquidity and the credibility of the process. For a given issuer, investors could for psychological reasons prefer to hold securities denominated in the national currency rather than in euro and this could lead to differential rates emerging. Whilst this is a remote possibility, redenomination would remove this risk. Redenomination would also allow the re-opening of existing issues by tap issues in euro.
While markets could operate with securities remaining temporarily in national denominations, there is a clear case from the point of view of increasing confidence in a new European capital market, for securities to be converted at the beginning of 1999 to create a uniform euro market as swiftly as possible. Most Member States have announced the intention to redenominate existing stocks of government debt into euros at the start of monetary union. This is consistent with the decision at the Madrid European Council that new issues of government debt should be denominated in euros from 1 January 1999. Both issuers and market participants consider that a pragmatic approach aiming at the best balance between benefits and costs would be the most efficient approach to redenomination. Therefore, the most likely candidates for redenomination would be benchmark issues and highly liquid issues mainly defined for professional investors. However, the decisions concerning issues to be redenominated and timetable will be taken by the issuers themselves.
Concerning the technique for redenomination, a "bottom-up" approach is considered by market participants as being the best method. The redenomination can take place at the level of individual bonds or individual holdings. In essence, the securities, either individually or by each individual customer portfolio and by each financial institution, are converted to euro using the fixed conversion rates. After conversion, euro amounts would be rounded to the nearest cent. The sum of all individual bonds or holdings would be calculated by the financial institution and matched against the total held at the central depository. Holdings at the central depositories remain unchanged and thus redenomination would not affect the total volume of securities issued. The cash flow from coupon payments and the maturity value of a bond would be virtually unchanged except for small (not more than half a cent) potential rounding differences. Other methods of redenomination are possible although they would lead to greater adjustments following rounding differences.
These adjustment could have a significant effect on cash flows therefore modifying the investors’ risk position. They could also require a change on the global certificate. From the point of view of market participants a single method for redenomination would be preferable. Given that, according to the information currently available, a consensus on a single method of redenomination across Member States seems unlikely, at least the number of standard methods to be used should be limited to avoid confusion in the markets and reduce the technical adjustments required for systems. Concerning the conventions applying to redenominated debt, the basic principle of the continuity of contracts has the consequence that the original conventions and rules will continue to apply to and issue that has been redenominated. That would ensure that bond holders’ rights are left unchanged and that cash flows and existing hedged positions would be unaffected.
Issuers could consider the possibility to undertake exchange offers when they redenominate their debt. This would allow issuers to consolidate the debt into fewer larger issues, increasing liquidity and therefore reducing the cost of funding. It would also be possible to adopt the harmonised market conventions being applied for the new euro issues, thus enhancing fungibility.
Markets rely heavily on certain specific trading screens for reference information about bond prices and interest rates and in many cases details of the source of this price information are included in the documentation associated with bonds. It is therefore important that Central Banks and banking associations which sponsor specific rates (for example LIBOR, PIBOR, etc.) indicate whether these rates will continue to exist after the introduction of the euro and how they will be presented. The existence of a euro rate calculated on the basis of euro-area wide panel of banks is desirable. The local rates reflect average funding costs of banks in a single financial centre, while the euro-wide rate will reflect the average funding cost of a larger number of banks throughout the EMU area. In any event, it is important to ensure continuity from the current national currency local rates to either euro local rates or euro-wide euro rates.
The EMI, in its policy messages addressed to the banking and financial associations in March and July 1997 encouraged banking associations and money and foreign exchange markets in the euro area to arrive collectively at new definitions of representative euro area-wide published indicator rates. The Banking Federation of the European Union is currently working in co-operation with the European part of the ACI on the setting up of a European Interbank offered rate (EURIBOR). It is important that EURIBOR is representative of actual market activity, therefore panel membership should be defined on the basis of objective criteria ensuring that panel members are active market participants.
The availability of one or more euro rates is a competitive matter as today there are competing price sources for specific rates. If the methodology to calculate the EURIBOR is transparent, credible and the rate is reflecting the conditions prevailing in the whole euro area, there is likely that this rate becomes the most widespread used in the market. In terms of published rates, the screen providers have to make sure that they provide a substitute euro rate, either by replacing the current rate on the same screen or by referring the user to a substitute euro rate.
Stock exchanges will trade and quote in euro from 1 January 1999. Intermediaries will have to make conversions, when necessary, in order to account to their clients in the currency chosen by the latter. This means that individuals will still be able to deal in shares through a bank or another financial institution using national currencies. Harmonisation of market rules and conventions appears to be less important than for bond markets. The timing for redenomination of nominal share values from national currencies into euros is a decision for each individual company. It would be a sensible step to be taken at the same time as the company starts using the euro for internal accounting purposes. The need for physical exchange of share certificates could be avoided by moving to a system of "non par value shares". This approach would also avoid the need for any rounding adjustments to the overall capitalisation of companies when redenominating into euro. Non par value shares are allowed by the second Community Company Law Directive but in many countries the relevant national legislation has not yet been put in place. Some Member States are envisaging to amend the national legislation.
As mentioned above, Member States will issue in euro from 1 January 1999, thus the currency will no longer be a differentiating factor between sovereign debt. However, each Member States remains responsible for its own fiscal policy and for its own debt. The introduction of the euro raises the question whether ratings of Member States will be modified. Since the exchange rate risk disappears, the key factor for assessing the solvability of sovereign issuers will be the fiscal position, thus ratings will rely basically on convergence. The transfer of monetary sovereignty from national central banks to the European Central Bank (ECB) is not expected to have an impact on rating since the monetary financing of debt is already not available to Member States. Even if small adjustments in the credit rating would occur, they are unlikely to modify significantly the cost of raising debt for an individual country, given the importance of other factors, such as liquidity and the efficiency of country’s primary dealer system.
Concerning issuing procedures, markets consider that increased co-ordination between issuers and pre-announcement of auction calendars could enhance liquidity, transparency and predictability in the markets, thus reducing the cost for issuers. Co-ordination would be informal and flexibility for non-announced issues would be maintained.
So far there is no clear which issue will be considered as the best
proxy for the risk free return after 1 January 1999. Potential benchmark
issuers will need to present new-issue calendars with regular issues, scheduled
well in advance, to obtain market support. This may result in certain countries
introducing changes to increase the efficiency of existing issue procedures.
III FINAL REMARKS
The issues reviewed in this article reflect that preparations for the
introduction of the euro are well underway in the financial field. Although
they are not comprehensive, they underlined a significant number of aspects
where common views and harmonised collective decisions can lead to an increased
efficiency of the capital markets and to the development of a single euro
market. The introduction of the euro will create a much larger debt market
which will offer increased possibilities in terms of volume, instruments
and lengthening of maturities. The existing range of issues, maturities,
instruments and methods of distributions of securities will become the
key factors. The consensus which is being build in the market towards greater
harmonisation will contribute to develop a single, transparent and liquid
See the Giovanini report on the website at "Official documents - European Commission"
This article reflects only the opinion of the author and does not
commit at all the position of the European Commission, where the author
The European Council or Summit is the name given to the meetings of Heads of State and Government of the European Union Member States.
Council Regulation (EC) N° 1103/97 O.J. L 162, 19.6.1997
The euro and national currency units will co-exist during the period 1 January 1999 and 1 January 2002.
Resolution of the European Council of 7 July 1997 97/C 236/04 containing the text of the Regulation. O.J. C 236 2.8.1997
TARGET: trans European Automated Real-time Gross Settlement Express Transfer System
EBA: Ecu Banking Association
The group was established by Directorate General II, responsible for Economic and Financial Affairs, in cooperation with other Commission services (DG XV, FOS, Legal Service).
Mr. A. Giovannini currently works in Long Term Capital Management.
The impact of the introduction of the euro on capital markets. COM(97) 337 final, 2.7.1997
Actual/actual means that calculations should be based on the actual number of days in the months over which the interest has accrued divided by the actual number of days in the year.
Joint statement on market conventions for the euro. ACI-The financial market association, Banking Federation of the EU, Cedel Bank, European Federation of Financial Analysts’ Societies, European Mortgage Federation, International Paying Agents Association, International Primary Market Association, International Securities Market Association, International Swaps and Derivatives Association, Euroclear. 16.7.97