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Impact on capital markets
The European Commission examines the consequences of the introduction of the euro on bond and equity markets and to put forward technical solutions which may be adopted by markets.
Commission communication of 2 July 1997 on the impact of the introduction of the euro on capital markets [COM (97) 337 final - Not published in the Official Journal].
In order to derive maximum benefit from the introduction of the euro, it is desirable to attain a degree of harmonisation of future euro markets by defining common characteristics that will apply to the financial markets of all the countries in the euro area.
Under the reference scenario adopted in Madrid, all new tradable public debt will be issued in euros as from 1 January 1999. In addition to this requirement, most issuers are now considering redenominating into euros their outstanding debt: this operation will have the advantage of generating euro liquidity in government bond markets and of enhancing the credibility of the governments' commitment to the economic and monetary union (EMU) process.
The best method of redenominating the debt would appear to be the "bottom-up" approach:
- individual securities are converted to euros using the fixed conversion rates;
- the result is rounded up to the nearest cent;
- the sum of all individual securities is then calculated and matched against the total held at the central depository.
The operation is neutral at all stages and the only potential differences for operators lie in the rounding arrangements.
Greater harmonisation of market conventions towards best practice is worth pursuing because it will increase transparency and avoid disputes. Harmonisation would concern the following points:
- conventions governing the number of days used to calculate the accrual of interest: modern calculation systems enable the most accurate convention (exact number of days/exact number of days) to be adopted;
- coupon frequency: the possibility of choosing between various options should be kept open. Semi-annual coupons reduce credit risk and are the norm in the US and Japanese markets, whereas annual coupons are the norm in the EU (except in Italy and the United Kingdom) and are cheaper for issuers;
- business days: a standard definition could be to consider a business day as any day when TARGET is open for business (only Christmas Day and New Year's Day are holidays);
- settlement basis:
- the most common method ("spot standard with a two-day settlement period") would be a suitable standard to harmonise on for euro-money market transactions;
- on bond markets, the settlement standard is currently trade date plus three business days: this standard could be maintained in the short term and a move made to a shorter settlement period in the longer term.
As regards the changeover to the euro, the main European stock exchanges have announced their intention to pursue a Big Bang approach: as from 4 January 1999 exchanges will trade and quote all securities in euros. Intermediaries will have to make the necessary conversion in order to account to their clients in the currency chosen by the latter.
The decision to redenominate shares is a company decision independent from the decision of the stock exchanges to trade in euros. The denomination of share capital should not affect its economic value: accordingly, redenomination can take place at any time during the transitional period, in other words from 1 January 1999 to 31 December 2001.
The recommended solution is that of Non Par Value shares (NPV). Since each share is a fraction of the capital stock, there is no need for a physical exchange of share certificates. However, in many Member States the national legislation allowing NPV shares has not yet been put in place.
In general, there is not much of a case for harmonising market conventions in equity markets.
As regards historical series and stock market indices, the changeover should not give rise to any particular problems.
The transitional issues relevant to the derivatives markets mirror those of the underlying markets to which they relate. Accordingly, the same types of solution are recommended.
Other market features
Price sources. It is important to ensure the continuity of price sources. Prices calculated on a national basis (PIBOR, LIBOR, etc.) and on a European basis (EURIBOR) can coexist. It is desirable for rates to be published for the whole of the euro area or for harmonised criteria to be available for calculating national sources. The bodies responsible for producing and publishing price sources should provide clear information on the prices that will be available between 1 January 1999 and 1 January 2002.
Issuing procedures for sovereign debt. There is concern in some quarters that the coexistence of national debt offices and the European Central Bank (ECB) debt on markets could confuse monetary policy signals. Informal coordination between sovereign issuers could help to prevent this happening.
Ratings: sovereign debt. There is a debate between those who contend that membership of the euro area could result in an adjustment for some sovereign credit ratings and those who believe that membership of EMU will strengthen the credibility of budget policy and that ratings will not be adjusted.
In any event, the cost of raising debt for an individual country is unlikely to be changed significantly by a small adjustment in its credit rating, given the importance of other factors such as liquidity and the efficiency of the country's primary dealer system.
Ratings: corporate debt. The European Union (EU) will probably be rated AAA and thus corporate borrowers will no longer be potentially capped by the credit rating of the country in which they are located. Broadly, EMU should have a positive effect on corporate ratings.
Repos. Market participants are keen to avoid the overly aggressive use of initial margin (the amount that has to be deposited before entering into a margining transaction)/haircut (the value of a security as collateral) in the official repo market as this would be an unnecessary restriction on the development of the market.
In addition, the use of variation margins (the amount that has to be deposited by the borrower to ensure that the counterparties remain fully collateralised throughout the term of a transaction) is far more efficient because it is based on symmetric daily marking-to-market of the collateral.
Markets need certainty that no volatility can occur at the end of the process because they would not be able to hedge. Investor protection is considered as one of the key factors of an efficient financial market and is crucial in determining the international attractiveness of the markets.