When Novo Nordisk’s chief financial officer met marketing colleagues last Friday the conversation moved far beyond the usual discussion of sales and performance. Jesper Brandgaard asked a simple, far-reaching question: how would the firm set prices for two pivotal new insulin products if the euro collapsed?
The Danish firm, the world’s biggest maker of insulin for the treatment of diabetes, sits outside the euro zone but sells into it. It’s a question that is being echoed – in various forms – in the boardrooms of banks, brokerages, trading houses, law firms and the world’s leading manufacturers.
“It’s hard to make detailed plans but we need to think through how our pricing strategy would fare if there were suddenly a dismantling of the euro,” Brandgaard told Reuters. “How do we avoid falling into a trap? This is the first time I’ve asked such a question. It’s a topic that is increasingly on the radar.”
In the case of the products in question – Degludec and DegludecPlus, two ultra-long-acting insulins – Novo Nordisk has time on its side. The new drugs are still working their way through the regulatory approval process and probably will not reach the market until late 2012.
Planning for a breakdown of Europe’s 17-nation single currency is not easy. Like many business leaders, Brandgaard views a break-up of the euro as possible though not yet probable — but the odds are increasing. In a Nov 23 Reuters poll 14 out of 20 economists said the single currency would not survive in its current form – and companies are starting to plan for a worst case scenario.
Their trepidation is best summed up by Martin Sorrell, the head of the world’s biggest advertising agency WPP. “The complexity fills everybody with such appalling fear and is so complicated that the last thing in the world you want to happen is that,” Sorrell told Reuters on Monday. “But the honest answer is that, like everybody else, you try and contingency plan for any break-up of the euro zone.”
Drawing on interviews with company officials, bankers and lawyers in Europe, the United States and Asia and companies’ regulatory filings, Reuters has pieced together a picture of patchy preparedness for the possible demise of the 12-year-old euro currency, an event that would be unparalleled in recent history.
“These days, it’s a part of almost every risk management conversation that comes up,” said a senior player in London’s insurance market, speaking like many in this story on condition of anonymity because of the sensitivity to their business.
Some of the most active contingency planning is happening in European countries outside the euro zone that have strong trading links with the currency bloc – Denmark and Britain being leading examples. Of the 33 companies with the biggest exposures to the euro zone in sales terms, five are British, according to Thomson Reuters data. Health care, energy and consumer goods are among the most exposed industries.
A number of British firms, including the world’s biggest caterer Compass Group, have said they have discussed or put in place contingency plans to deal with a euro collapse but most are reluctant to give details.
“Most business people have given up waiting for the political Godots. You just can’t run your business on the basis that something will turn up, so you have to plan on the basis that it doesn’t turn up. So you think about what legally and contractually it is going to mean. You also say ‘I’m going to run my balance sheet as conservatively as possible’,” WPP’s Sorrell said.
Banks, brokers and exchanges are in the front line.
ICAP, the world’s top broker for foreign exchange and government bonds, said on Monday it has tested its trading system to handle the collapse of the euro zone and re-emergence of national currencies.
It is not alone in carrying out ‘war games’. A senior banker at a large investment bank said he had a team of 20 people globally running all kinds of scenarios all the time. That team was now spending a lot of its time on the possible break-up of the euro. They had simulated a weekend crisis by running through the different stages of Friday night, Saturday and Sunday in one full working day. In addition, they had looked whether they would have enough people (and the right ones) available and made sure they knew where to reach them.
“It’s my job to assume the worst. You can test all kinds of benign scenarios, but if something really bad – let’s say a sudden overnight default of Italy – were to happen and we hadn’t tested that, I wouldn’t be doing my job properly. If that latter scenario were to occur, things would look very ugly indeed. There simply wouldn’t be enough time to sort out all the various trading positions and look at all the paperwork,” the banker said.
In his estimation, a return to the drachma in euro zone minnow Greece was the least of his concerns. He likened Greece to bankrupt U.S. broker-dealer MF Global – annoying but not a real issue – and Italy to Lehman, whose collapse marked the start of the 2008 financial crisis.
Britain’s regulator, the Financial Services Authority, has told Britain’s banks to draw up contingency plans in case there is a disorderly break-up of the euro zone or exit of some countries. “We cannot be, and are not, complacent on this front,” Andrew Bailey, deputy head of the FSA’s Prudential Business Unit, said on November 24.
U.S. firms are testing their systems too. A.M. Best Co, the main ratings agency for the insurance industry, said on November 22 it is doing additional stress testing on insurers given deteriorating conditions in Europe. The agency, which just conducted a similar review two months ago, said it is looking at underwriters’ exposures on a case-by-case basis to see if any have additional risk from the weakening euro zone.
For non-financial firms, a key focus of efforts for firms worried about a euro collapse is in trying to safeguard their cash. Corporate balance sheets currently are very strong with upwards of $1 trillion net sitting on them, a reflection of companies’ reluctance to invest in adding capacity or in buying other firms.
The chief executive of a European company with annual revenues of more than $10 billion a year told Reuters during a recent visit to London that his board had discussed how to handle a euro zone collapse but that it had proved a very short meeting. Other than ensuring their cash deposits were in the safest possible banks and relying on the broad international nature of their business, executives quickly concluded there was little more they could do.
Treasury department teams are shifting money to safe havens and rehearsing rapid-action scenarios. Budgets for 2012 are being looked at again. And outside consultants are being brought in to advise on exposure to peripheral Europe – Greece, Ireland, Spain, Portugal and Italy.
Central bank data shows a decline in deposits from banks in weaker euro zone countries. Separating data on corporate deposits from personal bank accounts data is nigh on impossible, but anecdotal evidence points to corporations moving euro accounts to safe havens. Some big firms such as engineering group Siemens and carmakers BMW, Daimler and Volkswagen, are licensed to deposit funds with the European Central Bank, the safest of all safe havens in the euro zone.
Siemens finance chief Joe Kaeser said in a November 10 media call on the group’s quarterly results that a considerable proportion but less than half of its 12 billion euros in liquidity had been parked with the ECB. About a year ago, Siemens — a maker of fast trains and gas turbines — acquired a banking license to be able to deal directly with the ECB.
BMW said on Monday its approach to handling excess liquidity had not changed and that it continued to use a number of international commercial banks as well as the ECB’s deposit facility. Daimler said it used surplus cash mainly internally. Volkswagen did not immediately respond to calls seeking comment.
Similar caution emanated from companies in other industry sectors.
Simon Henry, chief financial officer of oil company Royal Dutch Shell, said as a consequence of Europe’s debt crisis it was taking extra care in investing its $20 billion cash pile. “It’s with secure counterparties and its short term,” Henry said.
Drugs firm AstraZeneca told Reuters it was carefully monitoring its exposure to the banking sector in light of the debt crisis and had increased its holdings of U.S. government Treasury bills.
The chairman of another company in Britain’s FTSE 100 index of leading firms said the shortage of AAA rated banks was complicating life. British firms don’t have access to the ECB because Britain is outside the euro zone.
Different industries also have differing abilities to reduce exposure to risky markets.
Pharmaceuticals is one sector where firms have limited wiggle room, since companies have an ethical obligation to supply life-saving medicines, even when payments are uncertain. In fact, drug makers have already been through something of a “dry run” in Greece, after being forced to accept government bonds instead of cash for some outstanding debts. Those bonds were either sold immediately at a discount to face value or are still sitting on their books at even lower value today. Greece accounts for only around 1 percent of the global pharmaceuticals market, so the impact on major international companies has been minimal. Italy and Spain, however, are much bigger markets.
A significant number of U.S. companies in a wide range of industries, including one in three members of the widely watched Dow Jones industrial average, warned investors of their rising concerns about Europe in quarterly regulatory filings.
“Western Europe appears to be experiencing increasing challenges given the uncertainty around fiscal and monetary policy direction, which likely impacts consumer confidence,” diversified manufacturer 3M Co said in a filing with the U.S. Securities and Exchange Commission.
Bank of America Corp added the European debt crisis into its regular list of risk factors it advises investors to be aware of: “There remains considerable uncertainty as to future developments in the European debt crisis and the impact on financial markets.”
And drugmaker Merck warned shareholders that cutbacks in spending by cash-strapped European governments could take a toll on how much it can charge for its medicines.
Other companies that called attention to the crisis in their filings included American Express Co, Boeing Co and Cisco Systems Inc.
U.S. companies that do business in Europe are expecting exchange rates on European currencies to be more volatile in the coming months, and have stepped up their efforts to hedge against these risks, experts said. Beyond financial hedges, though, which become pricier at times of vulnerability, manufacturers should think about “natural hedging” — localizing supply chains within the euro region, suggested Stefano Aversa, co-president of Alix Partners LP, a global consulting company.
“One of the things that companies have to think about is natural hedging, which is the only real protection, having production as much as possible balanced with where you sell and where you buy. This is the No. 1, because you might see swings literally of two or three points on the bottom line due to this here,” Aversa said in a phone interview.
Other companies are rewriting sales contracts to allow them to adjust prices if currencies experience large swings, Aversa said.
U.S. companies may be more prepared for a European meltdown simply because the credit crunch of late 2008 was felt more sharply in the United States, Aversa said. The downside to the resulting conservatism, though, is that companies are already having a harder time getting access to credit as banks tighten lending standards.
“All of the banks are doing the stress tests and frankly are becoming much more prudent,” Aversa said. “One of the consequences of it for the industrial companies, particularly the not-big ones, is a restriction on refinancing and credit in general, which is now pretty apparent.”
The prospect of a euro break-up raises a mountain of legal and financial questions. Lawyers and bankers have begun combing through loan agreements, leases and other financial contracts to see how they would survive any serious euro disruption.
Most contracts failed to foresee a collapse or partial disintegration of the euro and the stroke of a lawyer’s pen a decade ago could have heavy repercussions today, stemming from the choice of jurisdiction or the laws governing individual contracts. Some banks have already started thinking about how to revise the standard documentation used in future loan agreements to anticipate a break-up of the single currency.
“From the late 1990s onwards, commercial contracts were written to include express provisions to deal with the transition to the euro but I am not aware of any being written so far that contemplate any country exiting the euro,” said Jamie Wiseman-Clarke, a senior associate at London law firm Berwin Leighton Paisner, specializing in aviation, rail and shipping. “The euro was assumed to be stable,” he added.
It is a high-risk process.
Ill-judged wording might result in a creditor having to recover its money in the currency prevailing on the day in a country departing the euro area rather than the euro. There are also concerns that a euro exit would tip some companies into default on their loans. The redenomination of their local currency could trigger a drop in revenues that would in turn prevent them meeting their obligations on euro-denominated debt or force them to break loan covenants.
A rash of technical payment defaults on all the loan borrowers from a departing country is a Doomsday scenario that would keep the lawyers busy as they fix documentation that failed to envisage such an outcome, bankers said.
More likely than a mass technical default is that some companies would simply be unable to pay or meet loan conditions because of the dire economic conditions and drop in demand that some economists are predicting from a break-up of the euro.
Worse still, UK law firm Clifford Chance has warned there might be practical difficulties in recovering payments since any decision to quit the euro would probably go hand in hand with exchange controls. Depending on how courts read the background to the decision that could lead to a stand-off between the laws of different states.
Planning is not made any easier by the fact that many continental European companies tend to be more politicized than their counterparts in the United States, so the question of a break-up is virtually taboo. Franco-German-led aerospace giant EADS, for example, is often described as the industrial counterpart to the euro. Its stakeholders include the French government and, soon, the German state. During much of its 11-year history it was a conduit for Franco-German tensions.
“If people learned that a big CAC40 (French blue-chip) company was preparing a worst-case scenario it would spread anxiety and would be interpreted as a very damaging blow to the euro,” said a communications adviser to a number of top French companies, asking not to be identified.
As for a complete collapse of the currency, the consequences are so unpredictable – and unthinkable to a post-war generation immersed in European integration — that many say there is little point in running models. What counts more, they say, is a nose for survival.
“We are not running contingency plans like that. We want the euro to survive but we make tangible things. We would not die without the euro,” said the chief executive of one of Europe’s largest manufacturing companies.