1. What are the possible risk scenarios?
At the current time there are a number of possible scenarios that commentators are talking about. These are largely political rather than legal questions and we express no views on the likelihood of any of these events. The scenarios envisaged include:
- an exit by member state with a weak economy from the Eurozone
- an exit by a member state with a strong economy from the Eurozone
- a default by a member state with a weak economy (without exiting the Eurozone)
- a North-South break-up of member states in the Eurozone
- a complete disintegration of the euro
- the ECB stepping in to support the euro
2. What might happen if there is an exit from the Eurozone by a member state with a weak economy?
One of the scenarios to receive most comment is the possible exit of a member state with a weak economy. This scenario is therefore the scenario around which the Q&A is based in assessing the possible risks for businesses.
Aside from the legal issues as to how a member state might exit the Eurozone, any such exit would obviously have major political and economic ramifications for the remaining Eurozone member states and the value of both the new denominated currency of the exiting member state and possibly the euro. It would be envisaged that capital and exchange controls would need to be put in place to protect the value of the new currency of the exiting member (see Exchange and Capital Control risk section). Redenomination risk and Counter-party risk would also be an issue.
3. What might happen if there is an exit from the Eurozone by a member state with a strong economy?
Another scenario that has been commentated on is a possible exit from the Eurozone by a member state with a strong economy. As above, aside from the legal issues as to how a member state might exit the Eurozone, any such exit would obviously again have major political and economic ramifications for the remaining Eurozone member states and possibly the value of the euro. It would be envisaged that capital and exchange controls would need to be put in place to protect the value of the euro (see Exchange and Capital Control risk section). Redenomination risk and Counter-party risk should in theory be less of an issue as the redenominated currency and counter-parties should be stronger.
4. What might happen if there is a default by a member state with a weak economy (without an exit from the EU)?
A member state with a weak economy might default rather than leave the Eurozone. This would need to be done with the agreement of other Eurozone member states and financial institutions such as the ECB and the IMF. In such a scenario, it would be envisaged that some formal restructuring package would need to be agreed on a global basis both to assuage creditors and to calm global financial markets.
5. What might happen if there is a North-South break-up of member states in the Eurozone?
There has been some speculation that there might be a North-South break-up of the Eurozone with a Northern and Southern euro in operation. It would be envisaged that in such a scenario, capital and exchange controls would need to be put in place to protect the value of the Southern euro (see Exchange and Capital Control risk section).
6. What might happen if the Eurozone disintegrates entirely?
If the euro were to collapse entirely, there would obviously be very serious consequences not just for Europe but for global financial markets generally. The euro would need to be replaced by local new currencies of member states and legislation would be needed at both a European and a national level to address the political and economic fallout, including redenomination of euro payment obligations. Capital and exchange controls would also need to be put in place (see Exchange and Capital Control risk section).
7. What might the ECB do to help?
There has been an increased focus on the role that that the ECB might play in helping to resolve the Eurozone crisis, especially since President Mario Draghi announced on Thursday 26 July 2012, that "within its mandate" the ECB will do "whatever it takes" to save the euro although subsequent pronouncements have failed to clarify the possible tools. Speculation as to what the ECB might do has included one or more of the following:
- make further purchases of distressed government bonds
- provide a further liquidity boost for European banks through the LTRO1
- quantitative easing through the purchase of bond
- lower interest rates
- act as a "lender of last resort" via the ESM2
The question as to what the ECB can or cannot do within the scope of its mandate is set out in the Maastricht Treaty and the Treaty on the Functioning of the European Union (the TFEU) which define the role of the ECB as maintaining "price stability" (i.e. keeping inflation low) and supporting "the general economic policies of the community". However, articles 123, 124 and 125 of the TFEU have been cited by certain member states with stronger economies to argue that it was not envisaged that the ECB play the role of "lender of last resort" to member states. If the ECB was to play a role more akin to that played by the Federal Reserve, treaty amendments would probably need to be made to expand its current mandate. And there would need to be the collective political will to do this.
8. How might a member state exit the Eurozone?
The first possible scenario is a lawful exit by a member state in accordance with the TFEU, which sets out, amongst other things, the legal framework for economic and monetary union. However, the TFEU3 does not provide a clear mechanism for a member state to exit from the Eurozone. The only clear exit mechanism is article 50 of the Treaty on European Union4 (TEU), which permits a member state to withdraw from the European Union (EU) as a whole and which by logical consequence, would require a withdrawal from the Eurozone at such time. A member state which wishes to exit the Eurozone but remain a part of the EU would appear to have to exit the EU under article 50 and then apply for readmission5 , subject to ratification by other member states, to rejoin the EU.6 Given this would constitute a consensual exit, it is likely there would be legislation (both at EU and national level) to deal with the legal uncertainty created by a member state leaving the Eurozone.
A second possible scenario for a lawful exit is for member states to agree to amend the TFEU to allow for a lawful exit by a member state from the Eurozone without requiring a withdrawal from the EU as a whole. Again, given this would constitute a consensual exit, it is likely there would be legislation to deal with the legal uncertainty (both at EU and national level) created by a member state leaving the Eurozone.
A third possible scenario is a unilateral and therefore non consensual withdrawal by a member state from the Eurozone. This is the scenario which is most likely to create significant legal uncertainty because there is less likely to be time to implement EC legislation dealing with the legal uncertainty that would inevitably be created by such a unilateral exit.
For further commentary and analysis see Financial Times article and related briefings: " Euro exit as legal quagmire".
Footnotes
1 Long Term Refinancing Operation: the "cheap" loan scheme for European banks announced by the ECB towards the end of 2011 to ease liquidity in the Eurozone.
2 European Stability Mechanism: the European organisation which (if established) will provide financial assistance to Eurozone members in financial difficulty and replace the existing temporary funding programmes.
3 As amended by the Lisbon Treaty.
4 As amended by the Lisbon Treaty.
5 See article 50(5) and article 49, TEU.
6 The time this is likely to take is unlikely to make this a viable option.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.