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Markets Insight
September 5, 2012 5:00 pm
Greek exit fears strengthen Draghi’s hand
Would an orderly exit by Greece from the eurozone ever be possible? The question has become more pertinent for financial markets and investors this week, with a Financial Times/Harris opinion poll showing only a quarter of Germans believed the country should remain within Europe’s 14-year-old monetary union.
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Mario Draghi, European Central Bank president, will attempt on Thursday to take another step towards ensuring three-quarters of Germans do not get their way. The ECB governing council will discuss plans to eradicate – with eurozone politicians’ help – the “convertibility”, or eurozone break-up, risk priced into government bond markets.
So far, Mr Draghi has refused to discuss any scenario other than the eurozone remaining intact. The eurozone, now comprising 17 countries, was constructed on the principle of irrevocability.
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Subject to official disapproval by European authorities, contingency planning by banks and investors has been largely hush-hush. Once the possibility of a country leaving is admitted, the danger was of speculation becoming self-fulfilling.
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The trouble is that we have moved beyond that point – talk about Greece exiting has become semi-open in Berlin. But Mr Draghi could use the ending of a taboo as an opportunity. If the scope for widespread economic and legal chaos as well as malfunctioning European capital markets were more widely understood, pressure on politicians to avoid such outcomes might mount.
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Few European lawyers are brave enough to argue an “orderly” exit from the eurozone is possible, and they are not just talking their own book. There is no legal basis under EU treaties for expulsion – unless a country also quits the EU, which would expose a country to even more economic damage. And a treaty change would require approval by 27 EU countries, including ratification by parliaments or referendums.
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A first step towards exit would be the imposition of capital controls – without notice, probably over a weekend or public holiday – to prevent money fleeing before a new currency was introduced. Immediately, the legal problems would begin.
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The free movement of capital is a central principle of Europe’s single market. Controls could also breach International Monetary Fund agreements, or bilateral investment treaty deals. (Greece has 43 according to Freshfields, although not necessarily all contain clauses outlawing capital controls.)
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Athens could act unilaterally – and face the legal consequences later – or argue capital controls were essential to prevent a breakdown in public disorder. That would appear reasonable given that the likely collapse of the financial system, triggered by the withdrawal of ECB support for banks, would threaten riots on the streets.
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But any attempt, for instance, by Greek authorities to appropriate funds held by Greeks overseas would trigger a race to courts around the world; banks could be trapped between respecting Greek laws – or breaching obligations to customers.
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Further confusion would swiftly follow in determining what would be redenominated into the new currency (assuming, of course, that IT systems are able to cope with a change of currency). Until recently, lawyers devoted little thought to the definition of the euro. An established principle is lex monetae, whereby relevant laws are those of the country to which the currency belongs. Thus currency issues in a sterling contract would be subject to UK law. But the euro is not issued by a single country. Few bond or loan contracts define exactly what is a euro.
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One possibility would be to insist that the euro is the currency of Europe’s monetary union, but Greek companies have bigger legal issues on their plates right now.
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Eurozone investors might, anyway, be wary of defining the euro as the currency of the monetary union. What if Germany, rather than Greece, left the eurozone because it was fed up with the fiscal recklessness of its southern partners? German assets would then be denominated in the currency of a weaker rump euro bloc.
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Worrying about the legal definition of the euro would also deflect from the bigger picture. If Greece were to exit the eurozone fears of a wider break-up would almost certainly force Spain and Italy also to impose capital controls. Germany and other north European member states might want to impose restrictions to prevent destabilising inflows.
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In all probability, an eventual eurozone exit would follow only after time-consuming treaty change. Meanwhile, there would be a serious risk of financial market paralysis. The effects would quickly spread way beyond investors and banks with Greek interests. The impact on the European and global economy could be disastrous. Setting out plainly that horror scenario could strengthen Mr Draghi’s hand in his confrontations with eurozone politicians.
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Copyright The Financial Times Limited 2012.
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