London/Boston - 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 eurozone 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 breakup of
the euro as possible though not yet probable - but the odds are increasing.
In a November 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 breakup of the eurozone."
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 eurozone 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
eurozone in sales terms, five are British, according to Thomson Reuters data.
Healthcare, 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.
Testing the system
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 eurozone 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 breakup 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 eurozone
minnow Greece was the least of his concerns. He likened Greece to bankrupt US
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 UK banks to draw up contingency plans in case there is a disorderly
breakup of the eurozone 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.
US firms are testing their systems too. AM Best Co, the main
rating 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 eurozone.
Safeguarding the cash
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 $10bn a year told Reuters during a recent visit to London
that his board had discussed how to handle a eurozone 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 show a decline in deposits from banks in
weaker eurozone 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 (ECB), the safest of all safe
havens in the eurozone.
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 €12bn in liquidity had been parked with the ECB. About a year
ago Siemens - a maker of fast trains and gas turbines - acquired a banking
licence 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 $20bn 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 the light of the debt crisis,
and had increased its holdings of US government Treasury bills.
The chairperson 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
eurozone.
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% of the global pharmaceuticals market, so the
impact on major international companies has been minimal. Italy and Spain,
however, are much bigger markets.
Company filings
A significant number of US 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 US Securities and Exchange Commission.
Bank of America 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, Boeing and Cisco Systems.
US 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" - localising 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.
US 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."
Work for insurers, lawyers
The prospect of a euro breakup 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 how to revise the
standard documentation used in future loan agreements to anticipate a breakup
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, specialising in aviation, rail and shipping.
"The euro was assumed to be stable," he said.
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 some economists are predicting from
a breakup 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
standoff between the laws of different states.
Planning is not made any easier by the fact that many
continental European companies tend to be more politicised than their
counterparts in the United States, so the question of a breakup 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 g
eneration 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.