In order to study the impact of the introduction of the euro on capital markets, the Commission constituted a group of experts chaired by Mr. A. Giovannini.This report is the result of the work undertaken by this group.
The Commission considers that the market harmonisation is a matter for the finanical markets. In this context, it warmly welcomes the report of the group. It recommends the financial markets to take full account of the report in their preparations for the introduction of the euro.
The report reflects the Commission’s understanding of the conclusions of the consultative group. It is focused on technical and other issues that will have a direct impact on the functioning of the capital markets after the introduction of the euro. The report sets out recommendations on redenomination of the bond and equities markets, and on the market conventions that should be applied to the new euro market.
The report examines the consequences of the introduction of the euro in the bond market and the equity market, and in particular the necessary technical preparations. These are the issues on which market participants expect clear answers now to be able to proceed with the preparations for the introduction of the euro. The report is not a complete review of all the issues related to the changeover of capital markets. It is a reflection of the current state of knowledge and consensus. Other issues remain to be examined, aiming at developing best practices and at reaching consensus at the European level wherever it is necessary.
1. Aims and objectives
The main objectives of the report are to identify technical solutions which may be adopted by markets; and to provide guidance for both public authorities and markets.
The start of stage three of EMU offers the possibility of creating a euro securities market as broad, liquid, deep and transparent as possible by defining a set of common rules, applied in all participating countries of the euro-area, governing various aspects of market operations. In an ideal world, harmonisation might occur in one big bang. However, practical and political constraints make such an approach problematic. Harmonisation of legal and administrative issues is the responsibility of the authorities, but technical issues like market conventions, for example day counts, settlement periods and business day conventions, are market issues. The market has demonstrated in the past its ability to harmonise procedures to improve market efficiency. This paper draws together the current views of the market on how harmonised the future euro markets should ideally be, and sets out recomendations for the common technical specifications for these markets.
2. Main conclusions
Regarding the bond market, the main results on which the report presents recommendations are the following:
Redenomination of existing debt. Although redenomination does not appear to be essential for the transition to the euro, it would enhance liquidity and would enhance the credibility of the process by demonstrating governments’ commitment. For a given issuer, investors could for psychological reasons prefer to hold securities denominated in the national currency unit rather than in euro and this could conceivably lead to differential rates emerging. Whilst this is a remote possibility, redenomination would remove this risk.
Concerning the technique for redenomination, a "bottom-up" approach would be the best method. This method starts with each individual holding being converted into euro using the fixed conversion rates and rounded to two decimal places (i.e. to the nearest cent). The sum of all individual holdings is computed and matched against the total held at the central depository. Holdings at the central depositories remain unchanged and thus redenomination would not affect the total volume of securities issued. The cash flow from coupon payments and the maturity value of a bond would be virtually unchanged except for small (not more than 1 cent) potential rounding differences. Exchange offers could also be considered since they would allow the modification of conventions and the creation of more liquid issues.
Market rules and conventions. Harmonised rules would be desirable. They would provide greater transparency, avoidance of disputes (fewer back office errors) and greater clarity as to the format of the future market to allow preparations to go ahead. Actual/Actual should be recommended for day counts for bond markets. On coupon frequency, the choice should be left open given that semi -annual coupons have benefits for swaps and a reduced risk exposure, while annual coupons are cheaper for issuers. A standard definition for business days is recommended (i.e. TARGET business days). Although a common standard would be best for settlement dates, it appears technically difficult to move to shorter periods than two days. At the same time for financial centres operating on same-day basis it would be unacceptable to move backwards. Market rules and conventions suggested for bond markets are compatible with the ones suggested by the EMI for money markets.
Price sources. Continuity in price sources has to be ensured. Prices calculated on a national basis (PIBOR, FIBOR, etc) and on a European basis (EURIBOR) can coexist. Euro area-wide published indicator rates or harmonised criteria for computation of regional indicators are desirable. A statement from the price source sponsors on what prices will be available in Stage 3 is required.
Issuing procedures. Some informal co-ordination of government debt issuing would be beneficial. The development of issuing calendars would be welcome for the market but opportunistic issuing should not be precluded.
Benchmarks. In the absence of a federal issuer, markets will decide which is the benchmark issue on the basis of quality, liquidity and the range of derivatives products.
Ratings.It has been argued that membership of the euro-area could result in an adjustment for some sovereign credit ratings. This is based on the argument that euro denominated debt should be treated as foreign currency debt given the transfer of monetary sovereignty to the ECB. However, a number of counter arguments have been stated. Membership of EMU will strengthen fiscal policy in terms of discipline and credibility, and monetary financing of debt is no longer available to Member States.
Repo market. Market participants consider that overly aggressive use of initial margin/haircut in the official repo market should be avoided. On the other hand the use of variation margins in financing transactions is important for the efficiency of the capital markets.
Regarding the equity market, the main conclusions are the following:
- exchanges will trade and quote in euro from first January 1999. Intermediaries will have to make the necessary conversion in order to account to their clients in the currency chosen by the latter;
- coordination and harmonisation of market rules and conventions appears to be less important than for other markets;
- redenomination would be a sensible step to take at the same time as the change in the accounting unit. It is a company’s decision independent from stock exchanges decision about trading in euro. It is not essential that redenomination happens at the start of Stage 3 as the denomination of share capital should neither affect its economic value nor investors’ ability to trade the shares
- non par value (NPV) shares. This is a solution to be recommended. With NPV shares there is no need for physical exchange of share certificates. The share prices can be adjusted by simple splitting and there is no need for capital adjustment. NPV shares are allowed by the second Community Company Law Directive. However, the implementation of the NPV share solution would require national legislation to be adopted in most of the Member States.