Communication from the Commission - The impact of the introduction of the euro on capital markets
Date: 1997-07-02
Institutions: European Commission
Subjects: capital market, euro, financial market, monetary cooperation, monetary policy

COMMISSION  OF THE EUROPEAN  COMMUNITIES 

Brussels,  02.07.1997 
COM(97) 337 final 

COMMUNICATION  FROM THE COMMISSION 

THE IMPACT OF THE INTRODUCTION OF THE EURO ON 
CAPITAL MARKETS 

THE IMPACT OF THE INTRODUCTION OF THE EURO ON 
CAPITAL MARKETS 

Table of contents 

I 

II 

Introduction and executive summary 

Overview of the task ahead 

III 

Recommendations 

IV 

The  report 

1. 

The bond markets 

redenomination 
market conventions 

2. 

The equity markets 

general considerations 
market  functioning 

3. 

The derivatives markets 

general  considerations 
technical  issues 

4. 

Other market  features 

price sources 
.issuing procedures 
ratings 
benchmarks 
repos 
reserve  requirements 
regulation, restrictions and taxation 
other issues 

V. 

Glossary 

VI. 

Annex  : List of experts 

i(\ 

I. 

Introduction  and executive summary 

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  fmanical 
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.1  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. 

1  The members  of the group  participated  in  a personal  capacity,  rather than  as representatives  of their 
respective  institutions. 

lb 

2.  Main conclusions 

Regarding  the  bond  market,  the  main  results  on  which  the  report  presents 
recommendations are the  following: 

the  credibility  of  the  process  by  demonstrating 

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 
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: 

in  euro  from  first  January  1999. 
exchanges  will 
Intermediaries  will  have  to  make  the  necessary  conversion  in  order  to 
account to their clients in the currency chosen by the latter; 

trade  and  quote 

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. 

II. 

Overview  of  the  task  ahead 

The euro securities market will be composed  of a group of national  markets sharing  a 
single  currency.  Unless  the  market  takes  action  to  define  and  implement  a  common 
euro-area  wide  approach  the  market  in  euro  will  be  divided  by  the  current  different 
national practices, conventions and standards.  Most or perhaps all market  participants 
could operate in such an environment  (which would be little different  from  the  status 
quo), but a multiplicity  of markets in euro each with different  national  features  would 
not be as efficient  as a more homogeneous market. 

There  is a serious  risk thaj the  existence  of different  conventions  for  similar types  of 
euro  denominated  instruments  will  result  in  additional  confusion  and  increased  cash 
flow  matching  problems and reconciliation  errors.  This might be particularly  true  for 
the  non-sovereign  sector.  For  example,  whereas  the  retention  of  country  specific 
conventions  for  sovereign  debt  would  be  simple  to  manage,  in  the  case  of  a  large 
corporate that issued bonds in more than one country in the euro area, all  denominated 
in euro  but  subject  to different  conventions, there  could be considerable  confusion  as 
to which set of conventions should be applied.  It would be necessary for a check to be 
made  each time  there  was  any  doubt  as to the  appropriate  conventions.  Whilst  such 
checking  appears to  be simple, perhaps no more than a short telephone  call, it would 
be  an  additional  cost,  and  a  potential  source  of  errors.  Investors,  particularly  those 
from  countries  outside  the  EU,  might  also  be  deterred  by  the  lack  of  transparency. 
Thus  although  harmonisation  is  not  a  prerequisite  for  the  introduction  of  the  euro, 
there would be advantages in doing it  and disadvantages from  not doing it. 

the 

transition  period,  contracts  drawn  up 

During 
in  old  national  currency 
denominations  are  likely  to  be  executed  on  the  basis  of  pre-existing  conventions. 
Even  once  national  currency  units  have  ceased  to  exist  certain  differences  might 
continue:  for example, it is unlikely that national holidays will be harmonised, but  for 
other  technical  issues  it  should  be  relatively  simple  to  achieve  consensus  on  a 
harmonised  approach.  To extract  the greatest  gains from  the introduction  of the  euro 
with the least disruptive adjustments  it will be necessary to identify  issues that require 
a common technical approach and those which can be left  unaltered. 

III.  Recommendations 

The group  supported  the concept  of harmonisation  of market conventions for  the  new 
euro  markets.  The  group  recommends  that  issuers  and  other  market  participants 
employ the standards proposed  in the report. 

Specifically,  the group reached consensus on the following  recommendations: 

•  That  sovereign  issuers  redenominate  their  tradable  debt  at  the  start  of  stage  3, 
employing  a bottom  up methodology  with rounding to the nearest  cent, and  whilst 
other  methods  should  not be excluded, the group  supported  the aim of keeping  the 
number of approaches to redenomination  as small as possible. 

•  That  existing  conventions  are  retained  for  redenominated  debt,  and  for  all 
outstanding  issues  and  instruments,  and  that  exchange  offers  be  considered  to 
4 

repackage  existing  issues  into  larger,  more  liquid  euro  issues  with  round  nominal 
bond values. 

That new harmonised market conventions be applied to new euro debt. The method 
for  calculating  accrued  interest  should  be based  on Actual/Actual.  The  frequency 
of coupons  should be left  to individual choice.  There should be a single  definition 
of what is a business day for the euro, specifically  any day when TARGET and one 
settlement system are open. 

That  price  sponsors  and  subsequently  screen  providers  announce  quickly  their 
plans regarding publication of existing national rates. 

That the redenomination of equities would be the consequence of the change to the 
euro of a company's accounting unit.  Moving to non par value shares would be the 
best way to facilitate the changeover. 

IV.  The  report 

1.  The bond  markets 

1.1  Redenomination:  its rationale 

The  Madrid  European  Council  in  December  1995  decided  that  from  the  start  of 
Stage  Three  of EMU  all  new tradable public debt will  be issued  in euro.  It  now 
appears  that  in  addition  to  issuing  new  debt  in  euro, many  sovereign  issuers  are 
considering  redenominating  into  euro  their  outstanding  national  currency  unit 
debt.  Governments  see clear advantages to redenomination  in terms of  enhanced 
credibility  of their  commitment  to the  EMU  process.  Moreover  redenomination 
is identified  as a means of instantly generating euro liquidity  in government  bond 
markets.  Redenomination  would  also allow the re-opening  of existing  issues  by 
tap issues  in euro.  Were there to be no redenomination, then any tap stock  would 
have  to  be  made  in  old  national  currency  units.  While  repo  and  derivative 
markets  could  operate  with  securities  remaining 
in  national 
denominations  (up till the end of the transition period) there is a compelling case, 
from  the  point  of  view  of  increasing  confidence  in  a  new  European  capital 
market, for  securities to be converted at the beginning of  1999 to create a  uniform 
euro market as swiftly  as possible.  Given the central role of government debt it is 
clearly  of paramount  importance that if such a conversion  is to be successful  then 
governments must act quickly and decisively. 

temporarily 

Redenomination  is  also  put  forward  by  some  as  a  means  of  avoiding  any 
fragmentation  of  liquidity  during  the  transition  period  from  1 January  1999  to 
withdrawal  of national  currency units.  The hypothesis  is that if two bonds  issued 
by  the  same  sovereign,  with  identical  terms  and  conditions  are  treated  by  the 
market  as  different  and  not  fungible  simply  because  one  is denominated  in  euro 
and  the  other  in  old  national  currency  units  then  there  would  be  a  reduction  in 
liquidity  in  the  market.  Such  a  difference  in  treatment  would  have  no  legal  or 

rational  basis  but  would  rest  on  psychological  factors,  such  as  the  desire  by 
certain investors to hold debt denominated  in old national currency units. 

The consensus of the group is that the liquidity, transparency and efficiency  of the 
government  bond  market  would  be  enhanced  by  the  immediate  quotation  and 
settlement  of  all bonds, both  old  and new, in euro from  the  start  of  Stage  Three. 
In  addition  to  the  technical  arguments  in  favour  of  redenomination, 
the 
commitment  of governments to the process and the precedent set for others would 
be  reinforced,  and  their  position  as  potential  benchmark  issuers  would  be 
enhanced.  Thus although redenomination  of government debt is not essential  for 
the success  of EMU  it is highly  desirable and  should  be encouraged,  specifically 
for  highly  traded  debt  that  will  mature  after  the  end  of  the  transition  period. 
However,  the  group  thinks  that  the  case  for  redenomination  by  corporates  is  far 
less strong, and that it is likely that costs and technical problems would  outweigh 
benefits.  Corporates  are  therefore  unlikely  to  redenominate  their  debt,  but  may 
commence  before  the  start  of  Stage  Three  to  employ  market  solutions  such  as 
multi-denomination  issues  (parallel  and  catamaran  bonds). 
In  this  paper, 
therefore,  the  discussion  is  limited  to the possible  approaches  to  redenomination 
that might be attractive to sovereign issuers. 

In principle, the group would prefer that governments rely on a limited number  of 
methods  of  redenomination. 
It  is,  however,  clear  that  redenomination  has 
competitive  implications  for  issuers,  and  that  their  final  decisions  will  be 
influenced  by  such  factors  as  the  relative  costs  of  different  redenomination 
methods,  and  the  ability  of  national  and  international  securities  settlement 
systems to handle the change. 

Regardless  of  the  choice  of  methodology,  there  is  an  overriding  urgency  for  a 
decision  on  redenomination.  Market practitioners  and  settlement  providers  must 
be  provided  with  sufficient  time  to  undertake  all  necessary  preparations.  A  late 
decision could jeopardise the smooth functioning  of the market. 

1.2  Redenomination:  its definition 

The term  "redenomination"  requires  qualification.  In the  Council  Regulation  on 
the  euro  the  term  "redenomination"  means  the  change  of  the  unit  in  which  the 
amount  of  outstanding  debt  is  stated  from  a  national  currency  unit  to  the  euro 
unit.  It does not mean the  altering  of any other term  of the debt.  The  regulation 
does  not  address  changes  in  the  nominal  value  of  a  bond  (often  termed 
renominalisation).  In  a  sense,  from  the  start  of  Stage  Three  all  bonds  will  be 
redenominated  de facto  into  euro  because  there  will  be  only  one  currency,  the 
euro, and all participating national currency units will merely be expressions of it. 
In  terms  of  currency,  a  bond  expressed  in  participating  national  currency  units 
and  one  expressed  in  euro  are  both  euro.  At  the  end  of the transition  period  all 
national  currency  denominations  will  be  read  as  references  to  the  euro  unit, 
according to the conversion rate (Council Regulation based on  1091(4) article  14). 
In  this  report  the  term  "redenomination"  is  used  to  refer  to  methods  which  have 
the  intention  of  simply  restating  the unit  of a debt  in euro  rather  than  in  national 
currency  units,  without  affecting  in  a  material  way  the  economic  value  of  the 
debt.  It is however  the case  that all forms  of redenomination,  except  perhaps  the 

absolute  narrowest,  entail  a  small  change  in  economic  value  as  a  result  of 
rounding. 

The  narrowest  definition  of  redenomination  is  a  simple  conversion  of  a  value 
expressed  in one currency unit to another using a conversion  factor.  For  example 
a  bond  with  a national  currency  unit  value  of  2000  could  be  redenominated  as  a 
bond  with  a euro value  of  euro  312.600129  (2000/6.39795  [conversion  factor]  = 
312.600129).  Holding  values  to  this  many  decimals  might  prove  technically 
It  is  therefore, proposed  that  the  redenominated  amount  be  rounded  to 
difficult. 
the nearest  cent, thus the original  2000 would  become  euro  312.60.  This kind  of 
redenomination  will  be  made  possible  by  the  Council  Regulation  on  the  euro 
based on Article  109(1)4 of the Treaty (in particular Article  8.4). 

One likely consequence of  redenominating  debt is that the amount of outstanding 
debt  in  euro  will  not  be  a whole  number.  Whilst  redenominated  debt  should  be 
fungible  with  new  euro  issues,  its  non-round  form  could  present  difficulties  for 
trading  and  settlement.  Clearly  there  will  be  costs  for  traders  and  settlement 
providers;  however,  the  international  and national  clearing  systems  are  prepared 
to meet the requirements  of any redenomination process selected by governments, 
and the markets are more than capable of rising to the challenge of trading in non-
round lots. 

In  addition  to  redenomination,  it  is  open  to  issuers  to  consider  renominalisation 
mechanisms  to  change  the  nominal  value  of  their  bonds  to  round  euro  values. 
The  advantage  would  be  a  homogeneous  pool  of  euro  securities  delivering 
enhanced  liquidity.  Moreover,  the  trading  and  settlement  inconvenience  that 
bonds  with  non-round  nominal  values  would  generate  would  be  avoided. 
However,  renominalisation  would  materially  change  the  economic  value  of  a 
bond  and  therefore  would  require  the  agreement  of  bondholders,  and  possibly 
some form  of compensatory  payment, which could have tax and reinvestment  risk 
implications.  It might  also be necessary  to  issue new bond  certificates  or  amend 
existing  ones.  In either  case the issuer would have to absorb  significant  costs, in 
addition  to the  logistical  problems  or managing  such  operation.  Another  option 
for  issuers  might  be  to  make  exchange  offers.  To  guarantee  success,  investors 
would  require  incentives  to take  up  such  offers.  Thus  the  advantages  to  issuers, 
increased  liquidity  and  reduced  funding  costs,  would  be  balanced  against  the 
administrative  costs, which could be large, and the need to provide  investors  with 
a financial  incentive to take up the  offer. 

1.3  Redenomination: 

the  methods 

The method  of redenomination  should be quick,  easy  to  implement,  fair  and  cost 
effective.  To  avoid  disruption  to linked  derivative  positions  it  will  be  important 
to devise the most  exact  method  of redenomination  possible.  The  legal rights of 
bondholders,  which  cannot  be  limited  or  infringed  unilaterally  by  the  borrower, 
place  cost  and  practicality  constraints  on redenomination.  Additionally  there  are 
technical  factors,  such  as the  ability  of settlement  systems  to  handle  transactions 
in  cent,  which  need  to  be  taken  into  account.  Financial  institutions  perceive 
difficulties  and  high  costs  in 
handling  a  multiplicity  of  redenomination 
methodologies.  They  would  prefer  the  selection  of  a  common  approach  to 

redenomination,  that  is transparent  and  which  would  cause  the  fewest  secondary 
effects. 

The  form  of  any  public  debt  selected  for  redenomination,  for  example,  listed 
physical  bond, bearer bond  or dematerialised  security, has no material  impact  on 
the cost or on the complexity  of the redenomination process because there should 
be no need  to  undertake  any physical  exchange  or alteration  of bond  certificates. 
Whatever  the  method  used  for  redenomination,  it  will  be  necessary  to  inform 
bond  holders  of  the  change.  The  decision  on  whether  to  redenominate  will  be 
taken by the issuer.  According to Article  8(4) of the Council Regulation,  consent 
of the bond holders will not be required. 

There  are  a  number  of  basic  models  for  redenomination.  All  methods  generate 
the potential  for rounding errors.  There are four  broad levels at which the impact 
of rounding will have to be taken into account: 

• 

• 

• 

• 

individual  portfolios 

portfolios  at financial institution level 

depositories 

global volume of securities issued 

In practice, the main difference  between the methods  set out below is the level at 
which the rounding errors are generated.  The methods are: 

1.3.1. 

redenomination  on the basis of individual bonds or holdings - "bottom-up" 

This is the preferred  method of the group. 

There  are  two  basic  methodologies  within  the  "bottom-up"  approach.  The 
redenomination  can  take  place  at the  level  of  individual  bonds  or  individual 
holdings.  In essence,  the  securities,  either  individually  or by  each  individual 
customer  portfolio  and  by  each  financial  institution,  are  converted  to  euro 
using  the fixed conversion  factors.  After  conversion, euro amounts would  be 
rounded  to  two  decimal  places  (i.e.  to  the  nearest  cent).  The  sum  of  all 
individual  bonds  or  holdings  would  then  be  calculated  by  the  financial 
institutions  and matched  against the total held at the central  depository.  Any 
differences  between  the  total  calculated  by  the  financial  institutions  and  the 
total  calculated  by  the  central  depository,  which  should  only  be  a  mater  of 
relatively  small  amounts, would have to be accommodated  by adjustments  in 
financial  institutions'  trading  accounts,  adjustments  in  individual  holdings 
(possibly  with  cash  settlement)  or adjustment  via  a correspondent  bank.  The 
adjustments  would  ensure  that  the  sum  of  individual  holdings  equals  the 
converted  total  at the  central  depository  and  that  there  was  no  change  in  the 
global  certificate. 

Rounding errors are less if holdings are converted, as the maximum  rounding 
error  would  then  be  half  a  cent  per  holding  as  opposed  to  half  a  cent  per 
bond.  Redenomination  at the level of individual  holding  moreover  preserves 
more  accurately  the  economic  value  of  future  coupon  payments  and  the 

maturity  value.  Redenomination  at  the  level  of  each  individual  bond  will 
also  result  in  increasingly  significant  rounding  errors  being  generated  the 
smaller  the  nominal  value  of  an  individual  bond.  On  the  other  hand,  the 
redenomination  of  individual  bonds  removes  the  need  to  know  the  size  of 
individual  holdings, which might  be difficult  to ascertain, particularly  in  the 
case  of  bearer  bonds,  and  results  in  all  investors  receiving  the  same  euro 
value pro rata regardless of the number of bonds held. 

A benefit  of the  "bottom-up" method is that there would  be no change in the 
value  of  an  issue  at  the  level  of  the  central  depository,  and  thus 
redenomination  would  not  alter  the  total  volume  of  securities  issued.  The 
potential  for rounding errors is greatly reduced:  no more than half a cent per 
bond or per holding. The cash flows  from  coupon payments and the maturity 
value  of  a bond  would  only  change, due to rounding, by an extremely  small 
amount  (not more than  1 cent per rounding).  Such  small  differences  should 
be  judged  not  material.  However,  there  is  no  possibility  of  avoiding  the 
creation  of bonds with uneven nominal  amounts  expressed  in  euro  and  cent. 
This  could  cause  difficulties  for  trading  and  settlement.  There  are  potential 
solutions.  For  example,  the  minimum  tradable  amount  could  be  fixed  at  1 
cent, or a distinction could be made between sell orders (min.  1  cent) and buy 
orders  (min. 100 euro)  to  gradually  eradicate  uneven  amounts,  allowing  the 
trading  of  uneven  amounts  only  off-exchange.  The  simplest  and  most 
elegant  solution  is  to  trade  and  settle  in  cent,  but  this  would  reduce  the 
maximum value that could be held in a data field by two decimal places. 

1.3.2. 

redenomination  on  the  basis  of fixed  minimum  denomination  with  cash 
compensatory payments  -  "top-down  " 

In  "top-down"  redenomination  a bond  issue  is  converted  on  the  basis  of  the 
minimum  denomination  fixed  in  terms  of  individual  bonds.  The  original 
issue  is  broken  down  into  a  number  of  "pieces"  with  identical  minimum 
denominations.  The  issue  is  then  redenominated  into  euro  at  the  level  of 
these  "pieces" using  the  conversion  factors  and  rounded  to  the nearest  cent. 
The new total  amount of the issue is then  calculated  by multiplying  the  euro 
minimum  denomination  in euro  by  the number  of pieces.  This  new  total  is 
likely  to  be  different,  because  of  rounding  differences,  from  a  simple 
conversion  of the  original  national  currency  total  into  euro.  The  difference 
would  have  to  be  accounted  for  through  compensatory  payments  (for 
example  cash) to avoid the possibility  of artificially  generating  or  destroying 
stock. 

One  advantage  of  the  "top-down"  method  is  that,  by  use  of  a  cash 
compensatory  payment  and  an  adjustment  of  the  total  number  of  individual 
bonds,  it  is possible  to create new bonds with round  nominal  values  in euro. 
However,  the  payment  of  cash  compensation  would  expose  either  the  issuer 
or  investor  to  reinvestment  risk.  Moreover,  there  is  a  possibility  that  tax 
could .be  charged  on  the  cash  compensation  for  both  the  issuer  and  the 
investor.  Arguably, however, the levels of risk and tax could be negligible. 

A further  undesirable consequence  of the essential  compensatory  payment  in 
a  "top-down"  redenomination  is  a small  but  not  insignificant  change  in  the 

cash  flow  generated  by  coupon  payments  and  in  the  maturity  value  of  the 
bond.  These  changes  whilst  relatively  small  could  be  potentially  disruptive 
for  derivative  markets.  Hedges  set  up  prior  to  redenomination  might 
therefore  be  affected. 

1.3.3. 

redenomination  on the basis of fixed  minimum denomination  without  cash 
compensatory payments  -  "top-down  " 

As  in  the  previous  method,  the  original  issue  is  broken  down  into  "pieces" 
with  fixed  nominal  values  and  redenominated  in  euro  by  means  of  the 
conversion factor and rounded to the nearest cent.  The new total for the issue 
is calculated in the same way, but no compensation takes place. 

The most  important  disadvantage  is that rounding  errors are accumulated  on 
each  conversion  of  a bond.  As  a result  the value  of the customer  portfolios 
could  change  considerably.  The  same  holds  true  for  the  total  value  of  the 
issue.  Were  investors  to  view  the  conversion  as  interference  in  the  legal 
position,  they  might  take  legal  action.  Moreover,  without  compensatory 
payments  the  new  euro-denominated  bonds  are  likely  to  have  uneven  euro 
nominal  values  and  thus  would  present  complications  for  trading  and 
settlement. 

1.3.4. 

redenomination  on the  basis of the nearest round euro nominal  amount  -
"arbitrary conversion method" 

The strength of this method is the maintenance of the economic value of cash 
flows  and  redemption  values  coupled  with round  nominal  value  euro  bonds. 
To achieve this the nominal  value of a bond  is changed  to the  nearest  round 
euro  amount.  No  cash  compensation  is  paid,  but  the  coupon  rate  and 
redemption  price  are  adjusted  to  compensate  for  the  change  in  the  nominal 
value, thus preserving  all cash flows. There should therefore  be no  disruption 
to derivative products. 

However,  on the  down  side, there  would  be a discontinuity  between  the  old 
price  and  the  redenominated  one, and  repayment  at  a premium  might  cause 
difficulties  for  some yield  calculation  systems  and  some confusion  if  similar 
bonds  were  td  trade  at  par.  Moreover  there  is  a  question  as  to  whether  the 
change  of  the  nominal  value  of  the  bond  to  the  nearest  round  euro 
contravenes  the  requirement  that  the  full  conversion  factor  is  used  in 
conversions from  national currency units to euro. 

1.3.5. 

redenomination  on the basis of odd lots -  "odd lots top-down " 

This  is  a  variant  of  "top  down"  which  avoids  any  need  for  compensatory 
cash  payments.  It  converts  the  bulk  of  an  issue  into  euro  bonds  with  even 
nominal  values.  As  in  other  versions  of  "top-down",  the  original  issue  is 
broken  down  into  "pieces" and redenominated  into euro.  However  two  sets 
of nominal  values of the pieces are created.  The nominal  value  of one  set  is 
so  selected  that  upon  conversion  the  bonds  redenominate  into  round-figure 
euro amounts.  The other set, which represents the remainder which could not 

10 

be  converted  into  whole  euro,  converts  into  bonds  with  odd-figure  euro 
amounts. 

The advantage of this approach is that the bulk of an issue would convert into 
round  euro  amounts  and  hence  would  facilitate  trading  and  liquidity, 
requiring no changes to trading or settlement systems, while at the same time 
not requiring any compensatory payments.  However, the cost of the process 
would  be  carried  by  those  managing  the  odd  amount  bonds.  These  bonds 
would  presumably  be  more  expensive  to  trade  and  much  less  liquid.  One 
solution might be to repackage the odd lot bonds. 

^Bottom-up* 

A» issue consisting of tea bonds «acfc with a. nominal value in national currency 
uaifc < w* of NO ijm  *$ $pm i» &m watm  *•«&* "** *#* ****& 0*& 
2,000), holding *B* «tree bands (ND 5,000) and folding *ÇT five botids  (Î<ÈD 
5,0Q&i k  vtamtàm  i$ tfRdertâ&e» at *ae level of tbesfeboldfogs» a$kig a^vetsfa» 
factor of ï  «Jjro equals. KD 6J$9785,  Thus holdings convert after roundiajg. to: *A** 
euro. $12&U *Btt euro 46&9lt an** T* euro ?8i«$l*  Tbe sew total aœo&ti* lot ifee 
Issue Is therefore euro 1,563 ,Ô>?: equalling* ND ïO,0ÔQ.O3, and compared with euro 
J563+025l$ for a sftapfctfoaveisiOB of tfee original total aaiom  the roaj&ding mot 
is eleartyycry smalt  -

Were the same issue to  be converted on the basis of individual bonds then the 
holdings ,*ouid convert to:  "A" e&*o 312,60 (euro Î5430 * two)+ "B* euro 46&90 
(euro 156.30 * three) and *€T euro 78130 (euro 15O0 * five), in Ms example ail 
holdings have tost Î sent.  Clearly the larger the holdiag the larger the toss {or gain) 
could be.  lîie totaî amount of the issue afier conversion is euro 1563.00. Thus the 
difference is again greater by 2>5 cent» 

11 

Example Two 

«TojHtown» with compensatory jwryments 

An issue expressed in national currency units ("ND") is to be broken down into ND 
I  nominal value "pieces.*  These ^pieces* are bandied together  to produce new 
bonds with a euro 1 nominal value using the conversion factor, imbalances m terms 
of  fractions  of a bond left over are <5ompensated by small cash payments (though 
there ts still a smart rejwves&aent risk),  Thus an  issue often  bonds» each with a 
nominal value in national deiromination {*ND*) of ND  1000, is broken down  to 
10,000 W> I pieces.  Assuming a oonversion facto? of  i euro equals W> &397$5 
the holding is redenominated into 1,563 bonds each of euro 1 nominal value.  The 
difference  in valuo of tfa* feolding i$ 2 cent tWJSWfààWfô-là&MS 
il  Thus the 
issue would fee cQttverted.from the original 
bonds and a payaient to bondholders o£cent2«. 

ten ND lOOO bonds into 1?56& euro 1 

^Tojf^dow^ without compensatory payments 

A» ïssue often  bonds, sack witn a nominal value In national denomination (*NDW) 
of ND  1000, is converted into ten bonds of  euro  ! 5&30, assuming a conversion 
factor  of  Î  euro equals KD &W$$  O00O/&39?8$*J,5$.3O25i)<  Tfeus the issue 
would couvert &om  ten  bonds totalling ND  10,000 to ten  bonds  totalling  euro 
1,563. 

"Top-down* n$rng odd lots 

An issue often  bonds, each with a nominal value in national denomination C'ND") 
of  ND  l000t  is Broken down into fifteen  round-irlgure euro bonds and one odd-
figure  bonds  Assuming a  conver$ion  factor  of  î  euro  equals KD  $39785  the 
holding is redenominated into fifteen  bonds of euro 100 and one of euro 63.05 (ND 
1G,Q0U'&397$$^U63.O2S1 * l5*10O'phis4*63,O3)+ 

Alternatively» to tedu.ee the si$e of the odd lot» a nominal value of euro 50 could be 
selected resulting in thirty-one euro 5Q bonds and one euro 13L03 bond. 

Example Three. 

.  "Arbitrary conversion method1* 

Ten bonds each with a nominal value in national currency units ("ND"*) ofND  1000, 
and a  coupon of 5%, *s changed to the nearest round nominal.amount» based on a 
conversion factor of euro 1  equals ND 6.39735.  The nominal value of each bond is 
changed to 15 6 euro and the coupon and redemption price are adjusted: 

each new coupon equals 5 multiplied by 156-3025 divided by 156 

the new redemption price equals 1000 multiplied by 15&3025 divided by 156 

Were  the same arbitrary  figure  to  be^ chosen  p&t  national  denomination  then  all 
bonds would be subject  to the same conversion  factor  so simplifying the process. 
Ail cash flows would be preserved to the limits of money rounding conventions. 

12 

1.4  conventions  applying to redenominated debt 

The  basic  principle  of  the  continuity  of  contracts  has  the  consequence  that  the 
original  conventions  and  rules  will  continue  to  apply  to  an  issue  that  has  been 
redenominated.  The retention of the original conventions would ensure that bond 
holders'  rights  are  left  unchanged  and  that  cash  flows  and  existing  hedged 
positions  would  be  unaffected.  There  would  be  complete  continuity  in  the 
conditions  set  out  in  the  original  legal  documentation. 
It  is  the  group's  firm 
recommendation  that  existing  conventions  are  retained  for  redenominated  debt, 
and for all outstanding issues and instruments. 

Markets  do  not  require  that  the  same  conventions  are  applied  to  redenominated 
debt and new euro issues.  Fungibility would not be hampered since market  forces 
will  be  able  to  deal  with  variants.  Moreover,  to  change  the  conventions  would 
definitely  not fall within the scope of the Council Regulation on the euro. 

1.5  exchange  offers 

Exchange  offers  provide issuers with a tool that would allow the  redenomination, 
change  of  nominal  value  (renominalistion)  and  consolidation  of  debt  into  fewer, 
larger  issues.  This  would  increase  liquidity  and  reduce  funding  costs  for  the 
issuers.  It would also be possible to adopted the market conventions for new euro 
issues,  thus  enhancing  fungibility. 
Exchange  offers  are  voluntary  and  hence 
there would be no need to obtain bondholders'  agreement nor would  bondholders 
be  forced  to  accept  redenominated  stock.  On  the  down  side,  it  is  clear  from 
market  experience  that exchange offers  are costly to undertake,  expose  the  issuer 
to market risk whilst the offer  is open, and can result in  the portion of the original 
issue that remains outstanding becoming  illiquid. 

1.6  market rules and conventions 

Greater  harmonisation  of  market  conventions  towards  best  practice  is  a  goal 
worth  pursuing  regardless  of  EMU.  The  harmonisation  of  market  rules  and 
conventions  cannot  be achieved  without  costs;  however,  many  of  the  costs  will 
arise  from  the  introduction  of  the  euro  whether  there  is  harmonisation  or  not. 
Moreover,  it  is  conceivable  that  without  harmonisation,  systems  would  be  more 
costly to develop as the multiplicity  of conventions  for the euro would have to be 
managed.  The  costs  attached  to  harmonisation  will  largely  be  borne  by  the 
markets themselves, thus it is totally justifiable  that the markets  should  decide  on 
the  strategy  to  be  adopted.  One  possibility  might  be  to  move  towards 
those 
conventions  which  are  currently  the  most  common,  but  this  must  not  result  in 
harmonisation  to  the  least  efficient  or  outdated  conventions.  Given  the  natural 
desire  of  national  markets  to  retain  their  own  familiar  systems  a  move  towards 
harmonisation  based  on  a  current  national  standard  would  be  problematic  for 
those countries  giving up their current conventions.  A possible  solution  could  be 
to  harmonise  on  a  current  international  standard,  for  example  that  of  the  euro 
dollar  market. 
It  has  become  clear  from  the  considerable  work  already 
undertaken  by  the market  associations  in this  area, and the recent joint  statement 
on  market  conventions  for  the  euro,  that  the  market  consensus  is  in  favour  of 
harmonisation,  and  that  the  aim  should  be  to  select  the  optimal  conventions  to 
enhance efficiency  and transparency. 

13 

It  is  simple  to  produce,  in  isolation,  harmonised  conventions  for  new  euro 
denominated  contracts,  drawn  up  after  the  start  of  Stage  Three.  However  the 
impact  of  any  new* conventions,  for  example  on  the  ability  to  execute  without 
disruption  contracts  denominated 
in  national  currency  units  and  on 
redenominated  debt, must  also be considered.  Imposing  new conventions  on  old 
contracts  could  result  in  the  intended  economic  effect  being  disrupted.  For 
example,  a  change  in  business  days  might  result  in  a  position  no  longer  being 
perfectly  hedged  if  one  side  of  the  hedge  were  to  be  executed  a  day  later  than 
originally  intended. 

To  achieve  greater  harmonisation  decisions  on  the  following  will  have  to  be 
made: 

1.6.1.  day counts 

The day  count  convention  is the method  for  determining  the number  of  days 
used to calculate the accrual of interest. 

Within  the  EU  practice  varies  from  one  financial  centre  to  another,  and  in 
some  countries  the  day  count  convention  of  the  bond  and  money  markets 
differ. 

The current bond mariât éorivéntîbns in the EU ares 

Country.. 

flay  count basis 

Austria 
Belgium 
Denmark 
Finland 
France 
Germany 
Greece 
Ireiand 
Italy 
Luxembourg 
Netherlands 
Portugal 
Spain 
Sweden 
UK 
Eurobonds 

30/360 
mm 
3Ù/368 
30/160 
Act/Act 
3W360 
Act/3^5 
mm 
30/368 + i day 
30/360 
30/368 
30/560 
Act/Act 
30/360 
Act/365 
30/360 

The  30/360  convention  is the  most  common,  but  it  arose  largely  because  of 
limitations  in  the  calculation  capacity  of  the  systems  that  were  operating  at 
the  time  of  the  development  of  the  markets.  Thus  it  is  a  legacy  of  obsolete 
technology  and has well  known inherent weaknesses.  A move to Act/365  or 
Act/Act  would  be  totally  feasible  with  modern  systems  and  would  bring 
several  advantages. 

Act/Act  is  the  most  accurate  means  of  measuring  accrued  interest  on  bonds 
and  thus  provides  the  best  practical  solution.  Moreover,  a  move  to  Act/Act 

14 

would  provide  consistency  with  the  approach  adopted  by  the  US  Treasury 
bond market, whilst Act/365 would harmonise with the Japanese  government 
bond  market.  It has also recently  been proposed  that Eurobonds  issued  after 
1  January  1999  should  use  the  Act/Act  methodology. 
In  practice  the 
difference  between  Act/365  and  Act/Act  is  only  in  the  treatment  of  leap 
years.  A  move  from  30/360  would  enhance  transparency  for  investors  and 
analysts in the assessment of euro assets against dollar and yen assets. 

Were  the  EMFs proposal  for  Act/360  for  the  money  markets  to  be  adopted 
and  an  Act/Act  standard  selected  for  the  bond  market  there  would  not  be  a 
serious problem.  As stated above, different  conventions can apply  in the two 
markets.  For  example,  in  repo transactions  the day count  convention  of  the 
bonds  supplied  as collateral  is used  simply  to  calculate  the  interest  accrued. 
The  convention  to  be  applied  to  the  repo  is  that  prevailing  in  the  money 
market even if this is different  to that in the bond market. 

Any  change  in  day  counts  would  have  to  take  into  account  the  treatment  of 
outstanding  instruments.  Would  it be necessary, for  example, to continue to 
make  calculations  related  to  "old" instruments  on the  "old"  day  count  basis, 
or  could  there  be a complete  move to  the new day counts?  It  is feasible  for 
different  conventions  to  co-exist  in the same market, and were new  issues to 
be  subject  to  new  conventions  then  over  time  the  old  conventions  would 
cease  to  be  used.  It  would  nevertheless  be  essential  to  ensure  that  systems 
could accommodate any proposed change. 

1.6.2. 

coupon  frequency 

The  norm  in the  EU  is  annual  coupons.  Only  Italy  and  the  UK,  two  of  the 
largest  and most developed  bond markets  in the EU, provide  for  semi-annual 
coupons.  Semi-annual  coupons  would  improve  the matching  of  cash  flows 
and  would  reduce  the  investors'  exposure  credit  risk,  and  they  are  the  norm 
in  the  US  and  Japanese  government  bond  markets.  Thus  semi-annual 
coupons  would  be  beneficial  to  the  operation  of  the  market  and  derivative 
products  in  particular,  and  would  enhance  direct  comparison  with  the  other 
major  world  bond  markets.  However,  there  does  not  appear  to  be  a 
consensus  in  this  area.  For  issuers,  semi-annual  coupons  would  entail 
increased  costs.  Retail investors are also reputed to prefer  annual coupons. 

1.6.3. 

business  days 

The  existence  of different  business holidays  in the various Member  States  is 
a  factor  that  is  unlikely  to  change  in  the  short  term,  and  it  could  hinder  the 
use of the  euro.  The  best  solution  is therefore  to create a standard  definition 
of  what  is  a  business  day.  For  example,  today  the  ECU  faces  a  similar 
problem  and  the  ECU  Banking  Association  produces  a calendar  of  business 
days  for  the  ECU.  Its  calculation  is  complicated  but  in  broad  terms  only 
permits  settlement  of  ECU  on  days  in  which  a  large  number  of  financial 
centres  are open  in the  EU.  In practice  the ECU calendar  is unpopular  and a 
similar approach for the euro would probably be unacceptable to the market. 

One  option  would  be  to  define  a  business  clay  as  when  TARGET  and  an 
appropriate  settlement  system  are open  for  business.  This  would  provide the 
15 

greatest  number  of  business  days  as  it  is  proposed  that  TARGET,  like 
CEDEL  and  Euroclear,  will  function  for  all  but  two  business  holidays 
(Christmas  day  and  New  Year's  day).  The  need  is  to  agree  a  common 
approach  to  allow  for  there  to  be  as  many  business  days  for  the  euro  as 
possible,  thus  providing  the  greatest  flexibility  in  terms  of  matching  cash 
flows. 

/. 6.4. 

euro settlement  basis 

The  settlement  periods,  in the various markets,  differ  greatly  across the  EU. 
The most  common  inter-bank  offer  rate  settlement  period  is  a  spot  standard 
with  a  two  day  settlement  period.  This  would  be  a  suitable  standard  to 
harmonise  on  for  euro  money  market  transactions.  Were  no  standard  to  be 
implemented  the smooth  functioning  of the  euro  market  could  be  disrupted, 
and  the  search  for  a  solution  to  the  business  day  question  made  more 
difficult. 

The  settlement  standard  for  internationally  traded  bonds  is  currently  trade 
date  plus  three  business  days.  With  the  introduction  of  real  time  gross 
settlement  systems  and  the  obvious  advantages  to  reducing  settlement  risk 
there is likely to be a move towards a shorter  settlement  period.  However,  it 
may prove  least  disruptive  to retain the current  T+3  standard  for  the euro, at 
least in the short term. 

The most  common  standard,  in the EU, for  the  fixing  of  the  amount  of  time 
elapsing between fixing  of a rate and its application to a contract  is a two day 
period.  This should be applied to euro contracts. 

2  The equity  markets 

2.1.  General  considerations 

In general  the  impact  of the euro on organized  markets  for  equities  appears  to  be 
less strong and less immediate than on other segments of the financial  markets. 

Issuers  tend  to  focus  mainly  on  their  national  share  market.  Trading  tends  to 
concentrate  on the most liquid market which is generally the domestic  market.The 
choice  of  the  quotation  market  is  mainly  influenced  by  variables  other  than  the 
currency  of  denomination  (the  geographical  allocation  of  the  issuer's  main 
activities,  the  country  of  incorporation,  the  convenience  of  listing  requirements, 
the way in which the equity market is organized). 

The introduction of the single currency and disappearance of exchange rate risk in 
the  euro  area  will  not,  at  least  in  the  s-hort  term,  modify  the  existing  relation 
between  issuers and their domestic markets. 

16 

In  the  medium  term  the  combined  effect  of  the  single  currency  and  the 
implementation  at  national  level  of  the  Investment  Services  Directive2  will 
increase competition within the national  markets and might affect  the structure of 
the equities markets. 

The  Investment  Services  Directive  grants  authorisation  to  foreign  intermediaries 
to  operate  on  national  markets  either  by  physical  presence  (e.g.  a  branch)  or  by 
remote access from  other Member States. The conditions for remote access i.e. by 
electronic  trading,  are  already  present.  The  opening  of  domestic  securities 
markets  will increase liquidity on national markets and might even strengthen the 
existing links between issuers and their home market. 

From a technical point of view the  introduction of the euro will require  relatively 
few changes by the stock exchanges themselves. 

In  particular,  for  those  stock  exchanges  which  can  already  operate  in  a  multi 
currency environment  the switch to the euro will be simple in technical terms. 

2.2. Impact on market functioning  and on companies decisions 

As a consequence of the introduction of the euro, markets and market  participants 
will  have  to  review  their  operating  and  regulatory  procedure  and  modify  their 
trading,  settlement  and  reporting  systems.  Companies  will  have  to  manage 
conversion  of  their  share  capital,  and  therefore  will  have  to  deal  with 
redenomination issues. 

The  introduction  of  the  euro  could  be  an  opportunity  to  harmonise  market  rules 
and conventions. However,  any  benefit  resulting  from  harmonisation  would  have 
to  be  balanced  aginst  the  costs  it  will  generate  also  in  terms  of  smoothing  the 
transition. 

A  certain  level  of  coordination  will  be  needed  with  derivative  markets.  Stock 
Exchanges  will  have  to  ensure  that  there  will  be  a common  approach  with  their 
national derivative markets. 

2.2.1.  Stock Exchange  Operations 

Market  practitioners  will  be  looking  to  exchanges  in  defining  their  own 
changeover  strategy  and  it  will  be  under  the  aegis  of  the  exchanges  that  the 
markets  as a whole will  decided  on the changeover  strategy  of their  collective 
systems. 

The main European Stock Exchanges, led by the Federation of European  Stock 
Exchanges, have announced their intention to pursue a Big Bang approach. 

That  would  mean  that  as  from  4.1.1999  exchanges  will  trade  and  quote  all 
securities in euro. 

This approach is based on several considerations: 

2  Council  Directive  93/22/EEC  of  10  May  1993  on  investment  services  in  the  securities  field 
O.J. N°L141  11/06/1993 P. 0027 

17 

• 

• 

• 

having  a  common  changeover  date  for  all  organized  markets  (money 
markets,  bond  markets,  equity,  derivatives,  regulated  or  OTC)  would 
enable market participants to plan their own systems in the knowledge that 
all securities would be dealt in euro; 

for  many  Stock  Exchanges  this  choice  is  also  linked  to  their  inability  to 
handle multi-currency trading; 

in  the  absence  of any  significant  link  between  a  share nominal  value  and 
the  price  at  which  it  is  traded,  there  is  no  strong  argument  to  have 
securities  quoted  and  traded  partially  in  euro  and  partially  in  national 
currencies. 

However,  the  basic  working  assumption  is  that  only  one  currency  will  be 
supported in any given security for quotes, orders and trade reports. 

There seems to be a general agreement on the need to avoid dual quotation (i.e. 
having two prices, one in euro and one in national currency), for many reasons: 

legal considerations: there is only one price made on an exchange; 

-  .  the  cost  and  complexity  of  supporting  two  currencies  in  parallel  for  one 
to  exchanges  and 

less  attractive 

security  makes  that  alternative 
intermediaries; 

risk of public  confusion. 

The Big Bang approach would imply that: 

• 

• 

• 

quotations displayed on screens of trading systems would be in euro; 

transactions  would  be  executed,  recorded,  matched,  confirmed  and 
transmitted  to  settlement  in  euro.  The  inter-market  settlement  process 
would be in euro; 

intermediaries  will  have  to  make  the  necessary  conversion  in  order  to 
account to their clients in the currency chosen by the latter. 

Fixing date of the conversion rates: 

Stock  exchanges  have  expressed  the  wish  to  know  the  conversion  rates  in 
advance  (initially  at  least  one  month  before).  However,  conversion  plans  are 
now  being  presented  which  cope with  a fixing  taking  place on  the  last  day  of 
the year and a changeover on 4 January  1999. 

In  any  case  knowing  the  conversion  rates  does  not  seem  to  be  crucial  for 
testing  the  systems.  Tests  could  be  carried  out  in  advance  by  using  a  rate 
approaching  the  conversion  rates  such  as the  current  ecu  rate.  Anyhow,  some 
markets  might  decide  on  an  additional  closing  date  (31st  December)  for 
changing and testing the systems. 

Unsettled orders: 

According  to  the  big  bang  approach,  all  transactions  executed  in  national 
currency  for  due  settlement  after  1.1.1999  should  be  settled  in  euro.  The 
conversion  will  be  executed  by  the  Stock  Exchanges  and  the  security 
settlement  systems. 

18 

Unexecuted orders: 

Unexecuted  orders  remaining  in a central  order execution  system  on the  last 
business day of  1998 should be canceled. 

Intermediaries will have to convert and reintroduce such orders. 

Notice  should  be  given  sufficiently  in  advance  of  this  intention  in  order  to 
allow intermediaries  to agree on an automatic conversion  procedure with  their 
clients. 

2.2.2.  Redenomination 

In the  context  of equity  markets, redenomination  is the  conversion  of  the  par 
value of the shares into euro. Such simple conversion may be combined  with a 
change  of the nominal  value into a round  amount,  in such  case one  should  be 
talking about  renominalisation. 

Given  that  share capital  is permanent,  the case  for  redenomination  is  stronger 
than  for  other  securities,  One  cannot  expect  that  old  denominations  will 
gradually disappear on their own as will be the case for maturing debt. 

However,  the  impact  of  redenomination  on  market  liquidity  and  market 
operations  seems to be very  limited or even non-existent.  Indeed  equity  shares 
are  units  of  the  total  capital  stock.  Their  nominal  value  is not  relevant  to  the 
price at which they trade. Therefore  a change to the currency in which their par 
value is expressed need have no effect  on the value of a share. 

•  WHEN  SHOULD REDENOMINATION  OCCUR? 

Redenomination  is  a  natural  consequence, of  the  change  to  the  euro  of  a 
company's  accounting  unit.  It  is  a  company  decision  independent  from  a 
stock exchange's decision about trading in euro. 

It  is  not  essential  that  redenomination  happens  at  the  beginning  of  Stage 
Three  as  the  denomination  of  share  capital  should  neither  affect 
its 
economic value nor investors' ability to trade the shares. 
Redenomination  can  take  place  at  any  time  during  the  period  1999-2002. 
If nothing has been done by the end  of transitional  period,  redenomination 
will occur automatically by application of the "109 1(4)" regulation. 

In order to avoid extra costs, a company  wishing to redenominate  its  shares 
might  take the decision  at an annual  general  meeting  (AGM). A  resolution 
could  be made even before  1999 by empowering  the  Board  of  Directors  to 
make  changes  to  the  capital  in  a certain  specified  way  (by  moving  to  non 
par value shares or by having a capital increase). 

•  WHO  HAS TO DECIDE ON  REDENOMINATION? 

Redenomination  is a decision of the shareholders' meeting. 

In some cases there may be a need for prior changes in national  legislation. 

in  some  countries  to  authorize  non  par  value 
That  would  be  necessary 
shares or to authorize companies to issue shares in euro (e.g. in  Sweden) or 
to change the minimum authorized share amount. 

19 

•  WHAT  SHOI ILD RE THE PRINCIPLES SUPPORTING  REDENOMINATION? 

It seems generally recognized that as a consequence of redenomination: 

voting rights should not be adversely  affected; 
holders should not be obliged to sell any part of their holding. 

Moreover in order to avoid changes in relative prices it seems desirable that 
the number of issued shares remains unchanged. 

•  WHAT ARE THE MODALITIES FOR  REDENOMINATION? 

There  are  four  main  options  available  to  a  company  that  wishes  to 
redenominate its equity: 

A) 

leave shares indefinitely  with a par value of unrounded euro; 

B)  convert the share par value rounding to the nearest cent; 

C)  change the par value to a round number of euro and have a common 

nominal value; 

D)  move to Non Par Value shares. 

These  methods  should  be  applied  to  avoid  mismatching  between  the 
converted nominal capital and the total of converted par values. 

Examples of the different  methods are given below: 

A) Leave shares with an unrounded par  value in euro 

This  method  is  to  convert  the  share  capital  into  euro  at  the. fixed  conversion 
rate  (rounding  up  or  down  to  the  nearest  cent)  and  then  to  divide  by  the 
number of issued shares keeping the share par value in euro unrounded. 

This method would  avoid mismatching  between the converted  nominal  capital 
and the total of converted par values. No action would be needed on the part of 
the  company  apart  from  a  shareholders'  resolution.  The  shares  could  be 
rounded  up  on  some  future  occasion  when  the  company  wishes  to  make  a 
capitalization issue. 

In order to avoid rounding errors it might be necessary to have shares with par 
value  specified  to  several  decimal  places.  At  first  sight  that  doesn't  seem  to 
have any  implication. 

However,  unrounded  par  value  might  not  be  practicable  as  the  number  of 
decimals  will  need  to  be  limited  at  least  for  reporting  purposes  (i.e.  in  the 
company's  statutes). If a rounding  takes  place,  it would  result  in  a change  in 
the total  share capital  which should require additional  action on the part of the 
company. 

B) convert the par  value of each share into euro, rounding to the nearest cent 

This  method  is to  convert  the  share  par value  into  euro  by  applying  the  fixed 
conversion  rates  and  the  rounding  rules  foreseen  in the  "235"  EC  Regulation, 
the  nominal  share  capital  being  the  sum  of  the  par  value  of  the  shares  in  the 
issue. 

20 

If no specific  action has been taken by a company  at the end of the transitional 
period, shares par value will be deemed to be converted  into euro according  to 
this method. 

As' a  result  of  this  method  the  sum  of  the  rounding  ajustments  on  each 
individual  share  will  alter  the  nominal  share  capital  of  the  company,  up  or 
down. 

In order to correct this mismatch, two options are available to a company: 

i) 
ii) 

increase the capital by a capitalization of reserves, or 
decrease the capital by a transfer to reserves. 

Each of these options has different  implications: 

A  capitalization  of reserves would  not be practicable  for  companies  which  do 
not have sufficient  free  reserves available. 

A  decrease  of  capital  might  not  be permitted  by  national  legislation  or  might 
require a special procedure (in UK Court approval would be necessary). 

Changes to capital amounts might give rise to taxation effects  for shareholders. 

The  amount  of  capital  increase  or  decrease  required  will  depend  on  the 
conversion  rate and  on the nominal  value of the shares and  their  number.  The 
effect  will be greater for low value shares issued in large number. 

C)  Change  the par  value  to  a  round  number  of  euro  in  order  to  have  a 
common par  value of  1 euro ( Renominalisation) 

Following  this  method  the  share  capital  is  converted  into  euro  at  the  fixed 
conversion rates (rounding up or down to the nearest unit). The share capital  is 
divided  into  shares  with  a  par  value  of  1 euro  each.  In  order  to  retain  the 
original  share of the shareholder in the share capital, the euro share capital and 
thus the number of shares will have to be adjusted  accordingly. 

This could be achieved either by a capital increase or a capital decrease. 

The  effect  on  capital  will  be  even  greater  than  for  simple  redenomination  by 
rounding to the nearest cent. 

A futher  possibility  of renominalisation  would be  trading  in fractions  keeping 
the share capital  unchanged. 

Trading  in  fractions  would  involve  very  high  costs  as  it  would  require  either 
that  stock  exchange  mechanisms  be  modified,  or  that  intermediaries  trade  in 
fractions  to  build  whole  shares.  Moreover  the  fractions  method  would  oblige 
shareholders to sell part of their holdings. 

Renominalisation  would  change  the  number  of  shares  issued  by  a  company, 
thereby  changing apparent share prices. 

Given  that  the  price  of  a  share  bears  no  relation  to  its  nominal  value,  there 
seems  to  be  no  advantage  in  having  a  common  par  value  across  Europe. 
Moreover  such  harmonization  would  be  very  difficult  to  achieve  given  the 
differences  in par values across Europe. 

21 

D) Move to Non Par Value shares 

In a NPV system, shares are simply a fraction  of the capital stock.  NPV  shares 
make the conversion to euro very easy. ,Once the company's  articles have been 
modified  to provide for NPV shares, indicating the share capital, the number of 
shares issued and the minimum issuing amount, no further  acticta is required to 
convert to the euro. 

With NPV  shares there is no need for a physical exchange of share  certificates, 
if  any.  The  share  prices  can  be  lowered  by  simple  splitting  and  there  is  no 
need for a capital increase or decrease. 

Moving  to NPV  shares  allows  a company  to  avoid  capital  and  cost  intensive 
measures. 
NPV  shares are allowed by the second  Community  Company  Law Directive3, 
but  in many  countries the relevant national  legislation  has not yet been put  in 
to  national  legislation  would  be 
place.  In  the  short  term  an  amendment 
required to allow the NPV solution to be implemented. 

•  SHARE CERTIFICATES 

A  legal  requirement  to  replace  share  certificates  as  a  consequence  of 
redenomination  would 
for  Registrars  and 
substantial costs for issuers. 

involve  considerable  work 

If  redenomination  occurs  in  2002  as  a  consequence  of  the  "109  1(4)" 
Regulation  no  replacement  of  the  share  certificates  will  be  needed,  provided 
that  redenomination  is  effected  by  applying  the  fixed  conversion  rate  and  the 
rounding rules defined  in the "235" Regulation. In the case of renominalisation 
however,  where  the  number  of  shares  will  change,  it  is  likely  that  share 
certificate  will have to be replaced. 

Companies might take this opportunity to dematerialise their shares, where this 
is not yet the case. 

EXAMPLES 

The conversion of the share ftomfoal value into euro by applying the fttfed cottVersiou 
factor would result in. a. nominal value expressed in euro with several decimals. The 
examples below iltastratethe different effects according to the method used 
Company^ share sapitaU 250,000,000 (expressed in nôttooal dansmtoatfajft *NI>U> 
divided into 50,000,000 shares with a par value of 5 ND 
assuming a conversion rate of 1.95591 

3  Second  Council  Directive  N° 77/91/EEC of  13 December  1976 on coordination  of safeguards  which, 
for  the  protection  of  the  interests  of  members  and  others,  are  required  by  Member  States  of 
companies  within  the  meaning  of  the  second  paragraph  of  Article  58  of the  Treaty,  in  respect  of  the 
formation  of  public  limited  liability  companies  and  the  maintenance  and  alteration  of  their  capital, 
with  a view  to making  such  safeguards  equivalent.  O J . N ° L 0 26  30/01/1977  P.0001 

22 

Example  I ; Option  A "unrounded par value" 

Share capital in euro;  250,000,000/1.95591 «  Î27,817,742.13 

$îiare nominal value in euror 127,&7,742.13/50,000,000 « 2.55o"3S4&426 

gyanipk^Option B,»;gftare noniïnaMatoe,rot>ffîfcri  tff„fleg,rest,een<:* 

* 

Slim  nominal valW in Wot  5 /  l,9$59i^i556354$4iSQ3^round^ to the nearest 
\ - " )'  * 
cent)«*2*56 

-.' 

., ,s 

Mm  capital 12S6 x' 50,000,000 M 128#0OjÛO0 euro 

, ' 

Capital increase rgquJted.f* l$2,257+$7 euro* 

v 

Example 3? Option C MRettomiaalisatfoq faro shares with a nominal value of 1 euro 

share capital: 250,00,0,000/13559!-  127,317 J42 {rounded to the nearest unit) 

divided into  127,817,742 chares of I euro 

previous share nommai value 5 KD « 2.56 euro 

i)capltaj increase option 

the shareholder wjirreceive 3 one-euro abates for each 5 ftD share held 

total .share capita! «  150,000,000 euro 

capital  increase required:22,182,258 euro (17.35 %) 

u) capital  reduction  option 

the shareholder will receive 2 one-euro shares for each 5 ND $haie held: 

total share capital  100,000.000 

capital reduction required: 27.8 J 7,742euro (21,76%) 

Example 4: Option D "Non Par Value shares" 

share capital  250,000,000 ND represented by 50,000,000 shares 

each share represents  1/50.000,000 of the share capita] 

aftei  conversion; 

share capital  ~  127.817.742.13 euro 

each share slill represents  1/50.000,000 of the capital 

CONCLUSION 

Redenomination  of  shares  is  a  company  decision  which  is  not  linked  to  the 
operations  of  the  markets.  There  is  therefore 
immediate 
redenomination. 

no  need  for 

If  a  company  wishes  to  redenominate  its  shares,  several  solutions  might  be 
convenient. 

As  a  result  of  the  fixed  conversion  rales  it  will  not  be  possible  to  avoid 
rounding  errors  even  if  share  par  values  are  expressed  with  several  decimal 
figures. 

23 

The  capital  increase  solution  could  also  be  attractive  for  some  issuers  and 
could  be easily implemented  by having a prior authorization  given by an AGM 
(as authorized  by the Second Company JLaw Directive). 

The easiest solution would be to move to NPV. In countries wfyere NPV  shares 
are not yet  introduced, the necessary  legislation  should  be prepared  as soon  as 
possible. 

A  suggestion  has  been  made  that  there  should  be  legislative  measures  at 
national  level  which.might  facilitate  the  process  (for  example  by  authorizing 
redenomination by a resolution of the Board of Directors). 

Such  a  derogation  might  however,  be  interpreted  as  imposing  the  use  of  the 
euro  on  shareholders  therefore  breaking  the  principles  stated  in  "109  1(4)" 
Regulation. 

Although  it might appear difficult  to achieve, given the large number of issuers 
share  values,  harmonization  of  redenomination 
and  the  differences 
techniques  would  bring  considerable  advantages  for  market  participants.  On 
the  one  hand  costs  could  be  reduced  and  on  the  other  hand,  clarity  and 
transparency would be increased in particular for investors. 

in 

Particular  attention  should  be  paid  to  hybrid  instruments  such  as  preference 
share  and  interest  bearing  shares,  for  which  the  nominal  value  is  more 
important  and  which  would 
those  of 
redenominating bonds. 

involve  similar  problems 

to 

2.2.3.  Market  conventions 

In  general  there  seems  to  be  very  little  case  for  harmonization  of  market 
conventions  in  equity  markets.  The  general  attitude  of  Stock  Exchanges  is  to 
avoid  any change  in market conventions which is not strictly  necessary  for  the 
changeover. 

Trading  in round lots 

The size of a round  lot varies according to the price of the share. There appears 
to  be  very  little to  gain  by  looking  for  international  harmonization  of  the  size 
of  round  lots. Keeping unchanged conventions will contribute to continuity. 

Convention of tick sizes 

in  euro. 
New  conventions  should  be  defined 
The  possibility  of  a  standard  scale  of  tick  sizes  to  be  used  by  all  exchanges 
could be  studied. 

for  securities  quoted 

Thresholds 

New threshold amounts will have to be fixed  at convenient equivalent  amounts 
rather than directly converted  at the official  exchange rates. 

Settlement 

An  efficient  settlement  of  securities  is  a  pre-condition  for  efficient  markets. 
Domestic  settlement  systems  are  called  to  improve  their  efficiency.  However 

24 

desirable  a  standard  settlement  period  could  be  it  appears  improbable  that  it 
will be achieved  in a  near  future. 

For  some  countries,  moving  to  a  standard  settlement  period  (as  T+3  )would 
require  extensive  changes  to  their  settlement  periods.  Others  would  be 
reluctant as they are already considering same day gross settlement. 

This is, however, an issue on which further  work is required. 

2.3.  Other areas of concern 

2.3.1.  Historical  data 

Some exchanges provide  historical price series as part of their  service  to  their 
members  and  customers.  This  involves  making  adjustments  for  rights  issues, 
capitalisation  issues,  consolidation  and  other  corporate  events  which  affected 
the share price in technical ways. 

It  seems  perfectly  possible to ensure continuity  of this kind  of  information  by 
restating historical  series of prices in euro using the conversion rates. 

Particular  problems  might  arise  when  restating  historical  series  involving 
several participating currencies. 

2.3.2.  Stock market  indices 

It is of major  importance that indices are not disrupted, given the large  volume 
of index-linked  derivatives. 

What  is  important  for  continuity  of  indices  is  that  the  underlying  company 
composition  and  the  value  of  the  equities  stays  the  same  following  the 
changeover. 

Given  that  the  value  of  equities  is  not  linked  to  their  denomination,  and  that 
to  the  company  composition  are  based  on 
the  rules  for  making  changes 
relative  market  capitalisation,  there  is  no  need  for  existing  indices  to  be 
affected  by changes in the denomination of shares. 

3  The derivative  markets 

The  successful  resolution  of  issues raised by the start of Stage Three of  EMU  for 
the market  in privately  negotiated  derivative transactions  is crucial  to the creation 
of a broad, liquid, deep and transparent market for the euro. 

The  scope  of  activity  covered  by  the  swaps  and  privately  negotiated  derivatives 
market  is  extremely  broad,  ranging  from  interest  rate, currency,  equity  and  other 
swaps,  to  options  and  other  derivatives.  It  is  therefore  not  surprising  that  the 
transitional 
issues  relevant  to  the  derivatives  markets  mirror  those  of  the 
underlying  markets  to which  they  relate.  For example, the same  issues that  arise 
in  the  context  of  public  and  private  bonds,  the  money  markets,  equities,  equity 
indices,  foreign  exchange  and  futures  markets,  are  of  direct  relevance  to  the 
associated  sectors of the OTC derivatives markets. 

3.1  characteristics  of existing  EU  derivatives markets 

25 

Swaps and other privately-negotiated  derivative transactions are now widely  used 
by  corporates,  financial  institutions,  pension  funds,  governments,  governmental 
bodies and  investment  funds  as an essential tool to manage currency,  interest  rate 
and  other  financial  risks  to  which  their  day  to  day  activities  expose  them.  The 
size  and  breadth  of  European  derivatives  markets  together  with  their  innovative 
approach  to  facilitating  complex  financial  structures  means  that  Europe  is  a 
leading  centre  for  this type  of business.  The EU's continued  status  as  a  leading 
centre  for  the  world's  financial  community  relies  upon  the  existence  of  a 
It  is  therefore  essential  that  any  potential 
flourishing  derivatives. market. 
obstacles created by EMU should be overcome and that problematic issues should 
be  resolved  as  early  as  possible  to  maintain  confidence  and  create  certainty 
among market participants. 

3.2  principal  concerns regarding the introduction of the euro 

The  overriding  concern  faced  by  participants  in  the  derivatives  markets  is 
continuity  of  contract.  The  complex  nature  and  maturity  of  certain  derivatives 
transactions  means  that  they  are  more  likely  than  other  types  of  financial 
contracts  to  be  subject  to  claims  based  on  legal  doctrines  of  frustration  or 
impossibility.  Although continuity  of contract is beyond the scope of this report, 
it  is  worth  noting  that  the  adoption  of  the  two  Council  Regulations  on  the 
introduction  of the  euro  (under  Articles  1091(4) and  235  of the  Treaty)  will  help 
to ensure a firm legal basis for the start of the Third Stage. 

As  noted  above,  most  of  the  technical  issues  relevant  to  the  derivatives  markets 
are not peculiar to those markets and, in fact,  mirror the issues already  considered 
in  relation  to  the  underlying  markets.  However,  it  is  clear  that  any  measures 
taken  to  resolve  those  issues  for  the  underlying  markets  should  be  paralleled  in 
the derivatives  markets.  It is important to recognise, for  example, the close  links 
which  exist  between  a transaction  in the  cash  market  and  an  associated  hedging 
transaction.  Clearly  the protection  provided  by the hedge  against  movements  in 
the  underlying  market  should  not  be  disrupted  by  the  occurrence  of  EMU. 
Equally,  it  is  important  to  ensure  that  the  matching  of  cash  flows  between  the 
hedge  and  the  related  cash  market  contract  should  continue:  any  danger  of  a 
mismatch in cash flows  should be avoided. 

When  considering  the  impact  of  EMU  on  derivatives,  the  markets  should 
therefore  take care to: 

• 

• 

ensure legal continuity  of both the underlying  contract and the hedging 
contract; 

achieve  transparency  and  clarity  in relation  to  the  conventions  used  to 
calculate payment amounts and to determine payment days; and 

ensure  that  changes  made  to  the  underlying  contract  by  way  of 
conversion,  redenomination,  or  the  adoption  of  new  price  sources,  are 
accurately paralleled  in the related derivatives transaction(s). 

3.3  technical  issues 

26 

Since  many  of  the  technical  issues  for  the  derivatives  markets  rely  on  the  same 
analysis used in considering the cash markets, this section of the report is brief. 

3.3.1.  redenomination 

From  the  perspective  of  participants  in the  derivatives  markets,  the  preferred 
method  of  redenomination  of  debt  would  be  one  which  achieves  the  highest 
degree  of  accuracy.  Accuracy  in  the  redenomination  process  would  help  to 
limit  possible  cash  flow  mismatches  between  a  redenominated  bond  and  a 
hedge which was in existence prior to redenomination. 

The  method  of  redenomination  which  seems  likely  to  give  the  most  exact 
result  is  the  "bottom-up"  approach.  As  a  means  of  limiting  cash  flow 
mismatches,  this  approach  is  likely  to  find  favour  within  the  derivatives 
markets. 

A method  of redenomination  involving  an offer  of  conversion  would  also  be 
acceptable. 

As  noted  earlier  in  this  report,  there  is  unlikely  to  be  a  single  common 
approach  to  redenomination.  Market  participants  would,  however,  prefer  to 
see  a minimal  number  of  alternative  methods  used.  The  additional  resources 
and  systems  modifications  required  to  deal  with  more  than  two  or  three 
methods  of  redenomination  would  impose  an  unwelcome  and  unnecessary 
burden. 

Again,  as  noted  elsewhere  in this  report,  care  should  be  taken  to  ensure  that, 
whichever  method  of redenomination  is used, it is carried  out with due  regard 
to the legal rights of bondholders. 

3.3.2.  market conventions 

The  harmonisation  of  market  conventions  is  an  object  which  is  supported  by 
participants  in the  derivatives  markets,  including  the  International  Swaps  and 
Derivatives  Association,  Inc.  ("ISDA").  Although  financial 
institutions 
dealing  in swaps could be able to cope, as now, with the existence  of  different 
conventions  in  the  bond  markets,  the  benefits  of  harmonised  conventions  for 
the euro, in terms of creating  a broad,  liquid  and transparent  market, are  clear, 
as are the difficulties  of retaining  a diversified  approach:  increasing the  scope 
for inconsistencies and potential disputes. 

The  discussion  section  1.4 of  this  report  on  the  possible  application  of  new 
conventions  to redenominated  debt  is of particular  relevance  to the  derivative 
markets.  To  avoid  mismatches  between  the  conventions  applicable  to  a 
redenominated  bond  and  an  existing  hedging  transaction,  the  old  national 
conventions should be retained in respect of the bond. 

One  method  by  which  new  conventions  could  be  applied  to  redenominated 
debt,  but  which  would  cause  minimum  disruption,  would  be  to  make  express 
contractual  provision  in  the  terms  of  the  bond. 
Sufficient  contractual 
flexibility  both  to  redenominate  and  to  adapt  applicable  conventions  could  be 
introduced  into  bonds  issued  in  national  currencies  before  the  start  of  Stage 

27 

Three.  This  would,  of  course,  require  associated  hedging  arrangements  to 
include  the  same degree  of flexibility  on terms which  exactly  paralleled  those 
of the underlying bond. 

Another  way  to  maintain  consistency  between  redenominated  bonds  and 
hedging  transactions  would  be  to  redenominate  by  means  of  the  conversion 
offer  approach.  If  existing  national  currency  bonds  were  exchanged  for  euro 
denominated  bonds  subject  to  new  conventions,  associated  swaps  could  be 
replaced at the same time. 

joint 

statement  published  by  among  others, 

Specific  recommendations  for  harmonised  market  conventions  are  included  in 
a 
ISDA's 
recommendations,  which  are  in  line  with  those  recommended  by  this  report, 
are  based  on  a  consultative  process  among  its  member  institutions  and  other 
interested parties. 

ISDA. 

3.3.3.  price  sources 

The implications of EMU for price sources in general are dealt with  separately 
in  a  section  below.  Derivative  transactions  rely  upon  the  existence  of 
published price information.  This is therefore  an area of particular concern  for 
the derivative markets. 

Typically,  an  interest  rate  swap  document  using  ISDA  standard  form 
documentation  refers  to a price or rate, displayed  on a screen.  For example  the 
floating  rate leg of a swap may call for an amount to be payable by reference to 
French  franc  LIBOR  as  displayed  on  Telerate  page  3740  as  of  11:00  a.m. 
London  time, on a particular  day.  If,  due to EMU,  French  franc  LIBOR  were 
no  longer  to  be  displayed  on  Telerate  page  3740, the  1991  ISDA  Definitions 
would  enable  the  relevant  calculation  to  be  made  by  reference  to  a  rate 
appearing  on an alternative  screen page, provided the alternative page  displays 
a  comparable  rate  and  is  a  replacement  for  page  3740.  Failing  this,  the 
calculation  agent  for  the  relevant  transaction  would  be  required  to  obtain 
quotations from  a number of reference banks. 

The  exact  details  of  how  price  sources  will  alter  or  develop  during  the 
transition  to  the  euro  are  therefore  important  for  transactions  involving  "in" 
domestic  currency  units  and  documented  using  ISDA  definitions.  To  enable 
appropriate  steps  to  be  taken  to  ensure  that  continuity  is maintained  for  these 
transactions  decisions  have  to  be  taken  and  published  as  soon  as  possible  by 
the  current  price  source  sponsors.  Once  it  is  known  how  sponsors  intend  to 
proceed  the  screen  providers  will  be  able  to  liaise  with  their  customers  in 
developing  appropriate  replacement  screens  as  necessary,  and  subsequent 
systems and documentation  amendments can be made. 

4  Other market  features 

4.1  price  sources 

28 

The  introduction  of the  euro  raises  the  possibility  that  some  or  all  price  sources 
for participating  national  currency units could cease to exist, perhaps replaced  by 
euro  rates.  Moreover,  it  is  conceivable  that  some  national  price  source  panels 
might  cease  to  function.  Again  these  panels  might  be  replaced  by  euro-area 
panels.  Price sources are a key element of a number of financial  contracts and the 
exact terms  governing their  application  will vary  depending  on the  instrument  in 
question.  Thus  these  possible  developments  raise  legal  and  systems  issues  that 
must be addressed with urgency.  If price sources are to disappear or change then 
market  participants  must  have  sufficient  time  to  prepare  to  ensure  that  the 
continuity  of contracts is maintained. 

Therefore,  it  is  of  critical  importance  that  price  source  sponsors  quickly  state 
which  national  price  sources  will  continue  in  existence  after  the  start  of  Stage 
Three and how those prices will be generated.  It is equally important  for there to 
be clarity in what new euro price sources will be created. 

The  introduction  of the  euro  has  two possible  implications  for  price  sources.  A 
particular  price  source  is  no  longer  available.  The  panel  providing  the  defunct 
national  price  sources  decides  not  to  produce  a  replacement  rate  for  euro.  For 
example,  a  swap  may  currently  have  a  floating  rate  determined  by  reference  to 
FRF PIBOR.  Assuming the FRF is replaced by the euro will a FRF rate continue 
to  be  quoted  and  will the  PIBOR  panel  of banks  continue to quote  a rate but  for 
euro? 

The  principle  of  the  continuity  of  contracts  would  appear  to  argue  that  existing 
price  sources  are  retained.  Also  the  proposed  Council  Regulation  for  the  euro, 
based  on  Article  1091(4) of  the  Treaty,  states  that,  "acts  to  be  performed  under 
legal instruments  stipulating the use of or denominated  in a national  currency unit 
shall  be  performed  in  that  currency  unit".  On  the  other  hand,  there  is  no 
prohibition  on  moving  to  the  use  of  the  euro,  and  it  is  clear  that  the  money 
markets  will  switch  to the  euro  at the  start  of  Stage  Three;  moreover,  there  will 
be  only  one  currency,  the  euro.  It  would  therefore  appear,  on  balance, to  make 
sense  for  panels  to  cease  quoting  national  currency  rates  and  to  move  to  euro 
rates. 

Ultimately  it  will  be  for  the  price  sponsors  to  decide  whether  to  switch  to  euro 
rates.  In  many  cases  the  price  sponsors  are  central  banks,  but  several  rates  are 
sponsored  by  associations,  such  as  the  BBA  for  LIBOR  and  the  GBA/ZKA  for 
FIBOR.  The key requirement, regardless of who sponsors the rate, is for a quick, 
transparent  decision  to  be  made. 
If  rates  are  to  change  then  screen  service 
providers  will  require time  to propose how the new rates are to  be presented  and 
to reach agreement on the new format  with their clients. 

It  is  possible  that  price  sponsors  decide  to  cease  quoting  any  rates,  national 
currency  or  euro.  There  is  a  strong  possibility  that  a  number  of  national  price 
source  panels  will  be  wound  up  and  new  panels  will  emerge  providing  rates  for 
all or part of the euro area.  Such an initiative, called EURIBOR, has already been 
proposed.  To  ensure  confidence  in  any  new  euro  area  rate  the  methodology  for 
the selection  of the panel that would set the rate must be transparent  and credible. 
Whilst it is clearly  a competitive matter whether one or more euro rates should be 
available,  and  currently  there  are  competing  price  sources  for  specific  rates,  it 

29 

cannot  be  automatically  assumed  that  a national  prices  source  will  be  succeeded 
by a euro-area source rate. 

In terms  of published  rates, several  outcomes  can  be  envisaged  if pricing  panels 
disappear.  The  screen  provider  might  refer  the  user  to  a  substitute  euro  rate, 
displayed on a different  screen.  The existing reference  screen might be revised to 
display  a  euro-area  rate,  such  as  EURIBOR.  The  screen  might  still  display  the 
old national  rate (PIBOR etc) but the rates might actually  be euro ones, provided 
by  a  new  price  source  panel.  Whichever  route  is  selected,  again  the  key 
requirement  is  for  an  early  decision.  Screen  providers  face  a  significant 
challenge.  They  might  need  to  provide  additional  screen  pages  because,  for 
example, a switch from national currency rates to euro ones may involve the need 
to  change  market  conventions.  For  instance,  the  Belgian  Franc  money  market 
rates are currently quoted on an Act/365 basis whereas the most likely  convention 
for  euro  is  Act/360.  Thus  if  existing  contracts  are  to  be  governed  by  existing 
conventions  it  will  be  necessary  for  screen  providers  to  make  provision  for 
quotations  based  on market  conventions  for  both  old national  currency  units  and 
euro. 

4.2  Issuing procedures for  sovereign debt 

There  is  concern  that  the presence  of national  debt  offices  and  the  ECB  debt  in 
the  same  section  of  the  curve  could  confuse  monetary  policy  signals  to  the 
market.  This could  be particularly  dangerous  in the early  stages of the  transition 
to  the  euro  when  the  learning  curve  will  be  particularly  steep..  Increased  co 
ordination, formal  or informal, between sovereign issuers could enhance liquidity, 
transparency and predictability in the markets.  In addition, the pre-announcement 
of  auction  calendars  would  help.  However,  issuers  and  some  market  operators 
disagree  arguing  that  issue policy  is a matter  for  free  competition  and  should  be 
kept separate from monetary policy. 

The  harmonisation  of  syndication  and  tender  procedures  is  not  required  by 
monetary  union.  However,  the  introduction  of  the  euro  will  highlight  the 
existence  of  regulatory  barriers  to  a  true  single  market  in  this  area.  The 
introduction  of  the  euro  should  be  taken  as  an  opportunity  to  remove  the 
requirement  that  primary  dealers  have to  be  located  in the  country  of the  issuer. 
Regulatory  requirements  enforcing  institutional  investors,  such  as  insurance 
companies,  to  hold  specific  government  and  domestic  currency  assets  will  no 
longer be justifiable  on the grounds of foreign  exchange risk in the euro area. 

4.3  ratings:  sovereign  debt 

It  is  contended  by  some  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  because 
individual  participating  countries  will  not  be  able  to  monetise  their  euro  debt, 
having transferred  monetary  sovereignty to the ECB. It is also argued that there is 
uncertainty  about  the  efficiency  of  the  fiscal  policy  rules  to  be  applied  in  Stage 
Three of EMU 

Against  this  it  has  been  argued  that  membership  of  EMU  will  strengthen  fiscal 
policy  in  terms  of discipline  and  credibility.  It therefore  seems  counter  intuitive 
30 

that  a  country  that  meets  the  Treaty  criteria  could  end  up  with  a  lower  credit 
rating  than  a  "pre-in"  country  still  in  the  process  of  making  necessary  fiscal 
adjustments  for domestic currency denominated debt.  It should also be noted that 
monetary  financing  of  debt  is  already  not  available  to  Member  States.  Another 
important  factor  is  the  continuing  ability  of  participating  countries  to  levy  tax. 
Fiscal policy  remains firmly  a national  competence.  There is no "federal"  taxing 
institution  within  the  euro  area.  Comparisons  with  regions  of  federal  states,  for 
example the US or Canada, fail to take this difference  into account. 

The  cost  of  raising  debt  for  an  individual  country  is unlikely  to  be  significantly 
changed  by  a small  adjustment  in its credit rating, given the  importance  of  other 
factors, such as liquidity and the efficiency  the country's primary dealer system. 

4.4  ratings:  corporate debt 

The  EU  will  probably  be  rated  AAA  and  thus  corporates  will  no  longer  be 
potentially  capped  by  the  credit  rating  of  the  country  in which  they  are  located. 
In  general,  however,  corporate  ratings  are  unlikely  to  change  significantly 
because  of  EMU.  Broadly,  EMU  should  have  a  positive  effect  on  corporate 
ratings  as  the  main  benefits  of  the  single  currency  will  immediately  flow  to  the 
corporate  sector.  Over time investors may look to diversify  their portfolio  by the 
acquisition  of  corporate  issued  by  companies  located  in  other  participating 
countries.  Thus  credit  ratings  will  become  increasingly  important  in  a  larger 
market in which name recognition may be low. 

The  proposal  by  the  EMI  to  include  non-sovereign  debt  in  the  pool  of  eligible 
assets,  for  open  market  operations  of the  ECB,  based  in  part  on  credit  standing 
raises the question of how to assure consistency of ratings across the euro area. 

4.5  benchmarks 

The  benchmarks  for  national  currencies  are  provided  by  the  debt  issues  of  the 
respective governments since these are recognised by the market as the best proxy 
for the risk free  rate of return.  For the euro such an approach will not be possible 
because  no  one  country  will  have  complete  control  over  the  euro.  For  the 
foreseeable  future  there will  be no one euro-area  issuer  of appropriate  status  (i.e. 
In  this  situation  other  proxies  will  have  to  be 
no  "federal"  issuer  of  debt). 
identified. 

While  it  is not  foreseen  at  present  that  a euro-area  wide  official  issuing  calendar 
will be put  in place, informal  co-ordination of major  sovereign issues seems to be 
a  likely  result  of  EMU.  Potential  benchmark  issuers  will  need  to  present  new-
issue  calendars  with  regular  issues,  scheduled  well  in  advance,  to  obtain  the 
markets  support.  This  may  result  in  certain  countries  introducing  changes  to 
increase the efficiency  of existing issue procedures.  The degree of change will be 
determined  by  the  extent  to  which  such  features  are  seen  to  be  crucial  for 
benchmark status. 

It  is  also  worth  noting  that  supra-national  AAA  issuers  with  sufficient  issuing 
volume could  compete with  sovereign  issuers for  benchmark  status. The EIB has 
repeatedly  indicated  its  ambitions  in  this  respect.  It  is  perhaps  unlikely  that  an 
individual  supra-national  issuer  might  become  the  sole  benchmark  issuer  for  the 

31 

euro  but  it  is  conceivable  that  in  the  case  of  different  issuers  fulfilling  the 
benchmark  role  for  certain  particular  ranges  of  the  maturity  range  (e.g.  due  to  a 
lack  of  issuing  activity  in  certain  maturity  ranges  by  some  Member  States)  then 
one or more of those issuers might not be sovereigns. 

4.6  repos 

The EMI has set out its proposals for the official  repo market.  The intention is to 
provide  a  single  instrument  delivering  identical  economic  effect  in  all  countries 
participating  in the euro. 

Eligible counterparties will be selected on a uniform  basis.  The precise procedure 
has yet to be finalised.  Eligibility  of assets for  collateral will be based  on a two-
tier  system.  Tier  I  will  consist  of  assets  that  fulfil  euro  area-wide  eligibility 
criteria  specified  by the ECB.  Tier II assets will be specified  by the NCBs under 
guidelines  from  the  NCB,  and  will  be  of  particular  importance  to  national 
markets.  Though  individual  NCBs  will  select  Tier  II  assets  such  assets  will  be 
eligible throughout the euro-area, not only in the country of the relevant NCB. 

Market  participants  are  particularly  keen  to  avoid  the  overly  aggressive  use  of 
initial  margin/haircut  in the  official  repo market  as this would  be an  unnecessary 
restriction  on  the  development  of  the  market.  Margining  of  ESCB  financing 
transactions  is  of  utmost  importance  for  the  efficiency  of  the  capital  markets. 
There are three main reasons: 

• 

the higher the efficiency  of margining agreements the higher the transparency 
of money market rates as signals of monetary policy, 

•  more  efficient  margining  agreements  allow  those  institutions  that  rely  on 
central  bank  liquidity  provisions  to  manage  their  balance  sheets  and  their 
working capital much more  efficiently, 

• 

the  ESCB,  with  its  own  practices,  will  inevitably  set  the  standards  for  the 
whole  of the European  capital markets.  The adoption  of inefficient  practices 
will inevitably  imply a less efficient  European capital market. 

The  objective  of  margins  is  to  ensure  counterparties  remain  fully  collateralised 
throughout  the term  of  a transaction.  Thus  the  lender  always  holds  collateral  of 
value  equal  to  the  loan.  The  borrower  posts  collateral  that  never  exceeds  the 
value  of  the  loan.  This  general  objective  is  met  through  the  use  of  symmetric 
daily  marking-to-market  of the collateral.  If the collateral  has  fallen  in value the 
borrower  is required  to provide  additional  collateral  to ensure the  lender  remains 
fully  collateralised.  Similarly,  should  the  collateral  rise  in  value  the  borrower 
may  require  the  lender  to  return  a  portion  of  the  collateral.  This  returned 
collateral might then, for example, be employed to provide additional collateral to 
another counterparty  with whom the borrower has engaged in an offsetting  trade. 

Currently  in  the  industry  there  are  two  kinds  of  margins,  initial  margin  and 
variation  margin.  The  level  of  initial  margin  should  be  determined  primarily  by 
the  credit  standing  of  the  counterparty  and  the  term  of  the  repo  (because  the 
longer  the  period  the  greater  the  risk  of  default).  Market  risk,  which  remains 
borne  by  the  initial  owner  of  the  securities  not  the  buyer,  should  be  fully  covered 

32 

by  variation  margin.  In  the  repo  markets,  in  general,  initial  margin  is  seen  as  an 
inheritance  from  the  past,  and  is  being  discarded  because  variation  margin  based 
on  daily  symmetric  marking-to-market  is far  more  efficient.  Differences  in  credit 
risks  are  reflect  in the  repo  rate, that  is the rate  of return  earned  by  the  supplier  of 
cash.  However,  if the  ECB's  official  repo  operations  are  undertaken  on  the  basis 
of  a  single  repo  rate  then  any  differences  in  sovereign  credit  ratings  could  not  be 
reflected  in  the  repo  rate  and  would  have  to  be  reflected  in  different 
initial 
If  these  differences  were  ignored  then  there  would  be  a  danger  that 
margins. 
counterparties  would  tend to deliver the cheapest possible  collateral. 

Examples for variation to*irgt*un& for repos 

•  A central  tak  leads £€$2 JtèOt&n. to a cotHtferprty ma reserves the frertcfc OAT IQ% 
trading  *t 

Feb 26 £00 L  The fade & executed fot value Feb 24 19S& The bond h 
119JO in the cask market  Accrued interest Is 9346  points (364 days) so the all-in 
price is 129M&  W&  tte repo counterparty would need to deliver T74&3I iao of the 
OAT 10% Feb 26 2001 for the central bank tfr be My collateralised. 

Two days later the hoiiîï wjlî pay its coajjon {of BCtl 7,749,200} which, ander the terms of 
the repo  agreement,, the central  timk  is obliged  to pay  to- the  repo  eoutite^rty  as & 
manufactured dividend.  Hie central hank would now he under-coîïateraiïsed by almost 
WÂ wrthoatthe provisos» of additional collated 

»  The price of a bond could*fall, $ay, JO points over the coarse of ten tradiag tta$&  If a 
counterparty ha$ a<* abligation to Increase the collateral the central bank would sickly 
become under-coïtateraîîsed. 

•  A repo counterparty lends ECU  ïÛQmn of collateral to a central bank versus cash and 
then the market rallies over the following ten trading days.  The collateral increases in 
value to ECU  I Ifcnusu  If the eonoterparty ha$ an o$sefc*rjg matched book transaction 
the ECU lômn will be required as additional collateral. 

To prevent unnecessary transactions exposure the counterparties generally agree a margin 
trigger level» such that niarket taovements m the ^alue of the collateral that are below such 
trigger levels do not initiate variation margining. 

The example above illustrates the importance of symmetric variation margins, even  in the 
situation where the cash leader Is the highest possible credit* with zero default risfc  There 
are two reasons why symmetric margining is essential 

•  Asymmetric margining biases the economics of the transactions in favour of the cash 

lender.  This would result in bias in money market rates and reduce transparency. 

•  Asymmetric margins actually increase the credit risk of the cash borrower (as shown by 
the  third example  above).  Most market participants have matched  positions  in their 
securities portfolio.  Asymmetry in their collateral exposure increases the volatility of 
cash flows thus increasing the risk of default. 

There  are  situations  in  which  the  application  of symmetric marking-to-market  will not 
significantly  reduce  risk  exposure  to  the  underlying collateral.  The  typical  case is  the 
absence of reliable prices for the collateral, for example When the collateral is not actively 
traded in a liquid market.  This may potentially be the case for some assets included in Tier 
Ï1.  In tins situation  the application of the less efficient  initial margin  in conjunction  with 
symmetric raarking-tO'inarket might represent a satisfactory solution» 

33 

4.7  reserve  requirements 

The  EMI  has  published  details  of the possible  use of  reserve  requirements  as  an 
instrument  of monetary  policy.  This preparatory  work  is required  by  the  Treaty 
but  the  decision  on  the  use  of  reserve  requirements  will  be  taken  by  the  ECB. 
The  effectiveness  of  reserve  requirements  is  outside  the  scope  of  this  report; 
however,  it  is  important  to  acknowledge  the  significant  concerns  market 
participants  have  raised  concerning  the  effects  of  the  imposition  of  reserve 
requirements. 

In particular their concern is focused  on the additional  costs reserve  requirements 
would  impose  on  certain  financial  transactions  in  euro.  There  is  a  danger  of 
dislocation of the new euro markets and activity being driven offshore.  This view 
is a result  of a keen awareness of the past experience of the dislocation  impact of 
derivatives:  reserves have, for  example, been influential  in causing  DEM money 
market  and  repo  activity  to  relocate  outside  Germany.  Financial  activity  is  by 
nature  highly  mobile.  Financial  participants  can  quickly  restructure  business  to 
avoid  additional  costs,  and  any  who  did  not  would  be  subject  to  competitive 
disadvantage. 

There  is a very  large consensus  among market participants that the imposition  of 
reserve  requirements  might  undermine  the  development  of  a  unified  financial 
market in euro. 

While the  strong  industry  preference,  across  all markets  and  all  countries,  is that 
reserve  requirements  should  not  be  imposed,  if  they  were  to  be  employed  then 
there  are  mechanisms  that  would  reduce  the  adverse  impact.  Specifically,  the 
reserves  might be set at zero  or be fully  remunerated.  Either would  alleviate  the 
dislocation  impact;  however,  it  is  important  to  note  that  the  fine  margins  for 
some markets would mean that reserves that are only partially remunerated  would 
still distort prices sufficiently  as to provide an incentive to relocate activity. 

Finally,  as  a further  technical  matter,  it  should  be noted  that  in  order  for  market 
participants to make the necessary system preparations for reserve requirements it 
is important that the exact scope and structure of such requirements are decided as 
quickly  as  possible.  Markets  expect  therefore  the  ECB  to  announce  as  soon  as 
possible after  it is established, in  1998, a fully  detailed implementation plan. 

4.8  regulation,  restrictions and taxation 

Regardless of the level of harmonisation  achieved in terms of market  conventions 
and  practices  there  will  still  be  distortions  resulting  from  differences  in  national 
tax regimes and  regulatory rules that place restrictions on trading and  investment. 

Harmonisation  in this  area  appears  difficult  to  achieve  in the  short  term,  but  the 
introduction of the euro will increase the awareness level of such distortions as: 

•  distortions reflecting  national tax regimes 

34 

•  different  levels of investor protection 

•  national  restrictions  on  trading  and  investment,  such  as  restrictions  on  the 

kinds of assets pension funds  can invest in 

In  each  of  these  three  cases,  the  Commission  is  proposing  action  to  reduce 
distortions.  In order to remove tax distortions, the Commission's  Action Plan  for 
the Single Market asks Member States to confirm  the priority of working towards 
agreement on a tax package designed to achieve a balance between their interests, 
which will include: 

•  a  code  of  conduct  designed  to  tackle  harmful  tax  competition,  which  causes 

difficulties  for every Member State; 

•  measures  to  eliminate  distortions  to the taxation  of  capital  income, notably  to 
taxation  of  cross-border  savings,  while  preserving  the 

ensure  effective 
competitiveness of European financial  markets; 

•  measures  designed  to eliminate  withholding  tax on interest payments  between 
companies, which form part of long-standing efforts  to remove disincentives to 
cross-border economic activity (double taxation). 

In  the  case  of  investor  protection,  there  is  an  existing  structure  of  harmonised 
minimum  rules,  leaving  some  margin  for  national  interpretation,  notably  on  the 
meaning of 'the general good'  as applied to the protection of investors. 

In  the  case  of  restrictions  on  trading  and  investment,  the  Commission  Green 
Paper  on  'Financing  Retirement  in  the  Single  Market'  notes  that  the  prudential 
supervision of the investment of pension and life assurance assets has the effect  of 
keeping a large share of these assets in domestic government bonds.  It argues  for 
a  common  approach  based  on  prudent  man  principle.  This  would  remove  the 
need  for  most  of  the  quantitative  restrictions,  while  currency  matching 
requirements  in  particular  will  be  made  obsolete  within  the  euro  area  by  the 
introduction  of the single currency. 

The market  for  mortgage credit (mortgage bonds are the largest  instrument  on the 
European  capital markets after  government  securities)  is particularly  restricted by 
differing  regulatory  requirements.  These  will  be  accentuated  when  what  has 
hitherto been the main obstacle to cross-border funding  - the currency difference  -
disappears. A complete review of the regulatory  situation  for  these instruments  is 
therefore  appropriate. 

4.9 Other  issues 

There  are  a number  of  issues  that  will  need  further  examination.  Although  some 
of  them 
like  conversion  rates  and  settlement  systems  have  been  briefly 
considered,  further  analyses would be required. 

On  conversion  rates,  the  basic  concern  is  to  ensure  a  smooth  transition  and 
therefore  it would  be best to find a market  friendly  solution  that  used  the markets 
rather  than  opposed  them.  Markets  would  need  certainty  that  no  volatility  can 
occur  at  the end  of the process  because they  would  not be able to hedge. In order 

35 

to  increase  market  stability,  it  is important  to avoid  the  risk  of  markets  guessing 
what  will  be  the rule  for  fixing  the conversion  rates. It  should  therefore  be  clear 
that  continuity  is  ensured  and  that  political  fixing  is  excluded.  It  is  essential  to 
maintain  certainty  on  the  legal  framework  and  in  particular  that  the  one-to-one 
conversion from  ECU to euro be retained. 

Markets  consider  that  it would  be a risk to  leave the market  to  play  without  any 
additional  guidance.  Indeed,  market  rates  of  the  last  business  day  could  have 
moved away from  the long-term equilibrium level around which they would  have 
been  stable  for two years, thus not reflecting  economic fundamentals.  Credibility 
would  be  the  central  question  regarding  the  pre-announcement  of  conversion 
rates.  If  conversion  rates  were  to  be  announced,  the  announced  rates  should  be 
considered  as reflecting  economic  fundamentals. 

On settlement  systems, there is a need to further  examine technical  issues i.e. the 
redenomination 
handling  of  redenominated  securities  (decimals,  different 
techniques), settlement in different  currencies and cross-border  settlement. 

Investors  protection  is  another  issue  which  requires  more  in  depth  examination. 
Investors  protection  is  considered  as  one  of  the  key  factors  of  an  efficient 
financial  market.  Moreover,  it is a key  factor  for  the  international  attractiveness 
of the market. 

36 

V. 

GLOSSARY 

Actual/Actual:  a  day  count  convention  for  the  accrual  of  interest  in  which  the 
calculation of interest is made based on actual number of days over which the  interest 
is accrued  and the actual number of days in the year.  This is the preferred  method  for 
the bond market. 

Actual/360: a day count convention for the accrual of interest in which the calculation 
of interest is made based on actual number of days over which the interest  is  accrued 
and  a  360-day  year.  This  is  the  method  proposed  for  the  ESCB's  money  market 
operations. 

Business  day  for  the euro: any day on which  it is possible  to trade,  settle  and  make 
payments in euro. 

Central securities  depository  (CSD): a facility  for  holding  securities and  processing 
security transactions by book entry. 

Collateral:  an  asset  pledge  by  a  borrower  to  a  lender  for  the  duration  of  the  loan. 
Generally,  the  amount  of collateral  held  is calculated  so that  at no  time  is the  lender 
exposed to market risk. If the borrower  defaults  then the collateral  can be disposed  of 
to pay off the loan. 

Coupon  frequency:  how  often  over  a year  the  issuer  promises  to  pay  interest  on  a 
debt security (annually or semi-annually).  Practice varies from country to country. 

Day  count  convention:  the  method  for  determining  the  number  of  days  used  to 
calculate the accrual of interest (see Actual/Actual and Actual/360 above). 

Dematerialised  securities:  securities  that  are  held  in  non-paper  form  usually  as 
electronic entries on a computerised accounting  system. 

Euro area: the geographical  area comprising  of the Member  States that have  adopted 
the euro as their currency in accordance with the Treaty. 

Haircut:  used  in  the  securities  industry  to  calculate  the  value  of  a  security  as 
collateral.  The  haircut  varies  according  to  the  type  of  security,  the  market  risk 
attached to it and the amount of time to maturity. 

Initial  margin:  amount  of  cash  or  eligible  securities  that  has  to  be  deposited  before 
entering into a margining  transaction. 

Issuer: legal entity which has the power to issue and distribute a security. 

Liquidity: the ability  to buy or sell  an asset  quickly  and without  affecting  the  market 
value of the asset (i.e. to be able to convert to cash quickly). 

Marking-to-market:  increasing  or  decreasing  the  price  of  a  security  in  line  with 
movements in the market value of the security. 

37 

Non Par Value Shares: shares which represent a fraction  of the issued capital and do 
not  have  a nominal  value. NPV  shares  are allowed  by the  second  EC  Company  Law 
Directive and are widely used in Belgium and Luxembourg and in the US. 

Prudent  man  principle:  a  standard  adopted  by  many  authorities  to  guide  those 
responsible  for  taking  investment  decisions  on  the  behalf  of  others.  In  essence  the 
decision  taker  is  expected  to  act  with  discretion  as  a prudent  man  or  woman  would, 
that  is  to  avoid  speculative  investment,  to  seek  reasonable  financial  return  and  to 
preserve capital. 

Real-time  gross  settlement  system:  a  gross  settlement  system  in  which  processing 
and settlement operations take place continuously in real time. 

Redenomination:  the  change  of the unit  in which the amount  of outstanding  debt  or 
equity is stated from  a national currency unit to the euro unit, with no alteration of any 
other term. 

Renominalisation: the change in the nominal value of a bond or a share. 

Repurchase  agreement  (repo): agreement  between  a seller and a buyer  in which the 
seller agrees to repurchase the sold security at a fixed price on an agreed date or over a 
specified  period of time. 

Round  lots  size:  the  number  of  shares  which  can  be traded  and  for  which  a price  is 
given  on an Exchange. The size of round lots is specific  to each security  and  depends 
on the share price. 

Tap stock:  is an issue of stock  which has  identical  features  to an outstanding  normal 
issue.  The  tap  stock  is  thus  cqmpletely  fungible  withthe  original  outstanding  issue. 
Tap stock issues are generally  smaller than normal issues, and are aimed to respond to 
pockets of demand in the market for a particular stock. 

TARGET  (Trans-European  Automated  Real-time  Gross  settlement  Express 
Transfer  system):  a  payment  system  consisting  of  one  real-time  gross  settlement 
(RTGS)  system  in  each  of the  Member  States.  The  national  RTGS  systems  will  be 
interconnected  through  the  Interlinking  mechanism  so  as  to  allow  same-day  cross-
border  transfers  throughout  the  euro  area.  RTGS  systems  of "pre-in" Member  States 
may also be connected to TARGET, provided they can process the euro. 

Tick  sizes  convention:  rounding  method  of  a  share  price  for  quotation  purposes. 
Different  tick sizes may apply to different  ranges of prices. 

Variation  margin:  amount  of  cash  or  eligible  securities  that  has  to  be  deposited  by 
the  borrower  to  ensure  that  the  counterparties  remain  fully  collateralised  throughout 
the term of a transaction.  The amount of variation margin is determined by  symmetric 
marking-to-market  the collateral. 

38 

VI. ANNEX 

LIST OF EXPERTS ' 

Consultative Group on the Impact of the Introduction 
of the Euro on Capital Markets 

Mr.  A. 
Mr.  M. 
Mr.  G. 
Mr.  Ch. 
Ms.  G. 
D. 
Mr. 
J. 
Mr 
E. 
Mr. 
P. 
Mr. 
Mr. 
V. 
Mr.  Th. 
Mr.  S. 
Mr.  F. 

Giovannini 
Beleza 
Bishop 
Bourdillon 
Evans 
Hoehn 
Moro 
Namor 
Praet 
Remay 
Richter 
Schuster 
Von Dewall 

Mr.  D. 
Mrs  C. 
Mr  D. 
Mr.  B. 
Mr.  Th. 
Mrs.  V. 
Mr  J. 
Mr.  M. 
Mr.  W. 
Mr 
I. 
Mr  R. 
Mr.  J. 

Mr  P. 
Mr.  B. 
Mr.  C. 
Mr  S. 
Mr  P. 
Mr  P. 
Mr  J. 

Angel 
Bennet 
Blake 
Blower 
Bollier 
Bourcier 
Bruen 
Chatfield 
Claeys 
Clarke 
Cocquyt 
Corrigan 

Cotella 
Crowe 
Dammers 
De Forges 
De Grauwe 
De Weerd 
Dowsett 

Group members 

LTCM 

Banco Comercial Portuguès 
Salomon Brothers International Ltd. 
Société des Bourses Françaises 
Bankers Trust/ISDA 
Paribas 
BBV Bruxelles 
San Paolo 
Générale Bank 
Paribas 
Deutsche Bôrse AG 
Deutsche Bank AG 
ING Group 

Other Participants 

LIFFE 
Salomon Brothers International 
Goldman Sachs 
BBA - British Bankers'  Association 
LTCM 
MATIF 
LIFFE 
LTCM 
Euroclear 
Morgan Stanley Int. 
CGER 
Irish  National  Treasury  Management  Agency 
/EFFAS 
Credito Italiano 
Chase Manhattan Bank/ISDA 
IPMA 
Trésor Français 
Katholieke Universiteit Leuven 
London Stock Exchange 
Dresdner Kleinwort Benson 

39 

Mr J-F 
Mr. M. 
Mr A. 
Mr.  C.J. 
Mr. M. 
Ms C. 
Mr P. 
Mr J. 
Mr B. 
Mr J. 
Mr S. 
Mr . K. 
Mr R. 
Mr L. 
Mr. A. 
Mr Ch. 
Mr K. 
J. 
Mr 
E. 
Ms 
T. 
Mr 
I. 
Mr 
Mr  G. 
Mr P. 
Mr P. 
Mr R. 
Mr  M. 
Mr  M. 
Mr C. 
Mr D. 
Mr Y. 
Mr. O. 
Mr K. 
Mr  G. 
Mr. J. 
Mr N. 
Mr H. 
Mr P. 
Mr A. 
Mr  M. 
Mr F. 
Mr. Th. 
Mr. A. 

Dubroeucq 
Elderfield 
Evans 
• Farrow 
Fox 
Franke 
Gennart 
Grant 
Greborn 
Hardt 
Harry 
Hoekerd 
Hoffman 
Horngren 
Houmann 
Huhne 
Knappe 
Knight 
Letemendia 
Mackie 
Mackintosh 
Mazzuchelli 
Mercier 
Mortimer-Lee 
Monro-Davies 
Obstfeld 
Papenfuss 
Parry 
Pepper 
Poullet 
Putzeys 
Reuss 
Rutzel 
S amain 
Schabel 
Style 
Tamayo 
Tohani 
van Turenhoudt 
Veverka 
Weisgerber 
Wigny 

Federation of European Stock  Exchange 
ISDA 
LIBA 

> 

London Investment Banking Association 
Lehman Brothers 
Deutsche Bôrse AG 
Générale Bank 
Goldman Sachs 
VPC/The Swedish Central  Securities 
European Mortgage Federation 
SICOVAM 
ING Group 
CEDEL 
Swedish Debt  Office 
EBF 
IBCA 
German Banking Association - EBF 
Federation of European Stock Exchange 
EBF (European Banking  Federation) 
European Mortgage Federation 
Standard & Poor's Ratings 
Morgan Stanley Int. 
European Monetary Institute 
Paribas 
IBCA 
University of  California 
Deutscher  Kassenverein 
Morgan Stanley Int. 
Goldman Sachs 
Euroclear 
Groupement européen des Caisses d'Epargne 
Standard & Poor's 
Bayerische Hypotheken und Wechsel Bank 
Générale Bank 
European Mortgage Federation 
IPMA 
BBV 
LIFFE 
Association belge des banques 
Standard & Poor's  (France) 
German Banking Assoc. 
General Bank 

1.  Experts  participated  in a personal capacity  rather than as representatives of the respective  institutions 

2.  Chairman 

40 

ISSN 0254-1475 

COM(97) 337  final 

DOCUMENTS 

EN 

09  02 

Catalogue  number  :  CB-CO-97-345-EN-C 

ISBN  92-78-22411-1 

Office  for  Official  Publications of the European  Communities 

L-2985  Luxembourg 

m