Below we present the note from Nomura which is making the rounds today following the WSJ article referencing it and which touches upon a topic discussed by Zero Hedge way back before even the second Greek bailout from July 21, namely that the statutory law governing the sovereign bond indenture (i.e., whether bonds are issued under Greek or English law) should have major implications for trading dynamics due to the defatul fallback currency in the case of a currency collapse. In a nutshell: "Bonds issued under local law, such as Greek law, would likely be converted from euros into a new local currency—a blow to any investors left holding the paper. "New" currencies, such as a new drachma, could rapidly fall in value by as much as 50%, according to most estimates. Foreign-law debt, on the other hand, would be more likely to remain in euros, assuming a smaller euro still existed at all, the bank said." That Nomura and the WSJ is only half a year late with this discussion is not surprising. What is surprising is that the discussion has appeared in the first place: needless to say this is another rhetorical escalation in the push to get Merkel on the "same page" as it being telegraphed all too loudly that investors are now actively gearing up for a Eurozone collapse. Then again Nomura bankers are people too and deserve to be well paid for being part of the detested 1%. How else will this happen unless they too join the onslaught by the global banking syndicate which now consists of Deutsche Bank, JP Morgan, Barclays, Credit Suisse, and virtually everyone else, expect for Goldman of course, which appears quite happy with the chips falling as they may. After all, it already has Europe by the political short hairs. Now it just needs to take charge financially too. If in the process a few not so good banks are converted into omelette, so be it.
Nomura with a topic that diligent ZH readers are already well aware of.
Eurozone break-up risk has risen notably over the past few months, as European policy makers have failed to put in place a credible backstop for the larger Eurozone bond markets. Given this increased risk, investors should pay close attention to the ‘redenomination risk’ of various assets. There are important legal dimensions to this risk, including legal jurisdiction of the obligation in question. Risk premia on Eurozone assets are likely to be increasingly determined by this ‘redenomination risk’. In a full-blown break-up scenario, the redenomination risk may depend crucially on whether the process is multilaterally agreed and on whether a new European Currency Unit (ECU-2) is introduced to settle existing EUR contracts.
Full executive Summary:
- Escalating tensions in the Eurozone, around Greece as well as core Eurozone countries, mean that the risk of a break-up has sharply increased. The potential for a break-up raises the question about the future of current Euro obligations: Which Euro obligations would remain in Euros, and which would be redenominated into new national currencies.
- Investors should consider three main parameters when evaluating „redenomination risk?: 1) legal jurisdiction under which a given obligation belongs; 2) whether a break-up can happen in a multilaterally agreed fashion; and 3) the type of Eurozone break-up which is being considered, including whether the Euro would cease to exist.
- In a scenario of a limited Eurozone break-up, where the Euro remains in existence for core Eurozone countries, the risk of redenomination is likely to be substantially higher for local law obligations in peripheral countries than for foreign law obligations. From this perspective, local law obligations should trade at a discount to similar foreign law obligations.
- In a scenario of a full-blown Eurozone break-up, evaluating the redenomination risk is more complex, as even foreign law obligations would have to be redenominated in some form. In this case, redenomination could happen either into new national currencies (in accordance with the so-called Lex Monetae principle), or into a new European Currency Unit (ECU-2). This additional complexity in the full-blown break-up scenario leaves it harder to judge the appropriate relative risk premia on local versus foreign law instruments.
- The distinction between local and foreign law jurisdiction also becomes less important in situations involving insolvency. In those instances, the lower redenomination risk associated with foreign law obligations may be negated by higher haircuts. Hence, the legal jurisdiction therefore seems most relevant from a trading perspective in connection with high quality corporate credits which are highly resilient to insolvency.
- Redenomination risk is not only a legal matter. Redenomination risk for German assets has a different economic meaning compared with redenomination risk for Greek assets.