EURO: Ready or Not, Here It Comes

On January 1, 1999, eleven member countries of the European Union (EU) will adopt the Euro as their common currency. This move has complex implications for outsourcing in Europe. It will affect existing and new contracts and, more fundamentally, have an impact on the market structure.

Attempting to determine those market implications for Euro-sourcing has made crystal ball gazing the name of the game for economists across the EU. The impact of the Euro will be felt in areas ranging from interest rates, price transparency, and merger and acquisitions activity to public sector credit, and systems and training.

Interest Rates

The Euro-zone will have a single interest rate, which will impact each of the participating domestic economies in different ways. Ultimately, this will affect the relative strength of the Euro, and that, in turn, will affect the attractiveness of long-term Euro-zone outsourcing deals.

Although the EU, as a trade zone, is approximately the same size as the United States, with some 20 percent of the world’s GDP, the dollar currently accounts for a much larger proportion of government foreign exchange reserves and private portfolio holdings. If the Euro gains in popularity as a ‘portfolio currency’, then increased demand could help to maintain its strength at lower interest rates than would otherwise be expected.

Price Transparency

In any marketplace, prices vary according to a number of factors (e.g. distribution network, consumer preferences, differing rates of sales tax, etc). While these will still exist after the introduction of the Euro, the increased ease of comparing the cost of outsourcing across Europe may result in some leveling out of prices. Customers locked into long term deals at fixed prices may seek to break what have become bad deals and find better, more flexible contracts to realize the benefits of price transparency.

Mergers and Acquistions

On January 1, 1999, Euro-zone businesses will wake up to a new marketplace many times larger than the current one. The elimination of exchange-rate risks may encourage new activity in Europe. Competition likely will increase, as businesses fight to obtain and keep a share of the market. That competition and the inevitable mergers and acquisitions should affect customer demand for outsourcing services within the Euro-zone. Larger businesses may look for acquisition targets; smaller ones may need to look for a merger partner. And once transactions are completed, the pressure for cost reduction and further outsourcing benefits will intensify.

Public Sector Credit

While EU governments will be able to issue debt to raise money, they will no longer be able to issue new money to pay their debts. That, in theory, exposes them to bankruptcy. The other Euro-zone states might find it politically unacceptable to allow one of their number to become bankrupt, but vendors will need to assess possible new credit risks when bidding for public deals let by Euro-zone states.

Euro Services

What has been dubbed the next Y2K problem is providing the beginnings of a new lucrative income stream for outsourcers. Many of these soft services are being included in new deals, as the public and private sector seek to transfer responsibility for specialist areas to outsourcing vendors. For example, every vending and payment system will have to be replaced or altered during the transitional period — and cash tills may need to take both currencies during this period.

Businesses are preparing timetables for converting payroll systems and paying staff in Euro, all of which is creating a major resource strain on the already over-stretched IT services market. Moreover, increased training will be required in many areas of dealing with the new currency.

Businesses are preparing timetables for converting payroll systems and paying staff in Euro, all of which is creating a major resource strain on the already over-stretched IT services market. Moreover, increased training will be required in many areas of dealing with the new currency.

Existing Deals

The main legal concern in existing deals is whether a party to a contract could argue that the introduction of the Euro is a deal breaker. Under common and some civil laws, courts will not release a party from his contractual obligations simply because the circumstances which existed at the beginning of the contract have altered. However, in rare cases, courts will do so where a party can show that performance of that contract has become impossible, or has become something so radically different that the parties could not have contemplated it at the time they made the contract. In those cases, the contract is said to be ‘frustrated’.

In response to the concerns of the legal community, the EU passed legislation that states, in essence, that the introduction of the Euro is not adequate reason to alter or terminate unilaterally an existing agreement. In addition, the legislation states that references in contracts to national currency should be interpreted as references to the Euro.

So There’s No Problem?

Despite the regulation, a few contracts may still be at risk for the following reasons.

1. Change in economic circumstances — If economic conditions were to change radically on entry to the Euro, parties might argue that the EU legislation does not cover these changes. In most cases, this argument is unlikely to succeed, but there may be cases where it has true merit.†
2. Contracts governed by non-EU law — The legislation only applies in member states of the EU. Where a contract is governed by the law of a non-EU state like the US, it may be frustrated. This is potentially the most serious threat to existing contracts. Businesses which have such contracts should check whether the jurisdiction in question will recognise the contract after January 1, 1999. †
3. Force majeure clauses. The legislation only applies where the parties have not included a clause to the contrary. Many contracts do contain ‘force majeure’ clauses which bring them to an end if certain events, such as disruption of financial markets, occur.

ECU Obligations

The ECU is often used in pan-European outsourcing agreements for pricing and, typically, to denominate limits of liability. To ensure continuity, the EU legislation states that any reference to the ECU, as defined in European legislation, will be replaced by a reference to the Euro. It also states that ECU converts the Euro on the basis that 1 ECU = 1 Euro. If a definition of the ECU other than the official one has been included in a document, that inconsistent definition would prevail.

It’s All a Question of 10 Interpretations

EU law is written in ten languages, so its rules of interpretation are rather different to English law. An English court generally interprets legislation literally. In a multi-lingual environment, this autonomy is impossible. Having so many languages to deal with, the letter of the law is to some extent subordinate to its spirit.

New Deals

All of the issues covered under existing deals will impact the way new transactions are structured. For example:

1. Continuity. With the contract continuity risk high on people’s agendas, an EMU continuity provision is a must for a long-term deal which spans the introduction of EMU.
2. Set-up and operational issues. Businesses will need to consult their bank at an early stage to discuss the new banking services they will require.
3. Invoicing and payment. A number of multinationals have stated that they will expect to be invoiced, and to pay suppliers, in Euro. Outsourcing suppliers should consider paying their own EU-based suppliers in Euro and quoting and invoicing in Euro. Otherwise, vendors may be at a competitive disadvantage to European competitors.
4. Pricing. As prices will become more uniform, so wages will slowly equalise across the European Union, thus affecting the way bidders price new deals. In addition, the minimum wage potentially will remove the advantages of sourcing certain services from “cheaper” jurisdictions
5. Costs and taxation. The cost implications of the Euro are substantial, and businesses will want to ensure that these costs can be written off against tax as early as possible.
6. Euro-ready warranties. Warranties that confirm that all internal systems of the business are Euro-compliant are being included more frequently in certain contracts, such as loan agreements, business and share acquisition contracts. They should also be included in software purchase or leasing contracts.
7. Price sources. Some of the published interest rates (price sources) on which many loan interest rates are based will disappear on the introduction of the Euro. It would be sensible to specify replacement rates (or provisions for deciding them) in any new loan documents.
8. Increased costs clauses. Lenders normally include a provision in their loan agreements to pass on any cost increases resulting from regulatory changes. Such clauses should cover changes associated with the introduction of the Euro and the costs of complying with ECB requirements.
9. Business days. Many documents specify that certain events will occur on a ‘business day’ (defined as a week-day on which banks are normally open for business in the principal financial centre of the currency). Such definitions may need to be specific, considering the many different public holidays in the Euro-zone.

Heads in the Sand

Many business are not prepared for the introduction of the Euro and are simply burying their heads in the sand. The pressures of Y2K are already intense, and an additional wave of change and complexity is making life worse. As markets are beginning to identify opportunities and threats, the key with Euro, like all difficult changes, is to be prepared by understanding and anticipating problems and acting on them.

Timetable

The key dates for the adoption of the Euro are:

• June 30, 1998: The European Central Bank (ECB) is established. Member states have now approved the membership of the Executive Board of the ECB.
• January 1,1999: The transitional period starts. Exchange rates are irrevocably fixed to the Euro and responsibility for interest rates and monetary policy pass to the ECB.
• January 1, 2002: The final period begins. Euro bank notes and coins begin circulating, involving a mass changeover of retail activity.

Richard Lister is a partner in the London office of Berwin Leighton. He specializes in multi-jurisdictional outsourcing transactions, and his clients include National Westminster Bank, Departments of State in the UK and a number of U.S. corporations.

Lessons from the Outsourcing Primer:

• The Euro will affect almost every area of outsourcing in Europe.
• Price transparency will facilitate cost comparisons across the Euro-zone.
• EU governments, unable to issue new money to pay debts, theoretically will be exposed to bankruptcy.
• New legislation offers some protection against the Euro being considered a deal breaker for existing agreements.

About the Author: Ben Trowbridge is an accomplished Outsourcing Consultant with extensive experience in outsourcing and managed services. As a former EY Partner and CEO of Alsbridge, he built successful practices in Transformational Outsourcing, Managed services provider, strategic sourcing, BPO, Cybersecurity Managed Services, and IT Outsourcing. Throughout his career, Ben has advised a broad range of clients on outsourcing and global business services strategy and transactions. As the current CEO of the Outsourcing Center, he provides invaluable insights and guidance to buyers and managed services executives. Contact him at [email protected].