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How to Prepare for a Euro Crash

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Given the recent developments in Europe, investment managers are wondering when the euro will come crashing down. Challenges are likely to fall upon operations and technology departments within investment management firms. The steps to limit risk should be taken now.

The possibility of a complete collapse of the euro seems unlikely. However, the probability that one or more countries may exit the single European currency seems almost inevitable.

The risk of a change to euro participation should be subject to careful analysis and contingency planning. Yet, in a recent survey of 100 executives from U.S. and European investment management firms, half of those expecting a breakup in 2012 said their firm is not preparing or that they were unaware of any preparations.

If a disaggregation of euro participants occurs, the operations and technology departments of global investment managers will be faced with fundamental changes to core processing systems to unwind the currency. We recommend, at a minimum, addressing all operational and technology risks with a medium to high impact assessment. A consolidated plan to address all impacts associated with a changing euro would be most prudent.

Let’s look at two highly affected areas: data management and client reporting.

In the operational risk assessment of any euro breakup, an investment manager must consider potential impact across all data management processes and evaluate how the firm receives, stores and reports on data. The review should extend beyond operational workflow to the technology infrastructure underpinning it. Impact will be felt everywhere from investment models to client management activities, and a plan to provide coverage across the entire workflow should by now already be in a developed stage.

Given the shifting sands in Europe, it is wise to plan for the possibility of a combination of several governments exiting the single currency. Readiness for the day the first country exits the euro and re-introduces its legacy currency must address short-term, immediate issues as well as long-term consequences of the change.

The re-introduction of a new sovereign currency unit would require re-denominating assets as part euro and part new legal currency. Before this occurs, investment managers need to know how to handle open trades and how to alter settlement instruction including account number, identification code and place of settlement.

Taking a lesson from a complication during adoption of the euro, wherein the number of decimal places used in conversions differed from one party to the next, therefore conversion methodologies should be coordinated with data vendors. Systems should be put in place to preserve the integrity of return calculations in the split-currency environment. For seamless record-keeping, a mechanism may be needed to create a history for any newly reintroduced sovereign currency, since the currency would have had no relevance during the time of the euro.

Without proper planning and execution, incorrect settlement instructions or inconsistencies with the market could result in significant losses.

Following a euro breakup, data management changes made to support the new currency would ripple through a firm’s systems and crash down on the compliance, client and regulatory reporting functions. Special attention should be paid to client reporting impacts as small errors or delays could cause widespread negative repercussions on client service, confidence and revenue.

Communication and reporting will be vital. Transparency will be crucial for sustaining investor confidence and providing evidence that the repositioning of operations and investments is underway. Investment managers need to revisit their approach to client reporting from end to end. Those with transitional strategies in place will reap benefits in terms of efficiency and, ultimately, client confidence.

European investment managers have been strongly advised by the regulators to establish contingency plans in anticipation of one or more countries exiting the single-currency monetary union, and stateside firms would be wise to follow suit. The Eurozone is on the cusp of significant change, which requires immediate attention.

Michael Talbot is a managing director, Joe Morant is a director and Mohammad Ali is a managing consultant in the financial services practice of Navigant. Talbot leads the company’s operations strategy and transformation group.  

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