Speakers:

DANIEL P. CUNNINGHAM
Partner,
Cravath, Swaine & Moore

JOHN D. HOWLETT
Senior Marketing Manager,
New York Mercantile Exchange

FILIP MOERMAN
Partner,
Cleary, Gottlieb, Steen & Hamilton

PATRICK PONCELET
Director, Global Payment Systems,
S.W.F.T. Brussels

GONZALO PEREZ PIAGGIO
Strategy, Economics, & Marketing Group,
KPMG Management Consulting

HARRY H. WELLINGTON
Dean and Professor of Law,
New York Law School

JOLY DIXON
Director, International Economic and Finance Matters,
Directorate General II, European Commission

LEN BERKOWITZ
Advisor to the Governors and Head of the Legal Unit,
Bank of England

PETER R. FISHER
Executive Vice President,
Federal Reserve Bank of New York

JEAN-PIERRE PATAT
Directeur, Général des Services Etrangers,
Banque de France

HANS ULRICH WEGENER
New York Representative, 
Deutsche Bank

Host:

SYDNEY M. CONE, III
C.V. Starr Professor of Law and Director,
Center for International Law

Daniel P. Cunningham: The topic of today's conference is the tough question posed by the upcoming monetary convergence in Europe. From a lawyer's perspective, there are several questions that need to be addressed on both sides of the Atlantic. The first issue is continuity of contract. To the extent that there is a swap, a security, or an instrument where one or both parties have obligations to pay in a currency of a country that will participate in monetary convergence, continuity of contract becomes an issue. Will the advent of the European Monetary Union (AEMU@give rise to an excuse to performance? In other words, will the common law doctrines of impossibility of performance or frustration of purpose provide a basis for parties who are losers in this event to have a defense to performance once monetary conversion takes place on January 1, 1999. 

There is the related issue of disappearing rate in price sources. Many transactions, particularly in the derivatives markets today, set rates periodically by reference to screens, tolerate screens and writer screens. Those screens, in turn, refer to French franc rates set in Paris, Deutsche mark rates in Frankfurt, and rates for other currencies in London. When the relevant currencies disappear and are replaced by the Euro, those pages will either change or disappear. Will that event provide an excuse for parties to walk away from contractual obligations with a claim that an essential element of the contract is no longer present?

There are some interesting issues on how to treat the European Currency Unit (AECU@) as part of EMU. The ECU is a part of European Currency Unit. The ECU is a unit of count used for certain purposes. The ECU was never intended to be a currency, but it has come to act like a currency in certain respects since it was first developed. There are two different kinds of ECU. There is the official ECU, which is defined quite precisely in a regulation adopted by the European Council. There are also private variations on that scheme of financing using the ECU. In the latter scheme, the definition of what defines ECU will be set forth in the contract itself. There are many variations of this scheme because the countries participating in the ECU have changed and people have tinkered with the contractual provisions. 

There are several other intriguing elements of the legal infrastructure that should be addressed in the context of EMU. These elements include day count fractions, business day conventions, and redenomination of existing instruments. Unless there is a common day count convention across Europe, after convergence, there could exist obligations in the same currency, but some transactions will produce different amounts if a different day count convention is used. Actual 365 and actual 360 are common day count conventions that are used in the market. 

Business day conventions also seem like simple infrastructure. However, if after the adoption of the single currency, there was to be a decision that all existing business days were honored in all participating European countries, estimates predict that currency would not trade on roughly half the business days that it would now. Redenomination is a another complex subject that is being dealt with right now. 

Lawyers in New York started to think about the New York law issues that are presented by EMU and came up with a list of transactions that could be implicated. First, transactions involving a participating member's currency, like the French franc for example, will be implicated. France is quite likely to participate in EMU. There exist transactions involving the French franc and the U.S. dollar that will become transactions involving the Euro and the U.S. dollar. The value of the Euro that is derived from French francs will be irrevocably fixed when the conversion rates are fixed next year. More troubling, perhaps, are transactions involving two participating member currencies. Due to irrevocably fixed conversion rates for all participating members= currencies, certain transactions which today act as hedges will, in effect, become fixed annuities. Imagine, for example, a currency swap involving Deutsch marks and French francs. Today, that transaction acts as a hedge. When that becomes a Euro for Euro transaction, one party will simply owe more Euros than the other. The third transaction the New York lawyers were worried about was the transaction involving certain quoting rate/price sources that will probably disappear. Fourth, transactions involving the ECU will be implicated. If references to the ECU in Europe are replaced by references to the Euro at a ratio of 1 to 1, which is what is going to happen, the value of these transactions may well change, depending upon the level of which related conversion rates are fixed. Fifth, debt obligations denominated in a participating member's currency such as Deutsch mark, French francs or denominated in the ECU are a concern. In one sense, the conversion impact on these instruments will be simple because they will become obligations for the payment of Euros. The standard force majeure clause could be triggered by monetary conversions.

Legal analysis was conducted to resolve some of the concerns New York lawyers had about transactions that would be affected by EMU. On the one hand, the New York lawyers concluded that existing New York law is fairly reassuring in terms of the availability of the defenses to performance. This research on New York law involved what has been incorporated into the concept of lex monetae, law of the money. Under this old doctrine, each state and sovereign jurisdiction has the exclusive authority to decide what its currency is. As a related matter, under lex monetae it is a requirement to look to the law of the state that is issuing the currency to determine what constitutes legal tender in that state. That determination is used in transactions with other states. Unfortunately, lex monetae is not a part of New York law because it has never been adopted by a New York court or the New York Legislature. 

Extensive research was conducted on the doctrines of impossible frustration. A first year contracts course demonstrates that there can be an excuse to performing a contract if unexpected and extraordinary events occur that make performance unduly burdensome. Having analyzed all of this old English and American case law, the New York lawyers concluded that monetary conversions probably would not provide a basis for people walking away from most contracts and instruments. Nevertheless, this is an area of the law where courts have a great deal of discretion. In these cases, courts are allocating unexpected risk and that leads to unpredictability. 

Groups working on these issues, which included the International Stocks and Derivatives Association, the Securities Industry Association, the Bond Market Trade Association, and the Financial Markets Lawyers Groups, which meets under the sponsorship of the Federal Reserve Bank Act of New York, reached a joint conclusion that it would make sense to remove the element of uncertainty in all of this, however small that element might be. Researchers also looked to what Europeans were doing. Europe was well underway in adopting two regulations, which in the relevant European countries, would remove any uncertainty there. There is always competition in the financial markets, and if Europe is going to have 100 percent certainty, New York, as a leading financial center should provide the same precise degree of certainty for people doing transactions under New York law. 

On June 20, what is known as the 235 Regulation, adopted under Article 235 of the Treaty of European Union was adopted and came into force in Europe. It states in Article 3 of that Regulation: "The introduction of the Euro should not have the effect of altering any term of the legal instrument or of discharging or excusing performance under any legal instrument, nor give a party the right unilaterally to alter or terminate a legal instrument.@ This regulation ensures that EMU will occur and it will not provide a defense to performance. The terms of the deal cannot be changed, and there will be no repricing because of EMU. This regulation applies to all 15 member states of the European Union.

In New York, the working group that participated in the drafting of what has become part of the New York General Obligations Law reached an early decision that New York should try to replicate what was being done in Europe. No one wanted arbitrage between the two major financial centers. On July 29, 1997, the Governor of New York signed an amendment to Article 5 of the New York General Obligations Law which provides: "none of: (a) the introduction of the Euro, (b) the tendering of Euros in connection with any obligation..., shall either have the effect of discharging or excusing performance under any contract..., or give a party the right to unilaterally to alter or terminate any contract.@ Certain other actions shall have the effect of discharging or excusing performance under any contract or give a party the right to unilaterally alter or terminate a contract. One day later, the Governor of Illinois signed a quite similar legislation for instruments and contracts governed by Illinois law. Two of the leading commercial states in the U.S. have resolved the continuity of contract problem through legislation. 

There were also a few subtle changes made to New York continuity law. First in the "Definitions," in 5-1601, Clause 2, there is a definition of introduction of the Euro, that's defined as: "Shall mean and include the implementation from time to time of economic and monetary union in member states of the European Union.@ The phrase, "from time to time" was included, because from the U.S. perspective, it is clear that EMU will be an ongoing process. A number of European countries will join starting in 1999, but it is equally obvious, given recent statements by Mr. Blair, that England will not participate at the beginning. Mr. Blair wants to be re-elected. At the same time, Mr. Blair's heart is pretty clearly with EMU and England is expected by most observers to join roughly five years after the whole process starts. Then, of course, other countries may join EMU. 

Another subtle change was made to New York law in the definitions section. In the "Definitions," there is a reasonably technical definition of the ECU. This definition distinguishes between the official definition in European regulation 3325/94 and the private ECU which is defined by contract. 

The basic legal proposition for continuity is stated in 5-1602. It says that if a currency of a participating country, a country that is part of convergence, is a subject of a contract, then the Euro will be deemed a commercially reasonable substitute and substantial equivalent that may be used in determining values and transactions and may be tendered. In each case, the conversion rate specified in Europe will be used. 

Clause B then states the same basic proposition for the ECU. 

In subsection 2, there is the legal conclusion that follows from the basic proposition established in subsection 1. None of the various events will give people the right to walk away from their contracts. The introduction of the Euro and tendering of Euros in connection with any obligation in compliance with the provisions set forth above will not provide people with an excuse for nonperformance of their contracts. Subsection determines the value of any obligation in compliance with the provision set forth above. 

Finally, there is the calculating or determining of the subject or medium of payment of a contract, security or instrument with reference to interest rates or other basis that has been substituted or replaced due to the introduction of the Euro. This basis should be a commercially reasonable substitute and substantial equivalent. This is an attempt to state a basic rule for people who are troubled by the disappearance of prices. 

As this legislation was being prepared, no one in New York knew which rates would be published for Euros or whether they will be published on a national level or on a Europe-wide basis. Reasonable substitutes could not be determined. However, New Yorkers could state a principle. This principle indicates that when the rate sources are developed and assuming they are reasonable, that change in the way prices and rates are set in Europe should not provide a basis for nonperformance.

Section 5-1603 states that in all of these propositions, if people wanted to enter into contracts dealing separately with these topics, they are free to do so and their contracts will prevail. Next, section 5-1604 is a very important provision and it starts with the phrase: "Notwithstanding the uniform commercial code or any other law of this state." The New Yorkers were worried about the UCC. Under the UCC and New York case law, foreign currency i.e., non-dollars, can be treated as goods and subject to regulation by the UCC. The New York working group was informed early on that the Legislature had no real interest in tinkering with the UCC in order to handle EMU problems in Europe. The view of the United States was relatively sacrosanct. The New York working group wanted to change the General Obligations Law only, but also make sure that inconsistent provisions in the UCC were overridden. Hence, the phrase notwithstanding the uniform commercial code was added. The legislation then goes on to state that the New York continuity law shall apply to all contracts, securities and instruments, and that phrase was intended to make it clear that it did not matter when a contract was entered into. All existing contracts and all new contracts entered into after July 29, 1997 would be covered by this legislation. 

The final provision in the legislation came out of the working group's dialogue with the Legislature. The Judiciary Staff of the Judiciary Committee of the Assembly came back with a question. The question was based upon their understanding regarding whether other currency alteration in other countries would be affected by this Legislation. Working with the Judiciary Committee staff of the Assembly, the working group added this last provision to make it clear that by adopting a law dealing with this unique and extraordinary event in Europe, the New York legislature did not mean to suggest in any way contracts would not remain enforceable when other less dramatic effects took place reflecting currency values. As was previously set forth, New York and Illinois have adopted essentially similar laws on the subject. A similar law is under consideration in California, which will hopefully be adopted early next year. In Japan, a working group has been looking at the issues. Thus far, the conclusion has been lex monetae principles are strong enough in Japan so that legislation might not be needed. A working group in Switzerland has reached that same conclusion. Just last week, the New York working group sent a Euro care package down to Australia showing what had been done in Europe and what had been done in New York. It was suggested that Australia consider whether anything similar should be done there. This progress is moving very slowly around the globe given that EMU will actually not occur until the beginning of 1999. 

With this legislative certainty in place, the question is whether business people and lawyers are even concerned with drafting contractual provisions to deal with some of these continuity issues. There are arguments for and against this suggestion. To the extent that there are any weaknesses in the legislation in Europe or New York, a contractual provision clearly provides certainty. There might also be contracts that are not governed by European Union law, the law of the countries of the European Union, or by laws of the states of the United States. However, even with the uncertainty, it takes a lot of trouble to develop one of these clauses and to convince someone to sign it.

There is a pretty solid common law basis that has now been supplemented by what is fairly solid legislation. If contractual solutions to these issues are crafted, there will not be the benefit of a single set of rules that will apply to an entire portfolio transaction. Once a contractual solution is crafted, it will be negotiated. Slightly different approaches will be undertaken depending on the parties with whom the first party is contracting. The ISDA has prepared a clause for inclusion in swap master agreements, and this clause provides the benefit to the derivatives markets by providing with specificity the things that will not disrupt a contract.

ECU presents particular and specific problems. ECU is not officially a currency, but a unit of account. The ECU is not protected by any sovereign law, and it is not clear whether the principles of lex monetae will apply to a unit of account. The ECU can be defined and treated quite differently in private contracts. The market reality, however, is that, in many transactions, the ECU is treated as though it were a currency. In the European context, Regulation 235, Article 2, makes it clear that if there is a legal instrument or a contract that defines the ECU by reference to the appropriate European Court of regulation, the official ECU, it will be converted into Euros. 

If a legal instrument or contract refers to ECU without that official definition, Europe has created a presumption that it will be converted at a 1 to 1 ratio. This presumption can of course be overcome. The New York law on this technical issue takes a very similar if not an identical approach. The New York legislation establishes in the definition section that the difference between the official ECU and the private ECU is similar to those established in Europe. New York law establishes that official ECU will be converted at a 1 to 1 rate and that private ECU will be covered by the presumption that provides for conversion at a 1 to 1 rate.

In summary, Europe has adopted Article 235, which handles the ECU and translation of the ECU in a way that assures the continuity of contracts, whether the currency involved is the currency of a member state that is participating in convergence or whether it is ECU unit of count. This legislation also provides rounding rules for all conversion processes. 

In Europe, something known as the Article 109-L-4 Regulation, which is still in draft form, is being completed. This Article, which will be adopted next year, will identify the participating states. Also, it will provide provisions for how payments will be made during the three-year transition period during which participating members' currency will continue to exist but will be valued in fixed exchange rates for the Euro. It will protect netting, set up, set-off, and provides details such as printing of Euro notes and coins and details on what will be legal tender.

These two regulations should be compared from several perspectives. They have different purposes and they go into effect at different times. The Article 235 Regulation is in effect and Article 109-L-4 will become effective in the middle of 1998. These regulations differ in scope. Article 235 applies in all 15 member states, whether or not a given state is participating in convergence. Article 109-L-4 will bind only in the states participating in EMU. For example, Article 109-L-4 will not apply in England until England joins EMU. However, to the extent that one has transactions under English and transactions covered by Article 235, Article 235 is effective in England. To the extent that different concerns are covered by Article 109-L-4 and the transaction is covered by Article 109-L-4, the transaction will not be guaranteed the certainty that Article 109-L-4 provides until England joins EMU.

This is one topic on which New York took a slightly different approach. Section 5-16028 of the New York law, states that the transition period, if one has either a contract calling for the payment of French francs, either French francs or Euros can be used for payment at the party=s discretion. New York did not attempt to deal with the obligations of the recipient of that payment. One draft of the legislation provided that recipients would be obligated to take whatever currency was offered in payment. It was decided that at this time it could not be anticipated how the payment systems in Europe would work. 

There are also problems with the disappearance of price sources. The New York working group discovered a 1964 case from the 9^th Circuit, which was referred to as the Five Mills Case. In the Five Mills Case, there was a contract for the supply of plywood. The contract provided that prices would be set by reference to the average of prices set by five mills. Shortly after the contract was signed, one of the mills went bankrupt and stopped quoting prices and another of the five mills went out of business. Three mills were left to set the prices. Somewhat surprisingly, the 9th Circuit ruled that there was no longer a contract for the sale of plywood because essential pricing term no longer obligated the parties. This case provides the closest relevant U.S. precedent on this issue.

From the U.S. perspective, what will happen when there is no longer a Deutsch mark quoted out of Frankfurt or a French franc quoted out of Paris? How will Euro rates be established? Will there still be national rates? Will everyone roll over to a Euro-wide rate quoted somewhere by someone? Will Euro Eurobar or Euro libor become a standard? There is competition in this field. On October 13, 1997, the British Bankers Association put out a press release about their plans for creating Euro libor rates and Euro libor screens. One day later, the European Banking Federation and the ACI put out a similar press release about their plans for providing Euro libor rates on a Europe-wide basis. Will these successor rates, whatever becomes the market standard, be displayed on the same screen for people to be able to look at their contracts and find the same screens as their existing prices or will people have to go to new screens? How much uncertainty would these new screens create? 

ISDA has prepared a draft provision to deal with thee concerns. If it is inserted in some form in a swap master agreement, whether the swap master is governed by English or New York law, the two main alternatives in the derivatives market, some certainty will be created. Contractual provisions, however, can be difficult to draft and effectuate. Terms of the instrument cannot simply be amended. Parties in Europe are discussing multilateral solutions; perhaps all major financial institutions can enter into a protocol to try to remove uncertainties. There is discussion in Germany about legislation on this topic on redenomination and price source issues. Tomorrow, the City of London=s joint working group is meeting to discuss whether or not England needs legislation on some of these issues. Some people in London are skeptical about legislation of this nature, but it is being considered.

Retroactivity of New York Legislation.

Retroactivity of the New York legislation needs to be considered. Some observers in New York had concluded that the New York law is retroactive and only applies to contracts entered into after July 29, 1997. The New York working group prepared a memo to respond to this. First of all, the New York continuity statute is, in a fundamental sense, not retroactive at all. It neither takes away nor impairs vested rights acquired under existing law. It does affect the use of certain contractual defenses in the future. That is very different than retroactive legislation. To state that people entering into French franc and Deutsch mark transactions in 1992 had a reasonable expectation of protection against unexpected events is almost a contradiction in terms. Even if this legislation is deemed to be retroactive, one must look to the language of the law and appropriate legislation to see whether or not it is appropriately retroactive. There is New York case law indicating when the legislature says "all," it means "all," hence, all contracts should be covered. In terms of the context in which the legislature considered this law, it was provided with detailed information and legal analysis indicating the older the contract, the more serious concern. 

Under frustration of purpose and other defense doctrines to performance, because of unexpected events, foreseeability is not a dispositive element of the analysis. However, it is an important element. If the parties could have foreseen the event, then there is no need for a court to intervene and rearrange their bargain. Some commentators have stated that all this became foreseeable in 1989 when the Delore Report came out. That may not have been so obvious in the U.S. Other commentators state that this became foreseeable in 1992 when the Treaty of Maastricht was adopted. Once again, it was not so obvious in the U.S. Clearly, the New York Legislature knew very well as time went on that all of this became more foreseeable, and the Legislature decided to provide certainty for the market. The contracts, especially the oldest contracts, were of great concern. This is evident in the legislative materials. This is another example of frustration and impossibility, and not a serious issue.

John D. Howlett: The New York Mercantile Exchange (the AExchange@) is the largest physical commodity exchange in the world. Energy products, precious metals, electricity, natural gas, crude oil, energy products, heating oil and gasoline, gold, silver, copper, and metal contracts are all physically deliverable contracts. The only contract that the Exchange trades that is not physically deliverable is a stock index on European equities index called a Euro top.

There is concern that the advent of the Euro, which was brought on by EMU, will affect indexing. Data from the Bank of Ireland shows that there are 15 proposed member firms in a ten year bond yield as of May 1997. There is a 150 basis points differential. If the U.K. is removed, there will be only a 130 point differential. The U.K. probably will not initially join EMU. The Bank of Ireland has made predictions as to who will join in the first round of the EMU.

The concept of indexing, which compares active versus passive management, is a rather hot topic these days. Dr. Malkiel, a Wall Street doctor active against passive management, wrote a book on the topic, which pits active management against passive management. Dr. Malkiel=s theorizes that if a chimpanzee were to throw darts at a stock page, it would have the same success ratio as the most highly educated analyst. So the market is a zero sum gain. For every person who makes money, another person loses it. People who believe in the index theory focus on the market and not at the individual participants. An example of the type of business being transacted in these index products is provided by the American Stock Exchange on November 5, 1997, when the most actively traded issue was the spider. The spider was the Standard & Poor's depository receipt. In a pool one can buy and sell rights in the stocks, which do not change hands; one buys ownership for himself in the pool. That is an index trade. 

In the United States, Vanguard studies show that at the end of June 1997, 7 percent of the money that is in mutual funds is in index funds. Those are domestic index funds. There is another $8.8 billion that is generated from the United States that is in international funds. This could further be broken down to show how much is in European funds. The general idea is that there is money changing hands.

The concept of indexing removes the responsibility of management. Instead of having someone manage the money, there is a plan sponsor who allocates assets. The plan sponsors focus on portfolio diversity in order to lower risk. By being passive investors and focusing on portfolio diversity the plan sponsors are more active and they are managing the portfolios instead of doling out cash to money managers and hoping for the best. 

There are the leading index providers that provide European and pan European index information. The indexes are from Morgan Stanley Capital Investment International (AMSCI Int=l@). Those indexes are used by 90 to 95 percent of the U.S. money managers to benchmark their mutual fund performance. 

All of those other companies are out there sniping at MSCI Int=l in an attempt to get market shares. Out of those groups, Dow Jones and FTSE indexes are the only ones that currently calculate real time. They publish data on a minute by minute basis. The FTSE index is currently the only ECU denominated index. The Bank of Ireland has projected that of those projected entrants in 1999, almost half of them are members of the FTSE index and their stocks are in the Euro top 100. Additionally, 47 percent of the projected entrants are in the Euro top 300. Switzerland and Norway make up the balance, and they will not be part of the EMU. 

The Federation of European Stock Exchanges proposes that the preliminary exchange rates will be set for the first time in 1998. The European Central Bank (the AECB@) will hopefully be in operation at about the same time. The final rates will be set in late December of 1998. January 1, 1999 marks the beginning of the transition period. The official exchange rates will be grossly oversimplified. If the rate is set at two Euros to the Deutsch mark, something that used to cost 1 Deutsch mark is going to cost two Euros. A calculator will not be needed. Beginning on January 1, 2002, only the Euro will be valid and the other national currencies will be invalid. The Federation and European Stock Exchanges are so far recommending a Abig bang@ approach. 

On January 4, 1999, which is a Monday, all listed equity will be quoted in Euro. There will be the official exchange rates, but instead of having things on the DTB traded in Deutsch marks, they will be traded in Euro. Bonds will continue to trade in basis points, but will be settled in Euro. It has been recommended that the forwards booked for value after 1999 attempt to be booked in Euro. The anticipated results for the Federation is that because it will be a big bang, it is no different than a stock split. However, it will be a stock split of monumental proportions. Every stock on every exchange is going to split. The exchanges are supposed to be capable of providing back data adjusted for the split to any one interested. Bear in mind, the same people who will be calculating the back data will also be working on it in the year 2000 as well. 

When the stock splits, everything is going to have to be adjusted. There is a small percentage of the marketplace, the technicians, that is going to have the problem here. For all purposes, an ECU is worth 55. Technicians will experience technical difficulties. On December 31, the market will close. In Germany, a German investor who used to invest money in Deutsch marks will not be affected because it is a common factor. If an American investor invests a floating dollar, it becomes a floating Euro instead of a floating Deutsch mark. All the back data will need to be adjusted on a daily basis for where a Deutsch mark was. Forward data will need to be adjusted concerning where the dollar Euro will be trading, unless data that is published against the official Deutsch mark rate can be adjusted. Not only is there the continuation of currencies and the continuation of data and graph on the stock table, but there is going to be a lot of paper produced. Two sets of papers and charts must be kept.

So does converting the price history via the official rate corrupt the data? It depends upon who you are. Does converting the forward data to national currency present a more reliable picture? Probably. Eventually, dual data will not be necessary, but for the short term dual data is a necessity. This does not necessarily affect the commodities markets because commodities trade in dollars internationally. There is a small faction of the marketplace, including indexers, market timers, and technicians, who are going to be inconvenienced. In the grand scheme of things, this does not present another great problem. 

Filip Moerman: Problems of Convergence or Non-Convergence of Interest Rates Some challenges could arise as a result of the non-convergence, not only of interest rates, but of the economies of the member states of the European Union or convergences or divergences of political cultures. Convergence of interest rates will be a barometer to test whether EMU is going to happen. Data demonstrates the EMU and the current differences in yield among the interest rates of the European member states. Dramatic things have happened there over the past seven years, especially the past two years, that provide some examples. The spreads of the Belgium franc interest rates against the Deutsch mark have gone from 200 basis points in the beginning of the 1990's to 75 basis points in 1995 and are now in single digits. That is fairly dramatic. Economic studies that were performed on this convergence of interest rates in 1995, 1996 and 1997 are also very interesting in that they show an evolution. A professor of the University of Luven in Belgium conducted an empirical study of convergence of interest rates in 1996. His interesting conclusion was that there was an increase in convergence and growing together of the rates with maturities just past January 1, 1999, which is the starting date of EMU among the Deutsch mark, French franc and guilder. 

The ECU is not really a currency in its own right today. To date, ECU has already been used as a quasi currency, and securities that have been denominated in ECU contracts are denominated in ECU. The conclusion drawn in 1996 was that, as a result of this almost irreversible process moving towards EMU, the economies and the expectations about the fundamentals of these economies and the interest rates, which translate that of France, Germany and the Netherlands, were growing gradually together. It was an irreversible process of convergence and locking of exchange and interest rates. There was still serious doubt in the markets about whether that would be in the context of EMU or in a different fashion. At the same time, a study has been undertaken again this year by the same people, in a very recent publication of the Swedish Central Bank. Sweden has opted out of EMU. The Swedish Central bank=s empirical data are completely different and predict that EMU is going to be there. There will be 11 member states participating initially in EMU.

There are categories of benefits, expected from EMU in a broad sense. There is little debate that there will be benefits. There are people that disagree with the micro economic benefits of increased competition, elimination of foreign exchange risk, and the transparent pricing and increased efficiency of the markets in Europe. Importers dealing with the European markets will have to make these changes. People who oppose the changes are those who are going to lose in the short term. Within Europe, domestic operators or domestic businesses that are still protected, as a result of the separate currencies and the resultant lack of transparency in the market, are opposing EMU. For these people, there will be an adjustment. There will be increased efficiency in the market. They will have to compete with everyone within the European Union who is offering the same product.

Whether there will be macro economic benefits is a question. Convergence of these national economies will occur, but tensions will not disappear. The areas in which people expect these macro economic benefits basically revolve around the creation of the single market. The single market is the great plan of EMU. It was the famous 1992 plan pursuant to which the Europe Union, or European community, as it was called at the time, has enacted legislation in order to really make possible the four freedoms which are embedded in the European Treaty. These are freedoms of movement of persons, capital, goods and services. These four freedoms have been achieved in the single market. Legislation that provides for minimum standards for services and goods and protection of shareholders has been harmonized. For example, in companies throughout the European Union and in designated communities, these standards for services are recognized. That has already leveled the playing fields in Europe. The single currency will make it possible for people to compare the services and goods that are being offered in the other member states. This adds an element of competition. 

An important macro economic benefit which is definitely evident at this point is the enhanced public financed discipline. 

One of the primary objectives of EMU is price stability. In order to get to price stability, the member states have already been required to balance their budgets and to act in a way that achieves organization of public finances and eliminates excessive budget deficits. In general, the most important of the member states are urged to get their national debt below 60 percent of gross national product and to get annual budget deficit below 3 percent. Many states which otherwise would not have had an inclination to do that have had to get their act together. 

Some of the European countries have absolutely dramatic public sector finances and they have been working hard in order to get these convergence criteria satisfied. For example, this year Belgium decreased from a public sector debt of more than 135 percent of the gross national product to roughly 125 percent. That percentage of public sector debt is still a high figure and a distance away from the 60 percent which is required for convergence. Still, at the rate at which the Belgium public finances are being run, there is a gradual and steady diminishment of the public sector debt. The Netherlands is far better and has stimulated EMU. Since the late 1980's, the Netherlands has dramatically reversed its economic posture and is now a country which is a model in Europe concerning public sector finance. The benefits of that reversal are visible in other areas such as employment, where prospects are much better than in most of the other European countries.

Another area of economic benefit is the broadening of the European capital market. As a result of the completely open capital markets among the participating states in EMU, issuers of securities will be able to tap the complete market. They will no longer have to look solely to their respective countries for the issuance of their securities. Perhaps in the U.S., the point is not so obvious because in the U.S. there is an established culture for issuing debt securities. In most of the European countries, the private, corporate debt sector is fairly small. It is only the blue chips that go out on the Euro market or even on the U.S. market to register offerings in the United States. 

The vast majority of European companies are medium to medium-large companies. Those companies that do not have a tradition of issuing securities will find it easier in the settlement of EMU to issue securities. This will be due to increased transparency and efficiency of the market and the convergence of interest rates. As a result of the broad market, there will be increased liquidity within the capital markets and an avoidance of liquidity discounts. Liquidity discounts will be calculated in interest rates in the different national countries. In addition, the Euro itself, which is going to be a benchmark for interest rates, is expected to have a much lower interest rate than the individual components. This is already set in motion as a result of the process of convergence. This process of convergence has reduced interest rates dramatically in Europe. The private issuers will have the substantial benefit of the dramatically reduced interest rates. A 1 percent of reduction of interest rate will benefit the national debt of a country and the corporate issuer of securities. 

The last benefit expected from EMU is a debatable one. Euro contemplates European political integration. EMU could be the Trojan horse in Europe for the introduction of political union, and that is, of course, a totally different question. 

EMU has been described as an adventure and a necessity to achieve micro and macro economic benefits. The main area of challenge will be the area of fiscal discipline. Member states will use foreign exchange policy and monetary policy to the extent they have been able to do now to cope with economic disequilibria. They will have to rely exclusively on fiscal policy in order to get there. Fiscal policy needs to be implemented to maintain the fiscal conservatism orthodoxy in the future; there is a need to work without excessive public sector deficits. That will undoubtedly put a great strain on the economies of certain member states who will no longer be able to utilize competitive devaluations as they have in the past in order to enhance the competitiveness of their national economy. These are circumstances where certain member states have priced themselves out of the market as a result of unduly appreciated courtesies, the rigidities of labor markets, and high salary levels in existence in some of the countries. 

The stability factor is going to put strains on this system. For example, the difference between the United States, which is also like a huge single currency zone, and Europe, is that in Europe there is not the kind of labor mobility that there is in the U.S. Labor mobility is an important mechanism. Undoubtedly, Europe does not consist of cultures where significant unemployment in one member state results in the free movement of capital where there is relegation of industrial development from one member state to another. There are examples of companies closing down in one member state to set up shop in another member state. However, the labor force in Europe does not follow. Due to differences in language and culture, people just simply do not move. If an industrial investment is relocated from France to Portugal, the French labor force will not follow. Nor do employers or investors who conduct the relocation expect them to move.

In Germany, the Constitutional Supreme Court has indicated that Germans would have standing to bring suits in the German court system if EMU is enacted or implemented in a way which is not in conformity with the provisions that are in the treaty. 

In May of 1998, when the decision is made to go forward with EMU, notwithstanding a lack of convergence between the economies of member states and a lack of fiscal discipline in member states that fail to satisfy the convergence requirements, there is a possibility a German import action could arise challenging the transition to monetary union. The tensions arising from the monetary union could have repercussions beyond Europe. European member states participating in EMU will be irrevocably locked together in terms of economic and monetary policies. If these states experience these kinds of economic disequilibria, such as difficulties and shocks at the level of individual member states, this can be projected outside Europe if the states fail to negotiate a solution such as subsidy transfers. There would be a call for increased protectionism. 

One author, Martin Felstein, indicated in the last issue of Foreign Affairs, that this economic disequilibrium would be a factor of destabilization in the world. It could result in the externalization of economic problems in European member states. 

It is necessary to review how instruments will be utilized in achieving monetary union. In brief, the starting date for economic and monetary union is January 1, 1998. That is the magical date on which the individual currencies will become one. As a result of Euro, the exchange rates of those currencies will be irrevocably fixed. To determine who is going to participate in Euro, the European Treaty, which is like the constitution of the European union, provides that in the next year, a decision will need to be made to determine which member states will participate in Euro. The test for that is going to be convergence criteria. First, the member states must get their national debts below 60 percent of the gross national product and get their annual budget deficits below 3 percent. There is a certain flexibility in that member states that can demonstrate that they are steadily diminishing their public sector deficits could be admitted to the Euro with the expectation that these states will reduce their deficits. Belgium has difficulty on the debt side, but is doing well on the deficit side. Some other members states have greater difficulty meeting the deficit benchmark. There is a certain flexibility, and it is expected that about eleven member states are going to meet that test. 

There are a number of other requirements which have been fulfilled by most of the member states. There is a requirement that inflation rates in participating member states shall not be worse than 150 base points over the three best states. Again, the core member states have no problem meeting the requirement due to hard work and getting this convergence down. The requirement has triggered actions in the member states over the past three or four years that have proven very successful. Another requirement is that member states establish independent central banks to maintain price stability, the primary objective of the European Monetary Union. Independent central banks are necessary to ensure that monetary policy is independent. This is addition to a European Central Bank (AECB@). Finally, the long-term interest rates in the member states should not exceed 200 base points from the three best member states. This test has been met. The United Kingdom, at the time of the negotiation of the Maastricht Treaty, had opted out, but retained the right to opt in to EMU. Denmark, subsequent to the Maastricht Treaty, held its referendum, which was not successful to the surprise of the other member states. As a result, Denmark obtained a protocol and basically opted out. 

The test of the European treaty will occur when the European institutions decide next year who is going to be in. The European treaty does not provide for this - It will be decided by the European institutions. Notwithstanding this, Sweden has decided to opt out and has not filed with the European Union. It does not want to take part in the process. Greece does not meet the test. So, in May of 1998, the member states and the European Council will decide who is going to participate in monetary union. January 1, 1999, marks the date when the exchange rates will be irrevocably fixed. That is the date when the Euro is really going to take effect. It will be a seamless transition.

So proper legal instruments, the treaty, and various regulations provide that there will be a transition of ECU into Euro with maintenance of external value. Euro will have from day one the value which the ECU had the day before. At the same time, there is a provision which states that the composition of the ECU, which is now a basket currency, will be composed of a certain number of French francs, a certain number of Deutsch marks, and that proposition is not going to change. The seamless transition is left to the markets. There is, however, a difficulty. The markets normally found currency in terms of the fundamentals of the currency. After January 1, 1999, fundamentals of the individual component currencies will not will not be in existence anymore. These currencies will discontinue to exist as separate currencies. So the European institutions have decided, on the advice of the economic world, that the political world has to give an indication of what is going to happen. That is, in May 1998, the European Union will indicate the exchange rates for the transition into Euro. 

As a result of the criteria there is a problem with the continuity. Euro has to be the continuation of ECU. At the same time, there has to be maintenance of the composition of the basket. If the member states give an indication of the exchange rates, the market cannot play anymore. That would mean the ECU, which exists on the minus 1, is not necessarily corresponding to the reconstructed ECU which would result from the exchange rates which the member states would have indicated. The expectation is that the European system of Central Banks (AESCB@) of participating member states are basically stronger. The ESCB could impose its will upon the markets and avoid existing arbitrage. There may be speculation against the decision that the markets would not agree with the ins and the outs decided by the European institutions. Markets might not agree with the exchange rates which have been extrapolated by the European Council. It is possible that some operators would unfairly benefit by knowing where the markets and politics are heading in reference to Euro. 

The second half of 1998 will be critical in determining whether the market trusts EMU and whether the seamless transition transpires. The basic instrument for really having EMU take effect in Europe on January 1, 1999 is the famous Article 235 Regulation that has been already been adopted. This ensures that will be a seamless transition of ECU into Euro. 

Article 235 is the instrument Europe has adopted to cope with the continuity of contract problem. The perspective in Europe on the problem of continuity was initially different from that in other parts of the world. Most continental European countries have a theory of non-monolism. Each country is sovereign and establishes its currency and legal tender, and has a right to challenge that legal tender. As a result thereof, contracts that are expressed in changing currencies automatically carry over into the new currencies. The member states enact legislation that makes the continuity of contracts clear. This is despite that in certain countries, this legislation is arguably unnecessary. These ideas establish the principle of continuity enacted in the Article 235 regulation. 

The other regulation is Article 109-L-4. Article 109-L-4 is the Article of the European Council (AEC@) Treaty that describes what happens on January 1, 1999. There is a draft regulation which has been published in the form of a resolution by the EC. This regulation was promulgated in order to make sure that the business individuals know what will happen on January 1, 1999. This regulation applies only to the member states that participate in EMU. It deals, in particular, with the transition phase. EMU is going to be fully implemented in the course of two and a half years. During the first two years, 1999 and 2000, Euro and the member states will have co-existing currencies which will not be currencies in their own right. The member states= currencies will be irrevocably locked into Euro, as denominations of the Euro. The regulation provides that during the transition stage, obligations expressed in Euro or a domestic currency within member states have to be discharged by a bank transfer either in one currency or the other. In cross-border bank transfers, if there is a bank transfer involved, obligations expressed in Euro or in the currency of the recipient country can be discharged either in Euro or in the currency of the recipient country. For all other purposes, during the transition phase, there will be neither compulsions nor prohibitions. The operators are free to express their contracts as they wish. The other possibility is to press these transactions in Euro. In which case, the transactions have to be performed in Euro or the old currencies. In that case, they will have to be performed in old currencies. In the end, the old currencies, even if they are still technically legal tender, are not a currency anymore. They are an emanation, a presentation of the Euro.

The third instrument to highlights that there is a resolution regarding the exchange rate mechanism as it exists after Euro takes effect. Indeed right now, in the EC, there is an exchange rate mechanism which establishes a system of bilateral grid of the currencies of the individual member states around the system of the ECU. Presently, the member state currencies fluctuate within a bound around these bilateral grids. On January 1, 1999, there will be an irrevocable fixing of exchange rates of the currency. Of course, that system does not have any meaning among the currencies that participate in economic and monetary union. But the EC has determined that it is necessary to have a replacement system that would implement the out countries because the expectation is that the out countries will join at a later stage. These out countries could fluctuate around the new currencies. Instead of having the system where there is a matrix of lateral exchange rates, there will be a spoke system. The out countries that want to participate, Sweden, Denmark, the U.K., and Greece, in the exchange rate mechanism on a voluntary basis can do so. They will attempt to stay within a margin of 15 percent around the Euro. The system will provide an intervention at the margins. It will provide a 50 percent fluctuation range around the Euro by the ESCB and the member states marks. There is the possibility of the withdrawal of ESCB support.

Article 1056 of the EC Treaty provides in the context of EMU, that the counsel of the EC can decide unanimously that the ECB shall also discharge functions of prudential supervision of financial systems other than insurance firms. This is a somewhat radical and new development because the EC has not been involved thus far in the regulatory supervision of businesses. The EC is in charge of antitrust law and antidumping law. Given the stimulus for harmonizing legislation in the area of prudential supervision of banks, investment firms, and broker/dealers, the EC will embark in this new realm of supervision. The old national banks of the countries will assist in that supervision, and that is something radically new. In the majority of member states, the central banks are not even the lead regulators. The ECB could also establish reserve requirements, which is something that does not exist in some of the member states.

Post EMU, monetary problems could arise whereby there would be the nonconvergence or divergence of interest rates. Currently, the member states for their sovereign issues have a zero risk as long as they issue debt in their national currency. For example, issues of the Belgian franc by the Belgium government have a zero risk since they issue in Belgian francs and Belgium could simply issue Belgian francs. When there is a centralized system where member states are really going to issue a currency which they no longer control, the expectation that the sovereign issues of one member state compares to that of the other member state does not have the same quality in terms of risk. There is going to be a difference in interest rates that could result in arbitrage. It is clear that the quality of one issue will be better than the quality of the other issue. There will probably be a benchmark, a central Euro rate, provided by some of the operators such as the European Investment Bank (AEIB@). These operators are positioning themselves to become benchmark issuers. These benchmark rates are probably going to be lower than what would be the average of the interest rates that have existed historically, or at least in the past ten years in Europe. 

Tensions could arise after the advent of the EMU. The legal instruments that the Treaty creates do not address that possibility. There is no out from EMU provided in the Treaty, but some scenarios have been described where a member state could not go along and would have to issue its own currency. Of course, a country that would start issuing its own currency again would have to implement legislation. That is something totally unforeseeable. 

Patrick Poncelet: The Euro is going to have a dramatic effect on the banking world and cross-border currency transfers. SWIFT is a bank-owned corporation, which is owned by 6,000 banks that are part of the banking networks in 160 countries. SWIFT was founded in the early 1970' and was formed to replace telex at that time. SWIFT is the computer of the banking world. Everyday, it achieves the transfer over the network of about 3.5 million interbuying messages not only of payments, but any kind of bank transactions. SWIFT is based in Brussels. Every SWIFT transfer is encrypted on the network, but SWIFT transfers a flow over the network of about $3 trillion a day. That is why SWIFT has to be very secure. Security is the highest priority on the network. Banks have a European standard for slides, but SWIFT has to shift around. 

Banks are in the money business and money is a bank=s raw material. If this raw material all of a sudden changes or is substituted by another good, then there is bound to be a change in the end products which the banks deliver and in the way the end product is delivered. EMU and Euro are basically accelerating and accentuating more fundamental structural changes which would have taken place in the banking industry anyway. These changes have been taking place since the early 1990's, but with EMU, this process has been accelerated tremendously. There will be increased competition not only among banks, but also non-banks will compete with the banks. Consolidation among banks might result in as few as three to five global payment systems players. Consolidation among markets and marketplaces will take place in Europe. The major financial centers have really started to compete in the payment area. New market infrastructures, such as TARGET, Euro clearing, and new delivery channels and financial instruments, are appearing and will appear with the Euro. Of course, accent on risk management, netting and multilateral schemes are around. Payment formality through systems are being accelerated by the Euro. 

The impact of the Euro on banks will not really happen until January of 1999. Banking changes and market practices will change slowly. Second, and more importantly, there will be a lack of legal harmonization within the European countries which will remain for some time. The more negative impacts of this disharmony will unfortunately affect the banking world before the longer term positive impacts will affect the banking world. FX transactions and related high scale payments will be hit first. The intra-Europe crosses and effects will disappear, and that represents 13% for global X market and related payments. There will be a loss of income from currency trading which the consulting group has evaluated at 5 million U.S. dollars between 1999 and 2004. Fortunately, the other types of transactions, customer payments, trade services, money market, securities, will be neutral initially, but then increase. Especially if the Euro fulfills its promise of becoming global for trading, investments and commerce, there will be a positive effect on the use of the Euro and its prominence in cross-border transfers. 

The Euro is not simply a new currency, which is introduced, for example, when a new country appears, and that has occurred in Eastern Europe and in high inflation countries, where the old valid currency is replaced by a new currency. From a systems point of view, the Euro will be fungible with the old currencies, at least during the three year transition period. The currencies will be basically interchangeable during that period. The old currency will be denominated in the Euro. This concept is a problem from a bank=s point of view. For example, the duality will mean that there will be a need to transport a payment instruction in two currencies. This is because the no rule, which means no compulsion and no provision, will enable the use either of the two currencies during the transition period. That, for the bank, is a major system problem.

Cross-border transfers will be impacted by EMU. There are three main drivers of changes in payments. First, payments are always expressions of underlying transactions. Payments will evolve. Initially, there will be a decrease in the overall volume of high volume payments (AHVP@) because of increased FX. There will be a small shift in cross-border transfers with EMU.

These payments are on markets. The key banking market is called wholesale market FX. When the number of payments decrease, there is a shift on cross-border transfers, the number of payments decrease, or there are no more domestic currencies, there will be an impact. Any market maker, investor, or trader in FX will be able to trade anywhere in Europe. The money markets should be stable markets. Again, shift to cross-border and there will be a concentration. In securities, there will be a big increase of cross-border transfers. Capital markets will be affected as well. A place where the single currency will probably bring in an enormous amount of new transactions is capital markets. Concentration everywhere, even on the systems, the exchanges, and the clearing systems, will increase. On trade services, there is normally an increase in transactions. On the retail side, there is already free flow of capital and people. This is an area where there should only be a small increase and shift across the border.

Capital markets is the area within banking which will most evolve due to the Euro. The European capital markets are very fragmented, isolated, and domestic. All of a sudden, there is going to be, for the first time, a European capital market that compares to the United States=. This means big market competition and concentration. It is questionable as to how many stock exchanges in Europe will survive. There will be new investment behavior. Pension funds will be able to invest abroad. Currency risks will disappear. Many instruments today are driven by lack of an existent currency rate. Cross-border links for trading of equities will be created. 

Today there is a big puzzle over how many infrastructures are necessary. There will be the imposition of many infrastructures. There will be a Euro-based treasury from the part of the corporation. There will an expansion of what can be termed the wall of money. Especially with the privatization going on in Europe and the deregulation of the capital markets. There has to be harmonization of procedures, pricing, rate fixing and bench marking. Corresponding banking should be impacted. All banks, not only within Europe, but also outside, will need to review the market strategy and articulate their value proposition to new TARGET market. EMU will accelerate changes. There will be a big concentration of business relationships. Mutual accounts that exist today because of different currencies will not make sense tomorrow. The traditional role of reciprocity will evolve. Tomorrow both parties are in Euros. The one small bank will have to close its account, and the bigger bank will keep growing. Today, one needs an account with every single country in Europe. Tomorrow, all but one of the accounts can be closed. That would be a gateway for Euroism.

There is immense competition among banks to position themselves as a Euro clearer. It will be very similar to the competition that goes on among New York banks in the United States. This is going to be a big battlefield for the banks. 

For the customers, this is good news. Concentration of business will bring efficiency of transaction and lower costs in banking. There will be a few global banks for Pan-European payments, but the true European banks today are not European. Others will enter into partnerships to survive in that market or just decide to leave the market. Corresponding banking is not dead because it is needed for other services like customers= trading activities.

The third driver in the payment landscape concerns the developments in inter-bank payments within European countries.

The starting point will be new customer requirements. After all, the customers still drive the process. In the end, customer requirements will be convenience, lower price, certainty of payment, and the end of integratability. When payments have to be transferred from one country to the other, there would be TARGET, domestic clearing systems, Euro netting, and regional correspondent banking. Some banks will have their own networks and interlinking of automated clearing houses (AACHS@). 

European ACH's and the project of linking them together presents limiting features. ACH=s probably will not be in the game of cross-border transfers. ACH's as they exist today in the various European countries have to first deal with a variety of payment instruments. In some countries, ACH=s use direct debits or transfers or electronic drafts. They are all under different legal structures. They have poor capabilities for remittance information. Sometimes ACH=s can only carry 16 or 30 characters. Some ACH=s are government-issued and some are private. In the European banking world, Europe is vastly over banked. Some market studies predict a 25 percent decrease in the number of banks in the next ten years. Channels will divide between themselves the cake of European cross-border payments. 

How is it that banks will move funds cross-border? Banks will move the funds through the five channels. The first channel is correspondent banking. Corresponding banking will lose a big part of its present business because if one is in the same currency, there is no real reason to use two banks. TARGET is a new channel that interlinks European central banks. With the European central banks as links, commercial banks could use that channel. This could be quite effective, because funds would be transferred in real time. 

The third channel is chips and it will be a winner. Europe does not have chips. Europe has an ECU netting system. The Euro Clearing Banking Association (the AECBA@) is made up of the major banks in Europe, the United States, and Japan. The ECBA wants to set up what they call a European system of real time or netting that they will connect directly to the big players in the ECBA system. All big payments in Euro would go through that system. It will be very efficient and can be located anywhere in Europe. The system is in Brussels today, but it could be anywhere in Europe. Basically, banks will be connected to that system. This system will prevail.

Channel four is the dominance of the one domestic system. More than one country in Europe thinks its domestic system is the best. Countries assert most banks have a branch in their jurisdictions. A country will assert that it is a big market for equities, securities, or FX, and that it offers a very efficient local system. Those who live outside of a country=s borders can avail themselves of remote access to that country=s banks; that is a directive of the EC. The interesting point here is that there are central bankers here. These domestic banks are often operated by central banks. This is the first time where central banks will be competing with each other for payments. The Euro CHIPS, the U.K. system, the German system, and Spanish system, all came to SWIFT seeking assistance in creating the most efficient systems. Interestingly, these domestic systems compete with TARGET, the system set out up by the central banks to interlink domestic systems. 

The fifth channel is the three to five global banks. These banks have branches in every European country. The global banks will claim that they can ensure that their customers= payments are transferred most efficiently. How the business is going to be divided is still a question. It is extremely unlikely that each of the five channels will receive an equal share of the 

business.

The first objective is to implement the Trans-European Automatic Real Time Gross Settlement Express Transsytem (TARGET). TARGET is the interlinking network of the European central banks. It is a new channel and corresponds to federal wiring. The European central banks act as links, and commercial banks can use them as a channel. That could be quite effective because funds will be transferred in real time. TARGET has two objectives. The first objective is to serve the needs of a single monetary policy. This objective reduces systematic risk and improves efficiency. This objective is real time. Commercial bank assert that systems are already efficient, and that this system is not needed. TARGET is a decentralized system of the Bundes Bank model. It is composed of three parts: the domestic part, the RTGS systems of each of the 15 countries, and interlinking. Each member must have RTGS systems in place by January 1, 1999. They must have not only common procedures, but also common pricing. The third part is that the banks need to be interlinked. They need a net. They have chosen SWIFT for that net. For the first time, a domestic payments systems will be used for two purposes. First, the domestic payment system will continue to clear local payments. Second, it will have a cross border function. But, it is not a monopoly. The central banks said that TARGET is not needed.

Only central banks are part of TARGET, because all the commercial banks are basically linked to their domestic systems. 

If these banks want to send payments to another country, they send them to their central banks, just as they would do for domestic banking. Conversion takes place in SWIFT format and it then goes into the interlinking systems. The central bank of the issuing country debits, and then the commercial bank credits the central bank of the receiving country which in turn credits the commercial bank. This can be done in a matter of minutes. This is a good system that is needed only for the very high, urgent payments where instant finality is a necessity. The Euro clearing is going to be a private system owned by EBA. Today, 49 banks take part in EBA, but it will open up to more banks. These banks are going to exchange payments, and these payments will be basically sent to a netting computer on the slide which will do real time netting. It will have limit monitoring and is risk secured system. Payment will not go through passes and there are a number of limits. The amount at the end of the day, and the net positions are reported back to the clearing banks, and then the clearing banks will settle these net positions through TARGET. 

The EBA will hold an account with the ECB in the same way chips hold an account with Fed wire. So the banks in the net debit position first pay into the Euro clearing account, and then the Euro clearing account pays out to the banks with a credit position. This will also be efficient. Here, there is not instant finality. Funds are really final at the end of the day. The central banks state that it is not as secure as RTGS. However, how often does a customer need to know that the funds are final the minute that they are. For most customers, it sufficient to know at the end of the day that the funds will be final. Again, this is a secure system with many collateral agreements. This is new and happening solely because of Euro.

There are a few practical issues that need to be dealt with. There is the need to transport to two currencies. Currency is the wrong word. Two denominations of the same currency during this transition period need to be transported, which creates extra work for all the banks. Transactions in national currencies are still possible. The Euro is already used in the markets. At least Euro will be used starting in May of 1998. Traders, speculators, and hedgers will use the Euro. For example, the Euro code, Euro currency, is already usable on SWIFT. There are already some messages referring to the Euro on SWIFT. Payments cannot be made in Euro at this point because Euro cannot be settled. Messages in Euro will be transmitted, but SWIFT will stop any Euro messages that have a settlement date in Euro prior to January 1, 1999. There is no question as to which system the banks will use. On the technical side, when one releases a payment, he must state to which channel he wants it to go on. The technical solution for that provides that there will be a commercial choice on the parts of the banks. Customers will have to determine the criteria for the commercial choice. The amount, urgency, and efficiency of the system will drive the customers= choices. To summarize, the impact of the Euro on cross-border currencies will effect a drop in current volumes.

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