Using hedges, such as credit default swaps, US banks have reduced their net exposure to troubled eurozone countries. But they are also engaged in more work behind the scenes to ensure that if a country leaves the eurozone they will not have to receive payments in a devalued drachma or peseta.The eurozone continues to be the predominant concern of US bank executives, ahead of the faltering US recovery. Last summer the worsening of the eurozone crisis produced wild swings in US banks’ stock prices and led the Securities and Exchange Commission to demand they provide more disclosure of assets in Spain, Greece, Italy, Ireland and Portugal.
An analysis of regulatory filings since then shows JPMorgan Chase, Bank of America, Citigroup, Morgan Stanley and Goldman Sachs have generally trimmed their exposure but the picture is not uniform.
No bank has dramatically adjusted its exposure to the five countries, betting that gross positions, which range from $5.4bn at Morgan Stanley to more than $20bn at JPMorgan Chase, are manageable.
But machinations in the eurozone continue to feed back to US banks. Last week the speculation on whether Mario Draghi, European Central Bank president, would take more aggressive action to tackle the crisis produced further gyrations in US stock prices.
One senior Wall Street executive said his bank was approaching derivatives counterparties to say: “‘We’ve got this contract, it’s in euros, what I want to know is in the event that Spain were to be redenominated are we going to end up being adversaries on this or can we just agree that this is a euro contact? Let’s just move it to London law so we each agree that we know where we stand.’
“If they don’t … when that contract matures there’s not going to be any roll-over.”
Most derivatives contracts already use law for English or New York courts which, lawyers and bankers believe, are likely to insist that a counterparty from a country that has left the euro continues to make payments in euros rather than with a devalued new currency.
A trader heading a eurozone crisis unit at another US bank said counterparties were being told to use collateral that could not suddenly switch from the euro to a new currency.
“You can make sure you post collateral that has less redenomination risk,” he said.
Investors are not only having to deal with banks’ preparations for a eurozone break-up but make their own. Some hedge funds have stopped trading with Greek counterparties.
Securities linked to corporate issuers and denominated in euros should still have enforceable contracts while the euro still exists, said one hedge fund chief financial officer. For government debt, it becomes a matter of “unenforceability”, he said.