Wednesday, May 30, 2012 Stamford, CT USA — As governments, investors and companies scramble to prepare for the chaos that could arise from a Greek exit from the euro zone, it is interesting to note that few seem at all concerned about how global foreign exchange markets would function amid a sudden breakup of one of the world's major currencies. The reason: The global FX market is perhaps the most liquid, robust and well-functioning market on the planet.
Despite that fact, an event of this magnitude will have a real effect on market volumes, practices and possibly even functionality. Bear in mind: Governments and market participants spent the better part of a decade preparing themselves and their systems for the introduction of the euro. Since a Greek government determined to exit the euro would have every incentive to cut the cord as quickly as possible to stem capital flight, what was built over the course of years could split essentially overnight.
In a new white paper entitled, "The Impact of the Greece Crisis on Global FX Markets," Greenwich Associates analyzes trading data compiled from its annual foreign exchange studies from a 13-year period and offers the following projections and conclusions:
- Due to recent efforts by the EU, the ECB, national governments, companies, and investors — and to the longer-term evolution of FX into perhaps the world's most liquid and resilient marketplace — a euro breakup is unlikely to materially disrupt the normal functioning of global foreign exchange trading.
- The exit of Greece and/or one or more "periphery countries" from the euro zone would likely produce a temporary spike in trading volumes as markets react and adjust. Greenwich Associates estimates that volume spikes during the ensuing months after an announced Greek exit would inflate global foreign exchange trading volumes for the following year by approximately 7.5% and by roughly 5.5% in subsequent years.
- Despite these increases, overall trading activity would likely normalize in relatively short order, leaving the market to revert to recent historic growth rates within a span of less than five years. It is important to remember that, although any split in the euro would represent a historic event that would create massive, temporary shifts in global FX trading, the drachma accounted for only 0.6% of pre-euro European FX volumes and 0.5% of global volumes.
- Based on Greenwich Associates projections, a more extreme event involving a wider breakup of the euro zone would inflate global foreign exchange trading volumes by 25% in the ensuing year. Trading volumes in subsequent years would be affected by the moderating influences of potential decreases in market liquidity, a slow-down in global commerce and potential disruptions in global bond issuance.
The Benefits of Time
Although European Union leaders have been widely criticized for "kicking the can," their attempts to engineer a solution to the simmering sovereign debt crisis have not been without benefit. To the contrary, they provided markets, countries, banks, and investors invaluable time to prepare for a Greek default and/or exit from the euro that seems increasingly likely.
ECB liquidity provision — which took many observers by surprise in terms of both its timing and its size — has been the crucial lifeline for Europe this year. Regulators have also forced banks to deleverage and boost capital reserves through the ongoing implementation of Basel III. In addition, by holding off a disorderly Greek default to this point, Europe's political leaders have given the region's banks time to directly take down exposures to periphery debt — although these exposures remain in cases dangerously large. All of these steps have made Europe's banking system more robust in the face of a possible default than it was just a year ago. By achieving this important goal, the EU has greatly reduced the risks of the one event that could pose a real risk to the proper functioning of foreign exchange markets — widespread bank failures.
More broadly, these efforts have given Europe time to plan for a euro zone exit by Greece if and when the time comes. Companies and investors should take advantage of this window to likewise prepare for an exit — be it orderly or disorderly. Investors and companies are asking banks for advice on how to protect themselves, and major banks themselves along with the interbank settlement system, CLS Bank International, are very quietly making plans to update systems and guide clients through any change in the composition of the euro zone.
Greenwich Associates Projections
The analysis presented in the new white paper is based in part on Greenwich Associates extensive historic database. Greenwich Associates has been conducting its annual Global Foreign Exchange Services Study since 1987. As part of that Study, Greenwich Associates interviews thousands of the largest and most important financial and corporate FX market participants every year, asking them about trading volumes, product use, dealer relationships and many other important topics. The data compiled from these interviews comprise a set of data that allows us to bring a unique perspective to this discussion. In particular, we can look at elements of the FX market as they existed before the creation of the euro, compare these data with those of the contemporary foreign exchange market, and then use the results of this analysis to inform our estimates of what the market might look like in the wake of any meaningful transformation of the euro zone.