Navigating Europe’s minefield - Scott Appleton

Greece’s plight has highlighted the crisis in democracy, the eurozone and the financial system. The position of Europe’s bigger but no less beleaguered economies looks precarious, too. IBA Global Insight assesses the way ahead.

New Democracy’s emergence as the largest single party in the Greek general election on 17 June was hailed not only as a victory for Greece’s conservatives, but also for the stability of the European Union (EU) and business confidence right across the eurozone. The country’s second general election in little more than a month, it was considered a test of Greece’s commitment to a painful economic austerity programme, the terms of its €110bn bailout by the EU and International Monetary Fund (IMF), and ultimately its membership of the euro.

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The predicted collapse of the Greek economy and a forced return to the pre-euro currency may have been avoided, but the euphoria was short-lived. Concerns over the stability of the Spanish banking system, Italian bond yields and the Cypriot economy, have raised fresh doubts about a consistent European economic recovery almost five years after the onset of the global financial downturn – uncertainty that is inevitably impacting on business confidence and strategic planning.

Anxiety over the cohesion of the eurozone, levels of sovereign debt, and a lack of liquidity among European banks, mean that those companies that can are stockpiling cash and looking to restructure away from the most volatile European markets. There is an ongoing drive to mitigate currency risks, and for greater contingency planning, including potentially the exit of a Member State from the euro.

‘In many respects there has been an enforced pause in decision-making imposed on companies – chief executives are now extremely risk averse – but we are seeing new types of investors emerging, including distressed investment and alternative capital funds, while in some sectors major developments are still occurring,’ says Iñaki Gabilondo, Managing Partner of Freshfields Bruckhaus Deringer in Madrid.

The international media coverage of events in Greece, Spain and elsewhere, suggests business confidence is at a record low, but in truth the situation is not so black and white, he insists. ‘Companies are certainly questioning what events across the eurozone mean for them, and many businesses are facing obvious challenges, but others are adapting to the new more uncertain environment.’

Get out quick
Post-election, Greece may be more likely to keep the euro but it is the collective inability of European leaders and regulators to find a coherent way out of the crisis that has to date proved so unsettling for businesses. ‘Parties considering transactions are going into them with their eyes open much wider, deals are taking much longer, and are vulnerable almost up until completion,’ says Freek Jonkhart, Partner with Loyens & Loeff in Rotterdam and Senior Vice-Chair of the IBA’s European Regional Forum. ‘Businesses are also looking more closely at how their revenues are generated, and any potential liabilities or risks, and this includes trying to understand the implication of events at home and abroad.’


‘There has been an enforced pause in decision-making imposed on companies… but we are seeing new types of investors emerging, including distressed investment and alternative capital funds’
Iñaki Gabilondo
Freshfields Bruchkhaus Deringer, Madrid

Businesses more than ever want to know what the options are if something goes wrong, agrees Pedro Siza Vieira, Managing Partner of Linklaters in Lisbon. ‘People are looking more closely at currency risks, potential drops in asset values and payment obligations – including how an agreement might work in a non-euro situation; can things be re-negotiated, re-denominated or even negated?’

Portugal formally requested a €78bn bailout from the Troika – the EU, European Central Bank (ECB) and IMF – in April 2011, under the terms of which the government has embarked upon a major privatisation process, regulatory reform and a cost-cutting programme – all of which have impacted significantly on business confidence. The Memorandum of Understanding outlining the terms of the bailout included new capital adequacy rules obliging Portuguese banks to raise their core Tier 1 ratios to ten per cent by the end of 2012. As institutions have sought to rebuild their own finances there has been a virtual stop in corporate lending, as well as subtle but significant changes to the structure of the banking sector, including of foreign banks’ local operations.

‘Financial institutions are looking very closely at their structures in response to both the downturn and changing regulatory situation. For domestic Portuguese banks this has meant a much greater focus on redefining their core operations as well as closer management of their international liabilities. For international banks, the trend has been towards placing greater reliance – from a regulatory standpoint – on their home operations,’ says Pedro Cassianos, Head of Banking and Finance at Lisbon’s Vieira de Almeida.

Indicative is the firm’s work advising Germany’s Deutsche Bank on the conversion of its Portuguese subsidiary, Deutsche Bank Portugal, into a branch of the German parent, thus reducing its local regulatory exposure while drawing on a stronger capital base. Spain’s Banco Santander has similarly written down €600m in goodwill on its Portuguese subsidiary Santander Totta. 

What goes for Portugal goes for other European economies. The uncertainty surrounding the economic direction of Greece, including its membership of the euro, has seen businesses pulling back from the country. ‘Greece is no longer a major consideration for most German businesses. It only accounts for around four per cent of German trade and in many respects the major banks and insurance companies have already either reduced their exposure to Greek debt, or already factored it in to their decision-making,’ says Jörg Menzer, Managing Partner of Germany-based Noerr in Bucharest, and Vice-Chair of the IBA’s European Regional Forum Committee.

‘There is much more worry, in this respect, about what might happen in Spain or Italy, which are significantly bigger economies and trading partners. The potential impact of structural problems in either of these will have a very much greater impact across Europe as a whole.’

Safe as houses!
Spain is however now in the eye of the economic storm. In mid-June the government of Mariano Rajoy formally requested an EU bailout of up to €100bn to stabilise the banking sector, heavily exposed to the collapse of the country’s real estate market.

‘Recapitalising the banks has long been regarded as key to Spain’s economic recovery. The question has been however, where will the money come from? Despite some attempts to access the capital markets they have on the whole proved insufficiently liquid, while rising regulatory demands have also brought significant challenges,’ says Gabilondo at Freshfields.

Since the bursting of Spain’s real estate bubble in 2008 there has been a dramatic consolidation of the country’s savings banks (cajas), reducing numbers from 45 to around ten – mergers providing comfort in greater size and geographic diversification. A number of the largest cajas have also taken advantage of new rules enabling them to restructure as publicly-listed entities.

This consolidation process has been encouraged by the creation of a dedicated government fund to cover finance gaps – the Fund for the Orderly Restructuring of Banks (FROB) – and the imposition of capital adequacy demands now set at ten per cent. In January, Spain’s Minister for the Economy also requested that the banks collectively set aside an additional €50bn to safeguard against rising real estate loan defaults, new rules have also since been introduced obliging institutions to divest more non-core assets – while previously banks had swapped debt for equity in debtor businesses, now they are being forced to sell such holdings.

‘The banks’ difficulties are in part caused by an economic and regulatory situation that has changed so much over the last year that they simply cannot operate in the same way as before. New regulation is impacting on liquidity levels and limiting the ability of many to maintain their day-to-day operations,’ says Gabilondo.


‘Parties considering transactions are going into them with their eyes open much wider, deals are taking much longer, and are vulnerable almost up until completion’
Freek Jonkhart
Loyens & Loeff, Rotterdam; Senior Vice-Chair,
IBA European Regional Forum

Spanish banks had until mid-June to present a definitive set of accounts setting out their total liabilities, which were independently assessed as between €51–€62bn. This includes €19bn already pledged by the government to fill a funding gap at Bankia, the product of a 2010 merger of seven cajas to create the country’s largest savings bank, holding the largest real estate portfolio.

Nonetheless, some insist that despite the obvious issues faced by certain institutions a distinction has to be made between perception and reality.

‘There has, I think, been an over-reaction to the negative news. There was a hole in Bankia’s finances but this has now been filled and the independent stress tests showed that banks require significantly less than the €100bn originally reported. Some banks do have problems but this is not an issue solely restricted to Spain,’ says Juan Picón, DLA Piper’s Managing Director Groups & Sectors, and Senior Partner of the firm in Spain.

Banks across Europe have faced downgrades and shown to have liabilities significantly higher than was previously presumed. ‘Further issues will need to be faced but we do not now expect any more adverse surprises, which – financial speculation aside – should give the market more stability,’ he adds.

Record yields
Indeed, some suggest that the economic challenges facing Spain and other peripheral European countries are partly the result of investment decisions by others. The downturn may not be business as usual, but there is still business to be done. The yields now demanded on Spanish and Portuguese government bonds, for example, are consistently reaching record highs.

‘Looking from a different perspective, there is money to be made out of a crisis of confidence. At a time when it is increasingly difficult to generate profits from equities and traditional asset classes, yields on government bonds offer good long-term returns,’ says Menzer at Noerr.

It is perhaps no coincidence that the hard line taken by investors in Spanish and Italian bond auctions comes when disproportionately large amounts of debt are up for renewal. The perception of Europe from elsewhere in the world may be of a continent in economic freefall, but the downturn is presenting new, albeit different, business opportunities. Finance may be harder to come by, and investment decisions much more considered, but companies continue to plan for the long term while trying to manage short-term dips in confidence.

At the end of 2011, German automotive manufacturer Audi announced a €900m expansion of its Hungarian production facility, while in March 2012 Daimler likewise began production of its A-Class and B-Class Mercedes-Benz models at a brand new €800m facility in the country – its first Mercedes plant in Eastern Europe. ‘Many industrial companies, including the luxury market, are feeling the crisis in different ways to those in other sectors. Many are sitting on relatively large cash piles and when it comes to assessing their strategic options they are finding that land is now cheaper, rents can be negotiated more aggressively, and finance is still there for the very best-rated businesses,’ says Menzer at Noerr.

Major investments are also being seen in those countries perceived to be the most economically vulnerable. In late December, the Portuguese government successfully completed the sale of its 21.35 per cent stake in leading utility company EdP to China Three Gorges for €2.7bn. The tender process also saw bids from Germany’s E.ON, and Brazil-based Eletrobras and Cemig.

Subsequently, the government has sold a 40 per cent stake in electricity and gas distributor REN for almost €600m, with a 25 per cent share going to China State Grid and 15 per cent to Oman Oil Company – first time investments for both entities in Portugal. ‘The privatisation process may be uncomfortable for some but it is bringing new investors and new finance to Portugal. And the tenders are not just about raising money for the government, they are also safeguarding the future of the companies themselves,’ says Siza Vieira at Linklaters, which advised E.ON in the EdP sale and State Grid in the REN deal.

Such sales have already raised 60 per cent of the government’s projected privatisation revenues, which has yet to see the sale of major stakes in national airline TAP, its ground handling operation Ground Force, airport operator ANA; water operator Aguas de Portugal; rail freight company CP Carga, and the government’s seven per cent holding in leading oil company Galp. ‘The acquisitions have also brought new lines of credit that mean that both EdP and REN are now able to think strategically about the mid- and long-term opportunities both inside and outside of Europe,’ says Siza Vieira.

New momentum
When assessing the facts that reflect business confidence across Europe, more than one conclusion can inevitably be reached. ‘Over the last six months, clients have raised questions about the potential outcomes in the event of a country leaving the euro, and even of the break-up of the eurozone. So people are ? considering the possibility, and are concerned, but can you genuinely plan for a break-up? I am not sure. People want to mitigate their risks but they cannot avoid them altogether,’ says Siza Vieira.


‘Major central economies, including Germany, are as dependent on us as we are on them. This shared vulnerability is what will ultimately drive demands to unfreeze the lending markets and to get business going again’
Juan Picón
DLA Piper, Senior Partner Spain

Despite the ongoing challenges facing economies like Greece, Portugal, Ireland and Spain – all of which have now received outside financial assistance – there is no benefit to any country if the eurozone breaks up. ‘As Europeans we need each other, but so does the US and China. Looking ahead, I think the Greek issue will be addressed one way or another and things will begin to calm down. The major Spanish and Italian long-term bonds will also be renegotiated. Even the most aggressive investment funds want to see a return on their investments – they may be pricing in risk but even they do not want a default,’ says Menzer.

Momentum may also be emerging towards a more cohesive response by European leaders, with vocal and consistent calls for greater fiscal and economic unity. More banks and businesses see the rationale, while bodies such as the European Banking Association are already setting the standard for national regulators.

‘The major barriers remain however to overcome popular resistance, and to harmonise issues like Europe’s retirement ages, while the investment funds sector is perhaps more nervous about greater regulatory interference, than say the banks. If financial integration does come it will not however happen quickly, but the acceptance of the need for it is speeding up,’ adds Menzer.

National governments also recognise that more emphasis needs to be placed on encouraging new economic growth, rather than just cost-cutting.

The Spanish government has notably launched a €35bn repayment fund, backed by over 25 domestic banks, intended to help regional municipalities clear outstanding debts to suppliers. The Spanish economy, like many across Europe, remains dominated by small and medium-sized companies and it is these that have proved most vulnerable to the drop in bank lending and payment delays. ‘This year will be a difficult one and we now know that no one country is immune to the crisis. The peripheral EU countries have had it bad but the major central economies, including Germany, are as dependent on us as we are on them. This shared vulnerability is what will ultimately drive demands to unfreeze the lending markets and to get business going again,’ says Picón at DLA Piper.

Despite the apparent lurching from one crisis to another, Europe nonetheless remains an attractive investment destination. Foreign direct investment may have dropped since the onset of the global financial crisis, but an economic union of over 500m people, which prides itself on rule of law – whether this is in reality fully functioning or not – still makes it very attractive from a global perspective.

There may be a lack of business certainty but there is legal certainty. Governments may be reconsidering major project expenditure but there is little danger of companies being nationalised. In fact the exact opposite is true: in order to raise money governments are selling off some of their most attractive assets, bringing new investment.

The results of the Greek elections may not surmount the challenges faced by the EU, but it has given a glimpse of an alternative scenario, with a vacuum of leadership, economic direction and investment. ‘The reality is that not all parts of the economy, or even all parts of the EU, can perform equally well all of the time. So companies have to adapt to the situation as they find it, reducing their expenditure and being much more cautious about new investment decisions,’ concludes Jonkhart at Loyens & Loeff. ‘But the argument that what is ultimately required is to focus on the long term and ride out the short-term storms remains compelling.’




Scott Appleton is a freelance writer and can be contacted at

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