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Risky Business

Risky Business

For companies accustomed to doing business in up to a dozen European currencies, the arrival of the euro should be a blessing. But only if they first ward off a couple of potential cursesAs the big Boeing comes in to land in Europe, business class passengers dive into their briefcases and fish around. Out come small, jangling envelopes, which are opened, the contents examined and then transferred to the pocket or wallet. It's a curious ritual of the savvy business traveller who never leaves home without small change for the half dozen European countries he or she may be visiting. But it's a ritual under threat. In January 1999 the euro age will dawn -- and over the following three years huge economic and monetary changes will be wrought across Europe, breaking forever the rituals of the traveller -- and the rituals of international trade. According to the ANZ Bank, which has been overhauling its own systems to be euro-ready, the coming of the euro and the European Monetary Union (EMU) will drag with them huge changes, for which many Australian businesses are ill prepared. Tony Donohue, euro program director for the bank, acknowledges that the most immediate and obvious impact is that the single euro currency will ultimately replace most of Europe's currencies. However, he argues that "The big change is the economic 'piece'.

The creation of a single European bank is a very big change which will drive the economic zone, setting exchange rates and interest rates right across Europe," he says.

Donohue maintains that any companies which trade with Europe need to closely monitor the changes and their knock-on effects. For example, he predicts a slew of merger and acquisition activity as nimbler predators gobble up those companies slow to react to the opportunities and threats of the new economic environment. "If you are importing or exporting, the company that you do business with now may not be around in 12 months," he warns. "The good news is that this is a much simpler way to do business and substantially reduces the exchange risk -- reducing the number of currencies (initially) from 11 to one.

But," he cautions, "it won't eliminate risks." The ANZ, along with other Australian banks, has embarked on an education campaign to alert customers to the changes now imminent in Europe. Even so, "there is certainly a fair amount of naivete about what is happening," Donohue admits. And time is running out.

In and Out

The first steps toward monetary union were taken in 1991 when the Maastricht Treaty, which underpins the EMU, was signed by the leaders of the 15 European Union member states. The next significant step was taken in May 1998 when 11 European countries -- Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland -- were named as those nations which will start banking in the euro from January 1999. From that time on those nations' currency units will legally and economically stop existing independently, but become in essence denominations of the euro.

Excluded from the initial 11 countries using the euro are the UK, Denmark and Sweden. Greece, which wanted to participate, has yet to comply with the EMU's strict economic criteria. From January, businesses may choose whether to operate in euros or in national currencies under the principle referred to as "no compulsion, no prohibition". However, it is widely expected that there will be a rapid migration to the new currency as corporations seek to take advantage of the foreign exchange benefits. Also starting in January, monetary capital foreign exchange and interbank markets will be converted to euros, which will require substantial updates to information systems.

Thankfully, business has won a three-day breathing space to allow databases to be updated -- the so-called Big Bang weekend which starts at close of business on Thursday, December 31, 1998, until the markets reopen on Monday, January 4.

Such is the magnitude of the database conversions required that in Europe the leading banks have cancelled all leave for information systems staff from September to March. The physical euro currency -- the first samples of which were minted in 1998 -- will not arrive until January 2002, with other European currencies, such as the franc or the lira, withdrawn from circulation by July that year. The EMU puzzle will then be completed, assuming, that is, that the laggard European nations join the union. As far as an organisation like information broker Reuters is concerned, which has accurate economic data as its very lifeblood -- the "introduction of the euro is one of the largest single events in the world's financial markets". Managing director David Brocklehurst says that over the Big Bang weekend Reuters will have to revalue "tens of thousands of instruments, bonds and equities" so that its clients can have access to accurate information for their future operation. Reuters, which has been working on the problem for a couple of years, believes it will be euro-ready come January.

It's less clear how well prepared other organisations will be. Although Brocklehurst believes the Australian financial sector is pretty mature -- and understands the issues involved -- he is less sure of how well business has grasped the economic ramifications of the changes. "This is much more complex than just adding a field," he warns. Certainly the banks have recognised that.

Ready, Steady, Euro

St George -- a relative newcomer to foreign exchange transactions, having been granted its licence in 1994 -- has recently installed Reuters' Condor Plus v1.8 in its dealing rooms, in readiness for trading in the new environment. It also has an in-house steering committee shepherding through the necessary changes to its internal systems. The ANZ has had a team working on the euro since 1997 and has identified more than 100 programs which need changes. Donohue acknowledges that while some systems required little more than a currency field addition, systems used by treasury and capital markets required "a fair bit of change", but he's not saying how much that has cost. One bank which has acknowledged a cost for euro compliance is the NAB. It has to a large extent run its year 2000 program in tandem with euro compliance, and has reported a combined Y2K and euro budget of more than $230 million. At least $30 million of this is being spent on the euro. Mark Watson, regional program director for EMU Australia at the NAB, explains that one of the drivers for NAB is its extensive network of banks in Europe. For one, it owns the National Irish Bank -- which will be "in euroland" from January 1999. In addition, the NAB owns the UK-based Clydesdale Bank, Northern Bank and Yorkshire Bank.

"People say this is just another currency, which it isn't," Watson says. "There is a significant period of three years when the customer will call the shots." And if the customer of the National Irish Bank wants to do business in punts or euros, then the NAB had better have systems which will allow that or the customer will walk to another bank which can meet those requirements. Intense banking competition is expected to be a hallmark of the EMU's dawn.

Rewriting the Landscape

GartnerGroup analyst Nick Jones says: "The euro will rewrite the landscape of the banking industry. What will happen is that small banks will be unable to compete with huge pan-European mega banks offering services across all countries. And so multinational corporates who currently have a banking relationship with two or three banks in every country will want to rationalise that to two to three banks across Europe." NAB's Watson maintains, however, that "we're regarding the introduction of the euro as a challenge not a threat." It's a different take than the bank has on the Y2K issue. "With Y2K you've got to spend a lot of money just to stay in business. You could say the same of the euro -- but it's creating a new trading bloc and new opportunities," Watson says.

Like the ANZ, the NAB has spent time and effort on an education and marketing program to alert its customers to the implications of the changes. "It is up to the customers to look for the opportunities," Watson says. "There will be fewer currencies; they will be able to put a product into a market of 300 million plus people, and market it with a single price," he says. "All three of those create an additional challenge to non European customers." A further challenge or opportunity, depending on your vantage point, is Watson's assertion that "in the past there has been one major reserve currency: the US dollar; now there will be another one." In spite of the many and varied implications of the euro and the EMU, PA Consulting managing consultant Graham Lloyd, who has been charged by his company with oversight of the euro issue in this country, remains dismayed at the level of interest shown in the euro. "There has generally been dead silence from the RBA, the accounting groups, and some of the financial sector," he says. "Contrast that with the US and Europe. We're grappling on our own down here and I don't think the issue's been fully grasped."NAB's Watson agrees. "I think that with all the energy going into the Y2K, and the hype, the EMU has not had the attention it would otherwise [have had].

Between the financial organisations and the press we have got to get this out to the marketplace." Lloyd warns that even those companies which currently do no trade with Europe will feel the changes percolating through to the region.

"I think we will see a lot of the losers in Europe hitting on Asia as an opportunity, and Australians might get used to new levels of service offered by the Europeans," he says.

Opportunity and Threat

Setting the scale of the emerging market in context, Lloyd claims that the Australian market may be about a third the size of France -- but it will be 5 per cent the size of euroland -- and that is both opportunity and threat. He suggests that the pan-European price transparency afforded by the euro will make companies increasingly competitive -- and also force supply chain changes as organisations look for the best supply price available. Such supply chain effects will have an impact on a wide range of Australian trading organisations. Melbourne-based Southcorp, for example, has already announced that it plans to invoice in euros come January, in order to present itself as a competitive organisation. Unlike the NAB, which has linked its Y2K and euro program, Southcorp has taken an alternative approach of devolving responsibility for euro -- preparedness to the divisions. Chief information officer Wayne Saunders says that of the four divisions in the group, in fact only the wine division faces significant exposure to Europe. "Packaging, water heating and appliances have exposure in the US, but less so in Europe," Saunders says. That said, Southcorp's treasury department has recently implemented KPMG's Quantum package, which at least prepares them for the currency's arrival.

Saunders, who is responsible for "policy, standards and architecture", has devolved responsibility for euro conversion to the operating group, leaving the matter in Trevor Hollitt's hands, in Adelaide. Hollitt, the wine group's manager of information systems, said that the original intention was to have a euro-ready system in place by July 1999. About a quarter of all Southcorp's table wines are sold into Europe via its London-based sales office, and the organisation was keen to be able to conduct business in euros as soon as possible. In fact, Hollitt now is reasonably confident the organisation will actually be able to start doing business in the euro from January. Much of the necessary updating work has been in the accounting systems, where Southcorp has had to include extra currency fields. But Hollitt says that the company had also built additional functionality into the management reporting systems in order to fully reflect the impact of the European changes. Leading retailer Coles Myer is also preparing for the upheaval. Company officials say it "discovered" the euro two years ago and since then has been working to ensure it will be ready by 1999. The retailer took the opportunity to examine its existing treasury system -- a Midas Kapiti system -- and like Southcorp opted to migrate to the KPMG Quantum system for treasury and cash management, which is operating on a couple of Sparcstations.

Some 15 to 20 per cent of all Coles Myer's imports now come from Europe -- but most are traded in US dollars. That will change. The retailer is preparing to push its supply chain towards the euro, banking on euro debt markets being larger than those of the US. This will make the currency a more attractive option than either the US dollar or the currencies of the 11 European nations.

For the last nine months the company's European buyers have been actively seeking out euro business, and so far about 50 per cent of forward contracts are in euros. By the middle of next year the company wants that figure to be 100 per cent. Coles isn't saying how much it's all cost, but claims that the bottom line in achieving euro-readiness would be less than $100,000.

The Bottom Line

Costing the systems changes required has proved difficult -- even for the professional consultants. GartnerGroup costs the problem globally at somewhere in the very broad field of $US150 billion to $US400 billion. IBM reckons it will cost $US175 billion. International Data Corporation, in conjunction with European Consulting and Management Services, has scoped the worldwide euro spending slightly lower than Gartner at $US145 billion (spread over the seven years between 1996 when work began in Europe to 2002 when the euro matures into a full-blown currency). As a rule of thumb, the Business Accounting Software and Developers Association in its euro white paper has found that in accounting systems about 4.6 per cent of lines of code need a new currency field. It also claims that up to 80 per cent of corporate business applications will need some level of change. As the generally accepted figure is $US1.50 per change per line of Cobol code, the euro is adding up to a lot of $US1.50s coming hard on the heels of similarly expensive Y2K programs.

Qantas has absorbed the cost of euro compliance largely into the information systems department's Y2K program, which has run in tandem with euro updating.

Group treasurer Peter Gregg sits on the euro steering committee alongside executive general manager corporate services David Burden and representatives from commercial and marketing. He says that the airline is currently asking departments to sign off on their euro readiness, with the airline expecting to be euro compliant from January 1. "From our [point of] view we have needed to make sure we can handle another currency and have it flow through to our yield management and pricing systems," he says. The airline has also made education of its employees a priority so they are aware of the new currency and the airline's obligations regarding the euro and the EMU. Unlike its partner British Airways -- which characterises itself as a "euro-athlete" -- Qantas is comfortable in its status of being "euro-fit", says Gregg. "The difference is cosmetic and related to the amount of business that you do in Europe."Qantas does fly to three of the 11 initial "in" nations -- Germany, France and Italy -- but isn't expecting any significant change in the amount of business in those countries, nor in the level of competition it faces across the continent. "The single currency and transparent pricing will have some effect," admits Gregg, "But we're not sure what yet."So how well prepared is Australia? It is the proverbial curate's egg; good in parts. But as the NAB's Watson notes in his masterly understatement: "I think the first week of January will be very interesting."

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