Major stabilisation efforts behind the euro will certainly be undertaken this autumn, even if the legal powers of the Eurozone governments and central banks to take these measures have been questioned.

In parallel, the preparations for payments market harmonisation, in the form of the Single Euro Payments Area (SEPA) continue, apparently unaffected. Indeed, the headline is that the regulation for a SEPA Migration End Date (aka the SMED) is imminent, and that market participants must then migrate to the new harmonised environment.

This article challenges the separation of the two issues and tries to pinpoint where the SEPA rubber hits the Eurozone debt crisis road.

The SEPA programme outlined by the European Payments Council addresses a wide range of technical and operational matters i.e. new payment schemes, the usage of International Bank Account Number, clearing and settlement infrastructure, governance and data standards.

SEPA is an action to underpin a Single Market, following on as it does from the Lisbon Agenda in 2000 to promote the EU to the leading knowledge-based economic zone on earth by 2010 (the end date on the original SEPA Roadmap). SEPA was also meant to contribute to much increased direct SME-to-SME trading cross-border within the EU.

SEPA is absolutely predicated on the existence of a Single Money in this Single Market. An admission either that the Single Market contains different country risks or that the Euro is no longer a single currency (because it exists in many guises in what should be its purest form – central bank money) could lead to stakeholder behaviours that frustrate the SEPA programme.

Both admissions can be substantiated. It is clear that the eurozone contains different country risks: the threat of a Greek default and the wide spread of government bond yields demonstrate this.

But we also have the proof that the Euro is no longer a single currency. Any form of central bank money should be fully fungible with all other forms of Central Bank money in the same currency, meaning they should be convertible into any other form at face value. There are four forms of Central Bank money in Euro:

Notes, which are legal tender and are the obligation of the European Central Bank (inspection of a Euro note will tell you since it carries the ECB acronym in five languages, but interestingly no equivalent of the statement on a GBP note from the Chief Cashier of the Bank of England – I promise to pay the bearer on demand..);
Coins, which are legal tender but bear national characteristics relating to the member of the European System of Central Banks (ESCB or Eurosystem) which struck them. Indeed the wording, for example ‘Espana’ or ‘RF Liberté – Egalité – Fraternité’, infers a sovereign obligation of a country;
Account balances at a Central Bank that is a member of the ESCB, which are then the obligation of that Central Bank;
Sovereign debt of a country (the obligation of the Central Bank’s country).

The backing of the various forms of Central Bank money in Euro is not as clear as, for example, the backing of the dollar by the Federal Reserve:

Are notes backed solely by the ECB, or by every member of the ESCB?
Are coins backed by the issuing NCB, or by the entire ECB and ESCB?
Are account balances at a central bank, as an obligation of the Central Bank:

i. the same as a sovereign risk obligation of the country of that Central Bank; or

ii. backed by the entire ECB and ESCB; or

iii. not backed by anyone else?

Further to that it is clearly not the case that the sovereign debt of Greece and other Eurozone countries can be converted into the other forms at face value, if the conversion is attempted in the open market. The only counterparty with whom that conversion can be done is the ESCB, and even then not as a purchase-and-sale, or as a repo, but as a borrowing against the sovereign debt as collateral. The ESCB will not take ownership of the bonds at an off-market price (i.e. face value) but is quite prepared to lend against them at an off-market valuation.

The place where the rubber hits the road is TARGET, which is both the place of final settlement for all SEPA payments and – at present – a major lending mechanism from the stronger Eurozone nations to the weaker, playing an important role in holding the dam against the impact of capital flight out of Eurozone countries with perceived high country risk. That means helping a Eurozone country pay for its oil and food imports when it has no money – apart from more of its own central bank money.

In order to keep TARGET afloat – and by inference keep the SEPA plane airborne as well – the Eurozone central banks are having to stretch the definition of Euro central bank money to include the bonds of Greece and similar nations which are trading a discounts of 30-50% in the secondary market: these bonds are being assigned face value in TARGET as opposed to 50-70% on the street. This is an extension of the semi-covert term financing of commercial banks by the Eurosystem. Furthermore the ECB – through the other Eurozone central banks – has bought primary market bonds at near par which would have otherwise slid well below par, in order to prop up the primary market price. That runs very close to the edge of the ECB’s legal powers.

These actions create a distortion between the market value of certain types of Euro central bank money and its valuation within the Eurosystem. The latter currency is a debased version of the former. Central bank money should be the ultimate base of any currency, but in Euro there are multiple bases.

How does that feed through into SEPA? The Eurosystem and TARGET are meant to be perceived as Euro counterparts to the Federal Reserve System and the Fedwire, and in their relationship to the US Treasury. These are the foundations upon which a Reserve Currency is built.

The reality is that the Euro is built upon a much more fragmentary and diffuse framework, with less clear-cut governance, backing, recourse, liability etc.. This could be rectified with sweeping change to the Eurosystem and movement to a US model, but that would mean the giving up of EU member sovereignty and there is no appetite for that, amongst the voting public at least.

Instead, the current plan – to push ahead with SEPA based on the existing fragmentary foundations – is likely to be the default path, leaving it to market participants to decide whether to suspend any disbelief about its viability and go ahead with it, or to behave in ways that frustrate it for themselves and others.

The main beneficiaries of SEPA should include SMEs who should then trade more widely cross-border with one another. Is it really unthinkable that SMEs, and indeed larger corporates too, might revert to techniques to mitigate risk where they had lost confidence in the currency and/or in one of the countries that used it by:

Refusing to sell on open account and require an L/C or any of the instruments where you do not trust the counterparty’s ability to pay;
Invoicing in a different currency (USD, CHF, GBP);
Increase invoice prices towards certain countries, or building in a EUR:EUR FX rate to reflect country risk – where is Price Transparency then?
Not agreeing to a cross-border payment: making the counterparty open an account in EUR in their country and get them to pay out of that, notwithstanding Article 8 “Payment Accessibility” in the latest SMED draft;
Not selling into that country at all?

Those responses would completely negate Price Transparency, the Single Market, Single Currency and Lisbon Agenda and would, of course, render SEPA irrelevant in its currently planned state.

Bob Lyddon, Managing Director of IBOS Banking Association

PDF of article in Treasury Management International, November 2012