By Clive Davidson
A splintering of the eurozone would require a host of changes to financial technology – from minor tweaks to major re-engineering. Some companies are working out how they would cope.
Two years ago, the break-up of the eurozone was unthinkable – admittedly, Greece had just revealed a budget deficit of 12.7% and there was some talk of contagion, but it was not seen as a threat to the eurozone as a whole. Twelve months ago, the contagion talk had a sharper edge – both Greece and Ireland had been bailed out, and there was a widespread expectation Portugal would follow suit – but the eurozone was still widely expected to muddle through......
......But the more interesting challenges are in the front office. Changes to the euro add another dimension to a market that has already significantly increased in complexity since the financial crisis of 2008, says Rohan Douglas, chief executive at New Jersey-based analytics and risk management technology supplier Quantifi. Today, even a vanilla interest rate swap has become complicated to price with the introduction of overnight indexed swap (OIS) discounting for collateralised trades and the need for a credit value adjustment calculation. Now, should a relatively benign euro break-up occur – in which Greece exits the currency, for example – trades with Greek underlyings would suddenly have an added currency dimension, becoming a quanto trade, in which the contract and underlying are denominated in different currencies.
“If a bank has a credit default swap with a Greek underlying, suddenly it will have a quanto CDS. Historically, there has been a certain liquid market in quanto CDSs, but the market has not charged any significant premium for the quanto piece of it. That is changing – there will be more emphasis on the currency dimension,” says Douglas.
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