In Supervisory Letter 9815 (the "Supervisory Letter"), the FRB provides a "broadbrush overview of the EMU's potential impact on banks," and outlines the supervisory plan adopted by the FRB in assessing preparations at those supervised institutions deemed most affected by the advent of EMU. Most importantly, the Supervisory Letter alerts supervised institutions to (i) information technology implications associated with EMU; (ii) contractual and markets issues; and (iii) communications requirements. The FRB's guidance as contained in this supervisory letter is definitely "broad brush" in nature. However, its issuance does reflect the concern that affected banking organizations must devote adequate staff and financial resources to ensuring that preparation for the euro is a top management priority, and that readiness efforts are targeting critical areas of operations.
As part of the FRB's efforts to monitor affected organizations' preparations for EMU, the Board first directs Reserve Bank staff to conduct a baseline review of each organization's EMU exposure, planning, and preparations. Fundamental questions that staff must address as part this review include the following:
- Has the organization assessed the impact of EMU on its operations?
- Has the organization developed an EMU project plan that addresses its needs and has been approved by the board of directors?
- Is the plan adequate in relation to the identified EMU risk profile of the institution?
- Is the institution's progress on implementation in line with plan projections?
The Supervisory Letter warns that modifications to bank information systems may be required for all participants in the European market, even at organizations without extensive or complex operations. Some system changes related to EMU may be more complex than those for Y2K because while most Y2K work involves behind the scenes programming changes to enable the work process to continue as it did prior to the century date change, EMUrelated programming changes often involve the development of new work processes. For example, the Supervisory Letter points out that it may be necessary that some system interfaces allow users to record and review transactions in both the euro and in the EU member state's legacy currency.
The Supervisory Letter also alerts institutions to several information technology issues related to the euro conversion. First, and perhaps most importantly, bank systems will have to accommodate "triangulation," the official methodology for converting between one legacy currency to another. As the name suggests, "triangulation" involves three stages: (i) conversion from the first national currency unit into the euro (by dividing by the conversion rate) and, if rounded (rounding is not compulsory), to not less than three decimal places; (ii) conversion from the euro to the second national currency unit (by multiplying by the conversion rate); and (iii) rounding to the nearest subunit or, if none, to the nearest unit, of the second national currency unit or otherwise in accordance with local law or practice. All systems will need to be able to reconcile the small unavoidable rounding differences that will occur during conversions.
The Supervisory Letter also alerts institutions to the following additional technology concerns: (i) systems may require dual entry and display capabilities that enable transactions to occur in either a legacy currency or the euro; (ii) close coordination with counterparties, vendors and customers will be required to ensure that system changes are compatible with the requirements of third parties; (iii) significant additional system capacity may be required during the conversion period in order to accommodate increased conversion volumes or to maintain dual ledgers; (iv) ongoing systems modifications may be necessary to reflect additional changes to market conventions, new entrants into EMU, and other evolutions in the panEuropean market; (v) systems will have to accommodate decimals that occur following redenomination of securities; and (vi) the euro symbol must be available in system character sets.
The Supervisory Letter further cautions banks of specific contractual problems, related to the euro changeover, in addition to contract continuity. For example, the possibility that banks and their counterparties may not be prepared to adjust to new pricing sources, create new nostro accounts and settlement instructions, or settle euro transactions under new market conventions gives rise to settlement risk under securities and derivatives contracts as of January 1, 1999. Banks are also advised to assess their exposure under outstanding contracts and establish communications with counterparties well in advance of the first payment or settlement date after January 1, 1999.
The Supervisory Letter further advises that in addition to reviewing specific contracts, institutions should consider their overall investment and hedging strategies in light of the euro conversion, with special attention to contracts, such as repurchase agreements, performed in part before and in part after January 1, 1999.
Finally, the Supervisory Letter discusses how banks should communicate with customers, employees, and vendors regarding the euro conversion process. In summary it advises banks to educate employees to understand how euro conversion affects their duties, and enure that vendors have clear plans and schedules for making necessary modifications to systems. Changes to customer transactions, accounts statements and other reports to customers, as well as new cost structures should be fully communicated in writing as far in advance as possible.
This article was first published in the August/September 1998 Issue of Mayer, Brown & Platt's Financial Services Regulatory Report. The Financial Services Regulatory Report is edited by Melody A. Chestnut of the Washington, DC Office.
Copyright © 1999 Mayer, Brown & Platt. This Mayer, Brown & Platt article provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
