Perspectives

The introduction of the euro

Published: Sep 2014

An important date for the world’s financial markets and for tens of thousands of corporations, 1st January 1999 marked the launch of the euro, which became the currency of 300 million people in Europe. The single European currency had originally been set out in the provisions of the 1992 Maastricht Treaty, with European Union (EU) member states (or at least those who had not opted out of the single currency – namely Denmark, Sweden and the UK), both initial and subsequent, required to meet stringent membership criteria.

Eleven EU countries (Austria, Belgium, France, Finland, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain) had their currencies irrevocably fixed against each other in January 1999, with Greece, whose economy did not meet the initial convergence criteria, joining later in 2001. Since then, six further countries (Estonia, Cyprus, Latvia, Malta, Slovenia and Slovakia) have joined the euro, with 18 of the 28 EU member states now using the currency. Lithuania has been approved by the EU to join this list in January 2015. Table 1 shows the current Eurozone member states with their fixed euro conversion rates.

Overseas departments, territories and islands which are part of euro area countries also use the currency as legal tender, while the micro-states of Andorra, Monaco, San Marino and Vatican City use the euro on the basis of a formal arrangement with the European Community. Montenegro and Kosovo also use the euro, although this is not based on a formal arrangement with the Community.

For the three years following its launch, the euro was an invisible currency – there was no physical cash, and the currency was used only for accounting purposes and electronic payments. Individuals and companies were able to convert their bank accounts to euro, or to open new euro accounts, during the three-year period following the launch of the currency. Then, in January 2002, banknotes and coins of the national currencies (these currencies ceased to be legal tender in March of the same year), such as the Deutsche mark, French franc, and Italian lire, were switched for euro cash at the previously set fixed conversion rates.

Table 1: Fixed euro conversion rates

Currency
1 BEF 40.3399 (Belgian francs)
1 DEM 1.95583 (Deutsche mark)
1 EEK 15.6466 (Estonian kroon)
1 IEP 0.787564 (Irish pound)
1 GRD 340.750 (Greek drachmas)
1 ESP 166.386 (Spanish pesetas)
1 CYP 0.585274 (Cyprus pound)
1 FRF 6.55957 (French francs)
1 ITL 1936.27 (Italian lire)
1 LVL 0.702804 (Latvian lats)
1 LUF 40.3399 (Luxembourg francs)
1 MTL 0.429300 (Maltese lira)
1 NLG 2.20371 (Dutch guilders)
1 ATS 13.7603 (Austrian schillings)
1 PTE 200.482 (Portuguese escudos)
1 SIT 239.640 (Slovenian tolars)
1 SKK 30.1260 (Slovak koruna)
1 FIM 5.94573 (Finnish markkas)

Source: ECB

The first years of the major new system across Europe were challenging, not least because the changes were political in nature (as well as economic and treasury-related). The introduction of the euro touched the nationalist sentiments of populations – some of which were more willing to embrace the changes than others. In France, for example, there was only a slim majority in favour of joining the euro in a referendum. Despite this resistance, the apparatus was ultimately established, progressing to unity across the Eurozone. It is also important to bear in mind that once entered, there is no official mechanism to exit the system.

European Central Bank

Administration and management of the euro is handled by the European Central Bank (ECB), whose headquarters are in Frankfurt, Germany. The ECB is an independent central bank and it alone has the authority to set monetary policy (which includes the setting of interest rates) across the Eurozone; the ECB’s stated aim of its monetary policy is to achieve currency price stability over the medium term. Before the introduction of the euro, this was handled by countries’ own central banks.

The difficulty for the ECB is that the existence of a single monetary policy and a single market implies that almost all fields of economic policy are affected by European economic and monetary integration, notably budgetary and structural policy. In a speech made just after the launch of euro notes and coins in March 2002, the then-president of the ECB, Dr Willem F Duisenberg, said the ECB’s challenges “are to maintain sound fiscal policies, foster efficiency in public expenditure and tax systems and improve the functioning of labour and product markets in order to enhance the euro area’s growth potential.”

The ECB is also responsible for the production and distribution of euro notes and coins to member states, operation of payment systems in the zone, and bulk transfers between members to ensure adequate supplies of the currency are available in each member state. However, the ECB has allocated each national central bank of the euro area a share of the total annual production of euro banknotes. In September 2002, the Bank established a cash stock for use in exceptional circumstances, called the Eurosystem Strategic Stock (ESS). This stock is intended to be used when logistical stocks in the Eurosystem are insufficient to cover an unexpected increase in the demand for banknotes or in the event of a sudden interruption in supply.

From a legal perspective, both the ECB and euro area countries’ national central banks have the right to issue euro banknotes. In reality, only countries’ national banks physically issue and withdraw euro banknotes and coins. Indeed, the ECB does not have a cash office and is not officially involved in cash operations. The legal issuers of euro coins are the euro area countries, with the European Commission coordinating all coin matters.

The ECB has overall responsibility for overseeing the activities of individual Eurozone member countries’ national central banks and for initiating further harmonisation of cash services within the euro area, while the national banks have remained responsible for the functioning of their national cash-distribution systems. The national banks put euro banknotes and coins into circulation via the banking system as well as via retail trade. The ECB is unable to perform these operations on behalf of Eurozone countries as it does not have its own technical departments (such as distribution units, banknote processing units, or vaults).

Logistical challenges

The changeover to euro notes and coins was a significant logistical problem for the ECB, which carried out an advertising campaign throughout 2001 to improve knowledge and understanding of the process. The campaign focused on the features of the notes and coins, security issues, size denominations and overall changeover modalities.

Beyond raising awareness of the changeover, the introduction of the single European currency also led to a number of other problems:

  • Lack of legacy currency in lead-up to changeover. With no more notes being printed nor coins minted, there was some concern over whether there would be enough notes and coins in the legacy currencies to last to the end of 2001. The Irish Republic, for example, reported shortages of the smallest denomination coins in 2001.
  • Lack of access to new currency. This was a challenge at the beginning of 2001, and was a particular issue for retail outlets, which saw significant demand for small denomination notes and also coins.
  • Queuing in retail outlets. A lack of familiarity with the new notes and coins led in a small number of cases to significant queuing at certain retail outlets, with rail and other travellers being especially impacted.
  • Vending machines. These had to be adapted or replaced to handle the new currency.

Impact on business

Many corporates also found euro implementation challenging. The initial hurdle for corporate treasury departments was handling the burden of foreign exchange management. Once their systems, policies and processes had been updated, they shifted their attention to cash management incorporating the new currency.

One key advantage of the euro to corporate treasury departments was that it further enhanced the benefits of cash pooling when carried out on a pan-European basis, thus increasing the value of centralised cash management. The majority of large multinational companies operating in Europe rationalised their European cash management structures once pooling in euro became possible. Some corporates, such as Siemens, changed their internal accounting systems over to euros early on (before 2002). Others also insisted that their suppliers invoice them in euro too. Despite the introduction of physical notes and coin being the final, and most visible, stage in the implementation of the single European currency, the actions of corporates to become euro-compliant at this stage made it clear that the euro already existed as a currency well before the actual cash arrived.

In addition to increased benefits of cash pooling under the euro, the single European currency offered a number of other wider advantages to the business community in the zone, such as:

  • The marketing of goods and services across Europe became more transparent in that prices and competitors could be more easily compared. However, differing tax rates and other costs still mean that there are some price variations across boundaries.
  • Currency settlements are now easier and more effective.
  • Currency fluctuations have been eliminated across the participating countries and their interest rates aligned (as we have seen, monetary policy is set centrally by the ECB, based in Frankfurt).
  • A larger and more liquid capital market has emerged for raising capital, or investing funds.
  • Merger and acquisition activity across Europe has accelerated, and a more pan-European view of stock markets is generally taken, replacing the focus on countries’ individual bourses. For example, following the launch of the euro, a FTSE Eurobloc 100 index was created, as was a FTSE Eurotop 100 and a wider 300 index.

Development and SEPA

Since its launch, the euro has gone on to become the world’s second reserve currency, accounting for 24% of foreign exchange reserves held by central banks. However, it is still some way behind the USD as the reserve currency of choice, which represents 62% of global foreign exchange reserves. Of course this could all change in the long term if China’s RMB continues its path towards internationalisation. The euro is also the world’s second most-traded currency, again behind the USD.

One of the most significant initiatives to be implemented since the launch of the euro has been the Single Euro Payments Area (SEPA), a payments integration initiative which forms a step towards the completion of the EU internal market and monetary union. SEPA is supported and promoted by the European Payments Council (EPC), the decision-making and coordination body of the European banking industry in relation to payments. The Council develops the payment schemes and frameworks which help to realise SEPA.

Since its launch, the euro has gone on to become the world’s second reserve currency, accounting for 24% of foreign exchange reserves held by central banks. However, it is still some way behind the USD as the reserve currency of choice, which represents 62% of global foreign exchange reserves.

Following migration to SEPA Direct Debits (SDD) and SEPA Credit Transfers (SCTs) in August 2014 (which had been extended by six months over fears of unpreparedness in the corporate community), 34 countries, 500 million people and 87.5 billion electronic payment transactions annually will be covered by the scheme, according to the EPC. However, despite the benefits of payments harmonisation SEPA promises, some have questioned whether payments technology has moved on too far in the decade it has taken to implement the initiative.

Nevertheless, the euro has significantly changed the way corporate treasury functions operate and this will no doubt continue to evolve as new initiatives come into being.

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