Should France ditch the single currency under a president Le Pen, redenominating nearly 2 trillion euros of government bonds in “new francs” could be legally straightforward, but hundreds of billions of corporate debt would be left in limbo.
The crux of the issue is that the sovereign debt is subject to French laws that could be changed by the government to prevent a currency switch triggering a default, while a large chunk of the 1 trillion euros ($1.1 trillion) of bonds issued by major French companies are governed by foreign legislation.
Such a scenario became a possibility this week after French presidential hopeful Marine Le Pen – one of two candidates likely to make a May election run-off – said she would take France out of the euro if she won and denominate its national debt in a new currency.
Polls suggest the leader of the far-right National Front will eventually lose to a mainstream candidate, tipped to be conservative Francois Fillon, and also indicate that despite strong misgivings about the EU and the euro zone, most French voters want to remain members of both.
But after the Brexit vote and Donald Trump’s U.S. victory, few people are taking anything for granted.
Le Pen did not specify whether she wants to redenominate all of the 1.9 billion of existing euro debt, or only new bond sales.
Lawyers contacted by Reuters said the government could convert its existing debt into a new French franc without major legal challenges.
“Given that most French government debt, if not all of it, is governed by French law then that would be an easy change for the government to make,” said Matthew Hartley, a debt capital markets partner at London-based law firm Allen & Overy.
“Similar to when the euro was introduced, they could introduce legislative provisions stipulating that any change in currency won’t give rise to any default under these contracts.”
France’s debt management agency AFT, part of the French treasury, declined to comment on the subject.
ut while France could pass a law that would allow all its debt to be redenominated – a fundamental change to the terms of the bonds – with legal impunity, that legislation is unlikely to be recognised by courts in London or New York, for example.
Of around 1 trillion euros of French corporate bonds outstanding, more than 50 percent is governed by foreign laws, according to Thomson Reuters’ data – mainly English legislation because many investors are more familiar with it.
Around 60 percent of French government bonds are also held by foreigners, but as they see less chance of a sovereign default and are likely to have less bargaining power with the state anyway, they are less concerned about the underlying law.
If the French private sector had problems servicing its legacy euro-denominated bonds with a new currency, it could lead to mass defaults that could be devastating for the domestic economy and the region, where France is the euro zone’s second-biggest economy.
In Italy, one of the bloc’s most indebted states, politicians campaigning to leave the euro zone have argued that their legal system would also allow a redenomination of its sovereign debt to occur without triggering a formal default.
A similar debate was last aired when Greece was on the brink of leaving the bloc in 2015 but its myriad debt issued under different legal jurisdictions was thought to have made redenomination problematic.
For the foreign investors who hold France’s sovereign debt, the lack of a legal recourse to redenomination would be compounded by the perils of inheriting assets with much greater exchange rate risk – especially for investors from other euro nations who currently assume no currency risk at all when investing in France.
As a result, if the prospect of France leaving the euro zone was seen as significant, many may not wait around to find out the impact on French debt.
“Redenomination might be the lesser of the two problems … however this could still damage France’s market reputation and adversely affect risk and pricing,” another senior financial lawyer told Reuters on condition of anonymity, adding that all France’s government debt could be changed legally via retrospective legislation.
Investors who have bought insurance against a French default – via the credit default swaps market – are also unlikely to get paid out if a redenomination takes place.
Definitions from ISDA, the market association whose members effectively decide whether a default has occurred to trigger these contracts, state that conversion from euros into another currency would not constitute a restructuring if it is the result of action taken by a government and there is a freely available market rate of conversion.
Euro area countries’ ascension to the single currency is one of few precedents for such a change. That involved years of readying investors with the introduction of a pre-euro basket of currencies known as the ECU – and Le Pen has proposed using a similar method to manage an exit.
But while investors at the time may have been happy to convert into the euro – a new benchmark currency likely to have proven more stable than the free-floating franc – they may not be so content to switch out.
As far as ratings agencies are concerned, sharp devaluation of the new franc after such an exchange could be enough for them to deem the country in default, even if it is not in legal terms. This could accelerate the devaluation.
“Ultimately the credit consequences would depend on whether we concluded that investors would still get back what they expected, when they expected it. If we not, we would likely call that a default,” said Alastair Wilson, managing director of sovereign risk at Moody’s.
Le Pen’s chances of becoming president have climbed to a record 32 percent, according to the website Oddschecker.com, which compiles betting odds from bookmakers.
While she still trails Emmanuel Macron’s 45 percent, the shift in candidates’ fortunes in the past few months is striking:
No matter how adamant pollsters are that she’ll lose the second round of the country’s two-stage election set for April and May, bondholders have decided they need some insurance against a Len Pen presidency.
They drove French 10-year yields to a four-year high last week against those of Germany, the euro region’s benchmark borrower:
It’s Le Pen’s anti-euro stance that’s worrying bondholders.
In a two-hour television interview on Thursday, Le Pen repeated her plan to take control of the Bank of France and print new French francs to meet the government’s debt obligations.
“I can’t implement my promises of intelligent protectionism and industrial policy with the single currency,” Le Pen said on Sunday. “It’s a brake on the economy, it’s an obstacle to the recovery.
The euro isn’t a currency, it’s a political tool.”
Her chief economic adviser, Bernard Monot, met with central bank governor Francois Villeroy de Galhau in September to outline the proposal.
Villeroy on Monday told France Inter radio that quitting the euro could increase France’s annual debt-servicing costs by as much as 30 billion euros ($32 billion).
“That might seem a bit abstract to listeners, but 30 billion euros, to be very concrete, is equivalent to France’s annual defense budget,” he said.
Le Pen insists that with about 90 percent of the country’s debt governed by French law, redenominating it into francs comes without a penalty.
But here’s a chart showing what France’s 10-year borrowing cost was relative to Germany’s prior to the euro’s introduction at the beginning of 1999:
The chart above tracks a decade of expectations for whether the euro would actually succeed in being introduced.
The French spread to German bonds declined from 1990 to 1992, then climbed as Italy, Spain, Portugal and Ireland all devalued their currencies between 1992 and 1993.
It climbed again at the start of 1996 as volatility surged for the Italian lire, before easing in the three years prior to the euro becoming a financial reality.
Euro membership was designed to impose greater economic discipline on the participants in the common-currency project, limiting budget deficits and restraining debt.
While it’s arguable how successful that’s been — the European Commission forecasts France’s debt as a percentage of its gross domestic product will climb to 97 percent by 2018, up from 96.4 percent this year and 92.3 percent in 2013 — it seems inevitable that French borrowing costs would surge relative to those of Germany if Le Pen were to succeed in redenominating government debt into francs.
“Marine Le Pen clearly could become French president,” former British deputy Prime Minister Nick Clegg told Bloomberg Television’s Francine Lacqua on Friday.
“She’s an accomplished political performer.” Given the failure of soothsayers to predict either the election in November of Donald Trump or the U.K. vote last June to quit the European Union, investors are probably right to seek a yield cushion against a Le Pen victory in France.