Wells Fargo Research Team
Wells Fargo
Executive Summary
French voters go to the polls in late April and early May to elect the 10th president of the Fifth French Republic. If elected president, Marine Le Pen, who is the leader of the National Front, wants to take France out of the Eurozone and bring back the French franc as the country’s currency. A re-introduced franc likely would depreciate sharply vis-à-vis the euro, which could entail financial losses for holders of euro-denominated French debt. Our rough estimates show that financial institutions in the United Kingdom and Germany likely would be among the foreign creditors who would have the most to lose in this scenario.
Even if Le Pen wins the French presidency, a French exit from the Eurozone might not occur for a number of years because she could not unilaterally take France out of the euro area. However, a victory by Le Pen would raise the prospect of an eventual French exit from the Eurozone, which would call into question the very survival of the euro area. In that event, financial assets in “peripheral” European economies (e.g., Greece, Italy, Portugal and Spain) could experience significant selling pressure. In short, the financial market turbulence associated with the European sovereign debt crisis of 2010-2012 could rear its ugly head again if Marine Le Pen is elected as the next president of France.
Le Pen Would Seek to Bring Back the French Franc
French voters go to the polls on April 23 and likely will return for second-round voting on May 7 to elect the country’s next president.1 Although victory by Marine Le Pen, who is the leader of the anti-EU, anti-immigrant, populist National Front is seemingly unlikely, it would be naive to completely dismiss her chances. Le Pen would be a transformative president because her platform includes a French exit from the Eurozone and perhaps from the European Union. Le Pen wants to bring back the franc as the national currency of France and she has said that she would allow it to float freely in the foreign exchange market. A freely floating French franc likely would depreciate sharply. Although franc depreciation would ultimately provide a boost to French exports, it could also entail financial losses for owners of French debt.
French assets and liabilities currently are denominated in euros. Redenomination of these assets and liabilities into francs would not have any direct financial fallout if both creditor and debtor were located in France. However, consider a scenario in which a German bank has extended a euro-denominated loan to a French company and the franc depreciates 25 percent vis-à-vis the euro. The German bank would suffer a 25 percent reduction in the value of its asset if the French company is allowed to make payment in francs. Conversely, the French company would realize a 25 percent increase in the franc-value of the loan if it needs to repay the loan in euros. Although the German bank would not suffer an initial loss in this scenario, it could eventually realize a loss if the French company were to become insolvent due to the increase in its franc-denominated liabilities. Moreover, owners of French debt securities would suffer mark-to-market losses if the prices of those assets were to fall.
In our view, it is prudent to ascertain which countries have the most financial exposure to France, and thereby potentially the most to lose, ahead of the French presidential election. In the event, however unlikely, that Le Pen becomes the next president of France, prices of French assets could fall significantly. In the rest of this report we use a number of different data sources to ascertain which countries would potentially have the most to lose financially from a victory by Madame Le Pen.
France Has a Significant Amount of External Debt
Data that are compiled by Eurostat show that the total amount of debt owed by French residents has grown from to €8.6 trillion today from €3.3 trillion in 1999 (Figure 1). Among sectors, the non-financial corporate (NFC) sector in France has the most debt at €2.8 trillion in Q3-2016. The outstanding debt of the general government is a close second at €2.5 trillion, the financial sector has €2.0 trillion worth of debt, and the debt stockpile of the French household sector stands at €1.3 trillion. Expressed as a ratio of GDP, total French debt has risen to roughly 385 percent today from about 240 percent in 1999.
So, who holds this debt? Available data do not allow us to provide a complete and precise accounting by country, but we can derive some general estimates. Data from the World Bank indicate that 57 percent of French debt is external debt. That is, 57 percent of the total debt of the French household, business and public sectors is owned by foreigners. That ratio may seem high until one considers that the French economy has extensive trade and financial ties with other countries, especially with its neighbors in Europe. Moreover, France’s external debt has grown from €3.5 trillion in 2008, when the data series starts, to about €4.9 trillion today (Figure 2).
The remaining 43 percent (about €3.7 trillion) of total French debt is owed to other French residents (households, financial corporations and non-financial corporations). As noted above, redenomination of French assets and liabilities from euros into French francs would not have direct effects on the French institutions, which have extended credit, either via loans or via purchases of debt securities, to French debtors. That said, there may be indirect effects for these French institutions if an exit from the Eurozone were to significantly weaken the French economy and the ability of French debtors to repay their franc-denominated debt.
Which Countries Have the Most Bank Exposure to France?
Returning to France’s external debt, we know that €4.9 trillion of French debt is owed to foreign creditors. These creditors would include foreign banks as well as foreign non-bank financial intuitions (NBFIs) such as foreign insurance companies, pension funds, and hedge funds, etc.
Data compiled by the Bank for International Settlements (BIS) show that exposure by foreign banks to France totaled about $1.6 trillion (roughly €1.4 trillion) at the end of Q3 2016 (latest available data). 2 Total bank exposure includes the loans that foreign banks have made to French residents as well as the French debt securities that those banks own.
Figure 3 shows the 10 foreign countries with the most bank exposure to French households, businesses and government. Collectively, these countries account for 85 percent of the total exposure that foreign banks have to France. Among foreign banks, U.K. banks have the most exposure to France (more than $400 billion) followed by Germany ($215 billion) and Japan ($190 billion). American banks have only $85 billion worth of exposure to French households, businesses and government.
British, German and Japanese banks have the most absolute exposure to France, but banks in these countries tend also to be large. Exposure to France via debt instruments (both loans and debt securities) accounts for nearly 6 percent of British banking system assets. The comparable ratio for German banks is 2.4 percent and 1.6 percent for Japan. The American banking system has only 0.5 percent of its assets exposed to French debt.
What About the Exposure of Other Financial Institutions?
So, that leaves about €3.5 trillion (nearly $4 trillion) worth of external debt exposure to France that is held outside of foreign banks (i.e, held by non-bank financial institutions in foreign countries). As noted above, we cannot pinpoint where the total amount of this debt is held. However, data from the International Monetary Fund (IMF) identifies about $2 trillion worth of holding by French debt securities in foreign economies. According to the partial IMF data, the countries with the most individual exposure to French debt securities at the end of Q2 2016 (latest available data) were Germany and Japan, which each held more than $300 billion. The United Kingdom held more than $200 billion, while the United States owned more than $150 billion worth of French debt securities.
However, the IMF data include the holdings of French debt securities by foreign banks and foreign NBFIs in combination. Unfortunately, we do not have a country breakdown showing the amount of French debt securities owned by foreign banks and the amount owned by foreign NBFIs. If we simply add the amount of exposure that foreign banks have to France (Figure 3) to the ownership breakdown that is contained in the IMF data, we would be double counting the French debt securities that foreign banks own. Using a simplifying assumption, however, we can estimate of the amount of French securities held by foreign banks and then derive estimates of total country exposure to French debt.3 These estimates are shown in Figure 4.
Not only do British banks have more than $400 billion worth of exposure to French debt instruments, but we estimate that NBFIs in the United Kingdom own about $100 billion worth of French debt securities. Therefore, we estimate that the exposure of British financial institutions to French debt total about $500 billion. In other words, British financial institutions (both banks and NBFIs) could experience significant financial losses in the, admittedly unlikely, event that France exits the Eurozone. We estimate that German and Japanese financial institutions could also experience meaningful losses as well. Unlike the British financial system, where exposure to France appears to be concentrated among banks, NBFIs in both Germany and Japan appear to own French debt instruments in roughly the same amount as banks in those countries. We estimate that American banks and NBFIs together own about $200 billion worth of French debt.
We should stress that the estimates shown in Figure 4 should not be taken too literally. That is, the absolute amounts of exposure that are shown in Figure 4 should be treated as rough estimates only. First, we had to make a simplifying assumption, which may or may not be entirely valid, to come up with our estimates of French debt securities that are owned by NBFIs in foreign economies. Second, we are unable to account for the entire €4.9 trillion worth of French external debt. As noted above, the IMF data on foreign holdings of French debt securities are incomplete— not all countries participate in the survey—and data on Chinese exposure to France, which do not appear in Figure 3 or Figure 4, are only partial. More complete data sources could alter our estimates of country exposure to French debt.
Although our estimates may be rough approximations, they may be useful when comparing relative exposure amounts. That is, it probably is reasonable to state that the United Kingdom and Germany have more overall exposure to French debt than do, say, the Netherlands or the United States. Consequently, the United Kingdom and Germany may be among the foreign economies with the most to lose directly from any financial market fallout associated with the potential (unlikely) election of Marine Le Pen as the next president of France.
Conclusion
France will hold arguably its most important presidential election in decades in late April and early May. A victory by Marine Le Pen, although seemingly unlikely, could have far reaching consequences because she wants to pull France out of the Eurozone and perhaps out of the European Union. A reintroduced French franc, which is one of Madame Le Pen’s policy proposals, likely would depreciate sharply against the euro. Foreign owners of French debt, which currently is denominated in euros, could suffer direct and indirect financial losses as the franc depreciates vis-à-vis the euro. Our rough estimates suggest that financial institutions in the United Kingdom and Germany would have the most to lose under this scenario.
Even if Le Pen wins the French presidency, a French exit from the Eurozone might not occur for a number of years because she could not unilaterally take France out of the euro area. Although an exit from the Eurozone would not require a change to the French constitution as an exit from the European Union would, the French parliament would need to approve legislation taking France out of the euro area. However, a victory by Le Pen would raise the prospect of an eventual French exit from the Eurozone, which would call into question the very survival of the euro area. In that event, financial assets in “peripheral” European economies (e.g., Greece, Italy, Portugal and Spain) could experience significant selling pressure. In short, the financial market turbulence associated with the European sovereign debt crisis of 2010-2012 could rear its ugly head again if Marine Le Pen is elected as the next president of France.
Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.
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