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New U.K. Leader Raises Currency Questions: Gordon Brown, known for big changes, pushes vision for a uniquely English euro
Asset Securitization Report--SourceMedia (July 2, 2007)

Jacob Gaffney

The United Kingdom - home to the CMBS and RMBS juggernaut as well as to London, Europe's financial capital - has a new leader. But the new prime minister, Gordon Brown, is not an average run-of-the-mill replacement for Tony Blair. Brown is a money man who formerly held the position of Chancellor of the Exchequer and is known for making big changes whenever he joins a new office - be it a change in the way interest rates are determined or announcing new taxes for private equity houses.

So it is only natural that, as Brown moves into 10 Downing Street, structured market players have begun to run the gamut of "what if" scenarios, with the biggest being the future of the almighty Great British pound. Many people had something to say about the impact of the abolishment of the pound on ABS, but most would speak only off the record. At least two U.K.-based banks, however, are said to be already running models of how firms will react when, and not if, the country moves from pound to euro.

"It's one of those things where, if you tell people you are doing it now, they will call you an idiot," a source at one of the banks said. "But once we switch to euros and we come out on top, the same people will call us visionaries."

According to Ravi Takhar, head of residential mortgages at Investec Bank, a switch to euros makes sense, as it would be a boon to the U.K. RMBS market, already worth GBP61.7 billion ($123.14 billion) in 2007. He downplayed the notion that borrowers will be turned off from buying new homes once the prices switch from, say, GBP350,000 to 520,000 ($699,151). "They will be getting paid more' with euros as well, won't they?" he asked. Furthermore, one source at Societe Generale said the euro zone would provide an interest rate that would be more favorable to borrowers and said that a switch in currencies will actually help homeowners repay their mortgages.

However, not everyone is considering an "England on euros" scenario. "The common reaction is that this has not even crossed investors' minds, so I think there is little for us to say at this point," said Carlos Melville, vice president of corporate communications at Morgan Stanley.

While Brown is not distinctly pro-European, he is in fact credited with keeping the U.K. away from the euro until now. But the recent high-profile defections of Conservative ministers of Parliament to the Labor camp, especially the staunchly pro-European Quentin Davies, is fueling speculation.

"We can expect him to announce something dramatic" during his first few weeks as prime minister, said a source at European law firm SJ Berwin. But to be sure, the source added that a single currency would not have an effect on ABS laws and legislation. "Each country will still have its own land-law system, and that will never change," he said, "regardless if a single currency increases liquidity [for ABS deals]."

Moving a Mountain, Stone by Stone
Indeed, a euro switch is not such a distant possibility. For example, Brown told the House of Commons on June 9 that the U.K. economy had passed his financial services test, one of five points he said would be necessary to shift satisfactorily to the euro. But, he said, it failed tests on sustainable convergence, economic flexibility, investment and employment. So, if the U.K. can satisfy Brown on these other four points, it's goodbye sterling.

In his speech, Brown added that the single currency would bolster British trade with Europe by up to 50% over the next 30 years, according to a British newspaper, The Guardian. Joining would also give Britain the advantage of greater influence over EU economic policy. Diminished exchange-rate volatility could bring gains for both large and small companies, and there would also be benefits from greater cross-border trade.

However, there are larger issues, according to a source at an investment bank. For instance, shifting to the euro killed the tourism trade in Greece, but led to a booming economy in the Republic of Ireland. An improperly handled euro handover would negatively impact the U.K. CMBS market, he said, which tends to be written with "long-term fixed-rate-type profiles," rather than the floating rates most RMBS loans are written on.

Despite the power of the pound, and considering that it is common to see ABS tranches written more and more in multicurrency denominations of dollar, euro, and sterling, the pound is not the most flexible currency when it comes to trading.

Pound paper tends to trade slightly wider than euro, given that the investor base is smaller, according to Alex Lazanas, head of ABS trading at SocGen. "Most U.K. banks and U.K. fund managers can do euro, though U.K. pension funds tend to stick with pound."

"But very few non-U.K. clients can do pound, hence the difference in the investor base results in a difference in spread," he added. "For triple-A U.K. RMBS, this tends to be one basis point. The gap widens as you go down the credit curve or if you compare other asset classes, such as CMBS."

Lazanas added that abolishing the pound would ultimately have little effect on ABS markets, a belief that rating agency Fitch Ratings backs up. Fitch analysts said that a single European currency would not have a big impact on ratings methodology.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.



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