In-Depth

European Economic and Monetary Union: Rare Enterprise Computing Business Opportunity

• 11/01/1999

Fifteen sovereign European nations have commenced a multifaceted process to propel them into the European Economic and Monetary Union (EMU) with the objective of eventually replacing their national physical currencies with a single European currency -- the euro. The proponents of euro believe that it will boost the competitiveness of the European Union against Japanese and American rivals in Europe, by allowing them to leverage the advantages of single currency trading.

EMU and a single currency are expected eliminate some businesses, such as currency trading and arbitrage. This has the potential to pose difficult questions for many business entities, such as banks, that currently realize substantial revenue from foreign exchange operations, which are likely to diminish substantially or be completely eliminated. In other cases, traditional patterns of consumer spending are expected to be dramatically altered as price variations across national borders become more transparent and narrow. Hence, information technology must be geared to adapt to the customer’s changing business requirements, facilitate a smooth transition to euro-enabled capability, deploy into new lines of business and provide competitive advantages.

EMU implementation will require any enterprise software that processes multiple European currencies in Europe to be modified extensively and the most recent estimate of this activity is estimated to be $100 billion for European businesses. While the initial changeover to the euro may be an unavoidable financial burden for European companies, the vast new market created by the euro is expected to be lucrative for American companies that provide Information Technology (IT) services. This article examines the impact of EMU on Information Technology and covers aspects of single currency, exchange rate mechanism, conversion options, impact on Information Systems and reflects on the extraordinary opportunity for American Information Technology firms.

Euro was introduced on Jan. 1, 1999, as the official currency of the EMU. Eleven countries -- Austria, Belgium, Luxembourg, Finland, France, Germany, Ireland, Italy, the Netherlands, Portugal and Spain -- participated in the first wave of the monetary union. Three countries -- Denmark, Sweden and the United Kingdom -- have chosen not to join in the first wave, but are expected to join the monetary union in 2002. Greece is the only member nation that failed to meet EMU-mandated entry requirements.

On Jan. 1, 1999, the exchange rates of participating currencies were irrevocably fixed and these national currencies will be defined only as expressions of euro. Monetary, capital and foreign exchange markets were converted to euro, and there will be no more trading of participating currencies. However, the European Commission (EC) has adopted a "no-compulsion, no-prohibition" rule regarding the euro, which permits any firm doing business in Europe to use either national currencies or euro during the three-year "transition period" from Jan. 1, 1999 through Dec. 31, 2001.

The timetable for implementing the euro is three and a half years. In the first stage, which commenced Jan. 1, 1999, non-cash transactions, such as those arising from credit cards, bank drafts, wire transfers and direct deposits may be denominated in either euros or in the old national currencies of EMU participants, the so-called "legacy currencies." After Jan. 1, 2002, all non-cash transactions must be denominated in euros. Also, Jan. 1, 2002 is targeted to be the day that will mark the introduction of euro notes and coins, which will completely replace all former national currencies. There will be seven euro notes of the denominations 5, 10, 20, 50, 100, 200, 500 euros and eight coins worth 0.01, 0.02, 0.05, 0.10, 0.20, 0.50, 1, 2 euros. One side will be left open for a national symbol, while the use of euro coins and notes will be possible throughout the EMU. Finally, on June 30, 2002, all national currencies within the EMU will be obsolete.

The most fundamental change mandated by the EMU is the requirement that all currencies be "triangulated," or converted through the euro with six significant figures (e.g., 1 EUR = 1.23456 Francs). Whatever conversion rates are used, they will have to be adopted exactly with significant figures and no rounding or truncating of conversion rates is allowed.

Currently, most software applications perform conversions of one currency to another by multiplying by a two- or three-digit number. For example, using illustrative exchange rates, if there are 0.2982 FRF (French francs) per DM (German deutsche marks) then FRF 5,000 equals 5,000 x 0.2982 = DM 1491. However, such direct computation will no longer be valid from Jan. 1, 1999, as individual EMU currencies, such as FF or DM will cease to exist, except as denominations of euro currency.

Hence, from that date, every EMU currency will be denominated in the euro by means of a six-digit conversion factor, which will never. After that, EMU mandates that all conversions to or from EMU currencies be "triangulated" by first converting to EUR and then reconverting to the required target currency.

Consequently, any financial software that performs conversions to or from EMU currencies will require modification of data types and computation. However, in case of conversions between EMU currencies and U.S. dollars, the EC has stated that official exchange rates between U.S. dollars and old national currencies will no longer be published, although unofficial conversion rates are expected to be available from Dow Jones and other financial publishers. Hence, determining whether to use triangulation or the unofficial rate of exchange will depend on the application and the business entity.

The EC recommends one of the three approaches for euro implementation. The first, the "parallel" approach, requires a company to create a complementary -- but separate -- information system that will track transactions in euro. This will require converting the existing financial information into the new euro (test) system, and as financial transactions occur, they are recorded in both the original legacy currency system and the new euro system after the appropriate conversion. This may require significant hardware resources to support parallel processing of two different systems.

The second, the "phased-in" approach, allows the enterprise to build and test on an incremental basis. However, organizations electing a phased-in approach to euro conversion will be faced with the issue of "bridging" between converted and non-converted systems, similar to the Year 2000 conversion, which requires expenditure on resources that will be discarded after the conversion is complete. Also, the presence of converted and non-converted systems raises the possibility of data contamination, either as test data flows into production systems or as euro denominated data is mistakenly run into a production system still set for the legacy currency.

The third, the "big bang" approach, suggests choosing a date somewhere within the transition period, such as the beginning of a fiscal year, and switch over the systems to support euro overnight. Organizations running behind schedule on euro conversion may have to utilize this approach and some other firms may choose this alternative to avoid the need to support both the legacy currency and the euro in their information systems.

Every conversion approach suggested has its share of pros and cons and an entity must consider all factors before embarking on a course of action. It is reported that a majority of enterprises are choosing the parallel approach in spite of the cost involved. Additionally, the location of the enterprise is also likely to influence the approach to be chosen and two such locational considerations are given below to illustrate this factor:

• Certain national currencies, such as the French franc, are similar in structure with euro (two decimal places) and may be easier to re-engineer in comparison with others such as the Italian lira (no decimals).
• After Dec. 31, 1998, most taxing authorities will be able to process euro-denominated tax returns. However, Germany is the notable exception and is not expected to have euro capability until 2002 which means that if companies in Germany convert to euros in 1999 to respond to the needs of suppliers and customers, they will still have to continue to file tax returns and pay taxes in deutsche marks until 2002.

The introduction of euro is expected to have a profound impact on all aspects of data processing of organizations in Europe and will not be confined to the domain of software alone, but will also affect the hardware in some cases. This impact is expected to be widespread across Europe and affect banks, insurance companies, utility companies and governments of all sizes in the following areas (only some major items have been listed):

• Automatic Teller Machines
• Vending Machines
• Point of Sale (POS) Machines
• Enterprise Resource Planning
• Operating Systems
• Distributed Platforms
• Financial Systems
• Accounts Payable and Receivables
• Electronic Data Interchange (EDI)
• Electronic Funds Transfer (EFT)
• Human Resources
• Shipping and Receiving
• Ordering
• Sales Support
• Database Management Systems
• Spreadsheets

Euro conversion, regardless of the approach chosen, is expected to affect all aspects of financial information systems in European companies because "single currency systems" now need to become "dual currency systems." The most common impact that will occur as a result of the euro is the conversion of accounting data from the legacy currencies to the euro and statutory changes that will have to be built into the software, such as value-added tax (VAT) and postage rates.

The EC has issued detailed regulations regarding the way conversions are to be performed, which includes the rule that the conversion factor should have six digits. Conversion to/from national currency to the base unit (euro), as mandated by EC, can cause "rounding differences." Hence, the common test of opening balance plus all transactions in a batch equal closing balance may no longer be valid because of rounding errors when converting between national currency and euro. These rounding difference are required to be tracked to a separate account, with full audit trail, to ensure that they are not material. These enhancements are likely to be more expensive and complicated. Therefore, attention to currency conversion and rounding rules are of paramount importance.

The process of switching the software from historical to future data needs close scrutiny. Historical data, which is in the national currency, will need to be converted to euro, such as previous/future loan payments or any recurring loan payments. Also, systems that compare historical data with future data (in euro), such as decision support systems in finance, manufacturing or finance, will need modification. In the case of companies that provide comparative financial information, they will have to add the euro to 10 years worth of records covering everything from trading prices to financial statements.

External interfaces, such as transmissions of files to/from electronic commerce partners, like suppliers or banks, need to be considered as part of euro transition activities. Organizations will transition to euro at different times and this requires coordinated modification, testing and implementation of such interfaces.

Systems must be capable of inputting, displaying and printing euro symbols, and in many cases dual display of currency amounts may be necessary of screen and reports. Internal controls and threshold actions, such as denying credit when credit limit is exceeded, may need to adjusted to reflect the revised euro amount threshold. Also, extensive changes may be required to systems operating in countries, such as Italy, without coins representing fractions of base unit, to operate in at least three decimals to support rounding.

The euro conversion is also likely to affect the customer’s approach to electronic commerce and supply chain interfaces by introducing business process improvements while maintaining the ability of relevant systems to convert to/from euros. Firms selling on the Internet may be forced to offer the payment in euros option, which is expected to affect intranets and Internet applications regardless of whether they are based in Europe or elsewhere. Also, desktop systems, such as spreadsheets, databases and word processing documents, will also need to be corrected/converted to support the euro.

The EMU system is not expected to collapse once it has been implemented, even when serious recession occurs. But, it is possible for a participating country to lose control of its fiscal policy, and, theoretically, become bankrupt. However, it is not clear as to what might happen if this crisis takes place and it is conjectured that other EMU countries might be forced to support the defaulting country, or the defaulting country may have to pull out of the EMU. Either way, companies should be prepared for such a crisis by incorporating the ability to reverse the euro back to the local currency if required.

Euro conversion is expected to have a major implication for companies that operate from the European Union and may cause many firms to re-engineer their business processes. Hence, similar to the Year 2000 conversion, the euro conversion is causing organizations to analyze certain aspects of their Information Systems Operations and decide whether to repair, upgrade, retire or replace affected applications. In addition, there are organizations that may decide to achieve new functionality by replacing existing legacy systems with new commercial products. Many American software firms derive a substantial portion of their revenue from overseas markets in banking; insurance and other finance related software packages, which at the minimum must be upgraded to accommodate basic EMU conversion requirements. These developments will drive new business opportunities for commercial software vendors, custom software developers and systems integration firms.

Non-availability of a skilled workforce of programmers/analysts also provides a tremendous opportunity for IT vendors. Euro conversion needs to be performed by technical personnel with specific understanding of financial systems and knowledge of local language(s), which has caused most European firms to have difficulty in recruiting skilled software professionals. Also, the introduction of euro is expected to eliminate some business functions such as currency trading and arbitrage, and IT consultants and system integrators need to respond to this situation in these companies by helping them redefine operations and redeploy assets to the new business environment.

American IT vendors who assist their European customers achieve their strategic goals, in terms of technology planning and implementation of flexible solutions, will see marked improvements in their bottom line for the next few years.

About the Author: Kris Swaminathan, CPA, is a Senior Software Engineer at Mastech Corporation, and is providing software consultancy services to Nissan Motor Manufacturing Corporation USA in Smyrna, Tenn.