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Much Ado About the Euro

Today it's Europe's problem -- Tomorrow, it's the world's.
John Xenakis, Others
April 1, 1998

Horror stories abound about corporate unpreparedness for the Year 2000 (Y2K) computer glitch. But occurring almost simultaneously is a sister glitch-- the European Commission's (EC) introduction of a single currency--that experts predict could eclipse the Y2K problem in both time and cost. Surprisingly, however, few American companies are paying attention, never mind panicking.

"Essentially, U.S. organizations have been ignoring the euro-currency issue and concentrating instead on the Year 2000," says Capers Jones, chairman of Software Productivity Research Inc., in Burlington, Massachu-setts, "while their counterparts in Western Europe have been ignoring the Year 2000 problem and concentrating instead on the euro-currency conversion."

To be sure, European companies and European subsidiaries of American companies are being forced to pay attention to the euro. After all, the currency conversion is set to take place on January 1, 1999--a full year ahead of the Year 2000 D-day. Still, there may be another explanation for U.S. corporate nonchalance: There isn't much to be done here in the States, even for multinational firms. The reason is simple: Multinational firms based in the United States use the U.S. dollar (USD) as their base currency, and their software is almost always capable of accepting multiple currencies. Essentially, the euro will simply be added as one more currency.

"Our currency trading system in headquarters has to be modified to accept transactions in the euro. But that's easily accomplished," says Donald Henderson, Texaco's director of IT for international marketing and manufac- turing. "All of our systems that have to be changed are in Europe. It's a very big issue in Europe, especially because it's happening at the same time as the Year 2000 problem."

American subsidiaries of European companies are equally unfazed, since they also keep their books in USD and report their results to Europe in USD. "In Europe, we handle lots of currencies, and the deutsche mark is the most important currency for our intercompany accounting in Europe," says Stefan Heuser, head of cash management for Siemens Capital Corp., a subsidiary of German-based Siemens AG. "But here in the States, the base currency is the U.S. dollar, and that won't change. From an IT perspective, the euro won't be a big issue for companies whose general ledgers are in dollars."

WHO'S PANICKING?
The euro's introduction, of course, is being greeted quite differently on the other side of the pond. Generally speaking, any company's European operations will be drastically affected by the euro adoption, according to Peter Chin, vice president of euro transformation services for consulting firm Cap Gemini. "The supply chain, human resource elements, pension funds, customer communications, and tariffs will all change," he says. Moreover, he adds, "interfaces with all IT systems--manufacturing, accounting, funds transfer, and human resources--all have to be modified."

In addition, corporate treasury departments will have to review their borrowing and investment strategies, according to Evelyn Fuhrer, partner, financial services technology, at Coopers & Lybrand LLP in New York. "They will need to see if their premises are still valid," says Fuhrer. "Their old rules of thumb regarding forecasted inflation rates and interest rates may no longer be valid when multiple currencies are replaced by a single currency."

And all of that transformation will come at a heavy price. The Gartner Group, an IT advisory firm based in Stamford, Connecticut, estimates that for some European companies or subsidiaries, the cost of preparing for the euro problem can be as much as five times the cost of remediating software for the Year 2000 problem. This is because the Y2K problem is actually much simpler. Fixing this problem changes software so that it will do exactly what it's always done, except that it will continue to do it correctly after the year 00. But fixing the euro problem changes what the software actually does. What's more, it's necessary to change everything from personnel and pricing policies to vending machines.

Adding to the problem is the shortage of available programmers, since so many technical people are already committed to fixing the Y2K problem. In fact, 47 percent of European companies recently surveyed by The Gartner Group reported vacant IT positions.

Finally, companies are faced with a very short time frame for euro fixes. Theoretically, companies have a slight reprieve from the January deadline. The EC has adopted a "no-compulsion, no-prohibition" rule regarding the euro, meaning that any firm doing business in Europe is free to use either national currencies or the euro during the transition period from 1999 to 2002, at which time the local currencies will be phased out.

However, the no-compulsion, no-prohibition rule may be an illusion, according to Nick Jones, euro analyst for The Gartner Group. "Although the euro is voluntary, several big companies, including Philips Electronics NV and Siemens, have announced that they will adopt it immediately on January 1, 1999, and some are asking their suppliers to trade in euros," he says. But Siemens Capital's Heuser insists that his company is simply"offering its suppliers and clients the opportunity to use the euro, and to receive and write invoices in euros. We expect the large [European] corporations to use it fairly early," he says. "And smaller companies will feel that they have to use it, because otherwise they would be falling behind."


CONVERSION CHOICES
The introduction of the European economic and monetary union (EMU) will mean that any computer software that processes multiple European currencies will have to be modified.

To implement the euro, the EC is recommending one of three approaches. The first is a parallel approach, whereby a company maintains two sets of books--one in its national currency and one in the euro--during the 1999-to-2002 transition period. The second, the "phased" method--in which systems operate in both currencies simultaneously--is available to only a handful of software companies, such as SAP and PeopleSoft. The third is the "big bang" approach, whereby the company chooses a date somewhere within the transition period, probably at the end of a fiscal year, and changes its base currency overnight from the national currency to the euro.

At this point, it appears that many companies are opting for the parallel approach despite the expense involved. Nick Jones explains that some firms will be forced by the nature of their businesses to keep parallel books. "Imagine what would happen if a bank maintained its books in euros and a customer deposited 100 francs in a bank, and got back 99 francs, 99 centimes [because of the round-off error in converting francs to euros and back]," he says. "The bank needs to keep full dual currency records, in order to be able to reconstruct the original transaction."

The parallel approach may also be the only solution available. While it would seem that many large and midsized businesses would opt for the lower-cost, big-bang solution, that option "might not be technically achievable at this point," says Capers Jones. For one thing, the ease of the big-bang solution will greatly depend on the former national currency used. Because euro amounts will be represented with two digits following the decimal point, it will be directly compatible with only some European currencies. For example, software that processes French francs, which are also represented with two decimal digits, will generally be much easier to convert than software processing Italian lira, in which there are no decimal points. In the latter case, variable data types and report formats will have to be changed, to accommodate the fractional values. And even if a company implements the big bang, it would still be required to print invoices and accept payments in both national currencies and euros during the entire transition period from 1999 to 2002.

WHAT'S EURO-READY?
Whatever solution is finally used, the tentacles of currency change will reach into all applications of the company's financial software. To identify the numerous changes that must be made, the UK-based Business and Accounting Software Developers Association (BASDA), whose membership includes SAP, Oracle, and more than 200 other financial and business software vendors, is developing criteria for "euro-ready" accreditation of accounting and financial software.

A major audit issue identified by BASDA occurs in software that tests whether the opening balance, plus all transactions in a batch, is equal to the closing balance. When single currency systems become dual currency systems, these quantities may no longer be equal, because of round-off errors in converting between the euro and national currencies. "Problems will occur when converting individual items and cumulative amounts based on the same items to the euro," says Dennis Keeling, CEO of BASDA.

To handle these round-off errors, BASDA has established the following additional requirements for financial data to meet before it can be accredited: "Software...will be required to post rounding adjustments to a separate account with full audit trail. This will enable the user or its auditors to review the conversion rounding differences and ensure they are not material.... Software will be required to be able to post the difference of any trial balance in the general ledger to a predetermined rounding account which in turn will be written off as an adjustment to reserves."

Another area of concern is how software will switch between historical and future data. When a company changes its base currency from a national currency to the euro, future data is in the euro and historical data is in the national currency. Previous or future loan repayments, or any sort of recurring payments, will have to be converted, and all decision support software used in marketing or manufacturing will have to be modified to be able to permit comparisons of historical data in a national currency to future data in the euro.

ENTER TRIANGULATION
The most fundamental computation change being mandated by the EMU is the requirement that all currencies be "triangulated," or converted, through the euro, following specific rounding rules.

Currently, most software applications perform conversions of one currency to another by multiplying by a two- or three-digit number. For example, if there are 0.298 FRF (French francs) per DM (German deutsche marks), then FRF2,500 equals 2,500 x 0.298 = DM745.00. (All conversion rates are for illustrative purposes only, and are subject to change until January 1, 1999.) However, such direct computations will not be valid as of January 1, 1999. At that time, EMU currencies will cease to exist, except as denominations of the euro (EUR) currency. On that date, every EMU currency will be denominated in the euro by means of a six-digit conversion factor, which will never change (see "What's the Euro Worth?" page 57). After that, EMU rules require that all conversions to or from EMU currencies be "triangulated" by converting first to EUR (see "How to Triangulate," page 57). Any financial software that performs conversions to or from EMU currencies will require modification of data types and computations.


What about conversions between EMU currencies and U.S. dollars? The EC has stated that it will not publish official rates between USD and old national currencies, although unofficial conversion rates will be available from Dow Jones and other financialpublishers.

Whether triangulation must be used in those cases depends on the application, according to Patrick O'Beirne, a Y2K/euro consultant with Ireland-based Systems Modelling Ltd. "Strictly speaking, if you're converting dollars to deutsche marks, you should go through the euro," says O'Beirne. "In practice, only banks will be computing final settlement rates, and everyone else will be doing only approximate conversions, since rates against the dollar are still floating. So, whether you do triangulation in that case doesn't matter."

This is a big break for IT departments in the United States, and explains why American businesses feel so little impact from the euro. Software in the States that converts currencies almost always does so to or from U.S. dollars, where triangulation isn't necessary. But comparable software in Europe typically makes all sorts of conversions between different European currencies. In those cases, the regulatory triangulation and rounding rules must be applied, often resulting in substantial changes to the software.

PREPARING FOR THE WORST
No one expects the EMU system to collapse once it's been implemented, even if a serious recession occurs. But it is possible for a participating country to lose control of its fiscal policy, and theoretically possible for it to go bankrupt. If something like that occurred, however, it's not clear what would happen. The other EMU countries might be forced to support the defaulting country, or the defaulting country might 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 needed.

At present, however, installing a reversion capability is the least of companies' problems. Most are wrestling with how to complete the Y2K and the euro conversion at the same time--with limited technical support. Not everyone is optimistic it can be done. "The simultaneous attempts to perform Y2K repairs and currency conversion work on nearly identical schedules will cause both efforts to slip well beyond their deadlines," says Capers Jones. "Western Europe will probably not be able to complete the currency conversion work until about 2005, and will probably not be fully recovered from the Year 2000 crisis until at least 2003."

However, there is some good news: Most of the Y2K work is involved in inventorying your software and testing your modified software, and that work is the same as for euroconversion, according to Y2K consultant William Ulrich. "If you do a good job with your Year 2000 project, then you'll have all the information you need for the euro project already stored in your repositories."

Ultimately, however, even if most of the work of adapting the euro is being done in Europe, there will still be repercussions in the United States. Says Vinnie Mirchandani, research director at The Gartner Group: "Europe is 30 percent of the world's economy, and the euro is going to affect the business processes of every company in Europe. That's going to be very expensive, and paying for it is going to affect budgets here in the United States."

John J. Xenakis is technology editor of CFO.




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