1. What capital controls might be put into effect?
Capital controls are government measures that restrain the movement of capital in and out of a country by imposing taxes, quantitative restrictions or other measures. These measures are introduced by a government in times of economic crisis to prevent capital flight, i.e. capital leaving the country.
By way of example, Chile enacted taxes on capital inflows1 (the encaje) from 1991-1998. In more recent times, the South Korean government placed limits on currency forward positions2 and in Taiwan overseas investors have had restrictions placed on access to certain bank deposits.
Most commentary on the Eurozone crisis to date has focused on capital and exchange control legislative measures that might be put in place in the event of a member state exit in order to protect the flight of capital and any new currency. However events in Cyprus in March 2013 created a scenario where a member state deemed it necessary to introduce capital and exchange even where that member state remained in the Eurozone.
The Cypriot Government’s decision to implement capital and exchange control measures followed panic withdrawals in March by account holders in Cyprus leading to a temporary closure of banks on the island to prevent a run on the banks. The problems were triggered by a proposed levy on all Cypriot bank accounts of 6.75% on small deposits and 9.9% on deposits greater than €100,000 under the terms of the original EU bailout proposed to Cyprus. The revised terms of Cyprus’s EU bailout agreement announced on Monday 25 March 2013 protected deposit holders under €100,000 but still impacted heavily on investors and businesses with deposits over €100,000 in Cyprus’s two largest banks, Laiki Bank3 and the Bank of Cyprus4. A link to information on current controls in place can be found here.
Capital controls in relation to the euro are without precedent and a number of commentators noted at the time that such controls are in principle prohibited under EU law5 which guarantees the free flow of capital. There would be certain exceptions for measures justified on grounds of public policy or security6, but the European Court of Justice has tended to interpret these restrictions restrictively.
2. What exchange controls might be put into effect?
From time to time countries have adopted measures to restrict the availability of currency or to manipulate its value. For example, central banks often introduce exchange controls during financial crises. Such exchange controls can take the form of currency restrictions7, multi-currency arrangements8 or discriminatory currency practices9.
In 2008 for example, Iceland, with the consent of the International Monetary Fund, implemented exchange controls which included a prohibition on foreign exchange transactions between residents and non-residents if the krona was involved.
Like capital controls, if a member state exited the Eurozone it is anticipated that it would implement exchange control legislative measures of some sort in order to protect the exchange rate of its new currency. However, for the reasons detailed above, events in Cyprus in March 2013 created a scenario where a member state deemed it necessary to introduce capital and exchange even where that member state remained part of the Eurozone. A link to information on current controls in place can be found here.
Again, exchange controls in relation to the euro are without precedent. Such measures would in principle be prohibited under EU law10 although there might be certain exceptions for measures justified on grounds of public policy or security. At the time the European Commission sought to justify the decision to impose capital controls on the basis that it was in the public interest.
3. How might capital and exchange controls present a risk to businesses?
Capital and exchange controls tend to reduce the supply of capital and raise the cost of financing especially for businesses that do not have access to international capital markets. Businesses should therefore consider the location of financial investments and/or bank accounts and the impact that capital and exchange controls may have on them. This might include assets held by a subsidiary in a risk member state or assets given as security by a third party. They should also consider how such controls would affect key counterparties and whether difficulties might arise when seeking to enforce a domestic or foreign court judgment against a counterparty’s assets.
Businesses may want to think about protections that can be built into new and existing contracts where payment obligations could be effected by capital and/or exchange controls. For example, MAC clauses and force majeure clauses could possibly be updated to reflect the possible introduction of capital and/or exchange controls. However any contractual agreement between the parties may not protect a party againstRedenomination risk or Legislative risk at the time of a member state exit. See Contracts risk section for more detail.
Businesses will also encounter various practical difficulties associated with capital and/or exchange controls. In particular, accounting and IT systems will need to be updated. In addition, suppliers, customers and distributors may themselves face issues and firms may wish to consider factoring in additional contingency to avoid interruptions in business. See the Risk Management section for more detail.
If an acquisition is contemplated then as part of its due diligence process a business may wish to identify any material contracts whose payment obligations could be affected by capital and/or exchange controls. The scope of any material adverse change clauses in any share purchase agreement or business purchase agreement should also be considered. The precise terms of any financing or equity commitments for the acquisition should also be reviewed.
4. Can capital and exchange controls in Cyprus be challenged?
The emergency legislation implemented in Cyprus is a matter of Cypriot law and Cypriot lawyers would need to be consulted on the detail on any legislation including the potential to challenge current controls in place. Your Norton Rose contact will be able to advise on recommended firms in Cyprus which whom we have a relationship.
The controls currently in place in Cyprus are in principle prohibited under EU law which guarantees the free flow of capital. However the treaty allows for certain exceptions for measures justified on grounds of public policy or security. The European Court of Justice has tended to interpret these restrictions restrictively. Any challenge to the emergency legislation though is likely to be lengthy and costly. In addition the European Commission has sought to anticipate any potential challenge by stating that the measures implemented by the Cypriot government fall within the exceptions and are therefore justified on these exceptional grounds.
The Central Bank of Cyprus website is the best place to check on a daily basis for the most up to date legislation.