6 December 2018

Here's How Europe Plans to Challenge the Dollar's Dominance

By Viktoria Dendrinou and Nikos Chrysoloras

The European Union is set to unveil plans for challenging the dollar’s dominance in global markets, including energy, as it seeks to strengthen the international role of its currency and become more independent from the U.S. amid a widening rift in transatlantic ties.

The EU must develop “a full range of trustworthy interest rate benchmarks” in financial markets, and a fully integrated instant payment system, according to a draft set of initiatives due to be released later this week by the European Commission. The bloc’s executive arm will also explore the possibility to further develop the role of the euro in foreign exchange markets.

The commission’s plans are aimed at mitigating the so-called “exorbitant privilege” of the U.S. dollar, which allows Washington to force global compliance with its foreign policy goals, including by the EU.

“There is scope for the euro to develop further its global role and achieve its full potential, reflecting the euro area’s political, economic and financial weight,” the commission said in the draft obtained by Bloomberg.

Hedging Transactions

The proposed measures include using the euro as default currency in energy contracts agreed between EU member states and third countries, as well as the creation of euro-denominated price benchmarks for crude oil. While the proposals aren’t binding legislation, their potential adoption by the bloc could upend the global energy market.

According to a separate memo also obtained by Bloomberg, the commission’s recommendations will reduce the risk of “disruption of energy supplies” due to the actions of “third countries.”

The commission will also seek to make hedging transactions in euros more attractive. This could be achieved by requiring a greater number of contracts to be cleared through central counterparties, it said, citing past success with creating liquid markets for such products through measures introduced after the financial crisis.

Finalizing the reform of scandal-ridden financial benchmarks could also help “increase the attractiveness of trading and pricing euro-denominated instruments,” the commission said. On top of that, officials will help foster “a fully integrated instant payment system” to reduce reliance on foreign providers of card and online payments, it said.
‘Wake-Up Call’

The commission’s effort to develop the euro’s international role reflects growing calls in countries such as France and Germany for the EU to also adopt tools that will allow it to pursue its foreign-policy goals with less recourse to an unpredictable U.S. ally.

“Recent extraterritorial unilateral actions by third country jurisdictions like in the case of re-imposed sanctions on Iran, together with recent challenges to the international rules-based governance and trade are a wake-up call regarding Europe’s economic and monetary sovereignty.”

The EU is the world’s largest importer of energy in the world, as its annual import bill averages more than 300 billion euros ($341 billion) per year, according to the memo.

A euro-denominated reference oil contract “could be used as an underlying asset for financial contracts, such as derivatives, that provide the necessary risk management tools for market participants,” according to the draft.
Oil Pricing

The pricing could be based either on existing production fields in the European Economic Area, or matched to physical properties in a “typical” barrel in the EU crude oil import basket.

The proposals also include European bodies and mechanisms increasing their share of euro-denominated debt and providing technical assistance to companies in Africa and the EU’s neighbors, and supporting them in adopting the euro as their payment currency.

The plans come in parallel with ongoing discussions on how to set up a so-called special purpose vehicle that will facilitate payments including for Iranian oil. Allowing transactions with Iran to go through -- even as the EU’s lending arm, the European Investment Bank, has exposure to the U.S. making it more difficult to act as a financing channel -- will help the EU economy and businesses grow more independent from the dollar and the U.S. economy, officials say.

Still, efforts to set up such a vehicle are facing several unresolved issues, including finding a location for the operation and a way to reassure banks interacting with it that they will be shielded from the risk of exclusion from the U.S. financial market.

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