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January 1, 1999

Dealing With the Euro Currency in the EMUA Move to Sector Coverage as Euro Reshuffles Desks

By Michael L.O'Reilly

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The practical conversion to the euro may seem a long way off, with new notes and coins not scheduled to hit pocketbooks until 2002.

But for brokerages and buy-side institutions and for all companies doing business in Europe the first stage of the euro conversion began this month, three years before the planned elimination of national currencies.

As of January 1, businesses had to have their computers programmed for euro values as well as for existing currency values, while invoices have to reflect both currencies.

For brokerages and institutions, equity trades need to be quoted, cleared and printed in euros. As a result, trading desks were forced to prepare their systems and backoffices by the end of last month.

But the conversion, which will ultimately make 11 currencies in Europe obsolete, had another effect: It pressured some trading desks to reorganize coverage.

In short, several trading desks are considering a move to sector-based trading, covering industries rather than countries.

"It's a logical step to be trading across sectors rather than across countries," said Adrian Pincus, managing director of U.K. and European trading at Merrill Lynch & Co. in London. "It's a step mainly driven by the euro. Analysts will research sectors, irrespective of where the stocks trade."

Traditionally, equity traders handled European stocks on a regional or country basis. So, for example, a broker dealer in European stocks might assign one trader to cover all orders in a particular country.

In sector-based trading, brokerages and sell-side traders handle orders in specific industries pharmaceutical companies, for example rather than cover stocks in regions or countries.

"I'm looking forward to sector coverage on the sellside," said Carolyn M. Croney, head of equity trading at Lexington Asset Management in Saddle Brook, N.J., whose firm invests almost half of its assets in international equities. "I'm always trying to get to the heart of a particular stock quickly, and it's harder to get that with a generalist on the sellside, someone who covers a country rather than an industry."

Merrill Lynch is among the first firms to shift its European sell-side coverage to a sector basis. "Merrill Lynch has been at the forefront of all this consolidation," said Adrian Hope, a convertible-debt trader at Jefferies & Company in London, who last year studied the euro conversion for the firm.

Merrill Lynch began planning for sector coverage early in 1998, with software changes, testing and practice weekends. In October, all of firm's desks worldwide dealing in European equities switched to sector-based trading.

Pincus said that on the U.K and European trading desk in London, all 18 position traders made the switch to sector trading. Sales traders did not reshuffle their institutional clients with the move. But the switch teamed Merrill Lynch sales traders with different position traders at the firm.

An official at Merrill Lynch in New York, who requested anonymity, said the shift was in part a response to the elimination of two key market fundamentals: multiple currencies and central-bank policies. In most markets, the official added, currency and central-bank policies are the biggest fundamentals affecting equity markets. With the euro combining those fundamentals across 11 countries, industry fundamentals become the biggest market determinants.