Friday, July 20, 2012

10 things to know about the European Stability Mechanism (ESM)


Published in Finnish daily Taloussanomat: http://www.taloussanomat.fi/kansantalous/2012/06/20/britit-kertovat-suomelle-10-syyta-hylata-evm/201231947/12 

 On Thursday, the Eduskunta will vote whether to approve the Treaty establishing the European Stability Mechanism (ESM), the permanent eurozone bailout fund, which is due to provide loans to eurozone countries and (indirectly) also banks that are in trouble. The aim is to get this fund up and running from July 2012 on, which will necessitate a strong sprint to the end, as it just emerged that the Italian Parliament might not succeed in this, and might therefore endanger the bailout for Spanish banks which European governments prefer to finance through the ESM.

Here are 10 things one should know about the ESM:

1.    On (or over?) the border of legality

It has always been very doubtful whether the rule in the EU Treaty, which makes each country responsible for its own debts (article 125), even covers all the bailout loans. Currently, these loans were being issued by a temporary emergency bailout fund, the “EFSF”. Through a modification[1] of article 136 TFEU, European governments want to achieve a legal basis for the 17 eurozone countries to set up a permanent transfer mechanism. The problem is that not all 27 EU member states will have approved this modification by 1 July (at least the UK won’t), so the ESM will be operating without legal basis from the beginning.

2.    This time, it’s about real money

Just like the EFSF,  the ESM will also be largely financed through borrowing (for 620 billion euro, of which Finland guarantees 11,14 billion euro), whereby member states only provide (risky) guarantees (which for the EFSF is happening on more and more expensive terms, by the way). Unique however, is that the ESM will also be given 80 billion euro of real capital, directly provided by member states, of which, most will need to borrow yet again more money to obtain this capital. Finland will need to pay 1,44 billion euro in full this year: a commitment apparently made in return for a special arrangement whereby Finland received collateral in return for aid to Greece, a doubtful situation. In financial terms, providing capital is similar to providing all kinds of risky guarantees (to which politicians have used since the banking crisis erupted). Politically speaking however, there is  a big difference, given the fact it isn’t possible  to just shift risks into the future.

3.    This doesn’t solve the eurocrisis

Money won’t solve the eurocrisis, as can be witnessed in the case of Spain.After Spain had  been promised 100 billion euro for its banks, Spain’s 10 year borrowing costs went on to drop for only a few hours  then reach more than 7,2 percent one week later. The eurozone’s periphery is stuck with an overvalued exchange rate, complicating growth. Until that issue is tackled, a hard task without fundamentally rethinking which countries can share a currency, all efforts to restore growth to the eurozone’s periphery will be fruitless. Until then, fiscal transfers will merely serve to pay unemployment benefits, not to create jobs for people in the periphery, where unemployment has now reached toxic levels.

As gigantic as the emergency fund of 700 billion euro may seem, in practice, the combined firepower of the ESM and the EFSF, which still has 200 billion euro at its disposal, won’t be more[2] than 500 billion euro. At least that is under the assumption that capital payments won’t be speeded up, as article 41.2 of the ESM Treaty requires that there should always be a minimum of 15 percent in capital from member states within the ESM’s coffers. Five hundred  billion euro is widely considered to be insufficient to deal with great shocks. Instead, something like 2000 billion euro or maybe even more[3] is needed to calm down the situation until the end of 2014,considering the refinancing needs of major periphery countries like Spain and Italy.

So far, the ECB has fulfilled the role of the euro’s saviour, and most likely the ECB will be asked again to come up with yet another way to support struggling member states through all kinds of acronym – designated - vehicles, named LTRO[4], ELA[5], Target2, or SMP[6].  In any case, few doubts remain on who will finally pay the bill: taxpayers.

4.    It can easily become more expensive 

Continuously, proposals are being put forward to enlarge the firepower of the emergency fund or to allow it to send money to banks directly and not through member states.[7]

Increasing the 700 billion euro capital stock or the total lending capacity (which is limited to 500 bilion euro), is allowed in the ESM-Treaty by unanimous vote of the Board of Governors (the body within the ESM composed of the eurozone’s Finance Ministers). No Treaty change is needed.[8]

Article 10 of the Treaty describes how the authorised capital stock can be increased, stating that “such decision shall enter into force after the ESM Members have notified the Depositary of the completion of their applicable national procedures.” This doesn’t however mean that countries can let such a decision depend on the approval of national parliaments. Once the Finance Minister has given such “notice”, the decision can’t be reversed any more, whatever national parliaments or courts  decide.[9][10]  

5.    Taxpayers, not banks, will pick up the bill

Ideas to let investors share the burden of the pain –after many among them have been enjoying the gain —have been abandoned. There will be no forced private sector involvement (PSI) in cases in which a country is deemed insolvent.[11] That’s unfair, and provides the wrong incentives if one wants to avoid a new debt crisis.

6.    Finland won’t be able to veto emergency ESM spending, unlike Germany, France and Italy

In emergency cases, only 3 countries  hold a veto against ESM loans to member states. This because article 4.4 of the ESM-Treaty, which allows in such cases to take a decision on granting a bailout with a qualified majority of 85 percent of the votes. Although there is still a requirement for the European Commission and the ECB to say that a failure to act “would threaten the economic and financial sustainability of the euro area”, this is something that can be applied to virtually every eurozone crisis event. Only Germany, France and Italy will dispose of minimal 15 percent of the ESM’s capital (and accordingly also of the votes within the ESM), and therefore only they will enjoy a veto.

Constitutional concerns raised in Finland were quickly rebutted by a promise[12] that the emergency procedure would only be used in “very exceptional circumstances” and that in case of bailout loans, a small amount of money will be set aside as an “emergency reserve fund” to be used by all ESM member states (not just Finland) “in order to prevent possible setbacks related to the loan,” the Dutch Finance Minister has declared. He specified that for a loan of 5 billion euro, this would involve no more than 0,3 billion euro, which makes clear it would cover only a tiny part of losses in case of hard sovereign defaults.[13]

7.    Also countries in trouble will need to contribute to the ESM’s capital 

As bizarre as it may sound: Greece, Ireland, and Portugal, which all are being bailed out already, are also obliged to put up capital, which their national budgets have taken into account already, although this sounds suspicious in the case of Greece.[14].[15] When a country doesn’t pay, the amounts which the others need to pay don’t change, because it is written into the ESMTreaty.[16] Countries that haven’t paid lose, however, their voting rights.[17] An estimate reveals that if Greece, Ireland, Portugal, Spain, and Italy would end up in this situation, Germany and France would together control more than two thirds of the voting power. Maybe that’s political fiction, but it illustrates how surreal everything is becoming. In Berlin, ESM critics can be heard mocking the rule as  its only purpose is that ultimately Germany (or Finland for that matter) will pay up so it doesn’t lose its voting power.

8.    Germany and France could use the ESM as leverage to influence EU policy

The ESM isn’t just another EU prestige project, but rather an instrument to indirectly provide the European level with influence on what was, until recently, the untouchable heart of national sovereignty: the national budget. About two thirds[18] of EU regulations for 500 million Europeans emerges at the EU level, but the EU budget only accounts for about 1 percent of GDP.

As a consequence of the Lisbon Treaty, from 2014 on, it will become possible[19] for the eurozone member states to outvote the non-eurozone members in cases where EU rules are being decided by qualified majority voting because the eurozone will then account for more than 65 percent of the EU’s population

It’s not a stretch to say that considering the importance of the ESM for the financial situation of member states, it will be hard for Germany and France to resist using this as a hedge to reach consensus at the eurozone level on issues which are being lumped together in the usual EU horse trading. The eurozone deal can then being imposed on the rest of the EU. Surely decision making at the EU level is often being decided in consensus, but always with voting power in the back of everyone’s mind. The loss of the Finland’s veto can therefore have far reaching consequences.

9.    Who are the eurozone’s future creditors? 

It’s interesting to look at who will actually lend money to that future eurozone bailout fund. If we assume that the situation won’t be much different than for the EFSF, Asia will become a fairly important player in financing European governments, given that it accounts for about 40 percent of borrowing to the EFSF, of which Japan accounts for about 20 percent.[20] China has also manifested itself, and immediately  set conditions for buying eurozone bailout bonds.[21] Considering the questionable democratic nature of many Asian countries, we should ask whether this is a positive evolution. As opposed to the United States, which also borrows much from China, European countries do not dispose of the “exorbitant privilege” of having the world’s reserve currency, so they are a lot more vulnerable when it comes to that.[22]

Of course it’s possible that China, or any new powers at the world stage, don’t have any appetite in the first place to help Europe.[23] Then letting the ECB go all out will of course become the obvious way out for many politicians. François Hollande, the new French President, has already openly called for the ECB to directly finance the ESM.[24] The European Commission also supports this position and is now trying to push Germany to agree with this.[25]

10.  Control on ESM spending is already being considered insufficient by national Courts of Auditors 

A number of national Court of Auditors have complained about the way in which many billions of euros of taxpayers money will be spent. [26] Unfortunately this is not a unique situation at the EU level: for years now, the Court of Auditors continues to refuse to give the EU budget a clean bill of health because spending suffers from too many errors. Since the criticism was issued, the ESM Treaty hasn’t been adapted in a sufficient way. In April, the Dutch Court of Auditors repeated its concerns in a hearing at the European Parliament, lamenting that “the arrangements formulated in the ESM Treaty for transparency and accountability are weak and as far as we know nothing concrete – aside from the hearing being held today – is being done to alter this”. It’s telling that before its start, heavy doubts have arisen on the reliability of the ESM.


[1] European Council Decision of 25 March 2011 amending Article 136 of the Treaty on the Functioning of the European Union with regard to a stability mechanism for Member States whose currency is the euro: http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2011:091:0001:01:EN:HTML
[2] See Open Europe Blog,’ who’s afraid of a big bad bailout fund?’,30 March 2012, ‘http://openeuropeblog.blogspot.com/2012/03/whos-afraid-of-big-bad-bailout-fund.html
[3] See Open Europe,’ who’s afraid of a big bad bailout fund?’,30 March 2012, ‘http://www.openeurope.org.uk/Article/Page/en/LIVE?id=1672
[4][4] See Open Europe Blog,’ What is cheap ECB liquidity actually solving?’,29 February 2012, http://openeuropeblog.blogspot.com/2012/02/ltro-no-2-of.html
[5]See Open Europe Blog, ‘A 'selective' Greek default and some emergency liquidity’, 28 February 2012, http://openeuropeblog.blogspot.com/2012/02/selective-greek-default-and-some.html
[6] See Open Europe Blog, ‘The ECB loads up on PIIGS exposure’, 20 April 2012, http://openeuropeblog.blogspot.com/2012/04/ecb-loads-up-on-piigs-exposure.html
[7] See Bloomberg,‘IMF's Vinals: ESM Needs Direct Access to Europe's Banks’, 18 April 2012,   http://www.safehaven.com/article/25109/imfs-vinals-esm-needs-direct-access-to-europes-banks
[8] Also see, article 5.6.d ESM – Treaty
[9] See Handesblatt, ‘ Wird Deutschland Zahlmeister einer Europa-Regierung?’, 11 May 2012,  http://www.handelsblatt.com/politik/konjunktur/nachrichten/stimmt-es-dass-wird-deutschland-zahlmeister-einer-europa-regierung/6618982.html
[10] Furthermore, ESM critics have claimed that there is even a way to leverage the ESM, which would make exposure to taxpayers more extensive and more likely. They argue that as article 8 ESM Treaty states that in special circumstances, newly issued capital shares can be issued on other terms than at par.  Member states’ exposure are linked to the issue price of ESM shares and not to the nominal number of 700 billion euro, which allegedly circumvents the limit. Responding in an internal letter seen by Open Europe to comments in this sense made by German liberal MP Frank Schaeffler, the German Finance Ministry didn’t deny, but noted that a similar arrangement was made for the European Bank for Reconstruction and Development [EBRD). That doesn’t look like a valid comparison, given the fundamentally different nature of the ESM  compared to the EBRD, as the former is constructed precisely to take on huge liabilities, which should therefore be regarded in a much more critical way. See also FrankShäffler weblog, ‘ Hat das jemand gelesen, als es unterschrieben wurde?’, 14 March 2012, http://www.frank-schaeffler.de/weblog/1913
[11] The preamble now only  states that private sector involvement will be “considered”: “(12) In accordance with IMF practice, in exceptional cases an adequate and proportionate form of private sector involvement shall be considered in cases where stability support is provided accompanied by conditionality in the form of a macro-economic adjustment programme.” Also see Euro area debt crisis, ‘ESM loses all its teeth’,7 December 2011, http://economistmeg.com/2011/12/07/esm-loses-all-its-teeth/.The 2011-draft of the European Stability Mechanism Treaty outlined detailed provisions about the private sector involvement, allowing members to “take initiatives aimed at encouraging the main private investors to maintain their exposure”(Article 12). For further information, see the online version of the ESM Treaty: http://www.scribd.com/PabloDRY/d/71849462-EU-Treaty-establishing-the-European-Stability-Mechanism-ESM-ENG
[12] Helsingin Sanomat, “Finland prevails in ESM decision-making dispute”, http://www.hs.fi/english/article/Finland+prevails+in+ESM+decision-making+dispute/1135270254048 and Bloomberg, “Euro Ministers Agree on ESM in Voting Compromise, Finland Says”, 25 January 2012 http://www.businessweek.com/news/2012-01-25/euro-ministers-agree-on-esm-in-voting-compromise-finland-says.html  
[15] Article 8.5 of the ESM – Treaty states that “the obligations of ESM Members to contribute to the authorised capital stock in accordance with this Treaty are not affected if any such ESM Member becomes eligible for, or is receiving, financial assistance from the ESM.”
[17] See also article 4.8 ESM - Treaty
[18] See Open Europe research, ’Out of Control? Measuring a decade of EU regulation’,February 2009,
http://www.openeurope.org.uk/Content/Documents/PDFs/outofcontrol.pdf
[19]See Open Europe research, ‘Continental shift:Safeguarding the UK’s financial trade in a changing Europe’, December 2011, http://www.openeurope.org.uk/Content/Documents/PDFs/continentalshift.pdf
[20] See also Credit Suisse research and analytics, ‘EFSF (R)evolution: An analysis of the developing infrastructure of the EFSF and ESM, 16 August 2011, https://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&document_id=804326740&source_id=em&serialid=OtY9EhZvgwxb53tmOyt21DVQZpT6XNymEqnLTTSYhI0%3D
[21] See Spiegel international, ‘China May Impose Conditions for Helping Euro Zone’, 28 October 2011, http://www.spiegel.de/international/europe/investing-in-the-efsf-china-may-impose-conditions-for-helping-euro-zone-a-794575.html
[22] Also the fact that 44 percent of the EFSF’s means are coming from governments, banks and “sovereign wealth funds”, which is therefore also the case for the means coming from Asia, should raise concern.
[23] See Financial Times, ‘China to Europe: that’s a sure nice EFSF you have there’, 28 October 2011, ‘http://ftalphaville.ft.com/blog/2011/10/28/715586/china-to-europe-thats-a-sure-nice-efsf-you-have-there/
[24] See Irishtines, ‘Hollande calls for ECB to lend directly to ESM fund’, 3 May 2012, http://www.irishtimes.com/newspaper/world/2012/0503/1224315513572.html. Similarly, German liberal MP Frank Schaeffler, the country’s most prominent “euro rebel” has even claimed that the ESM – Treaty already provides this possibility right now, through article 21.1, as this allows the ESM to borrow from “other persons or institutions”. See Handelblatt, ‘Die Währungsunion hängt am seidenen Faden’, 29 February 2012, ’http://www.handelsblatt.com/meinung/gastbeitraege/gastbeitrag-die-waehrungsunion-haengt-am-seidenen-faden/6227882.html
[26] Eén Vandaag, “Controle Europees noodfonds slecht geregeld”, 27 February 2012, http://www.eenvandaag.nl/economie/39854/controle_europees_noodfonds_slecht_geregeld  Letter: http://www.eenvandaag.nl/uploads/doc/DOC001.PDF and Algemene Rekenkamer, “Algemene Rekenkamer pleit voor verbetering controle ESM”, 27 February 2012,  http://www.rekenkamer.nl/Nieuws/Nieuwsberichten/2012/02/Algemene_Rekenkamer_pleit_voor_verbetering_controle_ESM
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