Lord Hill is the EU's new financial services Commissioner - but what is his remit and who does he report to?

With the future of the UK seemingly hanging by a thread it is understandable that events north of the border are dominating attention, but today's announcement of the new European Commission also has far-reaching consequences for the future of the UK's EU membership and the EU itself.

As we set out in our flash analysis, the appointment of Lord Hill to the key financial services portfolio (pending approval by MEPs) is a win for the UK, and the general reformist outlook of the Commission, with other crucial posts (Internal Market and Competition) held by liberal, pro-free trade, non-eurozone countries, provides grounds for cautious optimism.

What will Lord Hill's portfolio include?

• Overseeing the creation of the banking union – a crucial policy for the eurozone but also one which threatens to split the EU into euro-ins and outs. In his new role, Lord Hill can ensure this does not happen. That being said, this is a very tricky role to manage (with numerous competing interests), especially for a non-eurozone country.
• Power to review the role of the European supervisory authorities, institutions which have been controversial in the UK since their creation.
• Responsibility for a 'Capital Markets Union'. While this remains vague it could be a good initiative for the UK since London is already the centre of European capital markets. Lord Hill can base the union around the single market rather than the eurozone.

As the charts below show, the Commission has also been re-organised with a series of policy clusters, with the UK being at the heart of all the major decisions relating to the single market, jobs and growth and the Eurozone. Each 'cluster' will be headed by a Vice-President, previously a largely meaningless role but now with additional agenda setting powers and the ability to stop legislative proposals from other Commissioners.

Lord Hill will 'report' to two Vice Presidents who will "steer and co-ordinate" depending on the issue at hand - the new "Jobs, Growth, Investment and Competitiveness" VP Jyrki Katainen and the "Euro and Social Dialogue" VP Valdis Dombrovskis (both of whom are former PMs). In terms of the two VPs, Dombrovskis is likely to supervise the banking union aspects of Lord Hill's post while Katainen will oversee the more single market aspects, although even here, there is plenty of scope for overlap.

Lord Hill's portfolio also has some overlap (and therefore potential conflict) with France's new Economic and Monetary Affairs Commissioner Pierre Moscovici .The potential for Anglo-French clashes within the Commission is relatively limited since Moscovici will be primarily tasked with macroeconomic eurozone policies rather than financial markets, but one potentially fraught area could the be Financial Transaction Tax or a Common Consolidated Corporate Tax Base. Juncker has asked Moscovici to finalise negotiations over both.

It remains to be seen how the relationship between VPs and different clusters will work in practice, especially as Juncker himself has insisted that "In the new Commission, there are no first or second-class Commissioners", and since decisions in the College of Commissioners have traditionally been taken by a majority of all Commissioners in a secret vote. However, Juncker also made clear that the Vice-Presidents “can stop any initiative, including legislative initiatives” of other commissioners – effectively acting as “a filter”.

Time will tell how potential disputes play out or are resolved and to what extent the VPs can truly veto proposals. What is clear is that the relationship between these four men could be crucially important.

Banking Union challenged at the German Constitutional Court

It emerged over the weekend that five German academics have launched another challenge at the Bundesverfassungsgericht – the German Constitutional Court (GCC) – this time against the proposals for a banking union based on the Single Supervisory Mechanism (SSM) at the ECB and the Single Resolutions Mechanism (SRM) at the Commission, with a Single Resolution Fund (SRF) set up via a separate intergovernmental treaty.

For background on all these institutions, see these links: SSM, SRM & SRF. 

One of those bringing the complaint is Prof Markus Kerber of Europolis (who has been heavily involved in previous suits). According to the press release the key point of the challenge is:

• That the banking union plans overstep power given in Article 127 TFEU. This is the article which was used to create the SSM in the ECB. Essentially it seems the group take issue with the idea that this could be done since the article refers only to conferring “specific tasks upon the European Central Bank concerning policies relating to the prudential supervision of credit institutions”. The thinking seems to be that, article 127 allows for the ECB to take on certain specific tasks, but not to turn the ECB into the eurozone's single supervisor, giving it complete supervisory control over certain banks and, to an extent, superiority over national supervisors (which some might see as a transfer of power).

• A key question will be around the amount of power transferred to the ECB. (There is no doubt it has become one of the most powerful institutions in the eurozone crisis both due to de facto action and de jure changes. There are certainly valid questions to be asked here, particularly since the level of democratic oversight is limited due to difficulties in combining this with its strict independence when it comes to monetary policy matters).

• Although the details are yet to be released, the complaint is also likely to question the legal base of creating the SRM inside the Commission and the pooling of national funds through the SRF. The main questions here relate to the level of control and oversight from the national level, particularly whether the Commission is the right institution to take on this new role and whether it is gaining too much power - not least since the decision was taken under qualified majority voting due to the use of the single market legal base.

The group are far from alone in raising legal concerns surrounding the basis for the banking union. As we have previously noted, both the German government and the European Parliament have expressed legal concerns over the structure; the former with regards to the fiscal impact and the legal basis for pooling of funding and the latter with regards to the use of intergovernmental treaties and the circumvention of the EP. (Ironically, such intergovernmental agreements arose in large part to avoid Germany’s original concerns).  The German government’s concerns have also been mostly dismissed by the Council legal service previously.

The UK Government has also made noises about concerns around the use of the single market article (114) to create a new eurozone architecture.

As the FT notes, these cases take some time to work their way through the system and the GCC has shown a track record of generally siding with the EU, albeit often with some caveats.

Given said track record and the previous opinions expressed by the Council legal service, we can’t help but feel the outlook is already dim for this challenge. As with all eurozone policies, overturning it would likely cause huge market disturbance and shift the eurozone back towards an existential crisis – something the court is usually quite aware of.

That said, the court could add caveats in terms of the democratic assent required for banking union and the role of the Bundestag where funds are concerned. It could also pass the judgement onto the European Court of Justice, as it has done with the case over the ECB’s bond purchase programme the OMT, not least because it seems to mostly question the legality under EU treaties.

In any case, this is certainly one to watch and not just from the eurozone perspective. Any ruling could well set a precedent and have a role in determining how far the eurozone can push certain treaty articles in terms of legal bases but also how it fits with national constitutions. In other words, it could be important in determining the issue of euro-ins vs. euro-outs as the EU develops.

Rien à voir ici? Hollande says treaty change is "not the priority" for France, but...

David Cameron and François Hollande have just held their joint press conference following the Anglo-French defence summit in Oxfordshire. Predictably, though, most of the questions focused instead on Cameron's EU renegotiation strategy and the prospects of it being achieved by changes to the EU treaties.

Here's what stood out for us:

• Significantly, Cameron explicitly said that renegotiation of the UK's EU membership "will involve elements of treaty change". This is quite a rare admission, and is the most explicit he's been so far on the need to change the EU treaties. As The Times's Sam Coates flagged up, the Prime Minister has been categorical about EU treaty change once before, speaking of "the treaty change that I’ll be putting in place before the referendum", on the Andrew Marr Show earlier this year - although the question was specifically on EU migrants' access to benefits. 

• The Prime Minister also reiterated that "the eurozone needs change...It needs greater co-ordination, it needs those elements that make a single currency succeed. That's why in recent years we've already seen treaty changes."

• Hollande said that "France wants more coordination and integration in the eurozone", but treaty change "is not the priority" for the time being. Though this is what the headlines are likely to focus on, this is nothing new, nor surprising. It's been the French position for ages. However, Hollande didn't rule treaty change out. He said it wasn't "urgent" or "the priority". As we have argued from the beginning (see here, for instance), the timetable remains a weakness in Cameron's plan - not least because discussions on changing the EU treaties can drag on for years and the eurozone remains on an uncertain development path.

• The French President also stressed that major treaty changes (he mentioned the Maastricht Treaty as an example) would have to be put to a referendum in France - while for smaller ones parliamentary approval would be enough.

A couple of points are worth making. It is no secret that one of the reasons France is wary of changing the EU treaties is that referenda are not exactly easy to win (think of the one on the EU Constitution in 2005, but also the one on the Maastricht Treaty, both of which split the country and the political establishment).

This is true assuming that the new Treaty gives the EU more powers. But this is not what Cameron is aiming for. So it is not entirely clear that any UK-led changes would necessarily have to be put to a vote in France.

That said, though, the common wisdom on this point is that an EU treaty change would be part of a 'grand bargain' to strengthen economic coordination in the eurozone - meaning that the UK's new relationship with the EU would be negotiated alongside greater central controls in the euro area. This type of treaty change could clearly trigger a referendum in France (and elsewhere).

The question remains open. With Germany likely to keep pushing for an EU treaty change to complete the overhaul of the eurozone structures, we still think Hollande may have to face the issue sooner rather than later - with the question being what deal Berlin can broker.

And yet again, that brings us back to Angela Merkel.

Banking union hits another bump in the road

As Bloomberg and the FT reported last week, the recently agreed plans for a Single Bank Resolution Mechanism (SRM) could face further problems and possibly even a legal challenge at the European Court of Justice (ECJ).

The European Parliament announced last week that it will today send a letter to Commission President Jose Manuel Barroso outlining significant concerns over the agreement reached between EU member states last month.

The concerns focuses on the agreement to use an intergovernmental treaty to set up the resolution fund – a move demanded by Germany to provide additional legal safeguards against the pooling of risk and resources. The Commission has also raised concerns. More widely it relates to the fact that both the EP and Commission are unhappy with the compromise struck, believing it does not go far enough and does not follow the 'community method'.

According to numerous media reports and a statement by the EP, this dispute could delay the adoption of the SRM until after the European elections – a delay which could increase market uncertainty, especially around the bank stress tests.

The prospect of a legal challenge has also been raised. But, would the EP have a case? Unfortunately, at this stage we have more questions than answers for you, but below are a few points to consider:

• Given that the main point of contention relates to the intergovernmental treaty, which is outside EU law, it’s not clear that the EP has a role to play or has any legal protection to fall back on.
• That said, since much of the rest of the regulation is within the EU framework, the EP could potentially suggest its role as a 'democratic check' is being circumvented.
• To be frank, it’s really not clear either way at this early stage. But this could prove to be a very interesting test case if it ever does come to pass. Throughout the crisis there has been a working assumption that the eurozone can build the necessary structures to help solve the crisis through a combination of EU laws and intergovernmental treaties. If this is thrown into doubt, the view of the future of the euro could begin to change.
• It also has wider implications that affect the UK. The banking union deal illustrates the limits of the existing treaties and, as Chancellor George Osborne told our conference, that they are increasingly unfit for purpose in accommodating different degrees of integration. Intergovernmental treaties have been touted as the answer to any awkward UK treaty demands, but, if the scope for such treaties is limited, full blown treaty change of the sort David Cameron would like to use as a forum for reform might become unavoidable.

In any case, it will be an interesting dispute which could have some bearing on the future set up of the EU. One thing that is for sure though, is that it will lead to more delays and more questions being asked about the banking union deal.

The German banking union

A deal emerges. It seems that the negotiations are finally coming to a conclusion on the issue of banking union – after just a year.

There has already been lots of coverage of the details of the deal, see in particular the excellent summaries from the WSJ and the continued coverage from the FT Brussels blog, so we won’t bother rehashing all the specifics here. Instead we’ll provide some analysis of the deal and flag up what we think are the most important implications.

First point to make to those who are frustrated about this deal not going far enough: what did you think realistically could happen? 

The deal is not that different from the previous version which we laid out here, although a few (if not all) of the unanswered questions have been cleared up.

What’s new?

• Earlier this week an agreement was reached on the structure of the funds. It was, as expected, decidedly German. A €55bn fund will be built up from levies on the financial sector between 2016 and 2026. In the meantime, any funding required to aid banks above bail-ins will come from national coffers or ESM loans to sovereigns. Only after 2026 will a centralised fund be created and while there may be some mutualisation, it is yet to be defined and will be subject to future negotiations. There is also scope for national funds to lend to each other but this is to be defined in an intergovernmental treaty.
• The decision making process will be thus: as supervisor the ECB recommends a bank be resolved, the board of national resolution authorities devises a plan and votes on it ( any release of funds will require approval  two-thirds of voting countries contributing at least 50% of the common fund). This will then have to be approved by the Commission. If there is a dispute at any stage of this process the Council of EU finance ministers will decide on simple majority (if not then it will approve through a ‘silent procedure’).

What does this mean for the eurozone?

• Well, we’re seriously at risk of repeating ourselves here, but here we go. A deal is positive and necessary. That said, the process remains incredibly complex and still seems highly national or intergovernmental. If there was a serious failure of a large cross border bank, such as we saw with Dexia, would the process really be any smoother or simpler than last time around?
• The funding remains minimal and only enough to cover the resolution of one or two medium sized banks. It will also not be available for some time and certainly will have little role in helping to deal with any recapitalisation costs outlined by next year’s stress tests.
• Taking a broad view, it’s easy to question how cross border this ultimate banking union is. The single supervisor under the ECB will only cover the largest 130 banks. The resolution mechanism will cover the same banks, plus another 200 or so which are cross border. However, there are around 6000 banks in the eurozone, and the very large majority of these remain under national purview.
• Generally, this also raises questions about how effectively the ECB can do its job as national supervisor. While the cracks in the system could push it to be harsher to ensure there is not a systemic crisis, it also poses problems given the current issues on bank balance sheets. It is crucial that next year’s stress tests are credible, if the ECB shows signs of insecurity about the ability to deal with a large bank recapitalisation it could raise questions about the process.
• Clearly, given the intergovernmental nature and the prevalence of national governments it is likely to be insufficient to break the loop between sovereigns and banks in the eurozone.

How about for non-euro countries?

• Again we have outlined these points before. It seems that they managed to secure specific protections to ensure they will never be on the hook for eurozone banks, which is good but also the absolute minimum that should be expected.
• The use of an intergovernmental treaty is tricky. It side-lines these countries somewhat but also shows the limits of what the eurozone can do within the EU treaties.
• The creation of the resolution board as a new agency within the Commission does raise some concerns. It is clear it should be its own separate institution for the eurozone only, however, the lack of willingness to open the treaties has created this system. If the eurozone continues to push new institutions into older ones and distort the structures of the EU for eurozone use, it could become problematic. It also creates a complex and ineffective decision making procedure for the eurozone as is clear above.

Winners and losers

• Germany. Plain and simple. For all the talk of a compromise earlier this week, it was incredibly minimal compared to how closely the plans as a whole match the German desires.  Think back to the original Commission plan, which was incredibly centralised. We said then it wouldn’t fly with Germany and it hasn’t.
• The structure is intergovernmental, has minimal pooling of funds, is built up overtime, excludes smaller banks, does not include direct bank recapitalisation from the ESM and has a large bail-in element. All key German demands. They have made a vague promise to have some sharing of funds in a decades time, the details of which need to be negotiated over and may be limited to an intergovernmental treaty.
• If there are any losers, then it is likely to be France and the Mediterranean bloc. They were pushing for significantly more pooling of funds and a more centralised process. That said, France did previous publish a joint vision of the banking union with Germany, which is not a million miles from the current structure. The deal also allows them some more scope to use bailouts rather than bail-ins if needed – something else they were keen on. 

As we have noted recently, 2014 is likely to be another year where governments come to the fore in eurozone. 2012 and 2013 were the ECB's years, where its actions held the euro together. With the focus now on growth, more emphasis will fall on the governments of the eurozone to develop a new structure and strategy to put the bloc back on a sustainable footing and a path to prosperity. 

Merkel: If you want more Europe, be prepared for EU treaty change

Angela Merkel this morning delivered her first Europe remarks at the helm of the new German Grand Coalition. It wasn’t a “Europe speech” per se but rather her usual pre-EU summit briefing in the Bundestag - although it undoubtedly had a bit more meaning since it is the first under the new coalition.

Two key points stood out to us:

First, she wants a Eurozone “banking union” to be agreed – and possibly up and running – at some point during 2014. However, as we noted in our pre-German election briefing, and which is most certainly being borne out by events, this is a watered down, very German version of banking union. This was clear from last night's (partial) deal on banking union (more on this later). So if you’re the typical Anglo-Saxon economist hoping for a big, joint backstop – don’t hold your breath. This one will be messy.

Secondly, she again hinted at EU treaty change. It’s interesting that Merkel just won't let that idea go. She said,

“Those who want more Europe, also have to be prepared to reregulate new competences…We have a situation in Europe where everyone says, ‘We can do everything to evolve, but they one thing we can’t change are the treaties.’ I don’t think we will develop a Europe that functions in this manner.”  

Third, Merkel again pushed for so-called "reform contracts" arguing:

"It is necessary to ensure that the required structural reforms are pushed through...[there must be] contractual agreements...We will be discussing such contractual agreements at the European Council for the umpteenth time... [I expect] to see progress."

Translation: if you want us to underwrite the euro, we need 'see-you-in-court' style supervisory powers, firmly grounded in law. That means, EU treaty change.

Eurozone inches towards banking union but may need to resort to intergovernmental treaties

Eurozone finance ministers yesterday took a belated step towards the key part of the banking union, the single resolution mechanism (SRM), with many reports suggesting that the broad outlines of an agreement have emerged.

We’ve written about the background to this extensively, see here and here for example. As a recap, a deal was expected to be completed by the end of the year so that the framework is in place for after next year’s ECB Asset Quality Review and EBA bank stress test. This now looks unlikely, with technical details being ironed out into next year, but there is still hope for a political agreement at the EU Council on 19 December.

What are the key points of the latest agreement?

• The latest official draft of the plans was published early last week and things don’t seem to have changed massively.
• A board of national resolution authorities will make recommendations on how to resolve banks (after the ECB as supervisor recommends the need for action). The Commission then decides whether the plans are adequate or not.
• There will not be a centralised fund, at least not immediately. As in previous plans, one will be built up over the course of a decade to €55bn, through undefined levies on the financial system.
• A network will be set up between national funds allowing them to lend to each other and take action when there is a crisis. This may be governed by a separate intergovernmental treaty, to assuage German concerns over its legality.
• Taxpayer-backed funds remain a last resort, in particular European funds (either through the network or the ESM, the eurozone’s bailout fund), with bail-ins being the initial response. The plans for bail-ins, under the EU’s Bank Recovery and Resolution Directive, could be moved forward from 2018 to 2016 to help appease Germany further.

What is still yet to be agreed?

• Numerous points remain unclear, not least, who has the final say if the Commission and national authorities disagree. If it involves national funds, it is almost certain to be national authorities.
• The exact process for triggering the use of funds remains unclear, particularly in a situation where the resolution process involves a large cross border bank.
• More importantly, if a new treaty is needed, the details of this need to be thrashed out – as we saw with the fiscal compact, this can take time and will itself require a tricky negotiation. It also needs to be decided whether this will be incorporated into EU treaties, as is planned for the fiscal compact.
• There continues to be talk of the SRM and its rules applying only to larger banks, similar to the setup of the ECB’s single supervisor.

Has Germany really moved that far?

• Reports suggest a shift in the German position is the key factor behind the compromise. While Germany has clearly shifted a bit, it has also got plenty of things it wanted.
• Looking back at the proposal laid out by German Finance Minister Wolfgang Schauble in the FT in May, Germany has secured the following – significant national power, increased role for a board and less for the Commission as well as limited use of taxpayer funds, with no central fund. It could also potentially secure an SRM focused on larger banks and a quicker introduction of bail-in rules.
• It has of course compromised on its view that the treaties need to be adapted, after its position took a blow somewhat from the recent legal opinion on the issue. It has found a halfway house with the intergovernmental treaty, giving it some further legal protection.

What would this deal mean for the eurozone?

• As we have said before, progress towards a deal is positive. But the deal still suffers from some key short comings namely: the system will not be in place for the immediate aftermath of next year’s stress tests, the system is still reliant on national authorities and ad-hoc measures as well as suffering from constraints in terms of reaction time in a crisis. 
• Any funds, be they national or European or ESM, remain short of what is likely needed to help backstop and resolve any large failing banks in the circa €33 trillion eurozone banking sector.
• We remain unconvinced that this will be sufficient to break the sovereign-banking loop which has intensified during the crisis (breaking it remains the stated goal of the banking union) – national politics and money still has a huge role to play in this system.
• An important point to consider is that, given the current setup of the eurozone banking system, bank bail-ins remain, for the large part, national affairs. While this is separate to the sovereign-bank loop, it does highlight the tight feedback loops within many eurozone economies and could intensify the problem of nationally systemically important banks. This may change over time but is not guaranteed.

What would it mean for non-euro countries?

• The use of an intergovernmental treaty is interesting and could have ramifications. While it is far from ideal for the eurozone, it does side-line the potential influence and control of non-eurozone countries.
• One potential upside is that the eurozone will not be able to force through its own institutions under the single market article (Article 114) which does highlight the limits to how far they can stretch this.
• The ad-hoc part of the agreement does fragment the process and fails to provide a systematic blueprint for how future institutional changes will address the EU/eurozone conundrum.

EXCLUSIVE: First translation of draft German Grand Coalition agreement

We have seen a first draft of the German coalition government agreement (the final agreement is expected tomorrow), courtesy of Green politician Malte Spitz who published the draft on his blog late yesterday evening.

The German media has begun delving into the document while the English speaking press continues to lag behind.

The document contains some key insights about how the new government will view Europe and conduct its EU policy, below we pick out the most important parts:

Overall vision of the EU
The agreement stresses that German must become an official working language of the EU alongside French and English – not entirely surprising given that it was a CDU/CSU electoral pledge, but it highlights that Germany is slowly becoming more comfortable with its role in Europe.

There is also a strong emphasis on “subsidiarity” and that the EU must only act where action on other levels is not sufficient. It also highlights that Germany is keen to deepen ties with Poland and maintain the “unique” Franco-German partnership. This may not mean much, but it definitely isn't a nod to David Cameron.

In terms of democratic legitimacy, the agreement calls for a "strong role" for the European Parliament and "close involvement" of national parliaments  in the decision making process. It also calls for a standard minimum threshold for the allocation of seats under European elections and a "single European suffrage" to add to stable majorities at the European Parliament. The final point here is the call for a "stringent and efficient" set of Commissioners - possibly a hint towards reducing the number of Commissioners and focusing them on policy areas rather than allowing one for each member.  

Eurozone crisis
The agreement contains few details on the new government’s approach to the banking union and specifically the resolution funds – given that this is known to be a part of the negotiations it is surprising nothing has been included, maybe a sign that an agreement has been hard to come by.

The document also contains a rare admission from Germany that the causes of the crisis are "varied" and extend well beyond fiscal profligacy. Specifically to "competitiveness", "imbalances" and "design defects" in the EMU which led to problems in the financial markets.

As for the way out of the crisis - as we predicted - much more of the same can be expected:

“[The eurozone must] combine structural reforms to increase competitiveness, and a strict, sustained continuation of budget consolidation for increased competitiveness with future investment in growth that combines employment in socially-balanced way.”

Again as we pointed out in our pre-election briefing, the widely mooted ‘Reform Contracts’ are likely to be a key tool in enforcing these changes. In particular, the contracts will be democratically grounded and enforceable (although the exact mechanism for this is still unclear):

“We are committed to ensuring that the euro countries agree on democratically- legitimised binding and enforceable contractual reform agreements on the European level. [These reform contracts] will be directed to achieving the goals of competitiveness, sound and sustainable finances, growth and employment.”

Any form of debt pooling is strictly ruled out, as we predicted in our pre-election briefing:

“The principle that each Member State is liable for its own obligations must be upheld. Any form of pooling of sovereign debt would jeopardise the necessary national policies in each Member State. National budget responsibility and supranational, joint liability are not compatible.”

The new coalition will not rule out further bailouts and will consider them but “only as a last resort” when the “stability of the eurozone as a whole is at risk”. Importantly, the agreement reiterates that any use of the ESM, the eurozone bailout fund, needs “approval of the Bundestag”.

The City of London may also have some grounds for concern, given that the document hints at more action on financial sector regulation, saying:

 “The financial markets must be involved in the costs of the crisis, and must be guided back to their function as serving the Real-economy.”

Remember, this is only a draft. Nonetheless, the agreement looks to be very much as expected – no change of course on the eurozone, some mention of limiting EU power but a continued commitment to the EU and Europe. The draft however, remains vague on some key details. With important negotiations coming up on the eurozone banking union as well as in terms of the future of the EU, the new German government will have to flesh out its position significantly.

As discussions stall, leaked docs show divergent plans for bank bail-in and resolution from EU institutions

The Times’ Juliet Samuel has an interesting story today looking at the progress on bank bail-in rules and resolution funds at the EU level (via some leaked docs relating to the EU's Bank Recovery and Resolution Directive).

Despite another round of meetings little progress seems to have been made in finalising the format of the resolution authority or the fund it would use to aid banks, i.e. the creation of the second pillar of the banking union – although there does seem to be a move to increasing the direct involvement of national authorities. Germany also looks to have conceded somewhat on using the ESM, the eurozone bailout fund, to aid banks as agreed over the summer. But given that this will still require a change in German law and approval in the Bundestag to activate it, the hurdles remain very high.

See here for a recap of the country differences on bail-in plans, here for a recap of our take on the plans as they stand and here for our view of the banking union so far.

With this in mind the internal Commission assessment (which can be found in full here) raises some interesting points (it's worth keeping in mind the the bail-in plans and banking union are separate but very closely related when it comes to questions of aiding banks). The paper essentially provides a comparison of the different bail-in approaches favoured by the European Commission (EC), the Council and the European Parliament (EP). The EC proposal sees a very strict bail-in structure with all levels of investors and uninsured depositors facing losses before resolution funds are tapped. The Council waters this down slightly, with some use of resolution funds at different stages. The EP goes further with greater protection of depositors and therefore more use of resolution funds (see graph below for a useful graphic on all this).

Although the analysis is significantly limited by numerous assumptions and data constraints, some interesting points can be gleaned, which we outline below:

Greater flexibility, leads to greater use of funds: The key point seems to be that any flexibility introduced into the bail-in system will significantly increase the level of resolution funds needed. Broadly, under the Council proposal this could reach €70bn under a 25% loss scenario. Under the EP structure the figure could top €200bn if there was a systemic crisis. These are rough figures gleaned from the numerous scenarios, but the message is a clear warning to the Council and Parliament about allowing too much flexibility from the planned bail-in rules.

Where would these funds come from? This is the obvious follow up. No plan is presented in the paper and the general idea is that they would be built up over time from taxes on the financial sector. But under the current plans this could take up to 10 years, from a start in 2018. What happens in between? There seems little choice but to infer that national taxpayer funds would be tapped if another crisis hit.

Bank investors and even depositors lined up to take big hits under bail-in: Another key feature of this paper is that, for the first time, it highlights the type of losses investors and depositors will face if a crisis hit under the bail-in rules. In nearly all scenarios, albeit to varying degrees, even senior debtors and uninsured depositors take large hits. As these discussions develop and the final structure becomes clearer the market will begin to reassess the pricing of different instruments – whether deposits, debt or other instruments are favoured could well affect bank funding structures.

Beyond these points there is little more significant to draw from the paper. It debatably raises as many questions as it answers – what will the final format be? When will it be introduced? How will any resolution funds be funded? Will this be done at the EU or eurozone level?

The motivation behind the paper is also worth considering. It’s clear the Commission is trying to send a bit of a message here, warning the Council and EP against watering down the bail-in plans too much – at least if they don’t want to put up significant resolution funds. Whether or not this will be taken to heart remains to be seen.

No quantum leap on eurozone integration after the German elections

Our Director Mats Persson has an op-ed in today's Wall Street Journal, where he argues,

A satirical cartoon in the Italian magazine L'Espresso, depicting a father and son, illustrated it best: "Papa," says the son, "I have to go to the toilet."

"Hush," answers the father. "Hold it until after the German elections."

By now most commentators have realized that there won't be a quantum leap toward more eurozone integration following the German elections. However, while most have focused on coalition dynamics, there are in fact three far more profound limitations that will continue to restrict Germany's ability to act in Europe long after the Sept. 22 elections, and will prevent any swift move toward a euro-zone banking union or fiscal union: One of these limitations is political, one is constitutional and one is economic.

First, German public support for the euro remains highly conditional. According to a recent Open Europe/Open Europe Berlin poll, a majority of Germans support more euro-zone integration if it means more central controls over other countries' taxation and spending. However, a clear majority remain opposed to any policy that involves putting German cash on the line, such as further loans to struggling euro-zone countries, write-downs of existing loans, a joint banking backstop or fiscal transfers.

This is neither surprising nor new. In the 1990s when the euro was forged, the gulf between public and elite opinion was already conspicuous. But despite mounting scepticism, the cost of saving the euro hasn't actually trickled through to people's wallets. If that ever changes, via a slow-down in the German economy, or if savers start to really feel the pinch from the European Central Bank's low interest rates or future possible money printing, we may quickly hit the limit of what the public is willing to endure.

Let's not forget that, given Germany's regional structure, there's almost always another election on the horizon. Between now and when Greece is supposed to exit its bailout program in June 2015, for example, there will be at least five state elections in Germany, as well as the European elections in 2014. German politicians cannot escape public opinion.

Second, the German republic was set up after World War II specifically to prevent hasty centralizations of power. Ironically, this was done at the behest of the Americans and the British—though both Washington and London have been vocal critics of Berlin's cautious approach in the euro-zone crisis. Systemic circuit-breakers such as Germany's Constitutional Court were put in place to counter rash decision-making, while the modern German constitution in 1949 got rid of the federal government's Weimar-era emergency powers.

Today, slowness and consensus are encoded in the very fabric of the German constitutional DNA. This will not change after the elections, nor should we wish it to. While it is unlikely to rule against the ECB's bond-buying program, the Constitutional Court will continue to lay down new red lines for what Germany can and cannot do. The Court has already said that before the euro zone moves to a transfer union, a change to the German constitution will be needed, which will first require a referendum.

It's constitutionally complicated, for example, to write down Greek debt, given that 75% of it is now owned by taxpayer-backed institutions in Germany and the rest of the euro zone. If those institutions take losses on what until now have been loan guarantees, that will in effect turn the euro zone into a transfer union for the first time, which the Constitutional Court has said is illegal. German politicians will continue to have one hand tied by the court in Karlsruhe for years to come.

Then there is the third and most fundamental limitation: Germany can't afford to underwrite the euro forever. If implicit debt, such as the liabilities of Germany's social-security system, are taken into account, the real level of German public debt would be 192% of GDP—much higher than Italy's 146%. Germany has also racked up an exposure to the struggling peripheral countries of around €1 trillion—equivalent to some 40% of its GDP. If Berlin were to begin accepting losses on this, the cost could snowball quickly, as all its sovereign debtors would look for equal treatment. Furthermore, Germany faces a demographic time bomb.

By 2050, the country's current population of 82 million is projected to have declined to around 70 million—less than in 1963. Far fewer workers will be around to finance the country's pay-as-you-go social-security system. This is worse than it looks. Germany, of course, already has its own deeply unpopular transfer union. In this system, out of 16 federal states, only three—Bavaria, Hesse and Baden-Wurttemburgh—are permanent net contributors, with Hamburg moving in and out of that status. Under a hypothetical euro-zone transfer union, these four German regions would proportionally carry a huge burden.

All of this means that there's a relatively stable trajectory to German's EU politics, which defies electoral cycles. So can we expect any movement after Sept. 22? Maybe a little. Particularly in a coalition government that included the center-left Social Democratic Party, we may see some easing of austerity in favor of structural reforms in countries such as Greece or Portugal. But Germans won't give up their deep-held belief in frugality overnight.

Almost any German government is also likely to continue to insist on strong controls over other countries' taxation and spending, most likely via the EU institutions, as quid pro quo for more cash. So the complicated sequencing that's pitting the Germans against the French will continue to dog the euro zone. Make no mistake, Germany will remain a slow, deliberating and frustrating actor for years to come.

A subtle shift in German policy on banking union?

With talk of the upcoming German elections dominating over the weekend, a potentially important yet subtle shift for post-German election policy on banking union may have received less coverage than it ought to have.

Reuters reported on Saturday that Germany is working on plans to create a single eurozone bank resolution mechanism (SRM) within the EU framework without the need for changing the EU’s treaties – something the German government had previously insisted was necessary because it deemed the Commission had no legal base for the proposal to give itself the power to order banks to be wound down. Bloomberg followed this up with a report suggesting a tentative agreement had been struck with the Commission which would see the new resolution fund cover only the largest eurozone banks, thereby exempting the German savings banks (and their large pool of deposits).

German Finance Ministry spokesman Martin Kotthaus has since played down any German proposal, but stressed that "very many other member states" have also raised similar concerns to those of Germany.

It remains early days then, with lots of negotiating still to go but this could have important implications for the eurozone and the UK which are worth exploring.

What could this mean for the eurozone?

• As we have noted, Germany essentially had two choices following its stark rebuke of the Commission’s SRM plan – either work within the framework to alter it or propose an intergovernmental alternative (a similar ad-hoc set up to the temporary bailout fund EFSF). Judging from these developments it seems to have gone for the former, on the surface this is positive for the eurozone since any SRM enshrined in EU law will look more lasting and solid.
• That said, the German plan (if there is one) would clearly involve further watering down a mechanism which already looked woefully short of what was needed to help shore up the eurozone banking sector.  The crisis has clearly shown that smaller parts of the banking sector can cause significant problems (see Spanish cajas).
• The Commission is likely to have less responsibility but it remains unclear where the power will lie. Creating a new institution is impossible without treaty change while using existing ones for eurozone-specific tasks creates serious questions about the single market. The fundamental question of who decides to wind down a bank in crisis remains unresolved.
• Even if the above issue is settled, oversight of the banking sector would still look fragmented with many different institutional layers including – national regulators and supervisors, the ECB and the new SRM as well as possibly the ESM. Furthermore, the Council of Ministers, European Parliament and national parliaments will all have a role in decision making and/or accountability.
• Other problems, including the size of any resolution fund, remain – as we have pointed out. Last week’s legal opinion from the Council of Minister's legal service noted that the national budgetary implications of an EU bank resolution mechanism meant that the Commission's proposed legal base might need to be rethought.

What does this mean for the UK and other non-eurozone countries?

• How the SRM is established could well set the tone for future eurozone integration, therefore ensuring it does not alter the dynamic of the EU to serve eurozone ends using a single market legal base is important for both the UK and other non-euro countries.
• That said, a purely intergovernmental legal arrangement, outside the EU treaty, could reduce the UK's ability to influence the outcome still further. The upshot being that there probably needs to be a treaty change to ensure eurozone crisis resolution is kept distinct from and yet compatible with the single market. 
• Despite this latest attempt to avoid treaty change, Finland has also voiced concerns about the legal base for the SRM, while Germany still has concerns about the separation between the single supervisor function and monetary policy at the ECB - suggesting treaty change as solution. So, both are still keen on shoring up the banking union via treaty change in the not too distant future.

Some interesting developments then, but a long way to go yet. In any case the time line for the banking union looks the same with the process being phased in over the coming years to 2018 – far from an immediate solution to the crisis.

Meanwhile, the whole discussion over the extent to which the treaties can be stretched to help solve the eurozone crisis once again reminds us of the inherent tensions and structural flaws in the current eurozone/EU setup. Even if not done through the banking union, this will have to be settled at some point.

Third EU legal opinion of the week, this time on banking union: bad news for Germany?

It seems to be a week for big legal opinions in the EU. We've had opinions on the FTT, the EU’s short selling regulation and now on the European Commission’s plan for a Single Bank Resolution Mechanism (SRM) – a key component of the banking union.

We have noted the importance and implications of the others, but this might turn out to be the most significant - although it is far less categorical in terms of ending the debate.

As we noted when the SRM proposal was published, the plan is based on a significant legal stretch where the 'single market article' (Article 114 of the Treaty on the Functioning of the European Union, TFEU) is used to justify transferring bank resolution powers to the Commission. In particular, Germany raised concerns regarding this legal base, suggesting treaty change may well be needed.

In the meantime, the EU Council of Ministers' Legal Service had been tasked (by the relevant working group for the proposal) with answering two key questions:

i) Whether Article 114 TFEU is the suitable legal basis for adopting the proposed Regulation;
ii) Whether the delegation of powers to the Board envisaged in the proposal is compatible with the EU Treaties and the general principles of EU law, as interpreted by the so-called 'Meroni' case law of the ECJ (see here for some background on the case).

Those who have followed our coverage of the other decisions will notice significant similarities with the short-selling case for example, given that the questions focus around the use of Article 114 and the 'Meroni case'.

However, in this instance the legal opinion seems to mostly side with the European Commission:

"The Council Legal Service has reached the conclusion that the centralised decision procedure described in the proposal cannot be regarded as an isolated regulatory measure with autonomous purposes, but is conceived as an element contributing to an on-going harmonisation process in the field of financial services, without which its establishment would have no sense."

Essentially, the Legal Service shares the Commission's view that the SRM proposal is needed to prevent fragmentation of the single market and that it will be applied uniformly. It also notes that the SRM is vital to the implementation of the Bank Recovery and Resolution Directive and the Capital Requirements Directive (the bank bail-in plans and the EU’s transposition  of the Basel III rules, essentially), while also arguing that, given the move to a single supervisor, a single resolution mechanism makes sense. Later on in the opinion, it is noted that the judgement on whether the necessity of an SRM set up in such a manner is ultimately a political decision – leaving it open to interpretation.

Furthermore, the opinion does contain an interesting caveat:

"The proposal does not contain a robust system to guarantee the budgetary sovereignty of Member States, notably throughout the transitional period during which the target funding level has to be achieved. Purportedly, during this period, the Fund will not have the necessary means to face conveniently resolution decisions and recourse to extraordinary means of funding might be needed…the Council Legal Service is of the view that the use of Article 114 TFEU as legal basis of the proposal would be contingent upon the introduction of an adequate system to safeguard the budgetary sovereignty of Member States."

This highlights that the creation of the single resolution fund could have financial implications for the budgets of member states (an issue which usually requires unanimous approval). This is especially true given that the funds built up from industry levies will not be ready for some time (up to ten years).

The FT notes that the German government has focused on this point and stressed the need to protect budgetary sovereignty. It has also suggested that the recent ruling on the UK short selling case actually backs up their position, given that it shows the limits of article 114 and highlights the limits to transferring new powers to EU institutions (we’re inclined to agree with them on this one). Today's legal opinion reinforces the German government "in its central legal concerns", says the German Finance Ministry.

It seems clear that this opinion is unlikely to settle the debate. Even if it is judged legally sound, the proposal remains hugely controversial from the political point of view. That said, with Germany still weighing up whether to try to renegotiate the proposal or push ahead with its own intergovernmental plan, this opinion could shift the balance.

State of the (same old) European Union

It’s that time of year again, when European Commission President José Manuel Barroso delivers his ‘State of the European Union’ speech, laying out all his hopes and dreams for the coming year – few of which make it through the decision making gauntlet.

This year’s speech seems little different and, frankly, was a bit all over the place.

Barroso talked up the prospect of greater national flexibility, but, as always, within the end-goal of ever closer "political union". He said:

"The EU needs to be big on big things and smaller on smaller things - something we may occasionally have neglected in the past. The EU needs to show it has the capacity to set both positive and negative priorities."

"I value subsidiarity highly. For me, subsidiarity is not a technical concept. It is a fundamental democratic principle. An ever closer union among the citizens of Europe demands that decisions are taken as openly as possible and as closely to the people as possible.

"The European Union must remain a project for all members, a community of equals."

"I believe a political union needs to be our political horizon, as I stressed in last year's State of the Union. This is not just the demand of a passionate European. This is the indispensable way forward to consolidate our progress and ensure the future."

Therefore, despite mentioning subsidiarity, Barroso's end goal remains clear – full political union. A feature of the eurozone crisis has been that Barroso and the Commission have been increasingly sidelined when setting the agenda (which member states now dominate). This is also due to the fact that there will be a new Commission in place soon.

The Q&A session revealed that, despite Barroso's professed desire to "find ways" to "make Europe stronger", he is rather less open in practice.

In response to Conservative MEP Martin Callanan (who had said he had no interest in being European Commission President) he said:

"Let me tell you very frankly, I think that even if you were interested you would not have a chance to be elected as President of the Commission. And do you know why? I’m not saying that happily. Because I think your party, and your group, is increasingly looking like UKIP and the eurosceptic, anti-European group. And I start to have some doubts that you’re going to be elected in Britain yourself, and if it’s not UKIP that is going to be the first force in the British [European] elections. Because when it comes to being against Europe, between the original and the copy, people prefer the original. That’s probably why they’re going to vote more for Mr Farage than for Mr Callanan. And I don’t say this with any kind of satisfaction, because even if we have some differences, we have worked very constructively with the Conservatives – the British Conservatives and the Conservative group – in many areas."

Once again, it seems the Commission would rather help UKIP rather than work for reformers who don't share a belief in 'ever closer union'.

Barroso's analysis of the crisis hinted at his on-going denial of the role of the euro in causing the crisis:

"We can remind people that Europe was not at the origin of this crisis. It resulted from mismanagement of public finances by national governments and irresponsible behaviour in financial markets."

"What I tell people is: when you are in the same boat, one cannot say: 'your end of the boat is sinking.' We were in the same boat when things went well, and we are in it together when things are difficult."

There is still a sign that Barroso believes that all eurozone woes were caused by the financial crisis – though it may have been a trigger and there is no doubt that national finances were mismanaged, there can (or should) also be no denying that the structural flaws of the euro are what have caused the crisis to be as long and deep as it has been.

The Commission's hope that banking union is the eurozone cure has already come up against resistance from Germany, which is deeply sceptical of the Commission's desire to increase its own power. Barroso's insistence that the proposal be implemented in full before next year's elections will not have helped much on this front and simply highlighted how out of touch he remains with the concerns of even core eurozone countries.

So, despite some lip-service to greater flexibility, reform and acceptance of the shortcomings in the EU and the eurozone, the solutions presented by Barroso remain the same – greater political integration. Fortunately, this is very likely to be Barroso's last 'State of the Union' speech, while member states such as Germany and the Netherlands have shown themselves more open to reform.

Commission banking union plans met with scepticism

As we noted in our flash analysis yesterday, the European Commission has put forward its plans for a Single Resolution Mechanism (SRM) which would oversee the eurozone banking union, manage bank resolution and enforce the recent bank bail-in plans.

The proposal seeks to move quickly and decisively to create a strong banking union but do so within the current framework of EU treaties and domestic politics. Unfortunately, it seems to have found itself in the worst of all worlds. The mechanism is unlikely to be large enough or responsive enough in a crisis, while it will not be in place until 2015 at the earliest. Furthermore, it is based on a significant legal stretch of the EU treaties, which has already raised objections from Germany and creating concerns for non-eurozone members (due to fears that the EU's single market could be hijacked by the eurozone).

The German response was swift and hostile. At a press conference German Chancellor Angela Merkel’s spokesman Steffen Seibert argued:

“In our view the Commission proposal gives the Commission a competence which it cannot have based on the current treaties…We are of the opinion that we should do what is possible on the basis of the current treaties.”

Dr Gunther Dunkel, President of the influential VÖB (the German association of Public banks) added:

"We reject the creation of a European resolution authority for many good reasons …it is not up for discussion for us, that funds gained through the work of German banks are used to contribute to the rescue of banks in other Member States… [Furthermore] the SRM would require a change to the EU treaties to necessitate harmonised corporate, insolvency, and administrative procedural law.”

The FT cites an unnamed German official as saying:

“We would be willing to speed up the process, but then the proposal has to be realistic…The commission is behaving like a vacuum cleaner, sucking up everything into its proposal. It may be effective but it is not legally safe.”

Dutch Finance Minister Jeroen Dijsselbloem was none too keen either, suggesting (in what seems to be a veiled insult to the Commission) that the new authority had to be "decisive, effective, and impartial," adding, "It's not completely decided what that authority should look like."

All in all, a rather disappointing proposal given the numerous delays (it was due out at the start of last month) and the fact that it forms such an important pillar of banking union. The Commission’s inability to produce the full text of the proposal, making detailed analysis difficult, also provoked some understandable outrage.

There was also another interesting development on the banking front. The Commission yesterday confirmed the expected changes to bank state aid rules which will come into force at the end of this month. The rules mean that any bank receiving aid would have to present a restructuring plan in advance, likely with shareholders and junior bondholders taking losses. Any bank which accepts aid will also face strict limits on executive pay.

The move may seem innocuous but, as we have consistently pointed out, all other changes to bank regulation and supervision won’t come in for some time. This means that the new rules on state aid will de facto enforce some of these measures, in particular the move away from bailouts towards bail-ins. That at least adds some limited certainty but still leaves the banking union looking woefully incomplete.

Bank bail-in plans finally agreed, but its only a small step towards banking union

Despite some sizeable differences, EU finance ministers finally managed to reach an agreement on the bank bail-in plans last night (after only 25 hours of talks in the past few days). As always with this type of EU deals, it is a compromise and often an imperfect one. The agreement was much as expected in the end, given the drafts circulating over the past week. Below, we lay out the key points and the positives and negatives of the deal as we see them.

Key points

• Some more flexibility included, with government allowed to inject funds but only after minimum bail-in of 8% of the total liabilities of the failing bank – although such intervention is capped at 5% of the bank’s liabilities.
• The ESM, the eurozone's bailout fund, can also inject funds but only after all unsecured bondholders wiped out.
• The UK secured wording which allows it to avoid setting up an ex-ante resolution fund, as long as it is already receiving funds from the bank levy and/or stamp duty. Sweden also secured an adjustment to the text which allows for it to maintain its current model to a large extent.
• The agreement sees the bail-in plans coming into force in 2018, while the directive as a whole still needs approval from the European Parliament - so it could yet change.
• Certain creditors are excluded: insured deposits, secured liabilities, employee liabilities, interbank and payment liabilities with maturities of less than seven days. National resolution authorities can also exclude other creditors in exceptional circumstances.
• As in earlier drafts, insured deposits are completely protected, and the preference given to SMEs and individuals deposits (see here) has been retained as well.

Positives

• Reaching a deal is positive in itself, as it adds some much needed certainty following the Cypriot crisis. It also keeps the progress towards banking union inching along.
• The burden has been shifted away from taxpayers towards bank creditors.
• The added flexibility is important between eurozone and non-eurozone countries, with the UK and Sweden scoring some important caveats. The deal highlights that non-eurozone countries can still have influence on such rules and the acceptance of the need for flexibility between the two groups.

Negatives

• From a eurozone point of view, the flexibility could be counterproductive, particularly the use of exemptions in exceptional circumstances. How exactly will this be defined and determined? If at national level, then there could be clear political pressure in a crisis to invoke this. For example, it is hard to imagine that the crises in Greece, Portugal, Ireland and Spain would not have triggered this in some way.
• Could see cost of bank funding rise, particularly in terms of unsecured credit due to fairly strong depositor preference.
• Lots of unanswered questions – not least, when and how will these rules apply? It’s not clear in exactly what situation and at what time the new rules would kick in. Does it rely on a request for aid from the bank or the national government?
• Furthermore, there are questions over how this will work practically in different circumstances – for example, the difference between a bank which has almost completely failed and one which is simply struggling to recapitalise.
• The timeline also still seems very long, with the actual bail-in rules not in force until 2018, even though the directive is due to be in place by 2015. That said, the broad template may well still apply, particularly where banking union is involved.

In the end, this seems to be a reasonable compromise - not least because all sides seem fairly happy. It’s clear than a new set of rules was needed with the focus on creditors rather than taxpayers. That said, though, this is in the end only a very small part of banking union and the pace at which the eurozone is proceeding towards it remains fairly limited.

The key remains the single resolution mechanism and/or authority. As we have argued before, until this is in place it is hard to see how the poisonous sovereign-banking-loop will be broken or how cross border lending will begin flowing freely again. Until that is settled, the effectiveness of other factors such as the bail-in plans will remain unclear at best.