See you in Court? UK-Spanish dispute over Gibraltar rumbles on

The HMS Westminster leaving Portsmouth for Gibraltar

A week on there appears to have been no progress on the Gibraltar front - the Gibraltarian authorities are still not budging over the artificial reef, the Spanish are maintaining their additional burdensome controls and the UK is still "considering" a legal challenge under EU law.

As we have argued, neither a challenge on free movement rules nor one on "proportional" border checks carries a guarantee of success due to the ambiguity of EU law. Equally, the Spanish feel they have a strong legal case against the artificial reef based on the very specific wording of the 1713 Treaty of Utrecht - meaning a retaliatory case is not out of the question.

An alternative could be an individual or collective challenge by Gibraltarians (or even Spaniards working in Gibraltar) to the Strasbourg-based European Court of Human Rights, but that could take a long time.

Since then, tensions have escalated with the dispatching of several Royal Navy vessels to Gibraltar (reportedly as part of a long planned manoeuvre) and claims in the Spanish media that the country could from a united diplomatic front with Argentina, which of course has its own axe to grind with the UK. Although we think a diplomatic solution is still the most likely outcome, if none of the sides are willing to back down the UK may be forced to actually initiate legal proceedings, most likely under a 'fast-track' arrangement, as it will by then not have many other practical options.

While initiating a legal challenge may itself force all the sides to resume negotiations, should Madrid still not back down and should the ECJ rule in its favour, this dispute may have more fundamental repercussions on the UK's future in the EU.

Is Cyprus eyeing up an exit from its capital controls?

As expected the Cypriot government has finally reached a deal with the EU/IMF/ECB Troika over the final stage of the restructuring of the Bank of Cyprus (BoC).

As we noted in today’s press summary this was not an easy decision to reach, and has dragged on since Spring, for a couple of reasons:

• The Cypriot government was keen to limit the haircut and insisted that the BoC only had to reach a tier one capital ratio of 9% at the current point in time.
• The Troika however insisted that this 9% target applied to the end point of the bailout (2016) and therefore the bank needed a ratio of 12% currently since it will deteriorate overtime.
• As the Cyprus Mail notes the Memorandum of Understanding signed by both sides clearly fits the Troika view. Unsurprisingly it won out (as always) but the Cypriot government is still seemingly bitter about the whole affair (which doesn’t bode well for the many, many interactions between the two sides yet to come).

In the end the two sides settled on a 47.5% haircut for uninsured deposits over €100,000 – although these funds will not be completely lost but converted into shares of the bank. This is above the original target of 37.5% but below the potential limit of 60% (for the most part).

The most interesting part of this whole deal might be the following though:

“Following the recapitalisation, 12% of deposits that were previously blocked will be released (5% in total).

The balance will be split evenly into three separate time deposits of six, nine and twelve months, respectively. BoC will have the option to renew the time deposits once for the same time duration. These deposits will receive a rate of interest which will be higher than the corresponding market rates offered by the BoC.”

Of the remaining frozen deposits 12% will be released then, while the rest will first be converted to time deposits, meaning people may not have access to their money for between 6 and 24 months. There are likely a couple of motivating factors here:

1. Firstly, this eases the funding transition for the bank as it looks to return to normal operations since it locks in part of its deposit base.
2. Secondly, and more importantly, it locks in a large amount of deposits which would be liable to flee the country as soon as the capital controls are removed (not least because they tend to belong to rich and/or foreign depositors who would likely find it easier to shift their funds).

These funds are only likely to be worth around €6bn, so not a huge amount in a country with a deposit base still around €50bn and far from enough to settle the question of capital flight once the controls are removed.

But it suggests that both Cyprus and the Troika are planning for an exit from capital controls and looking for ways to stem the potential outflow. The quicker this can be done in a managed way the better for the Cypriot economy. As we have noted before, as long as the capital controls apply the hope of a recovery is slim to none in Cyprus and the euro continues to look incredibly fragmented.

(Note: the blog has been updated with new calculations. Previously it suggested the total coverted to term deposits would be €2bn, however, it is likely to be closer to €6bn).