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.

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.

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.

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.