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.

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.

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.

EU edges towards compromise on bank recovery and resolution plans

Tomorrow and Friday will see the next round of meetings between eurozone and EU finance ministers respectively.

The meetings will focus on a number of issues, but the key ones will arguably be the Bank Recovery and Resolution Directive (BRRD) and the plans for a single eurozone resolution mechanism.

The full agenda is spelled out in detail in this background briefing.

As we have noted before, the proposals for new rules for bank resolution are quite controversial and have caused significant splits both within the eurozone and the EU more generally. See our previous blog here which laid out each EU country's position.

Ahead of the meetings, we have managed to get a look at the latest draft of the Recovery and Resolution Directive. Despite being 300+ pages, it makes for some interesting reading.

From what we can see there are two key changes:

1. A compromise on depositor preference:
The previous draft looked to establish a clear hierarchy for bank bail-ins and put uninsured depositors on level pecking with other senior creditors. This draft moves away from that towards a bit more depositor preference. It says:

“In order to provide a certain level of protection for natural persons and micro, small and medium enterprises holding eligible deposits above the level of covered deposits, such deposits shall have a higher priority ranking over the claims of ordinary unsecured, non-preferred creditors under the national law governing normal insolvency proceedings.”

So under the current plans, insured depositors are the most senior, as previously. Uninsured (i.e. over €100,000) deposits from individual private citizens and SMEs will also be given preference over other senior creditors. Essentially, large firms' uninsured deposits will rank level with senior creditors (bondholders etc.)

As we noted before, this is similar to an idea put forward by Italy, but is also likely to appease France, Spain and Portugal.

2. A reduction in ex-ante funds
This is another controversial measure, with many (including the UK) disputing the usefulness of ex-ante funds (funds which are collected on an on-going basis and are therefore in place before any crisis). In the latest draft, the level of ex-ante funds has gone from 1% of all deposits to 0.5% of covered deposits – a fairly sizeable cut given that covered deposits are only a proportion of total deposits.

This looks like a concession to the other side of the spectrum, including the UK, Netherlands and Denmark.

Some concessions on key points to both sides then, as may have been expected. That said, there are likely to be plenty who are unsatisfied by the current draft and hopes of a final agreement this week may be premature.

We’ll keep trawling through the mammoth doc, and bring you any important developments.

Foreign Affairs Select Committee welcomes "Double Majority" voting at the EBA as concrete example of UK influence in Europe

Double majority lock voting at the EBA was a
significant and valuable use of UK influence

In a report published today the influential cross-party House of Commons Foreign Select Affairs Committee commended David Cameron "for launching an ambitious agenda for EU reform". The full report, including evidence presented by Open Europe, also makes a number of sensible observations such as:

"the point of a Member State having influence in the EU is to achieve EU policy outcomes that realise its interests and objectives."

We agree - too often the EU is described by politicians in terms of "influence" and being "at the table" something that looks (and often is) of more benefit to politicians than those they serve - something we pointed out in our evidence:

"Open Europe contended that 'influence’ is a term too often used in a rather lazy and undefined way”. Open Europe argued that the debate on UK influence in the EU should focus on identifying the concrete cases where the UK should exercise influence and had or had not done so."

One case made of very tough concrete we brought to the MPs attention is the tricky issue of EU voting weights:

"Open Europe reminded us that from 2014 the Eurozone states will command sufficient weighted votes in the Council of the EU to muster the qualified majority required to take Single Market decisions alone."

For this reason we have argued consistently that the UK needs a new safeguard to protect itself from Eurozone caucusing. The test case for this was the adoption of "Double majority" voting in the EBA - originally proposed by Open Europe.

The achievement of this new "double majority" was therefore a genuine success for UK diplomacy and has a significance well beyond that of the EBA. We are therefore glad the Committee picked up on it. As they conclude:

"The agreement on the Single Supervisory Mechanism (SSM) which was struck among EU Finance Ministers in December 2012 was significant on several grounds. It shows what the UK can achieve, in terms of protecting its position in the Single Market, through close and constructive engagement and innovative policy solutions."

"We note that the deal went some way towards entrenching the kind of safeguard against discrimination in the Single Market that the Government failed to secure in the December 2011 negotiations on the ‘fiscal compact’. We also note that the arrangements that were agreed to protect non-Eurozone states—on this occasion, for ‘double majority’ voting in the European Banking Authority—responded directly to a concrete proposal (in this case, one which gave rise directly to a risk of caucusing)."

They could not have put it better.

Easing of the Basel III rules - a test case on conflicts of interest?

A lot has been written over the past few weeks regarding the easing of the Basel III banking rules, which we've been meaning to cover but didn't get round to doing.

The specifics and details have been well covered so instead we'll look at some of motivations behind the changes. In our view, the change provides an interesting insight into the potential conflicts between monetary policy and financial supervision – something we have discussed at length with regards to the ECB being turned into the single financial supervisor for the eurozone (see also Felix Salmon’s blog for a wider discussion of this issue).

The changes, which are fairly technical and complex, focus on easing the burden of banks in creating what is known as the Liquidity Coverage Ratio (LCR). This is essentially a liquidity buffer which banks will be required to hold to ensure that they have enough cash (or cash like assets) on hand in a crisis to cover themselves for 30 days. The time frame in which the banks must have this buffer in place has now been increased by 4 years as well.

Again we won’t go into the detail of whether this change undermines the attempts to make banks safer but we would highlight that many banks already meet the adjusted standards, albeit with significant support from central banks (a point we’ll expand on in second) – given the on-going banking troubles in Europe and the US this is naturally a concern.

Monetary policy vs. financial regulation

More interesting from our perspective is the motivation for this change. As Bank of England Governor Mervyn King said:

“Most banks are completely overflowing with liquid assets…[Which] reflects the way in which central banks around the world have expanded balance sheets to provide economic stimulus. That won’t always be the case in the future.”

“Since we attach great importance to try to make sure that banks can indeed finance a recovery, it does not make sense to impose a requirement on banks that might damage the recovery.”

So it seems that the ultimate motivation for the move is to make it easier for central banks to remove themselves from non-standard monetary policy measures (such as QE or the LTRO) without fearing a massive drop in lending.

Clearly, both these concerns fall into the realm of monetary policy, rather than supervision or regulation. Obviously, a collapse in bank lending would be bad for everyone, so the measures are tied to some notion of short term financial stability, but surely these comprehensive Basel III regulations – which will set the basis for financial regulation over the next decade or more – should be taking a much more long term view than this. There are very real concerns that in the long term this could hamper the safety of banks and their ability to withstand future crises without taxpayer help.

A further motivation for the changes seems to be an attempt to encourage demand for a wider variety of assets by allowing them to be held as part of the LCR. Again this is all well and good, but it is the job of monetary policy to manage such demands and should not become ingrained in long term regulation. It is hard not to see this as a sop to the current crisis and immediate economic problems. (On the other hand we would note that this does help ease concerns that the requirements for banks to hold more sovereign debt would worsen the sovereign-banking-loop, although again increasing the risk on banks’ balance sheets is not a desirable trade-off.)

As mentioned above, the easing of regulations may make it much easier for central banks to exit their non-standard monetary policy measures without causing market distortions. The lack of a clear exit strategy is something which we have continuously warned of within regards to greater ECB intervention and the problem still applies. Obviously, finding the best way out is important but not at the expense of a safer banking system. Furthermore, taking such substantial action, such as that seen during the crisis, should not be done lightly and altering regulations to ease the potential problems or side effects of such actions could lead to a situation where the final cost of such actions are not fully considered. It is not hard to imagine similar pressure being applied to the ECB’s monetary policy, particularly if the eurozone crisis escalates again, while easing supervision would provide an easy out rather than managing the imperfect one size fits all monetary policy.

We must note that these regulations are produced by the Basel Committee and the BIS, not the ECB, so it is far from certain that the ECB will act in a similar way (although many of the central bankers involved do overlap). Additionally, the ECB will not be directly responsible for regulation but supervision, although there is substantial flexibility within this bracket and the people involved will still have a large say on regulation at the European Banking Authority (EBA). 

Our main point is that there will be very similar pressures and very similar powerful lobbies, which seem to have had a substantial impact here. This of particular concern for the ECB, where the Chinese walls could well prove insufficient, with the ultimate power for both supervision and monetary policy residing with the Governing Council.

We would suggest the previously mostly theoretical conflict of interest between financial supervision/ regulation and monetary policy just got a little bit more real.

Banking union: are you in or out?

Ask what is the ideal outcome for the UK from the talks on EU banking union and - much like when the super-computer in the Hitchhikers' Guide to the Galaxy is asked about the meaning of life, the universe and everything - you'll get a number: in this case 5 as opposed to 42.

This is the number of countries that should stay outside of the banking union for the UK to have the greatest leverage at the European Banking Authority. Anything less and, as we've noted, there may be a risk that the very beneficial "double majority" voting rules will be re-written, with Qualified Majority Voting amongst ministers and a simple majority in the European parliament (though there's a political agreement to solve the matter through unanimity in the European Council). Any more wouldn't be a disaster, but would proportionally dilute the UK's influence.

That's of course only one of many reasons why the exact membership of the banking union matters for everyone. So, who's in and who's out? This is the current state of play:

Definitely Out

The UK: As we've noted, even if the "referendum lock" and virtually every Tory backbencher weren't  enough to keep the UK out, add €10.2 trillion worth of UK bank assets, and there's no chance that the eurozone would ever allow Britain to join. The UK could not be more out.

Out "for now"

Czech Republic - Czech Prime Minister Petr Necas wrote an op-ed for Lidove Noviny arguing that Czech taxpayers can’t be asked to save troubled European banks. The government has said the country is out "for now", and requested guarantees that its domestic banking supervisor, the central bank, will have a decisive say if a foreign bank seeks to turn its operations into a branch from a subsidiary, which is subject to stricter local regulation.

Sweden – Swedish Finance Minister Anders Borg said that "These were tough negotiations. Sweden will remain outside the banking union, but we believe this is a good compromise." However, the Swedish Government has also left the door open for joining at a later stage.

"Wait and see"

Denmark – Both the centre-left coalition government and the main opposition party, Venstre, have said they have not yet decided whether Denmark should join the banking union. Two other opposition parties, the People’s Party and Enhedslisten, have called for a referendum on whether the country should join, saying it’s required under the country's constitution. Other than the UK, Denmark is the only EU member state with a legal opt-out from joining the euro. 

Hungary – Having been very strongly critical of the original proposals, Hungary's position is  somewhat ambiguous. PM Victor Orban is playing his cards close to his chest: "In view of the proposals, we are in a much better position than anticipated... The non-Eurozone countries are now free to decide whether or not they wish to join the European banking supervisory system. Sometimes even we can be lucky”. 

Poland – Polish Europe Minister Piotr Serafin said that Poland had not yet decided whether to join, and will not declare a position at this week’s EU summit. He argued that “Our job over the course of the last few months was to create a better balance between the rights and obligations of non-eurozone countries. I think a lot has been achieved, although there is still room for improvement in some areas”. Polish PM Donald Tusk announced he will be consulting the finance ministry, central bank and the national regulator prior to making a decision. Polish daily Gazeta Wyborcza suggests the government will wait for further details on the second part of the banking union proposals to emerge, in particular concerning the common resolution fund.

Latvia – Latvian Finance Minister Andris Vilks tweeted yesterday that Latvia’s three biggest banks may fall under European Central Bank supervision, but without giving additional details. Latvia hopes to join the currency bloc in 2014, the year the new supervisory mechanism should be fully ready, so looks likely to join.

Lithuania – No official position has yet emerged from Vilnius, but like neighbouring Latvia the country wants to join the single currency by 2014 so we would expect it to opt in.  

Romania - We are still waiting for official confirmation to emerge either way, but we hear rumours from Romanian officials that "the vibe is positive". Romania could therefore well opt in.

Bulgaria – According to Bulgarian National Radio, Prime Minister Boyko Borisov seemed to suggest ahead of the EU summit that his country would definitely join the system of single supervision. However, following a number of conflicting reports, we were able to clarify that the official position is that Bulgaria is ready to join, but it has not committed to a timetable for doing so.

So the UK remains the only one that is out - indefinitely - while the Swedes and Czechs are unlikely to join any time soon. On the other side, Latvia, Lithuania are the most likely to join while Hungary, Poland and in particular Denmark are very difficult to call at the moment.

So on current count - though this is an exceptionally moving target - two probably in, three out and five uncertain.

NB This blog post was updated at 11.21 on December 18 to reflect that Bulgaria was in the "wait and see" camp rather than being definitely in.

ECB as the single bank supervisor: How high is the Chinese wall?

We’ve already assessed the impact of the new single supervisor with regards to the UK and the EBA, here and here, but there is also the obvious question of how the ECB will fare as the single supervisor.

The utmost attempt has been made to stress the separation of supervision and monetary policy within the ECB, but the fundamental fact remains that the ECB Governing Council still has a veto over the decisions of the supervisory board.

The regulation introduces a ‘mediation panel’ to “resolve differences of views” between the Supervisory board and the Governing Council (GC). However, it seems fairly clear that this panel will not be able to vote to overturn the GC decisions but simply provide another talking shop to resolve any differences. As we pointed out before this is the maximum separation allowed under the treaties and therefore the limits how high the Chinese wall between supervision and monetary policy actually can be.  Practically, separation may hold in placid times but in times of crisis it is not clear whether this will be sufficient.

There are also a few other remaining concerns and questions:

• A non-euro country can reject a decision which has been altered by the ECB GC, however, it then runs the risk of being kicked out of the banking union.
• When exactly can the ECB take over supervision from national regulators? This seems to be mostly the ECB’s own decision, however, the instances are very loosely defined and the relationship between the ECB and the national supervisors remains fairly vague. Expect turf battles.
• What does the €30bn asset threshold apply to – i.e. does it include off balance sheet items – and who determines this?
• The regulation goes to great lengths to ensure that there is a clear flow of all “relevant” information between national supervisors and the ECB. However it is not clear who decides which information is “relevant”, meaning that the "principal-agent" problem still holds. In other words, the national supervisors are likely to have superior information about the banks still under their direct supervision and may have interests which run counter to the ECB.
• As we have noted previously, this puts a huge number of tasks under the ECB’s purview – there is yet to be a clear declaration of the democratic oversight of tasks (such as supervision) which should be held to account. There is also the practical question of how it will manage these tasks in terms of staffing, offices and funding.

Plenty of details still to be fleshed out then and questions remain about how effective a single supervisor the ECB will become. And as ever, though significant, this is only the first part of what will be a very, very long journey towards an EU banking union.

ECB's Chinese wall still full of holes?

We've had a look at the latest compromise proposal to turn the ECB into the eurozone's single banking supervisor. It has been put together by the Cypriot Presidency in a bid to finalise a deal at today's meeting of EU finance ministers. Below are some of our initial thoughts (we may update in due course).

Arguably, measures aimed at reaching a clear separation between the ECB's monetary and supervisory tasks - Germany's main concern - are the most interesting part. This is what the proposal under discussion says:

Composition  of supervisory board
Chair (can’t be a member of the ECB Governing Council)
Vice-Chair (is a member of the ECB Executive Board)
3 ECB representatives (with voting rights, but can’t perform ECB monetary policy-related duties at the same time)
National supervisors of participating member states – i.e. including non-euro countries that want to join

Decision-making 
Simple majority (Chair can cast vote in case of draw)
QMV for regulations on matters “having a substantial impact on credit institutions” – although there is no clear definition of what “substantial” impact is or who determines it.

What does the Supervisory Board do? 
Tables draft decisions and submits them to ECB Governing Council for adoption, “pursuant to a procedure to be established by the ECB” – so the details have yet to be fleshed out. Governing Council has up to ten days to object to draft decision, but has to give written justification – and is encouraged to voice any monetary policy concerns in particular.

If a decision taken by the Supervisory Board is changed following objections by the Governing Council, a non-euro country can express its disagreement (a safeguard, given that non-euro countries don't sit on the Governing Council).The country also can notify the ECB that it will not abide by the relevant decision if it is still not happy with the outcome. However, in this case the ECB will "consider the possible suspension or termination of the close cooperation with that Member State" - so if a country objects to a single proposal it runs the risk of being excluded from the banking union.

This draft then, contains some progress on the make-up of the boards and a bit more in terms of how they will interact, but the crucial decision making process still lacks some detail. Particularly over the exact interaction between the Governing Council and the Supervisory Board if the Council objects to a proposal.

It is also clear that ultimate power resides with the Governing Council and although non-eurozone countries do have somewhat of a get-out-clause, the separation between monetary policy and financial supervision still seems limited. (As we suggested would always be the case due to the legal constraints).

Much work to be done, especially on the finer points.

The Four Presidents Report?

Or was it the Van Rompuy report...looking at the report on moving "Towards a genuine economic and monetary union" released earlier today its hard to judge how closely involved the other Presidents were, notably ECB President Mario Draghi and Commission President Jose Manuel Barroso.

So to recap, this was meant to be a report reflecting the views of the EU's four Presidents (in addition to the three already mentioned, also Jean-Claude Juncker, the outgoing head of the Eurogroup).

First, we've spotted a couple of areas of confusion between what European Council President Herman van Rompuy and Draghi have been saying.

The report suggests that,

"The ECB has confirmed that it will establish organisational arrangements guaranteeing a clear separation of its supervisory functions from monetary policy." 

However in his monthly press conference today, when pushed on the ECB's view on the single supervisor Draghi stressed that the ECB is a "passive actor" in all of this and was not involved in designing the legal structure of the new supervisor. Clearly these two views are directly at odds, which fails to fill us with confidence that the new tasks of the ECB will be combined with its current ones in a legally sound and practical way. A concern which has previously been voiced by ourselves and many others.

Draghi was also at pains to stress that the link between sovereigns and banks can only be broken when the banking union is complete, i.e. with a common resolution mechanism. The report argues that the set up of the single supervisory mechanism (SSM) will play an important role in "contributing to breaking the link between sovereigns and banks". Not necessarily directly at odds, but it again peaks concerns that the Council plans for banking union over-estimate the impact of the SSM.

Additionally, as the FT's Brussels Blog notes, Van Rompuy also disagrees with European Commission President Jose Manuel Barroso on the issue of debt mutualisation, with the latter favouring eurobonds.

We at least can't blame Draghi for struggling to find the time to help write the report while also running a giant institution. But if the supposed authors can't agree on the logistics it doesn't bode well for next weeks EU summit...

Germany and banking union: building the chinese wall

Update 14.15: Reuters has seen an internal document drafted by German MPs from Angela Merkel's ruling coalition - setting out their views on plans for a eurozone banking union. The MPs focus on three main aspects:

• ECB oversight should be limited to systemically important and cross-border banks;

• Monetary policy and banking supervision tasks should be clearly separated within the ECB;

• The document also makes clear that deposit guarantees "will not be unified across Europe". They "may be harmonised, but the responsibility must remain national."  

And here is our original post from this morning: 

Yesterday's Die Welt claimed that Germany is pushing a proposal which would see less powers for the ECB's Governing Council under the Eurozone's banking union. Under the Commission's proposal, the ECB's Governing Council would have the final say over both monetary policy and matters of supervision. This could trigger a series of conflicts of interests as the Governing Council would in effect become the judge, jury and executioner - i.e. it would simultaneously make decisions on bond-buying, bank liquidity provisions and whether banks should be recapitalised or closed down (the latter could trigger losses due to the first two). That incentive structure does not feel right, and the 2009 de Laroisière report for the Commission explicitly warned against it.

The Commission's proposal sees supervision responsibilities being outsourced by the ECB Governing Council to a new  Supervisory Board - consisting of representatives from national authorities - but with the Governing Council still having the final say. In addition, the Chairperson and the Vice-Chairperson of the Supervisory Board would be elected from the members of the Governing Council.

According to Die Welt, during last week's meeting of EU finance ministers in Cyprus, Germany put forward a counter-proposal designed to address these concerns. It involves the creation of a completely independent committee within the ECB consisting of national authorities, where voting weights would mirror the size of each member country's financial markets (and therefore their share of the cost). All of this is unconfirmed, but such an arrangement would take care of two issues:

Firstly, a Chinese Wall would be erected between supervision and monetary policy (at least in theory). 

Secondly, unlike the Commission's proposal which fails to spell out whether non-euro countries joining the single supervisory mechanism (SSM) would get voting rights on the new Supervisory Board (an ambiguity which attracted the wrath of Swedish Finance Minister Anders Borg), this arrangement would make joining far more attractive for the likes of Sweden and Poland.

According to Die Welt, the German proposal would give non-euro members a vote on the supervisory board in return for subjecting their banks to the SSM.  There are a huge number of other issues that non-euro countries will still have to consider, such as the constant risk of being outvoted by a eurozone caucus and no discretion on tailored national regulation, i.e. capital requirements (hello Sweden). It is also unclear how this proposal reads legally (the ECB's statute will have to change anyway, but still).

What's clear is that the Commission's proposal still needs a lot of brushing up.