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.

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. 

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.

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.

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.