EU falling short on implementing bank capital rules

The BIS Basel Committee has today released its assessment of the EU’s (and the USA’s) implementation of the Basel III rules on bank capital and it does not make good reading for the EU. They key findings of the report are (as detailed in the press release and the graphic below, click to enlarge):

• “Eight of the 14 components meet all minimum provisions of the relevant Basel standards and these were therefore graded as "compliant".”

• “Four of the components were assessed as "largely compliant", reflecting the fact that most but not all provisions of the global standard were satisfied.”

• “One component - the Internal Ratings-based (IRB) approach for credit risk - was assessed "materially non-compliant" and pertained primarily to the treatment of exposures to SMEs, corporates and sovereigns.” In particular, the report notes that exposures to SMEs are given concessionary risk weightings, presumably to try to encourage this specific type of lending, however it is nonetheless not in line with the rules. Furthermore, it finds that banks are given a significant amount of leeway in how to value their sovereign debt holdings, with most across the EU simply applying zero-risk weighting – again this is a deliberate attempt to limit any distortions to the sensitive Eurozone government debt markets.

• “Another component was found to be "non-compliant". This relates to the EU's counterparty credit risk framework, which provides an exemption from the Basel framework's credit valuation adjustment (CVA) capital charge for certain derivatives exposures.” Essentially the current rules allow exemptions for instruments which are not traded on exchanges or the wider market and therefore may be hard to value. Furthermore, this “materially boosts bank capital ratios,” though the report accepts that the EU is considering changes to these specific rules.

• Overall the EU was given the second lowest rating (on a scale of four) of “materially non-compliant”, making it the first jurisdiction to be found on the whole not the be complying with the Basel rules. The assessment is also particularly poor compared to the US, which was found to be “largely compliant” with the rules, in general its failings also seem to be more minor as well as less numerous.

The European Commission’s response can be found here, while there is also a response section following the executive summary in the main report. The EC claims the EU’s approach is “particularly ambitious approach, unique in the world”, which is true to an extent given the diverse nature of national banking systems. The response notes that some changes are already in the pipeline, but largely challenges the interpretation which the Basel Committee makes of the rules. On the whole it is not entirely convincing but then, since the Committee cannot force the EU to change, it seems the Commission is largely happy to ‘agree to disagree’ on a number of areas.

While all of this may seem rather mundane and technical it does have some important implications.

First off, it raises questions about the quality and thoroughness of the recent ECB and European Banking Authority stress tests. We, along with plenty of others, have already raised concerns about this and the report adds further weight to those concerns. Furthermore, the specific problems outlined would certainly have helped present European banks as having higher capital ratios largely by reducing the perceived riskiness of certain assets they hold.

A report by Yalman Onaran for Bloomberg earlier this week highlighted the problems relating to the use of banks internal models to weight risk by contrasting this approach to that of using the pure leverage ratio. As the article notes, under the leverage ratio approach 12 large European banks would need to raise a further €66bn in capital. While neither approach is perfect, the Basel Committee’s indictment of the bank’s internal models and the way a large number of exposures in a number of sectors are valued seems to support such analysis and criticisms.

The second important implication is that is once again clearly highlights that the EU probably remains the more important level of policy making and legislation than international level or international organisations – at least when it comes to how things are structure on the ground.

Despite agreeing to follow the Basel III rules the EU is the one that designs and implements the specific legislation. In this case it has clearly altered the rules significantly to suit its own needs – the gap with the original rules as well as how they are interpreted and implemented in other jurisdictions is clear. Furthermore, while the Basel Committee can issue a damning judgement of the EU’s approach, it cannot force it to change. In this relationship all the hard (legal) power lies with the EU. This also extends beyond just implementation to interpretation. Despite writing the Basel III rules the Basel Committee is not even able to guarantee primacy on how they should be interpreted as the EU’s response to the report clearly shows.

Commission forecasts paint a less than optimistic picture for eurozone outlook

The European Commission has this morning released its Autumn 2014 Economic forecasts. While these forecasts can often be quite mundane owing to the very managed message they are trying to send, this set look to be a bit different (see here for our take on Winter 2014 and Autumn 2013). Maybe unsurprisingly the tone to more sceptical, critical and possibly realistic. Below outline some interesting themes.

Another downward growth revision
Once again growth for the Eurozone has been revised down. The previous forecast saw 1.2% and 1.8% growth in 2014 and 2015 respectively. The new forecast predicts 0.8% and 1.1% respectively, quite a significant downward revision, especially since growth next year is now expected to be below the original forecast for this year. The initial blame (in the press release) for this revision seems to be laid at the feet of “increasing geopolitical risks and less favourable world economic prospects”. However, that raises the question of why it is seen as enduring up to 2016. In the report itself the assessment is thankfully more candid highlighting “incomplete internal and external adjustment” and “low productivity gains”.

More realism about the labour market
There is a wider acceptance in these forecasts that unemployment will remain elevated for some time and that differences in labour market performance will persist. That said, at the moment any real prospect on employment growth in the Eurozone seems optimistic.

Bad news in nearly all the large economies
France and Germany’s growth prospects for this year have been revised downwards to 0.3% and 1.3%, from 1% and 1.8% respectively. Italy is expected to contract by 0.4% this year and only grow 0.6% and 1.1% in 2015 and 2016 respectively. Given that these three countries account for nearly 60% of Eurozone GDP this suggests a very poor outlook for the Eurozone with growth risks tilted to the downside. In general, the core vs. periphery split is less clear in this report, at least in growth terms as many countries are now acting as a drag on the Eurozone economy for a number of reasons.

Significant and increasing reliance on domestic over external demand
Early on in the crisis there was a clear focus on facilitating export led recoveries, often in the German model. However, over the past 12 – 18 months this has shifted, possibly driven by global economic weakness, and these forecasts finalise the shift. The Commission itself says,  “Net exports are likely to contribute only marginally to GDP growth over the forecast horizon”. Spain is a prime example of this, see here for a longer discussion of the issue.

While finding a balance between the two is important (we cannot have 18 Germanys in the Eurozone) the shift may have been too stark. Let’s not forget that there is still a huge amount of public and private debt (both household and corporate) in the Eurozone, especially in problem countries. This will limit potential domestic demand growth. So while the flows are shifting in a way which should see an uptick in domestic demand, we should not forget that the huge stock of debt may provide a ceiling on this as a driver of growth.

Low inflation is here to stay
The Commission has also downgraded its inflation forecast with CPI expected to be 0.8% in 2015 compared to previous forecast of 1.2%, while it is only expected to be 1.5% in 2016. The forecast for 2015 is below the ECB’s of 1.1% but the 2016 is above the ECB’s which is 1.4%. Interestingly, the Commission continues to make the case that “low, or negative, inflation rates as part of [some countries] inevitable adjustment process”. This is an argument which has been absent all recent ECB press conferences. In terms of deflation, the Commission sides with the ECB, saying the risks of outright deflation remain low.

We’ll update the blog throughout the day as we pour over the 185 page report. But for now, we’ll leave you with a thought from Commissioner Jyrki Katainen in the press conference, when asked how much the forecasts can be trusted given a history of being incorrect he simply responded, “Nobody knows”. Quite.

What to expect from the Commission's new economics team

Will France's Moscovici (left) be effectively shackled by
Finland's Katainen (centre) and Latvia's Dombrovskis (right)?

The new European Commission (EC) also sees the overhaul of its approach to the Eurozone. While Pierre Moscovici holds the Economic and Financial Affairs post (essentially Olli Rehn’s successor), he will be overseen by the Vice Presidents (VPs) for Jobs, Growth, Investment and Competitiveness and the Euro and Social Dialogue – Jyrki Katainen and Valdis Dombrovskis respectively.

An edge has been added to all this with quick German criticism of the decision to give former French Finance Minister Moscovici such a prominent economic post.

We have already pointed out in our full response to the new Commission that, contrary to popular belief (at least in some quarters in Germany), this does not necessarily change much – a lot of Eurozone rules are already set in stone. However, it is important to delve a bit more into who has what powers or controls which areas?

Katainen’s key responsibilities:

• Helping bring together an investment package to mobilise €300bn in additional public and private investment via the European Investment Bank within the next three months – expected to be discussed at tomorrow’s eurogroup meeting and unveiled soon.
• Coordinating the mid-term review of Europe 2020 strategy and long-term EU budget.
• Pushing economic policy coordination in line with view of “social market economy” while also pursuing a strong structural reform agenda.

Dombrovskis:

• Steering the ongoing reform of the Economic and Monetary Union and, importantly, in charge of pursuing the work of the four Presidents' report on creating a 'deep and genuine' EMU. This suggests he will play a significant role in the bid to create a sounder eurozone and finding a way to marry the existing currency union with greater political union. It's important to note that this will bring him into regular contact with Lord Hill who is responsible for banking union in the new Commission - exactly how the financial stability aspect and the eurozone prosperity aspect will fit together here will be interesting to watch.
• Formal oversight of the European semester – the mechanism through which budget rules are enforced in the eurozone. Also tasked with reviewing the mechanisms for achieving structural reform.

Moscovici:

• As might be expected there is significant overlap with those above. He has also been tasked with handling the European semester. It is expected he will handle the day to day evaluation and, in cooperation with others, will sign off on national budgets and reform plans.
• The language around the Stability and Growth Pact is also in line with previous thinking, tasking Moscovici with making “best possible use of the flexibility that is built into” the rules.
• The focus of this role seems to be on the macroeconomics and fiscal coordination of the eurozone. With that in mind, its expected Moscovici will attend eurogroup meetings on behalf of the Commission.

Overall then, while France may have got what it wished for, Moscovici looks firmly shackled to two fiscal conservatives. None of his tasks relating to the Eurozone are separated from these two VPs. More broadly, as the FT has pointed out, Moscovici (a French socialist) is also severely ideologically outnumbered not only within the broader Commission but specifically in the economic and financial posts.

Furthermore, the language used in the text of the letters remains quite Germanic and in line with the thinking of the current Commission:

“Combining growth-friendly fiscal consolidation, structural reforms and targeted support to investment will be key to a sustainable and strong recovery.”

“Sustainable growth cannot be built on ever-growing mountains of debt. We also know well that it is mainly companies that create jobs, not governments or EU institutions.”

There are also numerous mentions of “sound public finances” and the “social market economy” both core elements of the prevailing German economic thinking.

What to expect from the new Commission in terms of eurozone economic policy?

Finally, there are a couple of hints of what key proposals may be coming in the future. We have already mentioned the reference to a new investment package and the desire to push ahead with reviewing the current surveillance system. A further development seems to be for all those involved to try to engage a “broader range of actors at national level”, make the measures taken to improve the Eurozone more “socially legitimate” and find a more democratic alternative to the EU/IMF/ECB Troika. This suggests fostering national support for the likely continuation of significant structural reform and fiscal consolidation will be a key task for these Commissioners.

With that in mind, there is one final interesting line which is found in both Moscovici’s and Dombrovskis’ letter, they are tasked with forming:

“Proposals to encourage further structural reforms, possibly supported by financial incentives and a targeted fiscal capacity at Euro zone level”

This sounds eerily like a revival of the reform contracts, which Germany has been pushing for some time. The idea has been gaining ground once again after ECB President Mario Draghi suggested that structural reform should have similar oversight to that currently seen for national budgets. The latter part is also interesting, albeit very cryptic and vague. It could refer to the creation of a eurozone budget, possibly focused on tackling unemployment and related costs. Equally, it could refer to something along the lines of a wider assessment of the eurozone’s fiscal capacity and using it where there is scope to do so – meaning some kind of fiscal expansion in Germany (and other strong states) to offset fiscal contraction elsewhere.

Expect movement on these issues in coming months.

Commission's dismissal of national parliaments' concerns over EPPO shows why a red card is needed

While all eyes are on EU free movement and EU migrant's rights to welfare access, the Commission has put out its response to the 'yellow card' shown by national parliaments with respect to its proposal for a European Public Prosecutor's Office (EPPO) - a body which would "investigate and prosecute EU-fraud and other crimes affecting the Union's financial interests".

To re-cap, national parliaments in eleven member states - the UK, Czech Republic, Cyprus, France, Hungary, Ireland, Malta, Netherlands, Sweden, Romania and Slovenia - complained that the plans breached the subsidiarity principle - i.e. the principle that the EU should not act where member states are just as able to act on their own. This is only the second occasion on which the yellow card has been deployed.

The weakness in the current system is that a yellow card only compels the Commission to consider whether to "maintain, amend or withdraw the proposal", meaning that if the Commission is determined to push ahead regardless, it can do so. This is is exactly what has happened in this case, with the Commission concluding that the "proposal complies with the principle of subsidiarity... and that a withdrawal or an amendment of that proposal is not required."

The actual document is very detailed, and while its good that the Commission has properly engaged with concerns raised by national parliaments, it is clear that the Commission's mind is already made up as per the following section:

"the drafters of the Treaty have expressly provided for the possibility of establishing the European Public Prosecutor's Office in Article 86 TFEU... This provision gives a strong indication that the establishment of the European Public Prosecutor’s Office cannot be considered per se and in the abstract to be in breach of the principle of subsidiarity."

Very tellingly, the Commission has also appointed itself as the arbiter of what constitutes an 'acceptable' complaint on subsidiarity grounds, arguing that:

"In analysing the reasoned opinions, the Commission has distinguished between arguments relating to the principle of subsidiarity, or that could be interpreted as subsidiarity concerns, and other arguments relating to the principle of proportionality, to policy choices unrelated to subsidiarity, or to other policy or legal issues."

Although the Treaty states the decision has to be reached by unanimity (so no danger of the UK being vetoed), this episode highlights the need to turn the 'yellow card' into an outright 'red card' - i.e. a definite veto. This could apply to existing as well as proposed EU legislation.

In addition, national parliaments should be given more than the existing 8 week period to respond. The scope for national parliaments to object to EU proposals should also be widened from the narrowly defined principle of subsidiarity to prevent the Commission from being able to undermine their validity. As we've argued, in order for national parliaments to have a real impact in the EU they need real powers - otherwise this widely shared objective will not come to much.

Eurozone reform contracts take shape - and they include "fiscal transfers"

As we have predicted numerous times - as recently as in our previous blog post - ‘reform contracts’ in the eurozone could well become the next thing. As a recap, these are agreements where one country commits to a series of structural reforms in exchange for low cost loans, or other form of help, to aid its economy. As we argued back in September - when it was unclear whether the idea would make a comeback - it's one of the  politically more feasible options for Germany as it involves more control and less cash.

@michaelsteen Tricky one. Merkel seems to float reform contracts in this recent interview: http://t.co/rToOm65l9a @SpiegelPeter
— Mats Persson (@matsJpersson) September 16, 2013

@michaelsteen @SpiegelPeter In theory more politically feasible for Berlin than other options, as it involves more control and less cash
— Mats Persson (@matsJpersson) September 16, 2013

Well, Reuters have now got their hands on the latest draft of the plans for these contracts and have published them in full here. The idea now seems to be firmly on the agenda, which is not the same to say it'll actually happen.

Below are the key points of the plans:

• The contracts are seen as a supplementary part of the ‘European Semester’ – the new system of economic governance. They will build on tools such as the macroeconomic surveillance and budgetary oversight, which we have already covered in detail. The contracts are targeted at those countries not making adjustments under the other procedures.

• They are designed to promote “ownership” of reform and “home grown” policies (which lines up with Merkel's comments from yesterday). There is, of course, a tension here, given that by definition they are part of a system of increasing economic oversight and some would say a loss of control of economic policy. As Eurogroup Chief Jeroen Dijsselbloem suggested yesterday, if these countries aren’t pushing these reforms, slightly cheaper loans are unlikely to be the deciding factors in pushing them to do so.

• Further to the above point, the text does stress that the policies will be drawn up by the domestic authorities and will be renegotiable (unlike the bailouts or other parts of the governance system which are more set in stone).That said, they will come with significant “monitoring” – which, to us, evokes the feeling of the EU/IMF/ECB Troika trips to bailout countries.

• The loans will involve “limited fiscal transfers across countries”, the large majority of which would come through the lower interest rate on loans compared to the borrowing countries usual market rate. The open admittance of fiscal transfers has slipped into the draft, this sort of open admission is rare in the eurozone crisis, but given that the contracts are an explicit trade off, it is not entirely surprising (again, as we've argued).

• “The specific amount of financing would not be linked to the direct cost of reforms”. Instead it will be used more generally as an incentive to reform and aid any parts of the economy that need it or to help relieve funding pressure generally. This makes some sense since simply ‘paying’ for reforms seems rather circular and dictatorial. However, making sure the level of reform demanded matches up to the loan size will be very tricky.

So this is something that could fly with the Germans, politically, but how much difference will that make in practice? There are already numerous platforms for reform – bailout programmes, precautionary credit lines, macroeconomic surveillance and budgetary oversight (as well as good old political pressure).

In the end it all comes down to the money. How much will be available and at what price? These questions are yet to be answered, but as with much in the crisis, the likelihood of a muddy compromise looms large.

Reviewing Germany's surplus

As expected, the European Commission today announced a review into Germany’s current account surplus under its Macroeconomic Imbalance Procedure (MIP).

This has been a topic of hot debate recently and has the potential to become a very important debate in the future of the euro and Germany's role in it. We laid out our thoughts on the issue in a detailed post last week. We recommend re-reading it, but the thrust is that, while rebalancing is needed, boosting imports in Germany or cutting exports would do little to help the peripheral economies because they simply do not produce goods and services which Germany want and do not produce the same exports to replace Germany’s if it lost competitiveness.

That said, by the letter of the law the Commission was right to launch the procedure given that Germany has broken its threshold on the current account surplus (over 6% of GDP since 2007, see graph below). The key point is for the Commission to judge it on its merits not as a political process – to be fair the Commission itself stressed this point but there have been hints that it takes a bit of a dim view of the large surplus.

What happens now? It’s early days yet. The Commission will begin its review and complete it by spring next year. The recommendations will then be included in next year’s European Semester and country specific economic recommendations. The key will be how hard the Commission goes on the arguments and how Germany responds. If it fails to implement the reforms the Commission does have the option of imposing a fine or even sanctions on Germany.

Signs on this front so far show the potential for conflict. German reactions have already been quite hostile with CSU General Secretary Alexander Dobrindt warning that, “You don't strengthen Europe by weakening Germany” and CDU General Secretary Hermann Gröhe adding, “Our export strength is the corner stone of our prosperity”. Bundesbank President Jens Weidmann added that expanding Germany fiscal policy is also not the answer, saying, “The positive knock-on effects would be limited”.

There are also a few points in the Commission’s report which are worth picking up on:

Emphasis on euro strength: Numerous times the report argues that Germany’s long standing surplus is helping push up the euro exchange rate, making the periphery’s adjustment harder. This seems a strange point to focus on given that it’s not Germany’s job to manage the exchange rate. There are also plenty of other factors which influence the euro, including but not limited to: actions of other central banks (notably the Fed weakening the dollar) and the repatriation of funds to Europe as banks and business refocus on core European operations. The report also says that Germany’s real effective exchange rate (REER) has come down due to a weaker euro, which seems a tad contradictory.

Causality between deficits and surpluses: The Commission highlights that defining a clear link between one country’s deficit and another’s surplus is not as simple as first seems. This is a point we made in our previous blog. While Germany may have previously been the flip side of other countries deficits, these deficits have now closed and Germany has maintained a surplus by trading with non-euro countries. The Commission also notes that countries such as Germany can play a key role in the supply chain – this means its exports create demand of imports of inputs from other countries, it also highlights that Germany is not always the source of the final demand for imports. The German government itself flagged this up, saying that “40%” of its exports rely on intermediate goods imported from EU partners.

Germany did play a role in previous peripheral deficits: As mentioned above Germany did play a role in sustaining the large deficits in the peripheral countries which helped cause the crisis. However, as touched upon in the report, this is more a failure of supervision (both financial and macroeconomic) and a failure on the part of the periphery to invest the money into factors which would promote long term economic growth. After all these investments were helping to drive significant growth at the time and these countries did reap some benefits, but failed to make them lasting. This dynamic was also almost inevitable as a result of pushing such different economies into a single interest and exchange rate policy.

Germany has troubling demographics: Countries such as Germany, with an ageing population, are always going to be inclined to save more. Judging what level of saving is warranted or needed given such constraints is tough, but it’s clear that German businesses and people have already made up their mind to save more.

Germany does need to unblock obstacles to domestic demand: The report is correct to highlight that Germany can do more to promote demand, notably by liberalising its services sector and reducing the level of taxation.

Germany above the threshold for public debt: the Commission will review this imbalance as well, highlighting constraints to any demands for further public spending.

All in all, the Commission does try to cover both sides of the argument but the tone still seems to lean towards asking Germany to do more to boost demand. If this is through liberalising measures it will be welcome (at least by us), however, if it calls further jumps in spending and wages it could find a very hostile reception in Germany.

In any case, the scene is set for what could become a crucial debate over the structure of the euro. The crux of the argument comes down to – what is Germany expected to do to save/aid the euro and what is it willing and able to do (politically, legally and economically)?

Why Barroso’s pessimism about achieving EU decentralisation is sort of irrelevant

The Open Europe team is back from the UK party conferences and, when it comes to the UK’s attempt to reach a new settlement in Europe, by far the most common comment we get is: “The EU Commission won’t allow it.” Particularly true amongst the Tory grassroots. European Commission President Jose Manuel Barroso’s interview today with the Telegraph will no doubt have served to reinforce this view.

He said the only way to reform the EU was to review the EU’s body of legislation, the acquis, on a case-by-case basis:

“The other one is to have a fundamental discussion about the competences of the EU, even in terms of renationalisation. I think the second approach is doomed to failure…Britain wants to again consider the option of opting out. Fine, let's discuss it but to put into question the whole acquis of Europe is not very reasonable…What is difficult, or even impossible, is if we go for the exercise of repatriation of competences because that means revising the treaties and revision means unanimity.”

Barroso is sort of misrepresenting the UK position - the debate has moved away from unilateral opt-outs, but let’s not split hairs. In addition to that, there are two reasons why you can take these comments with a pinch of salt: first, Barroso is gone in a year. Secondly, if it came to it, the Commission has a very limited role in the negotiations over brining powers back anyway.

The European Council has to “consult” the Commission and it also has limited representation in a so-called European Convention (needed for a full-scale treaty change, as opposed to a limited one), but that’s pretty much it. Still, it’s very good to have the Commission on-board of course, for a whole range of reasons (some of the stuff the UK wants outside EU treaty change will require a Commission proposal) but an antipathetic Commission is probably not a deal-breaker.

An antipathetic Barroso certainly isn't.

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.

Open Europe publishes Commission regulation which seeks to move Libor oversight to Paris

As the FTT threat wanes (a sizeable victory for the UK we might add) another battle threatens to flare up in the wider debate about financial regulation within the EU – albeit a smaller but still concerning one.

As the FT reported yesterday, there is a regulation in the pipeline in which the Commission proposes significantly stepping up the regulation of benchmark indexes and rates used in financial markets and contracts. In particular though, it proposes moving the supervision of key benchmarks, such as Libor, to the European Securities and Markets Authority (ESMA).

As we did consistently throughout the FTT debate, we have got our hand on, and have exclusively published these latest plans – see here.

What are the key points of the plans?

• The main focus of the regulation is to move the oversight of thousands of benchmarks used in trillions of dollars’ worth of financial contracts and instruments away from self-regulation (or from being unregulated) to being under direct supervision.
• However, importantly, the proposal sees the most important benchmarks, such as Libor and Euribor, being supervised by ESMA since, in the Commission’s view, fractured oversight harms the single market.
• The plan also looks to step up the legal liability involved in the benchmarks (making any manipulation a criminal offence across the board) but also allowing supervisors more control to compel participation in certain benchmarks and allow for consistent oversight.

Open Europe's take on the plans

• First, let’s make it clear that Libor has patently failed and needs to be reworked. Everyone accepts that. However, the UK is currently in the midst of doing just this, following the recommendations of the Wheatley Review earlier this year (which happen to line up closely with those of IOSCO the international body looking into this issue).

• This makes the proposal particularly badly timed. It is ultimately based on an outdated view of Libor which is already under review and beign changed. In fact, if you look at the substance of the UK review and the international recommendations (upon which the Commission based its proposals) they line up fairly closely with the EU plans other than where the control rests.

• The Commission justification for needing an EU regulation on this issue also seems a bit of a stretch to us. Sure, some of these benchmarks are used in the rest of Europe but they are also used all over the world. However, all those involved in Libor will have a presence in London. As is well known, the large majority of European trades which involve many of these benchmarks will also take place in London. Why the oversight should not be focused there is still not clear.

• There is also rightly a significant concern over the rigidity of the Commission proposal. Firstly, the plan to base all submissions off actual transactions seems unrealistic. This issue came up in the initial debate about reworking Libor – ultimately, there are not nearly enough interbank transactions to actually produce the rates for the ten currencies and the 15 different maturities which Libor currently covers.

• Linked to the above point is the concern about the ability to force banks to comply and take on significant legal and regulatory responsibility for their submissions. Ultimately this is a large liability to take on off the back of what is still an estimate.

• This is a very technical subject. It is almost impossible to lay down all the rules and structures for how various benchmarks should be judged. Surely, the approach varies wildly depending on the benchmark and may even change depending on the wider economic and financial circumstance. This raises two concerns: the rigid framework presented may leave substantial grey areas but more importantly a lot of power for setting the technical details will be left up to the Commission, after the political negotiations have finished. As we saw with the bankers bonus’ regulation this can has a very large impact on the scope and practical implementation of the rules.

• It sets a worrying precedent, especially as the ECB is set to take over as the single eurozone supervisor and the potential for eurozone caucusing on this issue increases. As we saw with the regulation over Credit Rating Agencies (CRAs) over the last few years this can be dangerous. The initial drafts of the CRA regulations are quite similar to this one, however, worryingly it has extended and escalated over time. The UK government should look to tackle this issue head on to avoid a similar scenario.

Overall then, although Libor needs to be reworked and better supervised, it’s not clear why this needs to be done at the EU level, particularly when the UK is in the middle of its own reworking. The rigidity of the proposal also raises questions about its practical implementation. At the very most, there could be an EU directive on this issue setting out a broad approach with room for national flexibility. Ideally though, this should be left to individual states where the rules can be drawn by those who are most impacted by them and closer to the stakeholders. This should of course be combined with on-going global cooperation as is already underway.

Thankfully, it seems we are not the only ones with these concerns and some watering down of these rules already looks likely.

Why the Commission has grossly over-stepped the mark with its court challenge on right to reside

The Commission has now published its press release explaining its reasoning for taking the UK to court over its ‘right to reside’ test for EU migrants. This is the key passage:

“The ‘right to reside’ test is an additional condition for entitlement to the benefits in question which has been imposed unilaterally by the UK. UK nationals have a ‘right to reside’ in the UK solely on the basis of their UK citizenship, whereas other EU nationals have to meet additional conditions in order to pass this ‘right to reside’ test. This means that the UK discriminates unfairly against nationals from other Member States. This contravenes EU rules on the coordination of social security systems which outlaw direct and indirect discrimination in the field of access to social security benefits.”

The benefits that the Commission cites as being affected are:

- Child benefit
- Child tax credit
- Jobseekers' allowance (income-based)
- State pension credit
- Employment and support allowance (income-related)

So, some are asking, isn’t this simply a case of the Commission enforcing the law?

To answer this question, you have to get to the real heart of the matter, which neither the Commission nor the UK Government has really set out explicitly. It is a rather complex technical issue of how certain benefits are defined and how the UK’s welfare system interacts with different EU laws.

The underlying issue is that most EU countries tend to have a generous ‘social security’ system but one which is generally financed by in-work contributions (so as a migrant you wouldn't get access without substantial contributions and neither would a host national). They tend to have a lower safety-net ‘social assistance’ scheme (if they have one at all).

EU law (under the Free Movement Directive) allows governments to indirectly discriminate when assessing claims for ‘social assistance‘ and prevents people gaining residence rights by simply accessing social assistance. For social security (for which there is a separate EU Regulation) all forms of discrimination are prohibited. It is important to remember that the right to free movement within the EU is not unqualified – you have to be travelling to work or seeking to work. Travelling to access social security was not envisaged, but workers should be treated equally while in work.

In the UK, for unemployment benefit for example, there is a flat rate Contribution-Based Jobseekers' Allowance and also Income-Based Jobseekers' Allowance. The former is nominally financed by employee and employer contributions through National Insurance (but in effect are funded through general taxation) as pay-outs are not linked to contributions and the latter is means tested.

From the Commission’s challenge it appears that it thinks both types of JSA should be considered ‘social security’ and therefore there can be no indirect discrimination, which they argue the ‘right to reside test’ is. However, unlike in other countries, that means incoming migrants can potentially get access to the bulk of UK welfare system having contributed very little, if anything at all. This is why the Government is defending the ‘right to reside’ test as a means of ensuring you can only claim in the UK if you have a legal right to be in the UK and an economic link to the country. The Government would also argue that Income-Based Jobseekers' Allowance should be defined as ‘social assistance’.

The heart of this then is not necessarily that the ‘right to reside’ test is indirectly discriminatory as that is already accepted. In 2011, the UK Supreme Court ruled that the ‘right to reside’ test is indirectly discriminatory but “that this discrimination is justified because the Regulations are a proportionate response to the legitimate aim of protecting the UK public purse and that this justification is independent of the claimant’s nationality.”

Another recent case is also interesting. Austria is fighting the Commission in the ECJ about granting access to a certain benefit to an incoming migrant from Germany. As Work and Pensions Secretary Iain Duncan Smith told the World At One earlier, “the Austrians were told, in the Brey case, that they could not…they had to pay somebody who was a German the income-related benefits, because they were essentially social security, not social assistance.”

However, yesterday, the ECJ’s Advocate-General came down in favour of the Austrians, whose argument was supported by the German, Irish, Netherlands, Austrian, Swedish and UK Governments, in saying that the particular benefit constitutes social assistance and that Austria can therefore impose safeguards. IDS has taken heart from this opinion and the Government believes the same principle applies in the UK case.

In Spain, there is now a different but related argument about the refusal of some hospitals to recognise the European Health Insurance Card – it is as yet not clear why the hospitals have refused but Spain is also subject to legal challenge from the Commission.

In short, the EU’s current rules in this area, which have largely developed through case law, are hugely complex and do not reflect the different national systems that are in place. As IDS said, the UK Government is already talking with “the Germans, with the Dutch, the Danes, the Spanish” about setting the limits to the EU’s power in this area. Given that, this is completely the wrong time for the Commission to launch an intervention as politically explosive as this.  It is also worth adding that there is a cross-party consensus on this issue with Shadow Home Secretary Yvette Cooper today backing the coalition's position.

The UK should therefore avoid merely a narrow defence of its right to reside test but use this opportunity to settle this issue once and for all with root and branch reform.

When ideology meets economic reality (part III): Germany squabbles over the Financial Transaction Tax

The Bundesbank, The Deutscher Aktieninstitute (DAI), and even EU civil servants from the 11 participating countries have all warned against the FTT in its current form.

Today saw yet another German voice raised again the tax – this time from the very party that is meant to be its greatest champion. Nils Schmid, Baden-Württemberg's Minister of Finance – from the German social democrats (SPD)— wrote a letter to German Finance Minister Wolfgang Schäuble condemning the FTT in its current form as “rubbish.” Ouch.

Schmid’s intervention, says that "If the financial transaction tax is implemented as is currently planned, initial estimates show that it is likely to have a serious impact on certain segments of the market (money and capital)." He then calls for a “proper configuration” of the FTT.

So why is this important? Twofold:  first, it shows that in light of the overwhelming evidence of the negative economic impact of the FTT in its current form, the support for the proposal is quickly evaporating.

This now extends to the German political parties that have strongly endorsed it. Remember, the FTT is one of the SPD’s main campaigning issues, and served as the party’s quid pro quo for accepting the EU fiscal treaty. Although Schmid caveated his position, saying that he is not opposed to the idea of a FTT in theory, the point has most definitely been made.

Secondly, the FTT controversy has legs to become battleground ahead of the German elections in September. It is an issue that may split politics, both, within the parties and on a national level.

Officially, Schmid’s letter was met with a standard diplomatic line from the German Finance Ministry – which says it is taking concerns raised by Schmid and German banks “seriously.” They won’t say so in public, but the German finance ministry was most likely nodding approvingly…

Meanwhile, deputy chairman of the FDP parliamentary group ,Volker Wissing, saw his opportunity to strike – and took it, saying that Schmid's letter shows with which "naivety" and "rose-tinted blindness", the SPD had driven the demand for a financial transaction tax.

So far the SPD have remained stumm on Schmid’s intervention. But watch this space. If influential figures within SPD are the latest to start make noises about this, then surely, the Commission’s proposal cannot stand?

"If you had kept quiet, you would have remained a philosopher" - The Commission utterly fails to address flaws in the financial transaction tax

There's an old Latin saying, "If you had kept quiet, you would have remained a philosopher." Reading the Commission's defence of its proposed EU financial transaction tax (FTT), that phrase immediately sprung to mind. It's not the strongest piece, to say the least.

In our continuing quest for transparency, we have published the Commission’s direct response to the concerns raised by the 11 participating FTT member states (docs which we exclusively published last month).

The Commission's response ranges from weak to capricious to outright ridiculous. For example, when it says that "we're not aware of any credit crunch" in Europe. Right...

Arguably the most worrying part of this response is the tone. The Commission is essentially saying ‘we know better’ than financial markets. For example, in dealing with concerns over the impact of the FTT on short term trading, it suggests much short term trading is often “myopic” and that asset managers which trade predominantly in the short term should be subject to less investor demand in transparent markets, despite the success of money market funds and their importance for liquidity.

Now, 'financial markets' are diverse, far from perfect and certainly not always right. However, the Commission would be remiss to just dismiss concerns raised by governments inside and outside the FTT zone - but also actors from across the business and manufacturing community (in addition to virtually every bank in Europe).

We have long suggested that there are three key areas of concern which will have to be addressed before the FTT can even hope of being implemented without huge market distortions – the extraterritoriality, the impact on repo markets and the impact on government (and corporate) bond markets.

Many of the concerns raised by the 11 FTT states - and the Commission's response - related to these issues. Sorry in advance for the length of this post but here are the key points:

Extraterritoriality

As reported this morning, the Commission argues that a “business case” can be created for enforcing the FTT outside the FTT zone. Essentially, exchanges and clearing houses will be responsible for collecting the tax and if they don’t,  the firms in the FTT zone will not want to trade with them.

This is concerning development for a number of reasons:

• First, it will increase tensions and splits within the single market. Financial firms are unlikely to just roll over and accept this. In fact, given the size of the market outside the FTT zone, they could validly refuse to trade with those inside the FTT zone. In any case, the prospects of a scenario similar to that of escalating protectionism in trade dispute cannot be ruled out.
• It also seems very punitive, using alterations in the legislation (the joint and several liability) to enforce it in areas where the tax has already been rejected.
• This also assumes firms do not move out of the FTT zone to escape the tax. This seems unlikely in the first instance, while not being able to trade with those outside the FTT zone if they do not pay the tax (or having to pay their share yourself) seems to make staying inside even less appealing.

The Commission also accepts that double taxation is a concern. However, the proposed solution of setting up agreements on where the tax will fall, seems unlikely especially in the UK’s case since it has launched a legal challenge against the tax.

Impact on government and corporate debt

The Commission also fails to provide much comfort on the impact of the FTT on national debt and borrowing costs. It admits it has been unable to estimate the impact due to lack of info, but further accepts that “Member States might be better placed to have access to such information.”

This raises two questions:

• First, surely legislating on such a sensitive issue without fully knowing the costs on a key area, with many of countries involved in the midst of an economic crisis, is nothing short of negligent.
• Second, if member states are better placed to judge these issues, why does the Commission and the EU need to take the lead and push such a tax in the first place?

Furthermore, we doubt the concerns over ‘redistribution’ will have been assuaged as the Commission accepts that some money from the trading of government bonds will not go to the country that issued them.

This could be of concern for countries such as Spain, Italy or even France which have huge debt markets but whose debt is widely traded around the world and the EU but international firms. It also seems to punish small countries with less developed financial sectors, since the tax will be paid where the bond is traded firstly with the residence principle only kicking in afterwards.

Possibly more worrying is the response to concerns over the corporate debt market. The Commission seems to brush this off, adding that it is “not aware of any credit crunch” with regards to borrowing for businesses. This is despite the clear survey results showing businesses struggle to access credit in many European countries and the many, many press stories on the issue. It surely cannot argue that given the state of the economy, now is the best time to implement the tax.

Repo markets

As we have highlighted this is an area of serious concern. Unfortunately, the Commission continues to persist with a weak counter-argument insisting that repo markets can be easily replaced by secured loans or lending by central banks (while accepting the short term repo market will be all but destroyed by the tax).

This argument is flawed for numerous reasons:

• The market has access to these other instruments but see repo as preferable, the Commission still insists, however, that it knows better.
• Moving more lending to central banks is not desirable! European policy makers are working hard to restore usual financial markets and move lending off central bank balance sheets.
• Without normal functioning markets, monetary policy cannot have an effective impact, while in the eurozone money will not flow cross border and imbalances will continue to build up (any hope of an integrated banking union would be dead).
• Furthermore, all the risks will be taken onto the central banks’ taxpayer-backed balance sheet – surely this is a terrible form of risk being socialised but profit privatised.
• Secured loans do not provide the same level of legal protection as repos. Since collateral is purchased under a repo, if there is a default the collateral has already changed hands. However, under secured loans the claim would go back into normal (lengthy and costly) insolvency proceedings.

The Commission does raise the point that Repos can hurt financial stability, but surely this is more a case for effective supervision and regulation than taxing the market out of existence.

With widespread talk of the FTT being shelved for at least another year, perhaps it's time for the Commission to just admit defeat?

The UK manages to water down the EU's north sea power grab - to Scotland's benefit

MEPs yesterday voted on a new safety regime for offshore oil and gas platforms. And what do you know, it appears that the UK has managed to come up with an acceptable solution.

Fears that the Commission's original plan to push its plans via a regulation (which have direct effect) have not materialised and it is now to be done via a directive, giving states some leeway, and through careful negotiation the final outcome is similar to the existing UK rules.

This is interesting on a number levels. Firstly it is a good example of the UK successfully pushing its case in the EU. It is also a good example of how the UK can use its weight to influence MEPs and the Council of Ministers - and for the benefit of an industry based primarily in Scotland.

One interesting question is whether an independent Scotland within the EU would have the same potential to succeed (This is of course if they were in the EU at all.)

Why not shrink the European Commission?

The online edition of German weekly Der Spiegel reports on "secret" plans by EU heads of state and government to stick to the 'one country, one EU Commissioner' principle, despite the number of Commissioners being set to rise to 28 following Croatia's entry in July.

Under the Lisbon Treaty, from November 2014, the number of Commissioners is supposed to correspond to two-thirds of member states, but national governments can agree to keep things as they are by unanimous decision. Der Spiegel estimates that keeping 28 Commissioners instead of 19 would come at an extra cost to European taxpayers of at least €13.5 million a year. So why, the article asks, are Germany, France and the UK keen to keep one Commissioner per country?

A couple of points need to be made here.

• The plans are hardly a secret. Going back to the days of the second Irish referendum on the Lisbon Treaty, Ireland was given reassurances that the 'one country, one EU Commissioner' principle would stay (see the conclusions of the June 2009 European Council summit). Also, a European Council decision on the subject was drafted last October - and only needs to be rubber-stamped by EU leaders (see here).

• In the UK, Parliament has already cleared the draft decision for approval via the European Union (Approvals) Act 2013.

That being said it is increasingly hard to defend the growing size of the EU Commission, not least because it gets increasingly difficult to find a credible portfolio for everyone. To accommodate for Croatia's entry, for instance, the Health and Consumer Protection portfolio will be split into two separate posts.

The big question is, would it be so bad if the number of Commissioners was reduced and the proliferation of Commission DGs slim-lined into more rational departments?

True, smaller memebr states may take offence (larger ones like the UK would virtually be guaranteed a Commissioner). However, member states without a Commissioner for one rotation period could be given deputy Commissioners instead. Surely, there would be more influence to be had as Deputy Commissioner for Internal Market than as Commissioner for Education, Culture, Multilingualism and Youth?

Nevertheless, EU leaders look set to rubber-stamp the 'one country, one Commissioner' decision - so we'll continue to have 28 EU Commissioners after 2014. At the very least, if we are going to have an extra Commissioner, the European Commission should be obliged to find savings so net spending does not increase. Our report on reforming the EU budget from last June included some suggestions. 

This is welcome stuff: David Lidington says national parliaments could be given a 'red card' over EU proposals

National Parliaments' should be allowed
to show the EU the red card

This is an idea that's very close to our hearts - and an idea that we have promoted for a very long time.

The first bits of UK Europe Minister David Lidington's interview with German daily Die Welt have just been published on the paper's webpage. We'll have to wait until tomorrow to see the full version. But from what we can see so far, Lidington's interview is likely to reverberate quite a bit across Europe.

He said,

"Perhaps we should lower the threshold for national parliaments to take action against initiatives from Brussels; perhaps we should introduce the principle of a 'red card' so that a given number of national parliaments can block initiatives from the [European] Commission."

Sounds familiar? Well, the 'red card' was first advocated by Open Europe in 2011 in our report 'The case for European Localism'. And again by Lidington's PPS Tobias Ellwood MP in a publication for Open Europe in December 2012, where he argued:

"Any future [EU] Treaty change should include some system of the red card system with the right quota and powers."

A red card is an improvement over a yellow

Open Europe's Director Mats Persson pushed the idea in the Telegraph here in January. Under the Lisbon Treaty, if a third of national parliaments show the Commission the current 'yellow card', the Commission is obliged to reconsider its proposal and explain why it wants to change it, scrap it or push ahead with it. To date, the Commission has withdrawn a proposal in only one case after being shown the 'yellow card' - the so-called 'Monti II' Regulation on the right to strike.

However, this provision has several weaknesses. First, it doesn't oblige the Commission to actually drop the proposal, but only to reconsider it. So it's a far cry from a veto. Secondly, it's only supposed to happen on 'subsidiarity' grounds - and not on 'proportionality'. Thirdly, a third of parliaments are supposed to agree within an eight-week window, meaning that if the Commission tables a proposal in August or September - when most parliaments are in recess - it can basically push ahead with anything.

In other words, it really doesn't do that much to close the EU's infamous democratic deficit. Nor to strengthen the powers of national MPs - an aspect which, as we've argued repeatedly, is absolutely vital if the EU is to regain democratic legitimately.

Therefore, a 'red card' provision giving a certain number of national parliaments acting in unison (the threshold needs to be discussed) an actual veto right, would be an absolutely massive improvement. This is also an area where the UK will have support from Germany and others if it pitches it right.

In the interview, Lidington also pointed out that several times in the past,

"the content of [EU] treaties has been interpreted in a way which was not desired or expected at the time the treaty changes were decided on. Sometimes, the European Commission or the European Parliament try to expand the boundaries of their competences." 

The Europe Minister also stressed that the EU's single market for services is "painfully underdeveloped". echoing similar remarks on the importance of deepening the single market before. However, this time they come after he said that Open Europe's proposals to reignite the EU's services sector and boost EU-wide GDP by up to €294bn were "interesting" and "worth exploring".

More please!

Another tricky morning for the eurozone

It’s been a somewhat less than pleasant morning for the eurozone. Firstly, the European Commission put out its latest economic growth forecasts, which do not make great reading for many countries. Here is a comparison between the EC's forecasts and the latest national government forecasts for growth:

As the table shows, there is a long list of countries which seem to be overestimating their growth for this year including: Italy, France, Spain, the Netherlands and Ireland.

We expect to see a series of growth revisions throughout the year on the part of national governments – in some cases such as Greece, we expect that the Commission forecasts will also prove overly optimistic (notably the figures used in the Greek budget are actually below the Commission forecasts). The figures also highlight the growing cracks in the Franco-German axis as the two countries diverge economically; this was reinforced by the starkly different PMI (business activity) figures yesterday.

The implications of these inflated growth projections are also becoming apparent. Nowhere is this clearer than in Spain, where the Commission highlights that, without additional measures, the Spanish government deficit in 2013 and 2014 will be 6.7% and 7.2% of GDP respectively. This compares to targets laid down by the eurozone of 4.5% and 2.8% respectively.

The Commission’s estimates of Greek unemployment also still seem unrealistic, at 27% and 25.7% in 2013 and 2014. In November 2012 unemployment reached 27% in Greece, according to the Greek statistics agency. With plenty of structural reforms still to go we expect this figure to increase further.

Secondly, the announcement of the repayment of the ECB’s second Long Term Refinancing Operation (LTRO) came in significantly lower than expected – 356 banks repaid €61.1bn compared to average expectations of €122.5bn. The steep slide in the euro exemplified the market response.

This highlights that underneath the recent optimism there is still significant fragmentation in financial markets and concerns over liquidity (as we have noted previously). Although impossible to tell conclusively, since these are just aggregate figures, we expect that many of the banks that have repaid were from ‘core’ eurozone countries, further exacerbating the differences between eurozone countries.

If you are looking for a silver lining, it could be that the rise in the euro has been halted for now, which may aid the competitiveness of the weaker countries, and that a potential de facto tightening of monetary policy has been avoided - this could have been a concern if banks repaid the LTRO and deleveraged rather than investing the collateral elsewhere.

The picture emerging from this morning’s data, then, continues to be a bleak one for the eurozone thanks to stalling growth across the bloc and banks hanging onto ECB liquidity. Beyond the headlines though, there is evidence of growing divisions as some of the core countries post growth and their banks repay ECB funding while peripheral countries find themselves in economic decline with banks surviving on ECB money but lending little.

Stop me if you think you've heard this one before...

The Director of Open Europe Berlin, Prof. Dr. Michael Wohlgemuth, has dug up this old quote, which has a great deal of relevance for where we're at today. 

It's taken from the third Jean Monnet Lecture delivered in Florence by Ralf Dahrendorf - in 1979 (Dahrendorf was Member of the German Parliament, Parliamentary Secretary of State at the Foreign Office of Germany, European Commissioner for External Relations and Trade, European Commissioner for Research, Science and Education, Member and life peer of the British House of Lords, director of the London School of Economics, Warden of St Antony's College at the University of Oxford and Professor of Sociology at a number of universities in Germany and the United Kingdom...).

Pay attention:

"It is emphatically not the desire of some of the founding fathers to create another superpower; to have as much decentralization as possible and only as much centralization as necessary, is a prescription for a humane society to which many, including myself, would subscribe today."

He continues:

"The policy of the British government is to express its commitment to the Community – which is appreciated – to assure its partners that it does not propose to break the law – which is more than can be said of some others, though it remains to be seen what exactly the British Government has in mind – and to demand a « broad balance » of contributions and benefits. It will be for politicians to try and find out how much room for manoeuvre the notion of « broad balance » allows; at first sight, it certainly does not seem unreasonable. To say that we have to start again in order to build Europe would be wrong; there is much in the acquis communautaire which is worth preserving. But what we need is more than mere adjustments and reformlets; we need a fundamental reappraisal." 

 Then he absolutely hit the nail on the head:

"I have often been struck by the prevailing view in Community circles that the worst that can happen is any movement towards what is called a Europe à la carte. This is not only somewhat odd for someone who likes to make his own choices, but also illustrates that strange puritanism, not to say masochism which underlies much of Community action: Europe has to hurt in order to be good. Any measure that does not hurt at least some members of the European Community is (in this view) probably wrong. In any case it is regarded as unthinkable that one should ever allow those members of the Community who want to go along with certain policies to do so, and those who are not interested to stay out. The European interest (it is said) is either general or it does not exist." 

Full lecture here.

As they say, most things that are being said today, have been said better before...

Open Europe publishes (and analyses) leaked draft of Van Rompuy's new EU budget proposal

We’ve got our hands on a leaked copy of the latest HermanVan Rompuy (HvR) proposal for the EU budget (see here for the full doc). The headline spending figure remains broadly unchanged in the new proposal, standing at €1,014bn (a €4bn increase), but more cash is spent on farm subsidies and structural funds, in a move designed to appease France, Poland, Italy and Spain.

(The figures here includes off budget items, if they are discounted the second proposal is actuall a decrease, from €973bn to €972bn. This is mostly due to items which weren't off budget in the original proposal, being off budget in the second version).

No figure is given for payments appropriations – the figure that the UK government is targeting – but given that this figure has widely been cited to be €940bn, it’s likely that it’ll have to come down more if acceptable to the UK (with the government's initial proposal at €886bn).

Also, just like with the previous draft, the latest HvR proposal foresees cuts to the UK rebate – which is a non-starter for Britain.  As a refresher (from our recent flash analysis):

“The proposal also includes an adjustment in the way in which the UK rebate is calculated. This could result in the UK rebate falling by as much as 11% or €3.5bn across the next budget period, solely due to this adjustment.

The plan also suggests that ‘corrections’ such as the UK rebate will be “fully financed by all member states”. It’s not entirely clear what this means, but it does suggest that the UK could actually be responsible for funding part of its own rebate. If this were the case then the rebate could be reduced by a further €3.316bn, cutting the rebate by a further 11.5%, and 21% (€6.8bn) from its original amount.”

The increased spending on CAP and Cohesion moves further away from the spending split which many in the UK would like to see (more growth focused) while although the headline figure has not increased it is still probably slightly too high. See table below for the full break down (click to enlarge):

So, despite talk of progress last night, it still seems that, from a UK perspective (but also likely a Swedish, Dutch and German one) there are some significant divisions.
 

EU budget talks are heating up (and Brussels isn't doing itself any favours)

EU budget talks are heating up, with member states still unable to agree on the size of the next long-term budget, to run between 2014 and 2020.

EU leaders will try to settle differences at a summit on 22 and 22 November. As things currently stand, a deal looks unlikely, with David Cameron in a particularly tricky position (for just how tricky, see here). Today we got a taste of things to come: the Brussels institutions launched a three-pronged attack on economic common sense.

• The European Parliament voted for 6.8% increase to the EU’s 2013 budget (which is subject to Qualified Majority Voting and co-decision between national ministers and MEPs), thereby rejecting member states’ compromise 2.79% increase, instead going with the Commission.  

• In a report, the EP also backed a 5% increase to the EU’s long-term budget (and a lot bigger increase if off-balance sheet items are included), in line with the European Commission’s original proposal. This proposal has been rejected by all net contributing member states (which doesn’t mean that the net contributors agree amongst themselves).

• Finally, the Commission said today that it needs to amend the 2012 EU budget, since there's not enough cash left. If you’re a government on an EU-mandated austerity programme - or a a household - you’re forced to prioritise and find savings when there’s not enough money in the pot. If you’re an EU institution you ask for an additional €9bn (with roughly €3.1bn from fines imposed on member states, meaning that national governments will have to put up €5.9bn in total).  

Cheers for that.

So if the EP/Commisison 2012 and 2013 proposals stand, which they probably won’t (we’ll return to the long-term budget), UK taxpayers would be forced to cough up another £2bn or so (£1.3bn increase for 2013 + £700m extra funds for this year), depending a bit on exchange rate used and the UK's pre-rebate share of the EU budget (both vary).

And those people who want the UK to leave the EU just got some additional killer campaign material to play with.

Well done Brussels.

Banking Union Part II – now for the safeguards

Here’s the continuation of the EU banking union saga – the document (also leaked, see here) that sets out how the single market and banking union are meant to fit together. A crucial point for the UK and others. As we noted on Friday, the Commission was set to table a series of documents establishing the first step towards a banking union. Well, there will be three of them, to be precise:

• A regulation to make the ECB the supervisor for “all” banks in the Eurozone, with non-euro countries able to join if they wish. This is the one we looked at – and published – on Friday.  

• A regulation making adjustments to the European Banking Authority in light of the new powers of the ECB, with the objective to avoid the banking union fragmenting the single market. This is the one that we look at below. 

• A “communication” which sets out the Commission’s vision of the banking union long-term, including a deposit guarantee scheme and a single resolution fund (also known as wishful thinking, at least for now).

Following our analysis of the first document, here are our thoughts on the adjustment to the EBA’s rules and whether the ‘safeguards’ proposed by the Commission will address the risk of the Eurozone/ECB/banking union encroaching on single market territory or the 17 outvoting the non-euro 10 on financial regulation in particular (i.e. Eurozone caucusing at the EBA).

The EBA will have powers over roughly the same areas as before and the same voting weight too, and will continue to serve as the bank supervisor-cum-regulator for the EU-27 (which was already a quite confusing arrangement). However, the EBA may, in a round-about way, actually gain powers vis-a-vis the UK (which we'll return to). To avoid the ECB over-ruling or undercutting it on matters of the single market, the following safeguards have been proposed:

• Interestingly, when within its remit, the EBA would be able to circumvent the ECB in an “emergency situation” and impose a decision directly applicable to an individual bank or financial institution. In such cases, therefore, the ECB would be ‘junior’ to the EBA – much like national authorities. 

• A new “independent panel” of experts could be created by the EBA to judge on breaches of EU law i.e. when a country breaks single market rules or when two “competent authorities” (of which the ECB could presumably be one) disagree on whether rules have been breached. The panel’s decision could be over-turned by a simple majority at the EBA’s supervisory board, which needs to include at least three votes from non-euro members (if they have not opted into the banking union) and three votes from euro-members. This is an interesting one, and we need more details to make a clear assessment as to what this would mean in practice – or how effective it’ll be. Who will the independent experts be (drawn from the EBA itself)? How will they be appointed? Will it always be ad hoc or more permanent? And will this, in effect, make the EBA more powerful at the expense of UK authorities (this will be a tricky one, stay put)?

• Decisions on capital requirements for banks is addressed specifically. This is a key concern for the UK government and an area we’ve pointed to consistently where the Eurozone could face a fresh incentive to act as a block under banking union. The proposal suggests that issues relating to capital requirements – over which the EBA has some moderate powers – will be decided by QMV within the Board of Supervisors but can be overturned by a simple majority, again including at least three non-euro states. 

• The management board of the EBA must consist of at least two non-participating member states (out of six).

Marks for creative solutions, and it seems the Commission genuinely wants to preserve, as it puts it, “the proper functioning of the EBA in the interest of the union as a whole.” Part of the UK financial services industry might be reasonably happy that the UK would have a seat at the table, at least in the EBA. But this remains an awkward patchwork, and it probably won't be enough to eliminate British anxiety over the banking union.

And remember, this only addresses the relationship between the EBA and the ECB, which is only one of the many relationships within a banking union that needs to be clarified. As we’ve argued before, the biggest worry remains an incremental, de facto institutional shift from the EU-27 to the Eurozone 17, involving the Commission and the European Parliament as well, which is why we want to see stronger single market safeguards, also at Council-level.

And it ain’t getting any easier to work out who has final accountability over financial supervision in Europe…