Barroso's failed attempt to single out Cameron

There seems to be some continuing confusion over David Cameron’s demands at last week’s EU summit, specifically in reference to their impact on the 'integrity' of the single market. Unfortunately, European Commission President Jose Manuel Barroso, who should know better, is also doing his bit to propagate these misconceptions in a speech to the European Parliament this morning, in which he said:

“The United Kingdom, in exchange for giving its agreement, asked for a specific protocol on financial services which, as presented, was a risk to the integrity of the internal market. This made compromise impossible.

All other heads of government were left with the choice between paying this price or moving ahead without the UK's participation and accepting an internal agreement among them."

As we mentioned in passing yesterday (see here), this simply wasn’t the case.

Cameron’s first set of demands were to ensure that unanimity applies on decisions relating to: transfer of powers to EU supervisory agencies, the use of 'maximum harmonisation', issues impacting on fiscal interests of member states (taxes & levies) and the location of EU Supervisory Authorities (ESAs). In actual fact, Cameron's demands did not relate to the level of financial supervision but the rules governing the transfer of powers from member states to those EU supervisors. This is quite different to the functioning of the single market.

As is also instantly clear, there were no UK-specific demands, especially not for some form of opt-out as Barroso seems to imply. So, whether you agree with Cameron’s demands or not, it is clear that he was not seeking special treatment for the UK, these rules would allow unanimity for all EU members.

The case can, and should, also be made that, in terms of content, Cameron was defending the single market, particularly on the location of ESAs (i.e. they can't all be in the eurozone) and in defending the UK against the ECB's insistence that sizeable euro-denominated transactions only be cleared within the eurozone.

The source of the confusion seems to be that many people are conflating trying to protect a vital UK industry with seeking special treatment for the UK – these are clearly not the same thing legally or practically when it comes to the EU. All governments in EU negotiations try to protect their vital industries, for example: France with agriculture, Spain with fishing and Germany with manufacturing exports, and in some cases these countries have more protection than the UK does on financial services despite it representing a bigger share of the UK economy (see our recent report for a full discussion of this issue).

The other major misconception is that the UK's demands were to shield the City from all regulation - one major demand would have allowed the UK to impose tougher capital requirements on banks than permitted by the EU's desire for 'maximum harmonisation', for example. This was protection for taxpayers, not bankers. The Commission's logic that maximum harmonisation is necessary for the functioning of the single market is flawed and not one that it applies in other areas of EU policy. For example, on cutting carbon emissions, member states are free to go beyond the EU-agreed minimum.

Overall then, the UK did not seek any special treatment or specific opt-outs. Cameron asked for safeguards relating partly to an industry which is of importance to the UK (and other countries), but safeguards which could be accessed by all EU members. Neither the structure nor content of his demands were in anyway designed to hamper the single market, but in fact to bolster it. It can only be damaging to the integrity of the EU that the Commission President should openly encourage such a misconception.

Capital Requirements

There has been a lot of speculation and a fair few misconceptions about what Cameron asked for at the EU summit - we addressed many of them here. One key point we want to flag up is his demand on bank capital requirements. According to the document obtained by the Telegraph, Cameron's demand was for unanimity to be applied to any plans for "maximum harmonisation provisions which prevent member states imposing additional requirements".

This clearly relates to the current EU proposals implementing the Basel III requirements. Here the UK is keen to push ahead, imposing stricter capital requirements on UK banks. However, the Commission could block this by stating that all member states must adhere to their minimum and maximum levels, to avoid distortions to the Single Market. This difference raises a few key points to keep in mind during the debates over Cameron's veto:

1) The UK government is not pushing for more or less regulation on financial services, merely more suitable regulation and smarter control. The EU is keen to punish practices which it sees as problematic, such as short selling and the use of credit default swaps, but when it comes to tackling a fundamental problem in the make up of the financial system it dodges the issue. This is mostly because the eurozone states fear excessive deleveraging, while they cannot afford to recapitalise the banks using public money. Valid fears, but it highlights the differing needs for the UK and European financial sectors.

2) Leading on, the UK has a much larger financial sector - solvency is therefore paramount. This point is clearly highlighted by the FSA report into the failure of RBS which was released today. The UK cannot afford another crisis and another series of bank bailouts. This is a concern and problem which the many in Brussels and in some national capitals seem to not fully appreciate. The lack of scope for allowing the UK to deal with what it sees as a key issue is hypocritical given the number of times which the UK has been tagged as an 'awkward partner'.

3) Cameron wasn't asking for a UK specific opt-out. He asked for unanimity to be applied allowing all countries the option to veto maximum requirements. This highlights how the myth of 'special treatment' seems to be unfounded.

Leaving aside whether he asked for the right thing and the viability of his negotiation strategy (and here there are clearly lessons that need to be learnt), the demand highlights the crux of the issue for the UK. It is not about stopping regulation on the city but about realising that in some areas the UK may see a need to tailor its regulatory system in a way that better suits its economic and financial circumstances - but under general provisions of EU law, rather than special UK 'opt outs'. Much of the media coverage and comments relating to this point have left much to be desired in the accuracy department.

Cameron must persist with EU reform strategy

We've got a piece in City AM today, assessing what the EU summit conclusions really mean for the UK financial services sector. Despite much of the noise in the media not all that much has changed. That said it is vital that Cameron pushes forward with his strategy for EU renegotiation in order for his veto approach not to be in vain. See below for the full piece:

NOW that the dust is beginning to settle on last week’s tumultuous EU summit, where Prime Minister David Cameron blocked a change in the EU treaty, we can start to assess the consequences of his decision. So, what could the summit outcome actually mean for UK financial services?

Despite the clamour in much of the media, structurally it doesn’t change that much for the City. The UK would never have actually taken part in the proposals that were on the table to shore up the euro ­– for example, the monthly meetings among Eurozone leaders – so Cameron has not lost a seat at the table as some have incorrectly reported. The UK may not have gained any additional safeguards, but it isn’t visibly any worse off on financial services. That said, there are a couple of valid background concerns.

Firstly, since there are no safeguards in place, there’s still a risk of Eurozone caucusing, with the 17+ countries deciding for all 27. Some have argued that this risk is now greater since Cameron lost a lot of good will, which could lead to retaliation from EU partners, particularly with regard to financial regulation. Let’s be honest though, the Eurozone has much bigger problems to worry about for now and doesn’t have the time to punish the UK, nor can it afford self-defeating regulation.

Second, there is a concern over a Eurozone financial transaction tax (FTT) – an EU-wide FTT is still a non-starter and the UK retains its veto. The impact of a Eurozone only FTT on the City is unclear. It could be positive, as businesses relocate from the Eurozone to London to avoid the impact of the FTT – they would still have to pay the FTT to access the Eurozone, but would not have to do so with international trade. As such, London would have a competitive advantage. At the same time, it may have a negative impact by reducing financial transactions in Europe generally – something which the City would lose from since it is often seen as a gateway to European markets. The overall impact is unclear though and the same points can be made for any Eurozone specific financial regulation.

So, if Cameron didn’t gain or lose much, what was this all about? Fundamentally, it was about announcing a new strategy in the UK’s negotiations with the EU and flagging up the City as an area of vital interest. Perhaps Cameron’s demands were too detailed, so didn’t lend themselves to EU treaty negotiations, while his timing wasn’t ideal. Perhaps he also failed to link his arguments to wider efforts to develop a more competitive and outward-looking EU. But, due to domestic political pressure and the looming threat to the City from EU regulation, Cameron may have had little choice but to take the approach he did.

There is no doubt that Cameron expended substantial political capital with this move. For this not to be in vain he must continue to push a reformist line, ensuring sound and proportionate regulation. The agreement formed at the summit does not solve the Eurozone crisis and throws up huge legal questions, not least over whether the Eurozone will be able to use EU institutions to enforce decisions. There could be instances in the near future of the Eurozone needing the approval of the UK. Cameron should stick to his guns, but needs to do a better job of communicating his overall strategy and why the City is important to the UK economy. This is not over by a long shot.

Ten myths about Cameron’s EU veto

Over on the Spectator's Coffee House blog, we set out ten myths about Cameron's veto. This is the post:

The EU veto that Cameron pulled in the early hours of Thursday morning has been widely misunderstood on all sides. Here are the ten most common myths:

1. Because of Cameron’s veto, Britain lost a seat at the negotiating table. Not true. The UK was never itself going to take part in the Merkozy pact (and potentially be subject to EU sanctions), and therefore not in the monthly, parallel EU meetings that will begin in January, either. Even if he had approved the Treaty changes, Cameron still would not have had a seat at the table. Wider political challenges aside, the veto didn’t change anything structurally in terms of UK influence.

2. Cameron’s veto created a two-tier Europe. A two-tier (or, rather, multi-tier) Europe was a consequence of the formation of the euro, which would inevitably force its members closer together. Cameron’s veto was a reflection of a multi-tier Europe, not the cause of it.

3. The UK is now completely isolated. Define isolated. Yes, Cameron expended a lot of political capital and frustrated many EU leaders — and he could have done some things differently, including sequenced his demands in a smarter way. But as Fraser pointed out earlier, the UK remains an open economy plugged into the global network. And given the state of the euro Britain is — as Terry Smith of brokerage firm Tullett Prebon told the BBC — ‘as isolated as someone left on the dock in Southampton as the Titanic sailed away.’

4. Cameron used his veto to protect a ‘tiny part of our economy’. This claim slipped into the BBC’s Stephanie Flanders’ reports on Friday and is incorrect. Financial services accounted for a £35bn trade surplus last year — one of the few sectors that generated a surplus, as well almost 2 million jobs and it contributed £54bn in taxes.

5. Merkel got what she wanted. This claim was also part of most broadcast reports and is equally untrue. Merkel got something, but, as Spiegel noted, she also ‘paid a high cost’ — compromising on ECJ budget powers and private sector involvement in future bailouts, for example — without achieving a lasting solution to the crisis. As yesterday’s FT Deutschland put it, ‘The next rescue summit is guaranteed to come.’

6. The UK is alone in expressing reservations about Merkozy’s deal. Cameron was clearly all alone on the veto, but others are far from enthusiastic about what’s on offer. Part of the deal hit the wall in the Finnish Parliament, while the Swedish opposition parties are opposed to Sweden signing up, meaning that the deal may not make it through the Riksdag. Håkan Juholt, the leader of the Social Democrats, said, ‘The Swedish people rejected the single currency in a referendum and we have to respect that. We have no intention of becoming members through the backdoor.’

7. The UK asked for ‘special exemptions’. Whether or not he asked for the right things, Cameron did not demand UK-specific ‘opt outs’ from regulations, but for the reinstatement of general vetoes over transfers of power to the EU’s financial supervisors and a guarantee that business and trading activities won’t be pushed inside the eurozone through regulation. The closest he got to an opt-out was a proposal to exempt certain types of businesses that only operate in one country from certain aspects of EU regulation.

8. Cameron went to Europe to protect greedy bankers. One of his demands was to be able to impose stricter rules on banks (capital requirements) in order to avoid future taxpayer-backed bailouts of bankers.

9. The 17+ can easily use the EU institutions to enforce their decisions, making Cameron’s veto pointless. ECJ case law clearly states that an ad hoc group of countries can use the EU institutions but only subject to an agreement by all EU member states sharing and paying for the institutions. This means that the UK still has a veto. Some EU leaders are now set on manipulating EU law to get around the UK veto (we’ve been here before). It’s not easy, but they may succeed. However, to criticise Cameron for this is to blame someone for losing in poker because the rules changed mid-way through the game.

To be fair, there have also been some misconceptions among those who would defend Cameron:

10. The veto was about blocking the financial transaction tax and specific financial regulations. Not quite. Cameron already had a separate veto over the FTT, and the Treaty changes were merely about tightening the eurozone’s budget rules (from which the UK already has an opt-out). The veto was always a lever to push for safeguards against the UK being sidelined on key economic issues (i.e. financial regulation) in future as the eurozone integrated further. It was not a protective measure in itself.

So leaving misconceptions and domestic politics aside, did Cameron ‘trip over his own red line’ by spending a veto without actually getting any specific safeguards in return? There is a risk. But the truth is that it all depends on what happens next. As dramatic as Cameron’s veto may seem now, I suspect it is merely one of many acts.

Hail the all-conquering Iron Chancellor? Not Quite

Earlier this week (although so much as happened it feels a lot longer than that) we scored Merkel and Sarkozy’s pre-summit meeting in which they plotted their course of action. We decided Merkel had just shaded it in terms what was agreed.

However, in addition to giving up her stance on extensive private sector involvement in any activation of the ESM (the eurozone's forthcoming permanent bailout fund) - a key German negotiation position over the last few years - one of her key demands was to push for Treaty change at 27 (Sarko always favoured a more inter-governmental approach), and many of her other ‘wins’ were also premised on getting that agreement (e.g. the right to take other member states to the ECJ in the event of breaches of the new agreement on fiscal integration and budgetary discipline). This has now been blown out of the water for the foreseeable future, following David Cameron’s veto.

For all the predictable talk of the end of an era and the UK’s permanent isolation in Europe henceforth (we argue Cameron had little choice) did Merkel actually come out a winner in all of this? Clearly, Sarkazy if the one leaving Brussels the happiest (not minding doing business at 17, albeit now with the 'help' of some euro outs as well).

But Merkel didn't fare that well. This is not for lack of trying; Merkel has arguing that: “I am very pleased with the outcome”, and that the agreement on fiscal integration was a “breakthrough” in the debt crisis. The reality is that Merkel has no legal guarantee (despite her argument to the contrary) that the EU institutions, in particular the Commission and the ECJ will be allowed to play an active role in implementing and policing the agreement. Instead, the measures in the agreement will be subject to long-winded political wrangling and horse-trading, precisely the sort of scenario that Merkel wanted to avoid.

It is not surprising therefore that Merkel has acknowledged the need to transplant the agreement on fiscal integration into the Treaties as soon as it is possible to do so. This means the UK has not exhausted its veto quite yet (though, as we've noted, there's a complex legal discussion over whether a group of countries formed outside the EU treaties can use the EU institutions to facilitate and enforce its decisions), and Merkel will still have to accommodate British concerns on the single market and financial services if she wants to get around this amicably; any attempt to override do so would be highly acrimonious and subject to legal challenge, which would take time to resolve.

This has been noted back home, with Foreign Minister and former FDP leader Guido Westerwelle acknowledged the deal was "not great", while Der Spiegel wrote that Merkel “paid a high cost” in order to secure the agreement, noting that she had maintained all along that an intergovernmental agreement would be second best vis-à-vis Treaty change. For all the “UK is isolated” stories in the German press, SPD party leader Sigmar Gabriel struck a sober note when he pointed out that the agreement is "insufficient" and will remain so until Britain joins up.

Meanwhile Die Welt wrote a piece which examined Merkel’s reputation for toughness and consistence in Europe, i.e. “Madame Non”, pointing out that throughout the crisis, Merkel has already crossed plenty of what had initially been “red line issues”.

Politics aside, the German media are also sceptical that the agreement on further fiscal integration, and also the agreement on an additional €200bn in funding for the IMF, will be enough to arrest the economics crisis - an editorial in FTD argues that:

"For all the understandable anger both sides should not obstruct the possibility of one day making a fresh start under new governments. In summary: The euro will not go under. But the crisis is not over. The AAA rating of the Euro-zone remains at risk. The next rescue summit is guaranteed to come.
All in all, still plenty to play for…

The summit to end all summits

At least that was how it was being seen beforehand. Unfortunately, in the aftermath it seems to have fallen short of expectations (although admittedly the dust is yet to fully settle). Nevertheless, it was an interesting summit, especially for the UK. Below we outline the key outcomes of the summit giving our assessment of the economic, political and legal impact which the decisions may have (read our full press release here).

1) Treaty change

Summary: Failed to agree to a treaty change involving all 27 member states. Eurozone members will push ahead with a new treaty for the 17, plus a possible 9 other EU states, pending consultation with national parliaments. Aim to incorporate the measures into the EU Treaties as soon as possible.

Open Europe’s take: The legal basis for the new intergovernmental treaty is still not clear. It will be very legally complex for the new group to use EU institutions to enforce the new treaty without the consent of the UK. As such, the negotiations are far from over, particularly since eurozone leaders are still keen to incorporate the measures into the Treaties and push further in the future in terms of integration.

Was Cameron right to use his veto? How might it impact on UK – EU relations in the future?

- Cameron had little choice but to exercise his veto given the importance of financial services to the UK economy and his need to balance domestic party concerns. His demands were not excessive, particularly given that other EU members have issued similar national demands during this crisis, e.g. Germany over Eurobonds and the ECB’s role, France over using the European Court of Justice (ECJ) to enforce fiscal sanctions and now Finland over the use of QMV in the ESM.

- There was never any discussion of the UK taking part in the new ‘fiscal compact’ but merely whether it would approve the treaty change or not. As such, the UK’s position has not changed within the EU itself. The political dynamics may have changed but whether this will turn out to be better or worse for the UK remains to be seen.

- There is still a huge legal mess to sort out. Whether the new treaty will be enforced by EU institutions or not remains unclear, as is the UK’s role in future proceedings, but it looks likely to be a massive legal stretch to use the existing EU institutions for this new treaty.

- There are valid concerns that Cameron received no clear safeguards while spending a lot of political capital. In order for this to be a sound investment, it needs to be followed up with a concerted push for a more flexible, adaptable and competitive EU in which the UK can feel at home. In the wake of the eurozone crisis, Europe will need a new grand political settlement, which can take years and in which the UK, like all other EU countries, will push their interests.

2) Fiscal compact

Summary: Commitment to balanced budgets, with an annual structural deficit limit of 0.5% enshrined in law and a clear, automatic correction mechanism for when this is broken. Legal enforcement judged by the European Court of Justice (ECJ). The Excessive Deficit Procedure will be strengthened; any country which breaks the 3% threshold will be subject to Commission sanctions unless a qualified majority of eurozone states oppose them. Examine new Commission rules on economic governance and increase surveillance.

Open Europe’s take: Only difference from the stability and growth pact is that qualified majority voting is reversed. Not a particularly credible or strong fiscal compact. There are significant concerns that if countries such as Germany and France struggle to meet the requirements, they will be watered down. Missing out on strong ECJ enforcement and European level automatic sanctions reduces the impact of these measures, unlikely to be enough to convince markets or the ECB that fiscal discipline will be maintained in the long term. Not clear what a national automatic mechanism for correcting budget deficits would be. This seems to be the start of a process, installing fiscal straight jackets on struggling eurozone countries if they wish to stay in the eurozone long term – not clear where their growth and competitiveness will come from.

3) European Stability Mechanism (ESM)

Summary: Move up entry into force to July 2012 or as soon as members representing 90% of capital commitments have ratified it. EFSF will run until mid-2013 as expected, although deciding how the two will run at the same time (given current restrictions in the ESM treaty) will be delayed until March 2012. ESM wording on private sector involvement in future bailouts will be watered down, highlighting that Greece is “unique and exceptional”. An emergency procedure will be added to ESM voting rules, which states that 85% QMV threshold can be used to make decisions if the Commission and the ECB believe the financial and economic sustainability of the euro is threatened.

Open Europe’s take: Moving up the ESM is broadly positive from a market perspective, although the key issues about its implementation have been delayed. One concern is that the sped up timeline for paying in capital resulting from this move will increase pressure on the funding needs for eurozone states. Removing private sector involvement may calm markets in the short term but could be a mistake in the long term. Takes us back to where we were with EFSF bailouts, simply recycling debt around the eurozone with no clear goal for tackling solvency. Although the QMV rule has to be approved by the Finnish parliament, the “emergency procedure” seems misleading – in what instance would giving a bailout not be seen as an emergency?

4) IMF

Summary: Decide within 10 days whether to provide €200bn in bilateral loans to the IMF general resources fund, via national central banks.

Open Europe’s take: The IMF can apply more conditionality on lending, so it is preferable to the central banks doing it themselves. Still only offers a short term liquidity boost to countries, unless IMF is able to enforce broader economic restructuring which the eurozone looks set dead against. Raises questions over the independence of central banks, since they are giving up money to a general fund to be controlled by an institution with completely separate aims. May be opposed by the ECB and/or Germany depending on format. Even with this additional funding the IMF capacity for bailing out Italy and/or Spain still falls well short.

The legal scramble for the EU institutions

So, following the news this morning that the eurozone plus six more countries want to go ahead with their own treaty, where are we? David Cameron vetoed a treaty of 27 because of a refusal to insert a protocol safeguarding the City and other key economic interests (Sarkozy called Cameron's demands for safeguards on financial services "unacceptable").

Well. the EU now looks set for an almighty legal battle. Cameron has warned the new bloc of 23 (the UK has been joined by Sweden, Hungary and the Czech Republic so far but that group is fluid) that it would not be able to use the resources of the EU (the Commission or the ECJ), raising real doubts as to whether the eurozone would be able to enforce its fiscal rules in order to calm the markets.

Last night Spiegel was reporting that the European Council's legal service had advised that a smaller group of member states could not amend articles in the EU Treaties (e.g. the articles on budget deficits etc) without agreement of the 27. So, the UK has a veto over this.

The draft summit conclusions state that:

"This will require a new deal between euro area Member States to be enshrined in common, ambitious rules that translate their strong political commitment into a new legal framework."

This leaves the group of 23 pursuing a new treaty outside the EU framework. The next, and now most important, issue is whether they will be able to use the EU institutions to enforce the commitments set out in this new non-EU treaty.

The UK is clearly of the belief that they can't. Cameron said last night, "Clearly, the institutions of the European Union belong to the union, they belong to the 27. They are there to do the things that are in treaties that we have all signed up to over the years. That is an important protection for Britain."

As Bruno Waterfield tweeted last night an ECJ ruling from 1993 set a precedent that the EU institutions can be used by ad-hoc groups of member states, but only after unanimous agreement of the 27. This still gives the UK a veto.

The FT today reports that

José Manuel Barroso, the Commission president, said he believed there were ways to work around such legal prohibitions, but senior EU officials acknowledged it would be difficult to give Brussels new powers over eurozone national budgets outside the EU treaties, and diplomats expressed concern financial markets would not see the new pact as credible.

So Barroso may throw his hat in with the new group and support them in their desire to use the EU institutions - a key German demand. It all looks set for a legal standoff but, given the past history of EU law (the new interpretation of "no bailout" clauses and so on), where there's a will there's usually a way.

Everyone now naturally has their own take on the situation, ranging from "victory" to leaving the UK completely isolated. Clearly, few EU leaders expected this. The Germans thought that Cameron was bluffing, and possibly vice-versa. But remember, a treaty change not involving the UK was always a possibility - and it was never on the cards that Britian itself should participate in the new 'compact', only whether it would approve it at the level of all 27. The political dynamics have changed, and not being able to do this at 27 has made the situation a lot messier. Eurozone leaders now have to work out a non-EU treaty, based on Merkozy's letter but otherwise very little substance to work with.

Without the use of the EU institutions to enforce them, the new rules will have limited credibility (to be honest, they don't have a lot of credibility as it is).

However, if the new group does gain access to the EU institutions - which to us would be another example of a massive legal stretch of the EU treaties - this could clearly have a negative impact on the UK, possibly increasing the risk of the European Commission for example being colonised by eurozone interests. But that risk has been there since the very formation of the euro.

EU vs eurozone: Who has said what ahead of the summit?

Much has been said about David Cameron’s thinly veiled threat to veto Treaty change at 27 if he is unable to obtain satisfactory safeguards to protect UK financial services from overzealous EU regulation (as we have argued for), and also his determination to protect the single market from fragmentation. This is clearly a worry if the eurozone proceeds with closer integration and implements its own measures on issues such as financial regulation, labour markets, harmonisation of corporate tax base, and the introduction of a FTT at the eurozone level, as proposed by Merkel and Sarkozy in their recent letter to Council President van Rompuy.

However, amidst this Cameron vs Merkozy narrative, it is important to remember there are another 24 member states attending the summit, and they all have specific views on what they want to achieve, and crucially, how prepared they are to see a separate eurozone agreement. It is the stance adopted by these countries that will determine what, if anything, Cameron is able to bring back from Brussels.

While there is not much explicit support for Cameron’s position, the determination for Treaty change at 27 comes through strongly, suggesting that as we have argued, Cameron may have more leverage than widely acknowledged. Anyway, you can judge for yourselves:

Polish PM Donald Tusk criticised those trying to save their own money and further their own national interests at the expense of the community, arguing that this could “lead to the ruin of the European community… this is a devilish alternative”, adding that: “We can only protect our national interests by maintaining and strengthening a community of 27 countries”, although he acknowledged there was a "real threat" the summit could fail.

Finnish PM Jyrki Katainen said that: "It will be a very tough meeting I don't know how long it will take. It is always better if you change the current treaty of 27 because it's important to get a strong, united Europe and not to divide it. The situation seems to be quite tricky and now we all must be cooperative and ready for compromise. Hopefully we only have one common treaty for everybody."

Dutch PM Mark Rutte said that: "We also have to make sure that we keep the union of 27 together. It is not just a union of 17 euro countries. It is of great importance for a country such as the Netherlands, which is growth-orientated and believes in importance of jobs, that we keep countries such as the UK, Sweden and the Baltic countries and Poland in."

Danish PM Helle Thorning-Schmidt said that "I come with a mandate to negotiate this, and we're very open. We think that if the euro countries see treaty change as part of the solution, we are able to back that treaty change. What is most important right now is that we show a willingness to compromise and a willingness to find solutions in common, and then it is very important for all of us that we keep the 27 member states together. This is what has worked in other times of crisis for Europe, and that is what we will be working (for) now as well."

Romanian PM Traian Basescu warned that: “Any decision in Brussels will affect the everyday lives of all Romanians [therefore] Romania can not accept a Europe with two categories of members”.

Hungarian PM Viktor Orban said that: “The question today is whether the current two-speed Europe will develop into a three or four-speed Europe… Hungary’s national interest is that the euro zone members should find a solution that does not strain the framework of the 27-member EU. This compromise is somewhere in the direction of Germany’s position, that’s where we’d like to get to by Friday afternoon”.

Austria’s Chancellor Werner Faymann is more pessimistic, saying that the basis for agreement on EU treaty change at 27 was not very good.

Martin Shultz MEP, leader of the Socialists and Democrats in the EP, said that: "If there is too much insistence on treaty change there is a danger of backroom deals and trade-offs, which we do not want to see. I want clarity and transparency. I understand those who refuse to engage in horse-trading with a non-euro country. But we cannot allow the division of Europe into a 17-10 structure. Maybe, we should think about a 26-1 solution."

Separately but significantly, Spain’s incoming Prime Minister Mariano Rajoy (not yet allowed to attend EU summits, since his government will only enter office on 22 December), has allegedly urged outgoing Prime Minister José Luis Rodríguez Zapatero to demand that the QMV threshold on future euro bailouts via the European Stability Mechanism be raised to 90%, so that Spain can also have a veto.

What could Cameron hope for?

As has been repeated, and repeated again, in the UK media over the last few days, David Cameron isn't in the easiest spot as he attempts to square off a number of circles with EU leaders today and tomorrow. The referendum debate has taken on a life of its own (not so much driven by backbenchers as by media and high-profile interventions by two ministers and a mayor).

Cameron's squeezed position stems from an unusually complicated mix of domestic pressure, an economic crisis running out of control and an EU negotiation cobweb of massive proportions. But, we all know this. The question now is, what can he realistically hope for?

As Bruno Waterfield explained on the Telegraph live blog earlier today, Cameron is fighting to insert language in tomorrow's (or the weekend's - it might be a long session) conclusions that would commit EU leaders, on paper at least, to "consider and develop concrete and effective mechanisms" to ensure the integrity of the internal market at 27 and that the essential economic interests of non-euro members are fully protected (i.e. for the UK, the City).

The thing to remember is that the Treaty changes will not be agreed tomorrow - what this summit is designed to do is to lay the groundwork for a deal (and possible finalised Treaty changes) at the summit of EU leaders that will take place in March. So if Cameron managed to insert this kind of language in a political declaration attached to the summit conclusions, though it may on the surface seem like nothing, it could actually set Cameron up for negotiations to achieve some sort of "emergency brake" over new EU financial regulation - which we have called for.

Is it doable? It depends on a number of factors.

1) Treaty changes involving 17 or 27 (or 17+ or 17- ) - Berlin is set on 27, and for Merkel it will be difficult legally to achieve a eurozone-only Treaty, for reasons we've discussed before and though several countries have expressed reservations about the Merkozy proposals, they could well be adopted in some form at the end of the day and trasnlated into Treaty changes. As it has been over the last few weeks, our money is on a Treaty at 27.

2) A limited or even more limited Treaty change: The changes that the Germans want require a proper Treaty change (although often described as "limited") through what's known as the 'simplified revision procedure'. As these changes would involve the EU institutions, which as Cameron rightly pointed out are the property of all 27 member states, that would give the UK a veto over the Treaty change. But there's also a second way to change the Treaties, proposed by Herman Van Rompuy, which would only involve tweaking protocol 12, which is the protocol governing the eurozone. This would still give Cameron the right to veto the changes as they require unanimity in the European Council - but it would be a relatively small change to a protocol (a protocol which doesn't impact in the UK as it's not in the euro).

3) Will Cameron have any allies? Several countries are worried about fragmentation of the EU, including the Poles, Romanians, Swedes as well as eurozone 'ins' such as the Netherlands, so any moderate measure Cameron takes to counter such a trend could draw some support from these countries. However, many countries are fed up with the whole Treaty business, and see it as unnecessary (merely designed to cater to German domestic concerns) and the quicker they can move on from these talks, the better. Most EU leaders are unlikely to be too patient with additional demands.

However, as one of the EU's big three and given the importance of financial services to the UK economy and the domestic pressure Cameron is under, few EU leaders are out to get Cameron. He's still well liked among many. Question is if they feel it's politically possible to meet any of Cameron's demands.

And to say, as some have, that financial regulation is "not on the agenda" is pretty silly. It is on the agenda. And it wasn't put there first by the UK, but by France and Germany which are pushing for a Financial Transaction Tax and increased regulation of financial markets.

So Cameron's best hope is:

1) Insert a political declaration in the summit conclusions tomorrow that calls for concrete measures to protect non-euro member states' economic interests
2) Work out concrete protocol language amounting to a UK safeguard over EU financial services (see here for how it could work), which can then be inserted via Treaty changes
3) Insert such a protocol at the first possible opportunity (it's unclear to us whether this can be achieved legally under a limited treaty change - but political will and expendiency is king in EU law).

In combination, this would amount to establishing an effective veto over a key UK national industry - and would be a massive achievement.

However, what is more likely to happen is some sort of language in the text of the summit conclusions which makes no mention of 'concrete measures'. It would rather be a general formulation of the importance of the single market at 27. At the March summit, this could possibly be turned into a political declaration, which would be useful but would have no legal force.

In terms of 'safeguards', this wouldn't be perceived as enough, and Cameron would potentially have a grave party management problem on his hands...

Draghi's Den

It’s been a whirlwind entrance for Mario Draghi as ECB President and today’s meeting of the Governing Council was seemingly no exception. The key decisions which came out of the meeting were much what we expected, although with a few twists, while more importantly Draghi tackled some of the interesting problems facing Europe fairly bluntly (for a central banker anyway).

Key decisions

1) 0.25% interest rate cut: Essentially needed to be done since markets had come to expect it and the prospects of a eurozone recession next year are looming large. Probably highlights previous rate rises as a mistake, at least in retrospect, has been shown up by eurozone leaders failure to tackle the crisis. The failure of a single monetary policy looks to have been papered over while eurozone contraction sets in, but when/if Germany starts growing quickly again (relative to the rest of the eurozone) Draghi will have some much tougher decisions.

2) Long term liquidity to banks (3yr loans): Widely reported that banks would struggle to secure long term financing without such a move (have €230bn in debt maturing in Q1 2012). Not ideal given the ever increasing dependence from the banking sector on the ECB, but should be seen as a one off. Hopefully will increase lending in the broader economy but this is not assured, especially since unlimited short term liquidity has failed to do so.

3) Easing collateral rules: Greater acceptance of asset backed securities (ABS) – sounds ominous. Not ideal but does come with clear criteria and conditions. There have been indications that banks are running short of viable collateral. Without such a move, this could cause deleveraging or force banks to shift to Emergency Liquidity Assistance (ELA) which accepts even worse collateral and is more secretive. This could, however, potentially propagate the movement of poor quality assets onto the ECB’s balance sheet.

Interesting comments by Draghi

- “The ECB is not a member of the IMF”: Draghi went to some lengths to stress that the plan for eurozone national central banks (NCBs) to lend to the IMF so that the IMF could lend “exclusively” to struggling eurozone countries would not be possible. One point which has been raised is that IMF money is fungible, so the NCBs could contribute to the IMF general reserve account which could then lend to eurozone members. In any case, Draghi made it clear he’s not keen on ECB or NCBs lending to the IMF and may try to stop any proposal, even if it isn’t de jure illegal.

- “We shouldn’t circumvent the spirit of the treaty”: Draghi said this countless times. He reiterated his opposition to increasing bond purchases. He also seemed to suggest he would reject similar ideas of ECB lending to states even if they could be justified as de jure legal if they were de facto illegal and broke the principles of the treaty.

- ‘Other elements will follow’ fiscal compact comment was misinterpreted: Interestingly, Draghi highlighted his surprise that his comments last week had been taken as an indication of increased bond buying, stating that he did not mean that in anyway. He suggested that he was merely highlighting the sequence of events, in that fiscal consolidation needs to come first and can then be followed by a backstop but only through the EFSF or the ESM, the eurozone bailout funds.

So, a strong expansion of monetary policy to help the banking sector a promote growth and stability. We may not be onside with all of his measures, since they may raise long term questions over what gets put onto the ECB’s balance sheet, but they are clearly within the realms of monetary policy. Using these mechanisms is always preferable to the ECB wading into the murky world of fiscal policy.

Despite this boost, markets are likely to be unnerved by his comments during the Q&A session. Draghi essentially ruled out any ECB or NCB lending to the IMF or at least suggested he would oppose the process. He also put pay to this ‘quid pro quo’ theory that the ECB will step in and increase its bond purchases if eurozone leaders agree some fiscal integration or discipline. We have to commend Draghi for his firmness on these issues, although we still fear he could wilt in the face of the increasing clamour from eurozone leaders and their reliable inability to find any solution. But at least for now it puts the ball firmly back into EU leaders’ court ahead of tomorrow’s summit.

Now Turkey is raising concern over democracy in the EU

This is a sign of the times.

In an interview with EUobserver, Turkey's permanent representative to the EU, Selim Kuneralp, made some interesting comments on the future of the eurozone . In particular, he said that, although the Franco-German proposals to strengthen central control over national budgets, which could steer the eurozone "in the right direction", they also risk undermining democracy.

He argued,

"In an election campaign, you have one party that says, 'I'm going to reduce taxes and invest in this or that, to build nuclear power plants or spend money on renewable energy, build more schools and better hospitals.' And the other party says, 'I'm going to do everything this guy is promising, but more.' So you have a race on who is going to spend more. But if you have this kind of mechanism [of central control] they won't be able to do it. That means you would have such a loss of sovereignty as to make election campaigns meaningless."

Clearly, Mr. Kuneralp does have a strong point. Perhaps EU leaders should rememebr the 'Copenhagen criteria' - the rules on democracy (and various other things) that countries wishing to accede to the EU have to fulfill - as they're trying to deal with the eurozone crisis...

30 MPs and Lords back our proposal for "emergency brake" on financial services

In a letter to the Telegraph today 30 MPs and Lords back Open Europe’s recommendations that David Cameron seek, at the very least, a new Single Market protocol or an “emergency brake” on EU financial services laws at this week’s EU summit.

Here it is in full:

SIR – European Union proposals pose a grave threat to Britain’s financial services industry, which employs nearly two million people, accounts for 10 per cent of GDP, and generates over £50 billion in tax receipts annually.

Although there have undoubtedly been regulatory failures in recent years, future policy should primarily be decided by Britain, not the EU.

There are nearly 50 proposals under consideration by the EU. The most troubling include a unilateral, EU-wide financial transactions tax which would inflict enormous damage on Britain’s economic interests, a ban on some short-selling and a European Central Bank proposal that transactions on euro-denominated financial products are only cleared in the eurozone.

From 2014, Britain will have only 12 per cent of the votes in the Council of Ministers and 10 per cent in the European Parliament, yet it accounts for 36 per cent of the EU’s wholesale finance industry and enjoys a 61 per cent share of the EU’s net exports of international transactions in financial services.

It is imperative that the Government fights our corner by arguing either for a new EU protocol or a Britain-specific legal safeguard. Without strong action, the present drift seriously threatens both British jobs and Exchequer revenues.

Andrea Leadsom MP
Chris Heaton-Harris MP
George Eustice MP
Desmond Swayne MP
Sajid Javid MP
Nicholas Soames MP
Ben Gummer MP
Margot James MP
Nadhim Zahawi MP
Harriett Baldwin MP
Karen Bradley MP
James Gray MP
Amber Rudd MP
Anne-Marie Morris MP
Bernard Jenkin MP
Dominic Raab MP
Lord Trimble
Steve Brine MP
Lord Risby
Mike Weatherley MP
Geoffrey Clifton-Brown MP
Mark Garnier MP
Esther McVey MP
Caroline Dinenage MP
Andrew Bridgen MP
Michael Fallon MP
Matthew Hancock MP
David Ruffley MP
Lord Flight
Viscount Trenchard

London SW1

Significantly, the letter is signed by Cameron and George Osborne's Parliamentary Private Secretaries, Desmond Swayne MP and Sajid Javid MP, potentially a sign that the Government is sympathetic to the idea of UK veto over financial services.

There's a long way to go until close of play on Friday night when the dust will settle for a short while on this week's summit (there will be more like it before too long) but there are some encouraging signs that the Government is starting to get the message.

A busy day in Euroland

It’s been another busy day in the eurozone crisis, with European Council President Herman van Rompuy putting out his report on the prospects for treaty change and greater eurozone fiscal integration and then German Chancellor Angela Merkel and French President Nicolas Sarkozy sending a letter to Van Rompuy with their take on the issue. That’s just the formal announcements, not to mention the usual rumour mill of giant bailout funds, ECB and IMF intervention and a UK referendum.

To help digest this mass of info, we’ve picked out some of the key points from each text along with our thoughts on them.

Van Rompuy report:

- Need to enhance credibility of debt and deficit rules and ensure full compliance. Greater budgetary discipline to move euro area to true economic union. Commitment to balanced budgets.
- All introduced into national law – the ECJ would judge whether these rules had been correctly implemented.
- Two processes for achieving this: revise Protocol No 12 (in annex of treaty) or full treaty change with amendment to Article 48.
- Changing protocol 12, which relates to excessive deficit procedure, has the advantage of only requiring unanimous approval in the Council, therefore does not need national ratification and avoids triggering an Irish referendum.
- Amending article 48 would be a lengthy process but reforms could be much more far reaching including – automatic sanctions using EU institutions, specifically enhanced Commission oversight of budgets.
- Longer term move towards common debt issuance.
- Adhere to “well established IMF principles and practices” with regards to private sector involvement in future bailouts. Basically, rewrite the ESM treaty so that private sector losses are not encouraged. Also make most ESM decisions QMV.
- Allow ESM to recapitalise banks directly and have the “features of a credit institution”. This likely means that it should be able to borrow from the ECB.
- Review the clause which limits lending capacity of EFSF and ESM jointly – to allow them to run in parallel.

Merkel and Sarkozy letter:

- Commitment to push ahead with broad treaty changes although willingness to work with just 17 eurozone members.
- Regular eurozone summits (twice a year usually but once a month in the crisis). Focus on policies to foster growth, competitiveness and fiscal stability. “Ministerial Eurogroup” to prepare for meetings and enforce decisions.
- Framework of prevention using ECJ to ensure that fiscal rules are correctly transposed in national framework.
- Foster growth and competitiveness through eurozone convergence and integration on: financial regulation, labour markets, harmonisation of corporate tax base, introduction of eurozone FTT and more efficient use of European funds.
- Automatic sanctions for states which breach 3% deficit rule (can be reversed by QMV vote). Continuous failings will result in increasing interventions.
- Move forward ESM to 2012, rewrite clauses so it’s clear PSI in Greece was an exceptional occurrence. Decisions on ESM made by 85% QMV (based on ECB capital shares).

So, all in all a lot of words without saying much we didn’t already know. It is clear though that both documents line up fairly closely on many key issues. One area where they don’t agree, and where Merkel is apparently annoyed by Van Rompuy’s proposal, is the plan for the ESM and EFSF to run in tandem offering a boosted bailout fund.

Other things that caught our eye include: common corporate tax base - good luck getting Ireland to agree that, especially after all the austerity they have successfully introduced - and the plan for the eurozone FTT, which they seem determined to push ahead with, no matter how much havoc it would wreak on the European financial system.

In any case, as always, this doesn’t fill us with hope for the summit. If anything these plans are likely to be watered down through the negotiations, despite already looking relatively similar to the toothless stability and growth pact. Even if finalised in their current form the plans will only provide more austerity and take some time to implement. The (misguided) hope still remains that they will encourage the ECB to step up its bond buying – although if we were the ECB the commitment doesn’t seem large enough or credible enough for us to put our independence and principles on the line.

And the question would be....?

This week has seen the mandatory flare-up over the question of an EU referendum, following a remark by Ian Duncan Smith that any major EU Treaty would need to go to a referendum in Britain. For the Coalition it was most unfortunate that Nick Clegg, on the same day, was seen to say the opposite. Only thing was of course that he didn’t quite do that.

Both were actually expressing merely what was in the EU Act or referendum lock – and government policy - though IDS clearly failed to qualify his remarks. That is, any major new Treaty that has an impact on the UK will be subject to a referendum. There’s a lot one can say about the Treaty changes that Sarkozy and Merkel are pushing for, but one thing is for certain: they won’t have an impact on the UK in the sense that new powers will flow from London to Brussels, in contrast to what happened under the Lisbon Treaty or treaties before it. It merely creates a new set of arrangements for the eurozone.

Now, before you start to jump up and down, hear us out. The Treaty changes in combination with the ongoing eurozone crisis, do have an impact on Britain’s position in Europe in that they will create a more tightly knit eurozone bloc, to which Britain’s interests could become secondary. It’s this point that should and does concern most Tory backbenchers - very few of them are actually actively calling for a referendum at this point. And think about it: what would the question be? Something like:

"Do you think that the UK should accept EU Treaty changes which would allow the eurozone to integrate further and introduce measures to enhance budget discipline, which will not impact legally on Britain in the sense that new powers will be transferred from the UK to Brussels, but which could potentially lead to the eurozone voting as a caucus to the detriment of UK influence in Europe?" Yes/No

Hardly credible. Instead, the referendum would, in effect, be on membership of the EU (as it effectively asks voters to consider the current structure and direction of the EU as nothing has changed legally or institutionally for the UK, albeit a very significant political change). Option 2 would be to attach specific demands on EU reform and re-negotiation. The latter option could involve, say, the UK Government putting in a series of demands for repatriation or for vetoes to be restored. Subject to a successful conclusion of the negotiations involving those demands, the package, including the new budget rules for the eurozone, would be put to the British people in a validating referendum. It wouldn't exactly be a swift process but, minus all the complications involved in lengthy negotiations over Treaty changes at a time when the eurozone is on its knees, it could generate the kind of EU that the UK wants.

Now, there are a whole range of reasons why people might want to support one of those two paths - including the fact that people are understandably fed up about not having had a say on Europe for so long - but we need to be honest about what the consequences and political implications are. Either the exit door, or fundamental re-negotiations - that's probably what a lot of people want - but it wouldn't merely be a vote on the Treaty change per se. But for all the shouting in the press over a referendum over the last few days, it's absolutely amazing that no one has bothered to ask the question, what should the referendum actually be on.

This is not to say that the UK Government should not ask for concessions in Europe and start to embark on a reform programme aimed at reversing the flow of powers - we've been arguing that case for years. But if Britain wants to turn the EU into a 'network rather than a bloc' as Cameron reiterated in the Times today (which is the right vision), it needs, collectively, to be a bit smarter and think a bit deeper about the way forward.

* Update 1.16pm: Apparently, both London Mayor Boris Johnson and Northern Ireland Secretary Owen Paterson have now called for a referendum on Treaty changes involving all 27 member states - this is clearly becoming increasingly difficult for Cameron to manage. As ever, the nature of the referendum in question remains unclear, which is also what makes the issue so hard to manage...

Scoring today's Merkozy summit

Today's meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy is over and they have announced their proposal for treaty change and tackling the sovereign debt crisis in the eurozone. To give them credit its more substantial than we, and many others were expecting, with some clear agreement on key points. However, it is still an early stage - France and Germany need to gain the support of the other EU members at this week's summit.

In our view these are the key points (our reaction in bold):

- Automatic sanctions for eurozone countries running deficit above 3% of GDP. Only a qualified majority vote can block the sanctions. Merkel looks to have got her way on the automatic sanctions, although the QMV block does reduce the power to enforce them slightly, but most countries committed to austerity approach and Germany still wields substantial influence as largest guarantor.
Verdict: Merkel 2 - 0 Sarkozy

- Sarkozy said that the ECJ "will not be allowed to rule national budgets void", but will have the power to judge if the required fiscal rules (including the need for a 'golden rule' against persistent deficits) are being properly enforced by national law. Definitely a plus for Sarkozy, keeps hold of national sovereignty and keeps ECJ focused on legal not political matters. Also shifts focus towards intergovernmental procedures.
Verdict: Sarkozy 1 - 0 Merkel

- Permanent eurozone bailout fund will be brought forward to 2012, decisions on the ESM will be made by qualified majority. This move will help calm markets since it brings forward a significant amount of bailout money. Neither argued strongly for this in the run up, but had been considered by Merkel previously.
Verdict: Draw 1 - 1 (markets the real winner)

- Under the ESM no more losses for private bondholders (no more restructuring or private sector involvement clauses placed into ESM bailout agreements). Big and surprising win for Sarkozy. Had been touted in run up to meeting but slapped down by Germany before. Huge point for Germany previously when ESM was put together. Pledged to German electorate that private sector would take its fair share of pain under future bailouts. Merkel did hint she would consider a rule change last week, but never went as far as suggesting this was in the offing. Will have very positive impact for markets, hugely reduced likelihood of future losses, however, may be large political cost. From our perspective this may be a mistake, simply because the aversion to restructuring has not served the eurozone well so far. Ultimately, just recycling debt around the eurozone with no significant reduction, which many countries need, will not help in the long run.
Verdict: Sarkozy 2 - 0 Merkel (and markets again)

- Sarkozy said that France and Germany agree that "under no circumstances" can Eurobonds be considered a solution to the crisis. Expected, but Sakozy's openness to admitting that eurobonds won't come into force any time soon is a win for Merkel.
Verdict: Merkel 1 - 0 Sarkozy

- France and Germany will continue to abstain from making comments on how the ECB operates. Germany was keen to see this continue, although they didn't really stick to the agreement anyway so will make little difference. Keeping ECB out altogether is a plus for Merkel.
Verdict: Merkel 1 - 0 Sarkozy

- Eurozone heads of state and government will meet on a monthly basis until the crisis is sorted out. Sarkozy was keen to have this in place, although it was far from something which Merkel objected to. Does keep the intergovernmental slant which Sarkozy wanted.
Verdict: Sarkozy 1 - 0 Merkel

- To achieve all this, a new treaty is needed. The clear preference from both is for a Treaty change involving all 27 member states but a eurozone-only solution would be chosen if there is significant opposition from non-eurozone countries (read UK). The phrasing and focus here is a big win for Merkel. She's said all along that a eurozone only treaty is an option but not her first one. Statements here line up exactly with Merkel's earlier thinking. Does provide potential for UK negotiation although there is still a limit on how far Cameron can push his demands.
Verdict: Merkel 2 - 0 Sarkozy

Final Score: Merkel 7 - 5 Sarkozy

So, closer than many may have been expecting, but fair play to Sarkozy he managed to land a heavy blow in there with the removal of restructuring clauses from the ESM. The slant is surprisingly intergovernmental as Sarkozy would have wanted it to be, so another plus point for him there. But on the overall picture, we still have to say Merkel edges it, particularly with the focus on treaty change at 27.

All that said, this isn't a solution. Huge questions still remain over how countries will return to growth and competitiveness as well as how the divergent needs in terms of monetary policy and currency value will be overcome. We also suspect some of the positive market reaction will be from expectations that the ECB will step up its bond buying in response to these rules, but that is far from a given.

Super Mario Shows His Hand

The new Italian government has been in office for less than 20 days. That must have seemed an eternity given the record interest rates Italy has been forced to pay by the markets over the past few weeks, while uncertainty remained over what Mario Monti and his cabinet of technocrats were actually planning to do to get Italy out of the crisis.

A new package of austerity measures, tax hikes and economic reforms worth a gross €30 billion over the next three years was finally unveiled yesterday (it is becoming a habit for Italian politicians to work and announce measures during the weekend, when the markets are closed), during an exhausting 2-hour press conference. Monti will make an official presentation in both houses of the Italian parliament this afternoon, with a view to having the new package adopted before Christmas.

Some of the proposals (especially those affecting the pension system) are undeniably ambitious, and are therefore likely to face resistance from both political parties and workers' associations. Here are the most relevant measures announced yesterday:

• An in-depth reform of the pension system, which will effectively (although not formally) abolish early retirement pensions. Italians will be required to work for longer, and all pensions will be calculated exclusively on the basis of what each worker paid into social security during his working life (pensions for some professions are today calculated as a percentage of the latest average monthly salary);
  

• Retirement age will be raised to 66 years old by 2018 for men and women without distinction between public and private sector workers (the previous Italian government committed to 67 years old by 2026);

• As for the short-term, in 2012-2013 adjustments in line with inflation will be suspended for all pensions worth €1,000+ per month. Italian Labour Minister Elsa Fornero literally burst into tears while presenting this specific 'solidarity contribution' from pensioners at yesterday's press conference (see picture);

• The package also involves a number of tax hikes. VAT will increase by 2% in the second half of 2012, and a local council property tax will be re-introduced. In addition, people who used the 'fiscal shield' initiative launched by Berlusconi's government in 2009 to pay lower taxes on capital repatriated from non-EU bank accounts, will have to pay an extra 1.5% on that capital. Special levies are also envisaged for people owning certain 'luxury goods', such as yachts, private jets or high-capacity-engine cars - still not a fully-fledged tax on wealth, though;

• A new push to fight tax evasion was also unveiled. Under the new rules all payments in cash will be forbidden above a €1,000 threshold. The threshold was previously fixed at €2,500, surely a bit too high for a country struggling with endemic tax evasion like Italy;

• The package unveiled yesterday also includes the first concrete pro-growth measures, something which seemed to be off the radar of previous Italian governments. Tax reliefs for small and medium-sized businesses are envisaged, as well as a strong push on the liberalisation of certain professions. This is certainly not enough, but it is a start and more labour market reforms are expected.
  

At a first glance, the measures seem to go in the right direction, as it is quite clear that Italy needs some austerity to convince markets of its credibility and for the new government to establish its credentials. As expected, the markets have warmly welcomed Monti's proposals, with the spread between Italian and German ten-year bonds plummeting below 400bps (although this was probably aided by ECB bond purchases and talk of it stepping up its financial support). Widespread approval has also been voiced by the European Commission and some foreign leaders.

However, at least three big questions remain unanswered. First, as we previously noted here, what will Italian citizens' reaction be when the new measures - which, at the end of the day, are being imposed by an unelected government - really start to bite? Second, will Italian political parties give unconditional support to the package, even if it contains measures which are not in line with their electoral manifestos? To give an example, it was Berlusconi's government, when it took office in 2008, who scrapped the local council property tax. On the other side, the leader of Italy's main centre-left party, Pier Luigi Bersani, has already expressed doubts over the 'social equity' of Monti's proposals.

But, most importantly, will these measures be enough to tackle Italy's (but also Greece, Spain and Portugal's) real problem - i.e. the loss of competitiveness experienced since the introduction of the single currency? The answer, at least for the moment, seems to be a 'no'. The measures will certainly help address the markets' lack of confidence in Italy in the short term, but ultimately without any hope for growth and a boost in international competitiveness the future for Italy in the eurozone remains bleak.

P.S.: Credit where credit is due. At yesterday's press conference, Italian Prime Minister Mario Monti announced that, in his personal capacity, he had decided to give up his salary as Prime Minister and Economy Minister in exchange for the sacrifices that his government is asking to Italian citizens. Not expected to have any significant financial impact, but still you don't hear that every day.

P.P.S.: It went almost unnoticed in the press, but it looks like the UK has lost another ally in its opposition to an EU-wide financial transactions tax. In fact, Monti (who, by the way, took lectures from James Tobin, the father of the FTT, during his years at Yale) yesterday said that his government will have a "more favourable" attitude towards an EU FTT than its predecessor.

Summiting the mountain that is the eurozone crisis

The perpetual rolling meetings which have characterised this eurozone crisis look to be reaching a head this week. The EU summit which kicks off on Thursday evening will undoubtedly be preceded by a series of smaller meetings between European officials and bilateral meetings with foreign leaders keen to see a solution to the crisis found (and in town to apply the suitable amount of public pressure).

Below we flag up a few key points of discussion to look out for, and outline some of the key issues which still need to be resolved:

- Today’s meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy must produce a united front on the plans for budgetary integration. If they fail to produce a set of concrete and workable proposals from the summit, planning will already be behind schedule and markets will begin to expect another failure. That said, given outstanding areas of disagreement (see here) some broad political agreement short on detail looks likely as always.

- The role of the ECB. Reports over the weekend suggested that the ECB was ready to step in once an agreement on strict fiscal discipline is reached. Whether or not eurozone leaders’ commitments will satisfy the ECB's idea of austerity remains to be seen, and the unlimited backstop which markets want still looks unlikely. A plan involving the ECB lending to the IMF has been touted again.

- A greater role for the IMF. Germany agreed to explore the possibility of greater contributions to the IMF last week, although where these will come from is unclear. US opposition to expanding the IMF’s resources is significant (it requires congressional approval), but reports suggest financing could come from central banks in an attempt to circumvent political opposition.

- The UK’s approach to negotiations. Whether Prime Minister David Cameron will look to repatriate powers will depend on the details of any proposal Merkel and Sarkozy put forward, but it’s increasingly looking like he will keep his powder dry regarding his desired bigger push for retrieving powers from the EU. (For some of our recommendations see here and here).

- Italy unveiled a new set of controversial austerity measures yesterday, which look to have been well received so far. An important debate on the measures will take place in the Italian parliament today, while the reception which Italian Prime Minister Mario Monti gets at the summit will be a good gauge of what Italy can expect in the coming months. If the pressure is instantly for even more austerity, it could set the tone for a torrid few months for the interim Italian government.

- Other issues which still need to be ironed out include the leveraging of the EFSF, the eurozone bailout fund, and the second Greek bailout. Discussions over the extent of private sector involvement in the Greek package were put on hold last week – the package just looks too complex and will always be held up while it is voluntary. We would argue that the plan should be scrapped and a simpler, cleaner restructuring put in place for Greece, although that looks very unlikely.

All in all, plenty to keep an eye on.

ECB lending to the IMF

This is the third time the prospect of the ECB lending to the IMF has been brought up as a potential solution to the eurozone crisis. As such it might seem like old hat, but this time round it may have a bit more substance to it. Bloomberg reports that at Tuesday's meeting of eurozone finance ministers the ECB President Mario Draghi, who was also in attendance, approved the creation of a plan to allow the ECB to lend to the IMF, and then the IMF to use these funds to lend to struggling eurozone countries.

Very much an initial stage, but more than the recycling rumour which we had before. The report suggests the lending could top €200bn, so not pocket change but not enough to stem the crisis. The likely plan would see the IMF using the funds to provide precautionary lending programmes to the likes of Italy and Spain.

So could such a plan work? As you may expect, we think probably not. Here are a few of our initial thoughts on why:

- Ultimately, this proposal doesn’t change much may allow a small boost of liquidity but doesn’t solve the underlying competitiveness problems and structural flaws in eurozone. Italy and Spain need devaluation to become competitive again.

- IMF can impose conditions, so does circumvent the moral hazard problem posed by direct ECB lending. It does seem that ECB lending to the IMF is preferable to the ECB funding states directly with bond buying, due to this added conditionality.

- Although, may be conflict between ECB and IMF over best practice and use of money. Already disagreed over Greek restructuring (to the point where the ECB added a footnote into the troika report stating it did not agree with the level of write downs).

- ECB will essentially be ceding control over a large amount of funds, does again raise questions over its independence.

- Will not de jure break the ECB statute (Article 23 allows it) but definitely de facto against the fundamental principles of the ECB. The legal basis for it was never intended to sustain large bailouts. Will not be supported in Germany generally.

- German government has suggested it would support bilateral loans to the IMF. Not clear if this involves the ECB, unlikely, probably more in favour of countries boosting their IMF contributions.

- Where would the funds come from? The ECB would basically just create new money and lend it to the IMF. No indication that collateral would be taken on (not needed from IMF really, but separates it from usual lending options) or that this would be sterilised in anyway. Seems a big abandonment of ECB principles.

- Impossible to justify this as monetary policy (as ECB has done with SMP etc.) just direct lending to IMF to finance states.

- Still stigma attached to asking for IMF help. Not clear Italy and Spain are ready to cross that line yet. Once it is crossed will be more pressure for funding to continue if initial bout is not successful (which it looks unlikely to be – both countries need huge reforms which cannot happen overnight, yet have huge funding needs).

- Not clear who would take losses, should any occur. IMF is always senior so unlikely to take any losses. But existing debt holders may not like the introduction of €200bn in senior debt, especially if it originates at an equal creditor (the ECB).

- ECB exposure to PIIGS is around €630bn now, adding another €200bn to that, even through the IMF, cannot be seen as desirable.

All in all then, many of the same problems as with any massive ECB intervention. Legally and economically this plan could be preferable to the direct ECB financing of states (but then almost anything would be) but politically, it still raises a huge number of problems.

Sarko Has Spoken

The day after French President Nicolas Sarkozy's keynote speech (available here) on the state of French economy and the future of the eurozone, those who (like us) were expecting a bit more details on what exactly France is planning to change in the EU Treaties have been disappointed. Sarkozy made some general remarks on his vision of the future of the eurozone, but then announced that the specific proposals for Treaty change would be finalised at a bilateral meeting with German Chancellor Angela Merkel on Monday.

So have all the divergences between Paris and Berlin (which we discussed here) magically disappeared? Not quite. Here are some interesting quotes from Sarkozy's speech,

• France and Germany have "their institutions, their political culture and their idea of nation. One [Germany's] is federal, the other one [France's] is unitary. One needs to understand this difference. One needs to respect it."

• "France and Germany have chosen convergence...This doesn't mean that one is trailing behind the other, or that both want to give up their identities so that they confuse with each other."

• "Europe needs more democracy...A more democratic Europe is a Europe where it is the [national] political leaders who decide."
  

• "Europe’s re-foundation is not a march towards more supra-nationality."
  

• "The crisis pushed heads of state and government to take on growing responsibilities, because, at the end of the day, they were the ones who had the democratic legitimacy that allowed them to decide."

• "European integration will go the inter-governmental way because Europe will have to make strategic choices, political choices."

As expected, a clear political message to Berlin and Brussels. France also has its red lines on Treaty change: more coordination of economic and budgetary policies among eurozone countries is welcome, but the important decisions must remain with national governments. The European Commission (or the ECJ) should not be given the power to enforce the rules on member states.

As we said, Sarkozy didn't go into too much detail on specific proposals to strengthen economic governance in the eurozone. However, he did give a couple of interesting indications about what he thinks should be done to sort out the crisis,

• "Every eurozone country must adopt a 'golden rule' enshrining the balanced budget target in its juridical order."

• "We need to decide to move without fear towards having more decisions taken by qualified majority" within the eurozone.

• "Let's examine our budgets jointly, let's establish quicker, tougher sanctions for those who don't live up to their commitments."

• "The ECB obviously has a decisive role to play. There is debate over what it is allowed to do under its statute. I don't want to weigh into that debate. The ECB is independent. It will stay independent. I'm convinced that...the ECB will act. It's up to the ECB to decide when and with what means."

Meanwhile, the reactions to the speech in the French press were mixed. Centre-right Le Figaro argues that Sarkozy has substantially done his bit in terms of commitments, and therefore "it’s now up to the [German] Chancellor to decide if she also wants to accept a compromise to save the euro, through the mutualisation of national debts." However, Arnaud Leparmentier, the Élysée correspondent for centre-left Le Monde, accuses the French President of "intellectual incoherence", noting that he "imagines a French veto in Europe, but considers that smaller countries must accept the majority principle."

Indeed, Sarkozy knows that if the plans are seen as an excessive abandonment of France's souveraineté, that would almost certainly be the last nail in the coffin for his chances of winning another mandate.