From Saviour to Guarantor

EU Member States' Economic Intervention During the Financial Crisis

Fabio Bassan, Carlo D. Mottura

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN: 9781137441553
• eBook ISBN: 9781137441560
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

State guarantees commonly function as financial panacea, allowing states to consolidate banking systems and create intergovernmental funds. Rules surrounding state guarantees were relaxed during the 2007-2008 financial crisis, allowing states to use them for financing small and medium-sized enterprises (SMEs) and workers' severance payments. Despite many multi-level interventions in many areas after the financial crisis, from international treaties to EU regulations, no specific regulation has been put in place to control state guarantees.This book addresses the subject of state guarantees in the Eurozone, and questions the stability of the instruments implemented so far by states and by the European Union. Using a methodology combining law and finance, it examines the tools adopted by European institutions and Member States in the EU's evolving institutional context, in order to evaluate the effectiveness of the tools themselves as well as of the new European institutional framework. It also addresses the unconventional measures adopted by the European Central Bank, its role as safeguard for European state guarantees and its interaction with the European Union and national courts. In From Saviour to Guarantor the authors suggest that the absence of specific regulatory interventions and the variety and vagueness of existing rules has resulted in state guarantees further destabilising public international finance.

Part I

The EU’s Institutional Action

1

The EU Action to Face the Crisis

The actions of the EU Member States during the first stage of the crisis (2008) were aimed at guaranteeing market stability. The States intervened to support the banking system in random order and with different instruments according to the requirements. In some instances they acquired a share of the banks’ capital, underwrote special financial instruments, or directly purchased the securities ‘most at risk’ (the so-called toxic or illiquid assets). However, in each case their action caused an increase in the public debt.¹ The European Union intervened at a later stage, only to redefine the regulatory framework with respect to State aid to banks (which was done very promptly) and to the discipline of financial oversight (which is a more complex activity still ongoing).²

The European Central Bank (ECB) supplemented these two interventions with long-term funding auctions (LTRO) for the banks and interventions in the secondary market of public debt securities for countries particularly exposed to speculation. These interventions were later institutionalised, broadened in quantity to become unlimited, (Outright Monetary Transactions – OMT), and were used to buy time for the EU to pass adequate reforms.³ That time was used by the EU to address the sovereign debt crisis by imposing stricter public finance restrictions on the States: first with the ‘Six Pack’,⁴ then the ‘euroPlus’ pact,⁵ and the ‘Fiscal Compact’.⁶ The ECB also provided instruments that were originally provisional (to prevent moral hazard) and later final (to prevent further speculation by the markets) – the European Financial Stability Mechanism (EFSM), European Financial Stability Facility (EFSF), and European Stability Mechanism (ESM).⁷

The time bought by the ECB was instead used by the European institutions and the States ineffectively with respect to banking supervision. This response resulted in inconsistent developments. The creation of the European Banking Authority (EBA) was nullified as significant supervisory powers were entrusted to the ECB that were more far-fetched and objectively broader than those originally entrusted to the EBA but subjectively limited to banks of European relevance (the ‘systemically important’ ones). Even the European Banking Union, recently drafted and based on a Single Supervisory Mechanism (SSM) and on a Single Resolution Mechanism (SRM), was a major step forward, but has strong limitations and still lacks a third pillar (the Single Resolution Fund – SRF).⁸ Finally, new conventional measures (interest rate decreased by the ECB) and unconventional measures (from Targeted Longer-Term Refinancing Operations – TLRO to Quantitative Easing – QE) aim at injecting money and trust in the market.

This is the context in which the guarantee issue fits: guarantees given by States to other States, through financial institutions created for that purpose, and to banks. In the following pages, we review the interventions implemented by the EU in support of the States and the banking system, and then focus on the characteristics of guarantees.

1.1 EU’s actions in support of the Member States’ public debt

The EU’s financial actions are limited by art. 125 of the Treaty on the Functioning of the European Union (TFEU), which includes a ‘no bail out’ clause. But the EU is also limited by the equally significant albeit usually less quoted TFEU art. 124 which prohibits measures that are not based on prudential considerations in guaranteeing privileged borrowing access to EU institutions, States, local administrations and State-owned companies; and art. 123 which prohibits the ECB and national central banks from granting overdraft credit lines or any other form of credit facilitation to EU institutions, States, local administrations and State-owned companies. The only form of mutual support allowed by the TFEU on this matter is art. 122 (2) in which the EU’s financial assistance to a Member State which is ‘in difficulties or seriously threatened with severe difficulties caused by exceptional occurrences beyond its control’ is permitted under certain conditions. By common interpretation, these difficulties may be caused by a ‘serious deterioration in the international economic and financial environment’.⁹

Eurozone countries started acting along these guidelines and devised a financial support scheme for Greece which was based on a coordinated bilateral loans system: the Loan Facility Agreement and the Intercreditor Agreement, both executed on 8 May 2010.

The instrument (bilateral loans) and the method (intergovernmental) were regarded as already inadequate at the moment of signing of the agreements. Indeed, a regulation was passed more or less simultaneously (May 2010) to establish the EFSM¹⁰ that provided for forms of financial assistance from the EU to a Member State (subject to the restrictions of art. 122 (2) of the TFEU) such as loans or credit lines granted after a procedure which starts with a State’s request for support and ends with the Council’s decision which is adopted by qualified majority. The support to the Member State is granted on specific conditions that the Member State must meet at the beginning as well as for the entire duration of the support. These conditions relate mostly to the economic policy that is (considered) necessary to reach economic and financial stability objectives. The maximum amount of support allowed with this measure – which may however be raised by the Commission, authorised to borrow from the capital markets or from financial institutions – is €440 billion. The resources come from a ‘special vehicle’ (the European Financial Stability Facility – EFSF) which issues bonds guaranteed by Eurozone States proportionally to their contribution to the capital of the ECB. In practice, the 17 Eurozone States¹¹ subscribe shares in a limited liability company established under the laws of Luxembourg and guarantee its issues. Under a sunset rule, the company has an established duration of three years. So far it has adopted support schemes for Ireland, Portugal, and Greece (second tranche). In just over a year since its creation (Council of Europe of 21 July 2011), the function and the powers of the EFSF have been increased: on one hand, its intervention capacity has been broadened to include prudential (and hence preventive) measures and, on the other, its purpose has been broadened to include the banks’ recapitalisation. It performs these functions indirectly by operating in the secondary markets of public debt securities (whenever the ECB assumes that financial stability is at risk). Lastly, in order to increase the resources available to the EFSF, the European Council of 26 October 2011 gave the green light to the creation of public and private co-investment funds and to the issue of partial risk protection certificates independently tradable after placement. In the event that a Member State becomes insolvent, this guarantee to the purchasers who hold securities issued by that State provides a partial refund of the capital of the security.¹²

During the third stage (on 1 July 2012) the EFSF was replaced by a new measure, this time final and with significantly different characteristics: the ESM.¹³ The legal grounds for the ESM derive only partially from the Treaties currently in force. In fact, at the European Council meeting of April 2011, an amendment to art. 136 of the TFEU was deemed necessary. The amendment states that ‘the Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole’, and specifies that ‘the granting of any required financial assistance under the mechanism will be made subject to strict conditionality’.¹⁴ While the provision set forth in the TFEU rule clears any doubt about the possible exceeding of the thresholds set by arts 122.2 and 125, it is not enough because of the close connection between the ESM and the Fiscal Compact, an international treaty – outside the TEU and the TFEU – that requires the States to sign prior to apply for ESM assistance.¹⁵ Therefore, an international treaty ad hoc was required in this case as well (the ESM Treaty).¹⁶

The ESM is an ‘international financial institution’ (per art. 1.1 of the ESM Treaty) and its purpose is ‘to mobilise funding and provide stability support under strict conditionality, appropriate to the financial assistance instrument chosen’, and is therefore entitled to ‘raise funds by issuing financial instruments or by entering into financial or other agreements or arrangements with ESM members, financial institutions or other third parties’ (art. 3). The complex form of ESM governance (separation of ruling, executive and management powers, decisions adopted by unanimity except in cases of urgency or that require in any case a qualified majority of 85%), and the jurisdiction of the EU Court of Justice on all controversies regarding the treaty per art. 273 of the TFEU¹⁷ betray the mixed nature of the ...

Table of contents

• Cover
• Title
• Part I  The EUs Institutional Action
• Part IIIA  The State Guarantees in the EU: State Guarantees for the Safeguard of the Euro
• Part IIIB  The State Guarantees in the EU: The State Guarantees for the Stability of the Banking System
• Part IV  Innovation and Crisis-Fighting Measures in the EU
• Conclusions
• Notes
• Bibliography
• Index