European Central Bank’s room for manoeuvre provisionally confirmed
Last week saw a confirmation of the powers of the European Central Bank (ECB) to address the crisis with the delivery of the (non-binding) Opinion in a case before the Court of Justice of the European Union (CJEU, or European Court).
The Advocate General (AG) confirmed the wide discretion, which the ECB has when taking unconventional monetary policy measures. At the same time, the AG suggested the Court that the ECB be required, when implementing such measures, to be fully transparent in the reasons behind them (motivation requirement) and to respect the proportionality principle (the measures are to remain well within the limits of the necessary to obtain the stated goal). He warned that the ECB’s involvement in economic policy setting and monitoring should end in respect of Member States whose bonds the ECB would buy under such unconventional measures: an end to the troika (troixit). The AG addressed the relationship between the CJEU and the highest court of the largest Member State, which had referred the question to be decided by the European Court. The AG opinion should be seen against the background of a battle for supremacy of the law (Union versus State law), and a battle for the public’s mind in Germany on the need of unconventional measures, as well as their role in preserving the euro and the composition of the currency union. The Opinion will support the ECB in deciding on further unconventional monetary policy measures, and underlines the primacy of EU law.
AG Opinion: another step in legal battle on ECB crisis powers
The ECB’s response to the euro area debt crisis came under attack from Germany, with several measures being challenged before in court. The present case concerns the ECB’s ‘bazooka’ response to the crisis. Mario Draghi’s announced, in the summer of 2012: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The translation of this announcement in the ECB’s decision to engage in so-called Outright Monetary Transactions (OMT) was challenged by citizens, academics and a fraction in the Bundestag (the German Parliament’s Lower House) before the German Constitutional Court (GCC). For the first time ever, the GCC requested the CJEU on a preliminary ruling on the validity of the ECB’s announced OMT. On Wednesday 14 January 2015, AG Pedro Cruz Villalón outlined how the Court should, in his view, respond.
The crisis response by governments and central banks: bail-out and conditionality
A word of background on the crisis response is due. Policy makers and central bankers responded to the Euro area debt crisis by adopting unconventional measures. Governments established financial assistance schemes (‘bail-out funds’) for Member States that found themselves unable to borrow for on-going public expenditure. Central banks infused massive liquidity into the financial system, acted as lenders of last resort to banks in distress, extended credit to commercial banks on the basis of ever wider collateral, and instituted programs to kick-start the economy when their traditional major weapon (interest rate reductions) had lost its effectiveness with rates at, or below, zero. Interest rates are also central to understanding what happened to government funding. Rates on bonds of ‘peripheral’ Member States spiked, making it impossible for the governments of Greece, Ireland, Portugal and Cyprus to finance their budget deficits on financial markets. Without recourse to markets, governments needed to be financed by fellow governments, and by the International Monetary Fund (IMF). Special arrangements were put in place. The European Financial Stability Fund (EFSF) and the European Financial Stability Mechanism (EFSM) were followed by the European Stability Mechanism (ESM). The legality of these arrangements were tested before courts. The GCC had to rule on challenges by citizens, as had other national courts, notably the Supreme Court of Ireland, whose reference to the CJEU on the ESM lead to the Pringle judgment in 2012. In Pringle, the Court made a distinction between monetary policy and economic policy. It interpreted the no bail-out clause of the Treaty on the Functioning of the European Union (TFEU) in such a manner that the ESM Treaty was considered compatible with EU law. Lending by the IMF and the EFSF/EFSM/ESM was effected on the basis of strict adherence to ‘conditionality’: rafts of incisive economic policy measures and budget cuts to address the weaknesses undermining the competitiveness of the ‘peripheral’ economies and to restore budgetary soundness. The drafting and monitoring of this conditionality falls on the European Commission, the IMF and the ECB. The three form the ‘troika’.
European Central Bank’s response: unconventional measures, including OMT
As its cross-Channel and cross-Atlantic counterparts, the ECB responded by adopting unconventional measures. There was a specific European issue to address: trust in the single currency, and the unity of financial markets through which the ECB’s policy response normally translates to the real economy. The extremely high level of interest rates in ‘peripheral’ States thwarted the transmission of the ECB’s monetary policy: interest rates reductions didn’t any more translate across the Euro Area. Investors were not only weary of buying or holding public debt, they also openly speculated on States leaving the currency union, and on the demise of the euro. The mere announcement of the ECB’s willingness to defend the euro, and of OMT, calmed the markets and led to sharp reductions of interest rates.
AG’s core reasoning: OMT constitute a valid unconventional measure but implementation requires heeding legal parameters (reasoning, end of troika role, proportionality)
The OMT are lawful. The ECB has a wide discretion to act and a broad margin of assessment of what is appropriate in the circumstances. The AG says:
“The Courts, when reviewing the ECB’s activity, must therefore avoid the risk of supplanting the Bank, by venturing into a highly technical terrain in which it is necessary to have an expertise and experience which, according to the Treaties, devolves solely upon the ECB.”
Note the plural used here (‘Courts’), unmistakeably a hint to the referring German court. During the oral hearings, Portugal and Poland had empathically argued that there should be no ‘judicialisation’ of monetary policy and the Court should not take upon it to decide in such highly technical matters for which an independent expert organ has been given responsibility.
Nevertheless, when adopting unconventional monetary policy measures, which the ECB is competent to do, it should abide by legal parameters. This concerns, first, the motivation of the OMT which the AG sees wanting when looking at the September 2012 press release alone. There should be extensive reasoning for their activation. Secondly, the ‘dual role’ which the leftist party in the German Parliament saw as incompatible with the ECB’s monetary policy mandate, should be reconsidered once OMT become operational. The ECB is then to withdraw from its deep involvement in economic policy prescription and monitoring, at least in respect of the Member States whose bonds the ECB would start to buy. While he acknowledges that limiting OMT to Member States with an EFSF/ESM programme may be necessary to avoid moral hazard and accepts a regular role for the ECB in these programmes, the AG thinks that activation of OMT should end the ECB’s troika role. Thirdly, the AG extensively discusses the need for the OMT, when operational, to comply with the proportionalityrequirement to which acts by all EU institutions are subject (Article 5(4) TEU). OMT should serve to re-establish the transmission mechanism of monetary policy but may not become a source of cheap government financing. The latter would also run counter to the prohibition of monetary financing, laid down in Article 123(1) TFEU. This basic provision of EMU bars central banks from extending credit to the public sector, and from buying public sector bonds on the primary market. Such transactions are an essential element of central bank operations. The AG’s analysis concludes that the ECB should heed the underlying concerns behind the prohibition of monetary financing and the ‘no bail-out’ clause (Article 125 TFEU).
Market issues: preferential status, default risk, holding until maturity, selectivity
Addressing the GCC’s concerns with OMT, the AG relies on a draft decision and a draft guideline on OMT which have not yet been adopted or published but which the ECB submitted to the CJEU. These draft legal acts make clear that the ECB would observe a ‘lock-in period’ (‘embargo period’ in AG parlance) between the issuance of public debt and its purchases on the secondary market, thus allaying the first of the GCC’s nine fears, on the timing of the purchase and the price formation. The AG notes that central bank operations always entail risk so that (2) default risk cannot be excluded. But he considers this not such as to render the OMT program contrary to the prohibition of monetary financing. On the related issue (3) of preferential treatment, the ECB’s stated intention to oppose any restructuring proposals that may be made under the terms of the bond is considered sufficient. Collective action clauses (CACs) inserted in bond documentation provide for a (super-) majority of bondholders to decide on possible write-downs. The ECB, ranking pari passu with other creditors of a sovereign, may become subject to restructuring. Just these past days, ECB Board member Bernard Coeuré has reaffirmed, on two occasions, that the ECB would vote against any restructuring proposals; a write-off would implicate the ECB in granting credit to a Member State contrary to Article 123 TFEU. The GCC’s further fear (4) of market distortions resulting from the ECB holding bonds until maturity is allayed as well: the ECB has stated its intention not to do so, its practice under the Securities Markets Program (SMP) has also been to sell bonds before their maturity date, and the maturity band indicated by the ECB (1-3 years) implies that there will be no prolonged ownership of public debt. For strategic reasons, the ECB will not pre-announce any quantitative limits on the program of bond buying (5) when activating OMT: this would lead to speculation and undermine the effectiveness of the OMT. But there will be limits in practice so that this <dubious> aspect of OMT no longer raises proportionality issues. The GCC’s concern (6) that OMT encourage Member States to undertake even more debt would not materialize in the AG’s view as there will be no pre-announcement of OMT. But, the AG adds, this concern necessitates that OMT should be proportional to the aim the measure is seeking and not go any further. The AG accepts (7) selectivity as inherent in a program seeking to remedy the blocking of monetary policy transmission in specific Member States. He addresses the GCC’s issues with the (8) conditionality (OMTs will only be effected in bonds of States that are in a program with the ESM) and the (9) parallelism between the ECB acting in the same manner as the ESM in the context of the distinction between monetary and economic policy.
Other issues and outlook
Although, as the AG notes, monetary policy forms part of wider economic policies, in the context of the attribution of powers in the EU, it is necessary to distinguish between the two. Monetary policy is an exclusive Union competence, for the Member States that have adopted the euro (Article 3 (1) (c) and Article 127(2), 1st indent, TFEU). Economic policy remains largely with the Member States (Article 5 TFEU), subject to certain principles, prohibitions and procedures (Articles 119-127, 136 TFEU) and a limited own competence for the Union to act (Article 122(1) TFEU). For the ECB to act in a manner which may resemble an economic policy measure (selectively buying government bonds) may seem to be overstepping the dividing line between monetary policy, for which it is exclusively competent, and economic policy, which rests with the States and with other Union institutions. The AG considers that both the objectives (as the Court held in Pringle) and the instruments define a policy as either ‘monetary’ or ‘economic’ in Treaty terms whilst any policy should adhere to the fundamentals of EMU. Among these: the prohibition of monetary financing and the absence of shared fiscal liability (‘no bail-out’). Emphasis on these fundamentals meets the request by Germany which, during the hearing, requested the CJEU to emphasize the ‘stability nature’ of EMU in response to the concerns of the GCC.
The general relationship between the Luxembourg and Karlsruhe courts forms the background to the OMT referral. This blog can only note in passing the discommode vis-à-vis the CJEU’s supremacy felt by supreme judicial instances of several Member States. The AG clearly finds the reference by the GCC to be subject to a reserve. The GCC has made clear that it will decide ultimately on the acceptability of the ECB’s OMT under German law. Conspicuous by its absence, in the AG’s Opinion, is a reference to the supremacy of EU law which the European Court has declared on numerous occasions to be an essential element of the Treaties. It is to be hoped that, in its judgment, the Court will re-affirm its case-law since Costa/ENEL (Case 6/64).
The European Court may be expected to give a final ruling in the coming months. Barring an unexpected surprise (the CJEU is not bound by this week’s AG Opinion), the ECB’s Governing Council knows, when deciding to engage in QE later this month, that it is likely to be given ample discretion to adopt unconventional measures. The requirements of transparency (reasoning) and proportionality that apply to the activities of any EU institution must be heeded; troixit is imminent.