A legal perspective on ESM loans and Coronabonds
As COVID-19 threatens an unprecedented economic crisis, the Council asked the Eurogroup on 26 March1 to present proposals for common fiscal measures to tackle the crisis within the next two weeks. So far, three models have been put forward by economists that could serve as a template:
- First, the creation of a Covid Credit Line under the ESM (Bénassy-Quéré et al. 2020).
- Second, the one-time only joint issuance of Coronabonds by the euro area member states (Südekum et al. 2020).
- Third, the creation of a new fiscal capacity at the EMU level that issues common safe assets (Codogno and van den Noor 2020).
In this column, I add to the ongoing debate by offering a pragmatic legal perspective. It focuses on the first two proposals and takes a closer look at their compatibility with EU law, the ESM Treaty and German constitutional law. I argue that, from a practical legal standpoint, the use of the ESM is preferable to issuing Coronabonds, because it is more legally secure and could be implemented more quickly. However, jointly issuing Coronabonds would send the stronger political signal.
From health crisis to economic crisis to sovereign debt crisis?
A symmetrical external economic shock is currently hitting all euro area member states simultaneously. The short-term effects are already extreme (Roubini 2020). Forecasts suggest that the worst is yet to come. In order to counter the effects, almost all euro area member states have adopted fiscal aid programmes of unprecedented proportions, made possible by the first-time suspension of the EU Stability Pact. In the medium term, this threatens to cause a sharp increase in public debt. This could endanger their (re-)financing capacity. It also creates risks for the banking sector, as banks in the most vulnerable countries of the euro area still hold large amounts of their home countries government bonds. The vicious circle between states and banks may resurface and threaten the integrity of the euro area.
Use of the ESM for preventive purposes?
At first glance, the simplest way seems to be direct lending by the ESM. So far, the ESM has primarily fulfilled the function of a lender of last resort for euro area member states. Accordingly, until now, it has only used reactive instruments. These include, in particular, the loans to Ireland, Portugal, Greece and Cyprus, which were linked to far-reaching macroeconomic adjustment programmes.
No euro area country is yet in a sovereign debt crisis due to COVID-19. But the ESM Treaty also provides for preventive measures. In general, according to Art. 12 (1) ESM Treaty, the objective of the ESM is “to safeguard the financial stability of the euro area as a whole and of its Member States”. To this end, the ESM Treaty provides in Art. 14 two instruments which have not yet been applied: the Precautionary Conditional Credit Line (PCCL) and the Enhanced Conditions Credit (ECCL). The respective ESM guideline regulates these in more detail. The aim is to maintain market access for countries with still healthy public finances. The ESM grants the funds via loan or primary market purchase of sovereign bonds at the request of the state seeking assistance and after examination by the Commission and the ECB. The terms of the loan are set out in a Memorandum of Understanding. Both programmes initially run for one year, but can be extended twice for six months each.
The PCCL is aimed at countries whose financial position is fundamentally sound. The ESM examines this on the basis of six criteria, among which are compliance with the requirements of the Stability and Growth Pact, sustainability of public debt, and the absence of problems in the banking sector that could lead to systemic risks for the euro area banking system. However, PCCL is not eligible, particularly for Italy. This can already be concluded from the EU Commission’s country report on Italy for the European Semester 2019, in which it was described as having “excessive macroeconomic imbalances” (European Commission 2019). The same goes for other states with weaker fiscal positions. If a country is not eligible for a PCCL, but still has a healthy (“sound”) financial position overall, the ECCL remains, which is subject to much stricter conditionality (albeit not as strict as those of a loan with full macroeconomic adjustment programme). Within the existing instruments of the ESM, an ECCL is the right instrument for most of the weaker member states.
A COVID-19 Credit Line under the ESM
However, the problem with the PCCL and ECCL is their short maturity and their relatively strict conditionality. Thus, some call for a new special COVID-19 Credit Line (CCL) with much longer maturity and less strict conditionality. Would this also be covered by the ESM Treaty? According to Art. 14 (4) of the Treaty, the ESM Board of Directors adopts guidelines on the implementation modalities of the precautionary financial assistance. It has already issued such guideline. The ESM Treaty itself says nothing on the duration of the loans. These are only laid down in the guideline and could therefore probably be modified by amending it. However, an appropriately modified guideline would have to include instruments for continuously monitoring compliance and the possibility to terminate the loan in case of non-compliance, as Art. 3 ESM-Treaty calls for strict and appropriate conditions. This serves to ensure that the ESM, and ultimately the member states behind it, incur no losses. Art. 7 (2) and (3) of the guideline on precautionary financial assistance already provide for the possibility of closing existing credit lines in the event of non-compliance. The state concerned would then have to submit an application to switch from CCL to a loan linked to a macroeconomic adjustment programme.
The ESM Treaty allows issuance of precautionary financial assistance with a longer duration via a CCL due to the amendment of the relevant guideline, provided that the outlined requirements (appropriate and strict conditionality) are respected. However, depending on the specific conditions of the loan, national parliaments would most likely have to approve a corresponding use of the ESM. This is true particularly in the case of Germany. The German Constitutional Court plays an important role in assessing the legal boundaries of European integration in general, and specifically euro area crisis measures from the perspective of the German constitution. This became especially evident following the euro area crisis (see the cases of the ESM, OMT and PSPP). Under German law, the national parliament has to approve ESM measures in case they concern the overall fiscal responsibility of the German parliament (see Art. 4 (I) ESM-Finanzierungsgesetz – Act on the Financing of the ESM). This is especially so if the ESM seeks to grant new stability support to a member state, and this would clearly be the case with a CCL, irrespective of its specific conditions laid down in the Memorandum of Understanding or later in a respective facility agreement.
A one-off joint issue of Coronabonds by euro area member states
The idea goes as follows. For one time only, due to the COVID-19 crisis, the euro area member states jointly issue bonds with an aggregate value of up to €1,000 billion (equivalent to approximately 8% of the euro area’s GDP) at a long-term maturity backed by their joint financial strength. The funds thus created would be used to support member states that risk losing access to capital markets on acceptable terms. All member states would be jointly and severally liable for the repayment of the bonds; the amount of interest and redemption payments could be based on the ECB capital key. It should therefore be possible to place the bond on relatively favourable terms. Due to the low probability of default, Coronabonds would also represent safe assets that could be acquired in particular by banks in weaker countries.
However, many key practical questions remain open. How exactly would the modalities of distribution from the pool to the individual countries look like? What would be the terms of repayment? Which vehicle would be used to issue the bond? Who would manage the pool and process the loans from it? Could the ESM be used for this purpose? Would the ESM Treaty have to be changed? Could banks use the bonds for refinancing with the ECB and would the ECB be allowed to purchase them as part of its secondary market purchasing programmes?
The question arises whether a Coronabond would be compatible with Art. 125 (1) TFEU and whether EU law provides a sufficient legal basis. These questions can only be touched upon in the context of this column and cannot be assessed conclusively. In contrast to Eurobonds, whose admissibility under EU law is largely doubted, Coronabonds would only be issued once. No permanent mechanism for automatic joint liability for the national debt of all euro area member states, which would be incompatible with Art. 125 (1) TFEU, would be created. In light of the CJEU’s Pringle ruling, according to which Art. 125 (1) TFEU does not prohibit all types of financial assistance per se, such assistance would only be compatible with Art. 125 (1) TFEU if it did not provide an incentive for unsound fiscal policies. This in turn depends on the specific conditions under which the financial assistance would be paid. If necessary, such arrangements would have to be accompanied by clarifications under secondary law pursuant to Art. 125 (2) TFEU.
Thus, the admissibility of Coronabonds under EU law does not appear to be excluded from the outset. In addition, however, the question of compatibility with national constitutional law also arises, especially with regard to national budgets. According to the German Federal Constitutional Court, the German parliament has to approve such measures if the concern its overall fiscal responsibility. Coronabonds would be issued at EMU level, they would require joint and several liability by its member states. Nation states would therefore have to convey fiscal powers to the EMU level. Given the enormous volume envisaged, this would clearly concern the overall fiscal responsibility of the German parliament, and therefore require its consent.
Not least for the practical reasons laid out above, Coronabonds raise more complex questions than the use of the ESM. It is difficult for political decision-makers to resolve these issues conclusively and with legal certainty in the short time available. Thus, from a legal point of view, the implementation of a novel Covid Credit Line within the existing structures of the ESM would be the preferable to the issuance of Coronabonds.
Author’s note: This column reflects exclusively the opinion of the author.
Bénassy-Quéré, A et. al. (2020), “A proposal for a Covid Credit Line”, VoxEU.org, 21 March.
Codogno, L, van den Noor, P (2020), “COVID-19: A euro area safe asset and fiscal capacity are needed now”, VoxEU.org, 25 March.
European Commission (2019), “Country Report Italy 2019”, 27 February.
European Council (2020), “Joint statement of the Members of the European Council”, 26 March.
Roubini, N (2020), “Coronavirus pandemic has delivered the fastest, deepest economic shock in history”, The Guardian, 25 March.
Südekum, J et al. (2020), “Europa muss jetzt finanziell zusammenstehen”, Frankfurter Allge-meine Zeitung, 21 March.
Tooze, A, Schularick, M (2020), “The shock of coronavirus could split Europe – unless nations share the burden”, The Guardian, 25 March.