Friday, 17 June 2016

Pulling the rug from under Mario’s feet: the BVerfG and the ECB’s OMT programme

Ioannis Glinavos (@iGlinavos), Senior Lecturer, University of Westminster

A key decision relating to EU economic and monetary union will be delivered by the German Constitutional Court (Bundesverfassungsgericht, “BVerfG”) next week (Tuesday June 21). That court will be deciding on the case of Gauweiler (C-62/14), where it had asked the European Court of Justice (CJEU) for an opinion (preliminary reference) on the legality of the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) programme after 37,000 plaintiffs questioned the legal basis of the ECB’s scheme. It is notable that Jens Weidmann, Bundesbank president, had voted against the OMT programme and Eurozone Quantitative Easing (QE). The Court referred two questions to the CJEU in what it classified as an ultra vires review of acts of the European Union.

In summary, the BVerfG wanted to check whether the ECB had transgressed the limits of its powers derived from the EU Treaties. If the ECB had, this would have consequences for the constitutional identity of Germany. Therefore, the BVerfG asked for clarification on whether the OMT programme was an economic rather than a monetary measure and whether the ECB had as a consequence exceeded its powers by establishing it.  Second, the BVerfG raised the question whether the OMT programme was not violating the prohibition of monetary financing of Member States.

The BVerfG set out the following specific conditions that could render OMT compatible with the German constitution: (1) OMT should not undermine the conditionality of the EFSF and ESM (‘bail-out’) programmes; (2) OMT should only be of a supportive nature to other economic policies; (3) any debt restructuring must be excluded (no pari passu for the ECB) (4) no unlimited purchases of government bonds and (5) avoidance of interference with the price formation on the market where possible.

Indeed, the ECB is not allowed to engage in economic policy, neither is it allowed to finance member states, as articles 120, 123, 127 TFEU (primarily) set out. On the face of it, the concerns of the claimants at the BVerfG seem justified. Let us therefore examine the nature of the complaint in some more detail. The OMT, announced in September 2012, is an initiative aimed to help struggling Eurozone economies by buying short-term government bonds on secondary markets. It is widely perceived as an important tool to calm markets. The way in which OMT offers relief to states experiencing funding difficulties is by opening an avenue to short term affordable liquidity. In a way, it allows funds to reach governments by creating demand for sovereign debts in secondary markets, therefore lowering the costs of borrowing overall. Its critics, however, have argued that OMT exceeds the ECB’s mandate and undermines the rules that keep the Eurozone from becoming a transfer union’ where stronger members are constantly bailing out weaker ones.

These transfers are supposedly prevented by the fact that the OMT operates in conjunction with fiscal discipline measures in the affected countries. The ECB insists that a necessary condition for OMT is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full macroeconomic adjustment programme or a precautionary programme, provided that they include the possibility of EFSF/ESM primary market purchases. The ECB Governing Council considers OMTs to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected (which is why Greek government bonds are not included in the OMT shopping list), and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme. As to the transactions themselves, they are focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years. No ex ante quantitative limits are set on the size of transactions. In purchasing these bonds, which is likely to be a sticking point for the BVerfG, the ECB accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through OMT, in accordance with the terms of such bonds.

But how can the above transactions avoid violating the monetary financing prohibition? Benoît Cœuré (of the ECB) offers the following explanation for the actions of the ECB. He argues that the economic rationale of the monetary financing prohibition is clear, as central banks cannot ensure price stability if they have to permanently make up for weak performance in other policy domains. This is why Article 123 TFEU is central to the architecture of EMU. In the view of the ECB, the aim and design of OMTs fully respect this economic requirement, via the link to conditionality. As presented above, the link to policy conditionality of an EFSF/ESM programme ensures that central bank intervention via OMTs does not replace reform efforts in other policy domains. Rather, OMTs can only be complementary to national reform efforts. This is designed to prevent a scenario of harmful central bank support, or fiscal dominance over the central bank. 

Cœuré continues by arguing that OMTs would never be used to indiscriminately push down government bond spreads. By contrast, spreads should continue to reflect the underlying country-specific economic fundamentals, fiscal positions and market risk perceptions that incentivise governments to engage in sustainable fiscal spending and competitiveness-enhancing structural reforms. The aim of OMT is therefore not to reduce yields below the fundamentally justified level so as to preserve debt sustainability despite weak policy performance, but to aim at that portion of the bond yield spreads that is not fundamentally justified and based on undue risks of a euro area break-up. In other words OMT deals with market anxiety over Eurozone wide systemic risks not linked to the underlying fundamentals of Member State economies (at least as those are understood by the ECB). This is perhaps because central bank independence and a clear focus on price stability are deemed necessary but not sufficient to ensure monetary dominance. The ECB maintains the position that by creating the right environment and providing appropriate incentives for governments to take action to ensure fiscal solvency, OMTs create the conditions to affirm the monetary dominance regime, which is at the heart of the Treaty.

The European Court of Justice seems to be largely in agreement with the above. In its 2015 judgment in Gauweiler, it ruled that a plan by monetary policy makers to buy government bonds, even in potentially unlimited quantities, was legal. The court found that Mario Draghi’s pledge in the summer of 2012 to do “whatever it takes” to save the region from economic ruin through OMT, complied with EU law. “The programme for the purchase of bonds on secondary markets does not exceed the powers of the ECB in relation to monetary policy and does not contravene the prohibition of monetary financing in member states,” the ECJ declared, offering an important win to Draghi against German opposition to ECB attempts to stave off a Eurozone financial crisis. This decision is also perceived as shielding monetary policy makers from legal attacks on their landmark €1.1tn QE package, unleashed in 2015.

Alicia Hinarejos writes that the CJEU has recognized the broad discretion of the ECB to make complex economic assessments and technical choices, while at the same time striving to discharge a meaningful and necessary role. The Court clearly does not want to be seen to be second-guessing the other institution’s policy choices, so it focuses on procedural requirements and applies a light-touch review when it comes to assessing the proportionality of the scheme. This is most evident in the final part of the judgment, where the court assesses the compatibility of the OMT programme with the ban on monetary financing. Here the Court seeks to apply (and be seen to be applying) a coherent, rigorous-enough-yet-within-judicial-boundaries compatibility test. 

The CJEU found (para 103-5) that the ESCB is entitled to purchase government bonds — not directly, from public authorities or bodies of the Member States — but only indirectly, on secondary markets. Intervention by the ESCB of the kind provided for by a programme such as OMT thus cannot be treated as equivalent to a measure granting financial assistance to a Member State. The Court recognised however that the ESCB’s intervention could, in practice, have an effect equivalent to that of a direct purchase of government bonds from public authorities and bodies of the Member States. This could happen if the potential purchasers of government bonds on the primary market knew for certain that the ESCB was going to purchase those bonds within a certain period and under conditions allowing those market operators to act, de facto, as intermediaries for the ESCB for the direct purchase of those bonds from the public authorities and bodies of the Member State concerned. However, the ECB convinced the Court that the implementation of a programme such as that announced in September 2012 must be subject to conditions intended to ensure that the ESCB’s intervention on secondary markets does not have an effect equivalent to that of a direct purchase of government bonds on the primary market.

The decision can be said to continue in the Pringle vein of ratifying a move away from a rules-based EMU to a policy-based one in the wake of the crisis, with the CJEU limiting its role of review to a strictly formalist position. This can be seen in the fact that the discussion (like the AG’s Opinion before it) does turn on the specific features of the OMT programme rather than on more abstract questions such as the nature of EMU, its evolution, and the role of solidarity within its constitutional framework. 

Will the BVerfG decide along the same lines? Analysts at Société Générale model three possible outcomes. In the best case scenario, the BVerfG will simply find the OMT in line with the German Constitution based on the ECJ preliminary ruling. At the opposite end of possibility, the BVerfG could find the participation of the Bundesbank in OMT incompatible with German constitutional law or even declare German participation in ESM programmes that are supported by OMT incompatible. Such a ruling would then require German primary law to be changed to allow the Bundesbank to participate in an eventual OMT programme. A middle position is in effect more likely, with the BVerfG tinkering with some aspects of the programme (such as pari-passu for instance) and linking the operation of the OMT with ECB’s QE by highlighting the issue limits of QE as an important feature to respect under OMT. Such a move would address the concerns of Germany at being pushed under OMT to take on uncapped risks towards other euro area sovereigns, and assuage the fears of other EU members as to violations of Article 123 TFEU. At the same time, the BVerfG seems keen to avoid becoming an instrument of politics and is unlikely to allow itself to be used as a tool for the transmission of political concerns over ECB decision-making onto the constitutional law domain.

Will Mario find himself on the floor on June 21st? This is unlikely to happen, but considering the British are holding the Brexit referendum on the 23rd of the month, anything other than total support from the BVerfG to the architecture of Eurozone rescues is likely to cause a noticeable wobble.

Art credit: David Simonds

Barnard & Peers: chapter 19 

1 comment:

  1. Mario can sleep tight, the German Court agrees with the CJEU. See full judgment here