What will the German Constitutional Court ruling mean for the eurozone?
Summary: Today, the German Constitutional Court ruled that the Eurozone’s permanent bailout fund, the ESM, and its ‘fiscal treaty’ on budget discipline do not violate the country’s ‘basic law’ and do not undermine Bundestag sovereignty over budget issues. However, the Court added a cap to the size of the ESM. It also reinforced the effective ‘veto’ of the German Bundestag over ESM activation, and therefore in effect also over a debtor country’s access to the ECB’s bond-buying programme (OMT), since the two are linked. However, the ruling was not unambiguous and in many ways an invitation to further court cases – over ECB bond-buying and others – and a lot more political wrangling.
WHAT DID THE RULING SAY?
This decision merely referred to the question of whether to grant a temporary injunction against the ESM. The full ruling on the complaints is expected in early 2013. However, since the law can now be finalised, and as an international treaty may be difficult to reverse, many expect the final ruling to be along the same lines.
Cap of €190bn on German ESM contribution, which can only be overturned by the Bundestag
Both houses of German Parliament need to be adequately informed about all ESM decisions – something which needs to be enshrined in “international law"
Reinforced that Bundestag approval needed for all activations of the ESM
Explicit ban on ESM borrowing directly from ECB
The German Government can terminate ESM at any time, as recognised under “customary international law”
In its full ruling, expected in early-2013, the Court will also consider whether the ECB’s bond-buying programme, the OMT, has transferred illegal degrees of sovereignty to the EU-level
THE IMMEDIATE IMPACT OF THE RULING
Makes topping up ESM more difficult: The current lending capacity of the ESM, €500bn, is not nearly enough to take, say, Italy and Spain off the market, meaning that the cap could prove a real obstacle for large-scale Eurozone bailouts down the line. However, the impact of this could be offset by last week’s ECB decision to buy unlimited short-term government debt – via the OMT – which reduces reliance on the ESM. It is also worth considering that a situation where the ESM needed to be topped up, would mean the crisis had significantly worsened once again and an extra layer of parliamentary approval may be the least of the eurozone's worries.
Reinforcing Bundestag veto over ESM activation: The decision also reinforces that any future ESM bailouts will require parliamentary approval, stating that the Bundestag “must individually approve every large-scale federal aid measure on the international or European Union level.” Bundestag approval - either by the full chamber or a special committee - was already needed for activation of the ESM (as with the EFSF). The Court also called for both houses of the German Parliament – Bundestag and Bundesrat – to be kept fully informed of any ESM decisions, something which needs to be enshrined in “international law”.
Will the ESM Treaty need to be rewritten? The Court hinted that the cap on liabilities and the involvement of the Bundestag, will require changes to the ESM structure. If so, there are three ways this could play out:
1) German government protocol: The German government could insert the necessary changes into the German legislation implementing the treaty ahead of their signature into law by the German President Joachim Gauck.
2) Ratification in the Bundestag: German legislation on the ESM could be amended within the Parliament and then re-ratified and signed into law.
3) Rewriting of the ESM treaty: The entire ESM treaty must be altered to ensure that these requirements are laid out in the primary international legislation.
Clearly, (2) or (3) could cause further delays to the ESM coming into force, but are unlikely scenarios. In any case, this is again less of an issue since the ECB OMT can be activated using the EFSF, which will still have €150bn remaining following the Spanish bank bailout.
Ban on the ESM borrowing from the ECB: The Court says that “borrowing by the ESM from the European Central Bank” would be incompatible with EU law (Article 123 TFEU). This is a surprisingly categorical rebuke, especially over an issue of EU rather than German law. But given the ECB OMT a banking licence for the ESM is now less of an issue, so a negative market impact is less likely.
KNOCK-ON EFFECTS OF THE RULING
Focus shifts to ECB – but highlights that accessing the OMT could be difficult
With a firm cap on the ESM, the ECB is now most certainly the only actor with deep enough pockets to put Spain and Italy on life-support – together with the OMT announcement, the ruling has shifted the burden back to the ECB. However, the ruling and the role of the Bundestag highlights that activating the OMT will be challenging, since in order to qualify for ECB bond-buying, a country must first get funding from the ESM – and be subject to conditions. If the Bundestag agrees to activate more bailouts, it will most certainly push for harsher conditions than what debtor countries – most importantly Spain – are willing to accept. In the long-term, under current arrangements of linking ESM and OMT, the latter is also effectively capped and subject to a Bundestag veto.
The Court is likely to consider the ECB’s bond-buying programme next…
The GCC suggested in its press release that the ECB’s OMT will be considered in its final ruling on these complaints. The exact criteria upon which the programme will be assessed is unclear but broadly the Court will determine whether it transfers additional German sovereignty to the European level above and beyond that which the country has committed itself to in the EU Treaties.
Additionally challenges against the ESM could also be launched on similar grounds to the previous legal challenges against the Securities Market Programme (SMP) (inflationary tendencies thereby undermining the right of property by the owner of money, guaranteed by the German Basic Law, and distortion of capital markets). Like with the SMP, it is very unlikely that the GCC would rule against it.
…and expect more court cases
As the crisis piles on pressure for further EU integration – via a banking union and debt pooling – more court cases will inevitably follow. There are plenty of potential legal pitfalls ahead including: direct losses for Germany on loans to Greece, ECB losses on Greek exposure, pooling of risk through bank resolution fund and backdoor Eurobonds through the OMT.
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