Green light for ESM fund comes with strict rules

Thu, Sep 13, 2012, 01:00

The court dismissed the idea of the bailout fund as an undemocratic financial black hole, writes DEREK SCALLY

YESTERDAY’S DECISION in Karlsruhe, though a preliminary ruling, has far-reaching consequences beyond Germany’s borders.

Faced with injunctions against the ESM bailout fund, eight red-robed judges had to weigh up two interlinked risks. The first was the financial risk to the euro on markets by issuing an injunction against the ESM now, only to green-light it later. The second was the legal risk to German democracy of allowing through the ESM now, only to decide later it was unconstitutional but unstoppable.

Rather than a fast-track injunction or a slow constitutional ruling, the judges went a third way and delivered (by their standards) a quick ruling – just eight weeks after an oral hearing.

At its core, the judges said it was “highly likely” that the ESM is compatible with the German constitution and thus should not be held up any further, once some additional safeguards are built in.

Before the ESM Bill can be signed into law, the court wants a guarantee of “international law” standard that German liabilities to the ESM fund cannot rise beyond the €190 billion in the treaty, unless Berlin gives its permission.

In Karlsruhe’s view, the existing ESM treaty text is open to various interpretations of liability based on different scenarios.

For instance, if one member does not meet an ESM capital call, other members are obliged to chip in to close the funding gap. But have they contributed additional capital over and beyond their agreed contribution, or have they just brought forward a pay-in of their own capital and moved closer to their agreed liability ceiling?

On another crucial point – the ESM’s confidentiality rules – the court had critical words. It expressed understanding for ESM secrecy rules, to prevent sensitive information passing to third parties. But German MPs are constitutionally entitled to “receive the information they need to develop an informed opinion”. Thus the court ordered that Germany’s ESM governor, the federal finance minister, must be freed from the ESM’s secrecy provisions to answer questions put to him by German parliamentarians.

In both of these reservations, the Karlsruhe court demanded water-tight legal solutions from Berlin and reserved the right to revoke the treaty at a later date if, in hindsight, it decides these concerns had not been adequately met in practice. Before ratification, Berlin has to meet the high legal standard required by Karlsruhe without altering the text of a treaty ratified in all other euro zone states.

Beyond the immediate concern, stabilising the euro, the ESM ruling has wider consequences in the euro zone debate. The court dismissed concerns that the ESM could assist the ECB in backdoor state financing, saying its reading of the ESM treaty was that the fund is subject to existing EU law, which doesn’t allow the practice.

In addition, Karlsruhe said it understood the ESM treaty to preclude the fund from becoming a “counter-party of the euro system”, in other words being awarded a banking licence. This is based on a legal opinion from the ECB, but takes on a different character in a ruling by Germany’s highest court. Neither, it said, would the ESM be allowed to deposit sovereign bonds it held with the ECB as security for loans.

Interestingly, the court said it was reserving its opinion on a last-minute challenge to the constitutionality of ECB bond-buying until its final ruling (expected early next year). This new departure for the ECB may ease pressure on the ESM but is highly unpopular in Germany. It will be interesting to see whether Karlsruhe, in its final ruling, shares the widespread German concerns that ECB bond-buying is, effectively, state financing.

It remains to be seen, too, how financial markets will react to the ruling. Markets have welcomed the idea of a permanent bailout fund, but already worry that even a €500 billion lending facility may not be enough to support Spain and Italy.

Ahead of next year’s German general election, further Bundestag approval for further bailout funds is considered unlikely. Once markets have digested the verdict, they may not take kindly to its underlining of the limits of participation in a fund by its largest member before it even comes into effect.

Despite the conditions, Karlsruhe has dismissed claims of Germany’s vocal ESM critics that the ESM is an undemocratic, financial black hole.

The court insisted the fund does not constitute an infringement of parliamentary budgetary sovereignty. Even if it exists in perpetuity, the judges said, ESM activities are limited by its capital. Once Germany’s €190 billion contribution is exhausted, the judges said, the ESM has no further claim on Germany. “Each new payment obligation or commitment to accept liability requires a new mandatory decision by the German Bundestag”.

Germany’s constitutional guardians have given a green-light to a permanent euro zone bailout fund, making final demands to copper-fasten German citizens’ constitutional rights. Is it too late for their judicial peers around Europe to follow suit?