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The proposed reform of the European Stability Mechanism must be postponed

Vallée, Shahin, Cohen-Setton, Jérémie, De Grauwe, Paul and Dullien, Sebastian (2019) The proposed reform of the European Stability Mechanism must be postponed. LSE European Politics and Policy (EUROPP) blog (11 Dec 2019). Blog Entry.

Friday 3 April 2020, by Carlos San Juan

Eurozone finance ministers reached a preliminary agreement on a reform of the European Stability Mechanism in June, but failed to conclude it last week. The reform is now set to be discussed during the European Council meeting on 12-13 December. Shahin Vallée, Jérémie Cohen-Setton, Paul De Grauwe and Sebastian Dullien write that the proposal should not be endorsed in its current form. They argue it would represent a missed opportunity to secure a broader and more ambitious reform package. At the December European Council, EU leaders will be asked to endorse a reform of the European Stability Mechanism (ESM). They should refuse to do so. Closing the ESM negotiations now would remove an important element from a better potential reform package. Indeed, the reform is highly imperfect and imbalanced, and the issue of euro area reform deserves a broader and more ambitious agenda. The ESM reform has been under negotiation for three years and has had three important objectives. First, it aims to bring the ESM under community law so as to reform its governance, reduce the scope for potential vetoes by national governments, and increase the accountability of its decision-making in relation to the European Parliament. Second, it is intended to enhance the ability of the ESM to act pre-emptively and safeguard financial stability through precautionary instruments, improve the functioning of the ESM in programmes, and clarify the framework for debt sustainability. Finally, it seeks to expand the role of the ESM so that it can play the role of a backstop to the single resolution fund (SRF). European finance ministers agreed to a compromise in June this year and while they didn’t conclude this agreement last week, they are aiming to finalise the remaining details in the coming months, unless the European Council mandates them to take a step back. Yet the reform agreed by the Eurogroup falls far short of the initial objectives and risks undermining a future possible deal.

The proposed reform of the European Stability Mechanism must be postponed. LSE Research Online URL for this paper

Three key problems

The first issue with the reform is that the ESM would remain an intergovernmental organisation rather than one that has been transformed into a European institution or body. Its governance would remain dominated by national vetoes, its decisions would remain unaccountable to the European Parliament, and its powers would eat into those of the European Commission under a memorandum of cooperation that expands the monitoring and surveillance role of the ESM without increasing its accountability. The fact that memorandums of understanding will need to be signed by the ESM not only fails to improve its governance but actually makes the situation worse by transferring important authority to the ESM without appropriate accountability.

Second, the ability of the ESM to play a greater stabilising role thanks to the creation of a precautionary conditioned credit line (PCCL) has been undermined by a series of criteria that make it inaccessible to most countries. For instance, even today, France and Finland would not be eligible. In practice, there is thus no progress regarding the stabilisation capacity of the ESM. Together with the reform of the Collective Action Clauses and the enhancement of the ESM’s role in debt restructuring, these changes would most likely have a destabilising rather than stabilising effect in the absence of progress on the creation of a safe asset.

Finally, the agreement to use the ESM as a backstop to the single resolution fund is perceived as great progress. But it would remain subject to national parliamentary vetoes. As illustrated by recent experience and highlighted by the German ‘non-paper’ on the banking union, the Single Resolution Board is actually unable to undertake the resolution of even a small bank in Europe in part because national insolvency will always be preferred. Therefore, it seems hard to envisage that the SRF and its backstop could be used until a proper resolution framework underpinned by a genuine European insolvency regime emerges. The ESM backstop is therefore a paper tiger and even potentially a step backwards from the current ESM direct bank recapitalisation instrument. Because of these shortcomings, there should therefore be no qualms about delaying an agreement on the ESM. In fact, an agreement now would make progress more difficult in other critical areas of the euro area architecture. Given the new leadership of the European Commission, and the change of attitude in Berlin towards banking union, agreeing to the ESM reform as it stands would be a missed opportunity for a broader and more ambitious package.

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