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.