No Easy Fix: The EU Is At A Crossroad

By Agnès Le Thiec, CFA

A CFA Institute poll on eurobonds (sovereign bonds commonly issued by Member States of the eurozone) from January was conducted to help inform the CFA Institute response to the European Commission's public consultation on the feasibility of introducing eurobonds - called stability bonds. The European Commission took a high level of interest in CFA member views about what would make these eurobonds appetizing (or not) to investors - which ultimately would determine their success or their failure. The European Commission, in its report on the results of its consultation, in fact says:

An independent survey led by the CFA Institute is worth a specific mention. A wide consultation took place among members of the Institute, i.e. portfolio managers, investment analysts, advisers or other investment professionals, with a number of 798 answers. The results are in accordance with those of the public consultation concerning investors. The risk of moral hazard was considered substantial by the respondents to the CFA survey and the need for a better fiscal integration of euro area Member States ensured by an enhanced surveillance of national budgets was highlighted by an overwhelming majority of participants to this survey … 64% pronounced themselves in favour of a joint and several guarantees system and the exact same proportion showed a preference for a partial substitution of national bonds by Stability Bonds.

One of the main findings of the survey was in fact that a large majority of CFA Institute members believe strict preconditions should be met for common issuance to be effective, most notably: significant enhancement of economic, financial, and political integration, and increased surveillance and intrusiveness in the design and implementation of national fiscal policies. Another recurring comment from respondents was that a new financial instrument will not cure the structural problems of imbalances in trade and competitiveness, or excessive public debt in many member states.

This is also the opinion of Olli Rehn, the European commissioner in charge of economic and monetary affairs. In a recent speech in Brussels, Mr. Rehn stated:

There is no easy fix or single-issue movement to the complicated problems of the complex eurozone that alone will do the trick - be it a fiscal compact or, say, stability bonds. We will not be able to overcome our problems by focusing only on a joint issuance of public debt without simultaneously ensuring fiscal sustainability.

In fact, eurobonds, while they could be part of the solution, will not by themselves cure the ongoing financial disintegration in Europe. Our position remains unchanged: Even though the EU has taken unprecedented steps over the last couple of years to try to tame this crisis, more needs to be done.

A new step is the recent publication by the European Commission of a proposed Crisis Management Directive to avoid future bank bailouts and enhance coordination between Member States in a crisis situation. The rationale for this new legislation is that, during the financial crisis, a number of EU govern­ments bailed out national banks - the commission indicates it approved 4.5 trillion euros (equivalent to 37% of EU GDP) of state-aid measures to financial institutions between October 2008 and October 2011. Doing so, Member States avoided a potentially more serious financial meltdown, but also burdened taxpayers with seriously deteriorated public finances. The actions taken at the national level also put in evidence the lack of coordination between EU Member States when dealing with banking failures which often have a more global impact, and the absence of an EU framework for managing crises in the banking sector. The measures envisaged by this new proposed Directive, which will now be discussed by the European Parliament and the Council, are focused on:

Prevention: Banks and investment firms would be required to draw up recovery plans; resolution authorities will have to prepare resolution plans and may in the process force banks to make changes to their legal or operational structure.

Early intervention powers would be given to supervisors, which could require the banking institution potentially in breach of regulatory capital requirements to implement any measure set out in the recovery plan, or appoint a special manager to the bank.

Resolution: In case of failure, national authorities in all Member States will have the same tools at their disposal: (i) sale of part of the business; (ii) separation of the "good assets" or essential functions of the failing bank in a new bank (the bridge bank), the rest to be liquidated under normal insolvency proceedings; (iii) segregation of the bad assets in an asset management vehicle -a tool to be used only in conjunction with one of the other tools; (iv) bail-in tool, whereby the bank would be recapitalized with shareholders wiped out or diluted, and creditors' claims reduced or converted to shares. Funding for the resolution tools, which will certainly be the most controversial ones, would be provided by resolution funds established at national level, as the idea of a single European resolution fund has not materialized yet. These funds would raise contributions from banks proportionate to their liabilities and risk profiles.

Interestingly, the same day the Commission published its proposal for a Crisis Management Directive, it also published a memo on a future European Banking Union. This is timely. With growing market pressure on Spanish banks leading the 17 Eurozone members to agree over the weekend to the provision of up to 100 billion euros of financial support to rescue Spanish banks (support to be associated with "appropriate conditionality for the financial sector"), EU institutions such as the Commission and the European Central Bank, with at its helm Mario Draghi, are now indeed pushing for more banking integration at the EU level. Such a banking union would rest on four main pillars, which go well beyond the measures foreseen in the Crisis Management Directive as it stands: A deposit guarantee scheme at the EU level; a common resolution authority and resolution fund; a single EU supervisor; and a single rule book for prudential supervision of all banks.

These are very ambitious objectives, and if they materialize it would mean a considerable transfer of sovereignty from the national level to the European level. Clearly, the EU is at an historical crossroad. It remains to be seen if EU citizens will be willing to go for further EU integration and sharing more of the burden of this unprecedented crisis, or if they will choose the other path, which could end up being more painful for all. The next EU summit on 28-29 June could in this respect be very important, as Herman Van Rompuy, the president of the European Council, is expected to present a "roadmap" for future economic integration of the eurozone.