06 October 2014

Graham Bishop’s selected extracts from DRF/Eurobills Expert Group conclusions

Both a DRF/P and eurobills would have merits in stabilising government debt markets, supporting monetary policy transmission, promoting financial stability and integration, although in different ways and with different long term implications.

Both a DRF/P and eurobills would have merits in stabilising government debt markets, supporting monetary policy transmission, promoting financial stability and integration, although in different ways and with different long term implications. These merits are coupled with economic, financial and moral hazard risks, and the trade-offs depend on various design options.

 

Possible objectives of schemes of joint issuance of debt

The eurobills idea has been put forward with the primary objectives of stabilising government debt markets by reducing Member States' rollover risk and of fostering the integration of financial markets through the creation of a safe and liquid asset. Such an asset would also contribute to reversing the trend towards market fragmentation and support monetary policy transmission.

The introduction of any scheme of joint issuance could only be one step contributing to financial market integration, amongst other possibly needed steps, including those aiming at strengthening structurally Europe's banking sector. It should also be noted that no asset is completely risk-free. Creating a jointly issued government security that will be regarded as a safe asset for investors will thus imply some residual risk to governments participating in joint issuance.

Assessing eurobills: Design, merits, risks

Eurobills could contribute to promoting financial integration and financial stability. To the extent they create a safe and liquid instrument, eurobills could be a step towards diversifying sovereign debt holdings in bank balance sheets and thus reducing the bank-sovereign feedback loop. Market fragmentation might also be reduced and monetary policy transmission could be made easier; however, sustainable financial integration requires structural reforms of the real economy and the financial sector.

To the extent issuing limits are not reached, eurobills could lower the roll-over risk in particular in case of sudden changes in the perception of the markets, contributing to more stable government debt markets. Only a large eurobill fund is likely to provide this benefit in full. In normal times, when spreads on short-term debt are small, the effect on Member States' financing costs would probably be limited and would depend on the size of issuance and the liquidity premium.

The extent to which these objectives are attained depends on the design variants, which have not only legal dimensions but also mark trade-offs linked to financial risk-sharing and containing moral hazard.   

Setting up a eurobills scheme only temporarily and which would lapse unless renewed, i.e. as a “test run”, is an option that might offer some advantages. However, there is some uncertainty as to market acceptance of a temporary scheme and particularly to whether the unwinding option is really credible and without stability risks. In any event, most of the benefits for which eurobills have been conceived could only be obtained if the scheme was set up on a permanent basis (subject to regular votes in national parliaments on concrete liabilities assumed, see point 35 below).

Robust mechanisms to contain moral hazard should be part of any scheme of joint issuance. These could include prior conditions (a period of probation and restricting eligibility for participation), reinforced competences of the European level over Member States’ fiscal and economic policies in case of non-compliance, financial incentives and sanctions (e.g. mark-ups) and ensuring that market discipline will still be felt.

Given the still very limited experience with the EU's reformed economic governance framework, it may be considered prudent to first collect evidence on the efficiency of this governance and, if deemed necessary, further strengthen this governance framework, before any decisions on introducing joint issuance are taken.

Legal requirements and limits for introducing … eurobills

While the current EU Treaties do not allow any schemes of joint issuance of debt resting on joint and several liability of Member States, they may allow guarantee structures based on pro rata commitments and in particular a capital structure analogous to that of the ESM.

The current EU Treaties do not grant sufficient competence to the EU to set up a DRF/P or a eurobills scheme (even if based on pro rata) through EU legislation. At most, absent Treaty change one could argue that it is possible to set up a temporary eurobills scheme through a combination of an Article 352 regulation (in enhanced cooperation) with an intergovernmental agreement.

If a DRF/P or a eurobills scheme was established on a purely intergovernmental basis, legal limits would have to be taken into account. The EU's political institutions could not exercise any decision-making powers. The EU's economic policy coordination should not be undermined.

National constitutional laws pose pronounced limits to the possibilities of Member States to participate in a scheme of joint issuance of debt (see the example of Germany). There might be possible ways to respect those limits. A scheme could the more likely be found in line with those limits, the more clearly it were legally ensured that the maximum of a Member State's liability is in advance limited, that there is a possibility for regular votes in national parliaments on concrete liabilities assumed (on top of information rights and rights to influence) and that there are strict conditions and safeguards designed to ensure fiscal discipline.

Overall conclusion

Both a DRF/P and eurobills would have merits in stabilising government debt markets, supporting monetary policy transmission, promoting financial stability and integration, although in different ways and with different long term implications. These merits are coupled with economic, financial and moral hazard risks, and the trade-offs depend on various design options.

Given the very limited experience with the EU’s reformed economic governance, it may be considered prudent to first collect evidence on the efficiency of that governance before any decisions on schemes of joint issuance are taken. Without EU Treaty amendments, joint issuance schemes could be established only in a pro rata form, and - at least for the DRF/P - only through a purely intergovernmental construction raising democratic accountability issues.

(The full Conclusions of the Expert Group are here. Graham Bishop was a member of this group.)

© Graham Bishop