21 June 2013

Graham Bishop: ESM 'Direct Recap' Agreement – Big step to help Banking Union, but no dustbin for bust banks/duff legacy assets

If a State has to ask the taxpayers of the rest of the eurozone for assistance, then its electors should certainly want to question its bankers, supervisors and the political overseers about how it all happened.

1. Timetable for action: Interestingly, the completion of the agreement is contingent upon the Parliament agreeing to both the Resolution and Recovery Directive (RRD) and the Deposit Guarantee Scheme Directive (DGS). So Council is now playing Parliament at its own game of taking prisoners of other deals! But that is also a measure of the increasingly genuine bi-cameral nature of EU governance. However, in this particular case, Eurogroup/Council may have shot itself in the foot by failing even to put the DGS proposal on the Agenda for today's ECOFIN.

2. Decision-taking: is by mutual agreement so Germany retains a veto and may well need a Bundestag vote on each occasion.

3. Main Features: key elements include

• The ESM member requesting assistance must be unable to provide it internally
• The institution must be sufficiently systemic to pose a threat to the eurozone as a whole or the requesting member. So that cuts the number of eligible banks to 30 or less.
• The capital injection must be able to make the institution viable – to be checked for State Aid by DG Comp

4. Maximum funds to be allocated to this programme are €60 billion, though reviewable. So this programme is not going to be big enough to be a giant dustbin for Europe’s banks!

5. Robust valuation of assets to be undertaken by outside experts, ESM, ECB and Commission with ECB setting the final amount of capital needed. So the tainted national supervisors are not going to get another chance to shift their failure quietly onto the rest of the eurozone’s taxpayers. However, IF the ECB does its Asset Quality Review (AQR) properly in the next year, then the robust valuation should already be known and have been dealt with by the national authorities before the SSM takes over.

6. Burden Sharing:

• A critical element for shareholders and creditors is that it that will follow the RRD arrangements but the key phrase is an “appropriate” write down of creditors so everything remains constructively ambiguous for bond-holders. The RRD is not yet agreed and - presumably - such arrangements will have to be in force but that could yet remain at 2018 despite calls from the ECB to make it 2015.
• The governments requesting support will have to put in enugh funds to rebuild the Core Equity Tier 1 ratio to the 4.5 per cent minimum. It will have to provide 20 per cent of the additional funds needed, though that ratio may fall later.

7. Conditionality: 

• For the institution: will be driven by the Commission’s State Aid rules to start and then other rules from ESM and ECB.
• For the requesting State: an MOU on its general economic policies.

8. Retroactive application: To be decided case by case - and by mutual agreement.

Two important thoughts flow from this analysis:

• The European Commission will be deeply involved in every aspect of the resolution process and the MOU on economic policies to such an extent that it would make little sense if it were NOT the actual Resolution Authority. As the whole process of the AQR and Stress Test ahead of the start of the ESM should have removed bad legacy assets already, this process should be quite unlikely to be needed once the SSM is running satisfactorily. But the next year could see the AQR throw up bad, legacy assets that might force a State to request ESM assistance for a direct recap. Once this period of peak risk is over, this process should not be needed for many years.

• The Agreement is silent on the possibility of opening this support to non-euro area members. That may be the key to encouraging such states to joinBanking Union. To take a specific example, the recent spat between Denmark’s supervisors and Danske Bank (with a balance sheet around twice Denmark’s GDP) highlights that any confrontation would spill over quickly to Denmark’s Nordic neighbours in the euro area.

Eurogroup Communiqué

© Graham Bishop