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30 May 2014

A Plan for Eurobills: The next step for the euro area?


My Plan for a Temporary Eurobill Fund (TEF) was considered by the European Commission's Expert Group.

Recently, a European Commission `Expert Group’[1] published its analysis of the pros and cons of a debt redemption fund versus eurobills. My Plan for a Temporary Eurobill Fund (TEF) was considered. Given the late stage in the life of both the European Commission and Parliament, the Group’s mandate forbade making any recommendation for action, so it will fall to the Eighth Parliament to continue the campaign for deepening financial (and thus political) integration of the euro area. The new Commission will have to respond.   

What is the TEF?

It would follow a similar legal structure to that of the ESM with pro rata callable capital - but with a crucial difference:  only euro states in `good standing’ could join, thus excluding those in the ESM `sin bin’. The economic structure would be the plainest vanilla. The Fund would borrow from the markets - exactly matching quantities and maturities requested by borrower states – for maturities ranging up to two years. The key step is that participants would bind themselves to borrow all new funds in this maturity range only from the TEF. In short order, there would be a genuine, single European yield curve for this market sector – with a TEF size of €0.8 trillion (nearly 10% of GDP). Members would also have the right to re-finance maturing issues by borrowing from the TEF – thus removing roll-over risk and enhancing financial stability.

Political Governance

The decision-makers (the Finance Ministers) would also be empowered to buy-in members’ bonds with a remaining life of less than two years if they judged the margin above the TEF curve to be excessive - in the light of the member’s performance of its commitments to the new economic governance measures (Six Pack, Two Pack, Fiscal Compact). If performance during the next, say, five years encouraged Finance Ministers to buy in all under two-year debt, the TEF could reach about €1.9 trillion in size (+/- 30% of euro area public debt). It would then have many of the functions of a European Treasury. But exposure to the TEF must be limited by rules to prevent a member shortening its overall debt maturity excessively. On the darker side, if performance discouraged Ministers, they would scale back purchases progressively and perhaps even cease issuance altogether.

Can it be done?

Yes – The Expert Group was clear that an ordinary Regulation of the European Union could set up the operational platform although a separate Inter-Governmental Agreement would be necessary to bind participants to decisions about the financial management of the fund: membership, size, maturity etc.  The key is that there would be no need to change the main European Treaty. The mechanics are simple so the first bills could be issued after ratification of the Agreement - perhaps within a year. In the medium term, if the Treaty were going to be changed, then after a few years of successful operations it would be a natural step to make the Fund a full part of the EU as the vast majority of EU members could be in the eurozone.

The Plan would be good for Europe because:

·         Economically, it binds the participating euro area states into closer financial solidarity – thus encouraging greater observance of the economic governance commitments. But the obverse would be a correspondingly strong sanction. The natural flow of redemptions would steadily reduce the Fund’s exposure to a state – unless the politicians made a positive decision to replace these redemptions with new purchases. The absence of such a decision would send a clear message to the markets holding the other [70%] of the state’s debts.

·         Politically, the broadening of the `common interest’ of each EU member in the economic policies pursued by fellow members would be accelerated. The Two-Pack has already given a collective oversight of budgetary polices. The decisions of the TEF about borrowings would deepen that oversight substantially.

·         Monetary policy would also be simplified as the TEF would purchase more than half the securities of each state that the ECB would consider buying for OMT purposes. With current talk about QE, TEF bills would be a natural public asset to purchase as they would not represent monetary finance of governments and the state-by-state exposure would already have been agreed at the politically-accountable level of finance ministers.

·         Banking union would be re-enforced as short term TEF bills would be the most natural High Quality Liquid Asset (HQLA) for banks to hold to meet Capital Requirement Regulation liquidity rules as they would be the safest, most liquid asset in the euro area.  The `doom loop’ between banks and their sovereign would be cut by more than a third - at a stroke. This will make it much easier to tackle the remaining two-thirds of longer-dated inter-linkage that is necessary to restore the credibility of the `no bail out rule’.

·         The concept of a single euro financial market would be boosted as all financial institutions – insurance companies, pension funds, corporations and mutual funds – would have a `European’  asset to satisfy their legitimate economic needs for holding short-dated safe and liquid securities.

·         A minor practical benefit - but perhaps looming larger in restoring public trust in financial markets – is that a public authority would provide reference pricing based on massive activity for all financial contracts that need to specify an interest rate for any particular short maturity. That would include the variable interest rate on say longer term mortgages and bonds.

·         The existence of a yield curve for the safest and most liquid asset would naturally encourage the markets to innovate products with somewhat higher credit risk, and thus return.  This should provide a welcome boost to `good’ securitisation of say packages of loans to SMEs that would back commercial paper issued by banks and non-banks. The ECB’s easy money policy could then reach SMEs across the entire euro area.

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[1] The author was a member of this Group



© Graham Bishop


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