Presentation by Graham Bishop to ECON Committee of European Parliament: Eurobills

01 April 2014

About two years ago, whilst Rapporteur of a working group from the European League for Economic Cooperation (ELEC) chaired by Wim Boonstra, a plan was developed for Eurobills based on a joint & several guarantee structure.

However, for the legal reasons now set out so precisely in our Report, I came to the view that only a pro rata guarantee would be politically and legally feasible and so presented my variant - a complete plan for a Temporary Eurobill Fund (TEF) - to the Expert Group.  

The Group has laid out: sound reasons why action is in the general interest of all EMU participants today; the objectives of joint issuance; and the risk of moral hazard. Naturally, market participants have a view about the arrangements that will be ideal for them, but Parliaments must – absolutely properly – protect the long-run interests of their electors. The art of the possible is to find an acceptable `middle way’. So I shall discuss the aspects of the Group’s analysis that illuminate how a TEF could provide such a middle way.

Economics

  1. Only euro area states that are in `good standing’ with Eurogroup may borrow – thus complementing and re-enforcing the existing economic governance framework, including the TSCG commitment to remove the debt overhang  by reducing it annually by 1/20th of the debt above 60% of GDP.
  2. Range of bills from overnight to 2 year maturity – reflecting demand by borrowing states.
  3. Temporary – for say 5 years - for 3 reasons:
  4. A probationary/`test run’ so national Parliaments can consider making it permanent only if successful
  5. However, issuance could be halted by the decision-makers at any time, and liability/moral hazard will run off quickly
  6. National Parliaments keep budgetary control by renewing the Fund say every [5] years
  7. All participating states would be prohibited from raising any sub-2 year funds outside the TEF.
  8. Participating states may roll over maturing bonds by borrowing from the TEF – subject to limits on excessive shortening of their debt profile. This option removes roll-over risk and is a major contribution to financial stability.
  9. Investment powers for TEF to buy-in bonds as the remaining life of existing bonds falls below 2 years.
  10. Size of TEF: Minimum €0.8 trillion; likely €0.9-1.2 trillion; and for something like a `European Treasury’, a maximum €1.8 trillion. NOTE: Size is a political choice by decision-makers at European level to enlarge (or shrink) responding to market/economic governance developments – thereby managing the moral hazard of which the EU already has a great deal with or without a DRF or Eurobills.

Legal                                                                            

  1. The TEF can come into operation without any change to the TFEU.
  2. However, any mechanism to prohibit part of participants’ financial sovereignty would clearly be outside the `co-ordination’ functions currently permitted by the TFEU.
  3. The decision-making processes for this shared sovereignty would require an Inter-governmental Agreement (IGA) between participating states to create an “International financial institution” based on the ESM model.
  4. As much as possible of the technical structure of co-ordination of issuance should be set up under an EU Regulation. This would be based on TFEU Article 352 and be adopted under enhanced co-operation (based on Article 20) with technical support provided by Eurogroup (under Protocol 14).
  5. If the TFEU were to be re-opened at some future stage – perhaps to bring the TSCG within it - there would be a natural moment to include a `tried and tested’ TEF within the TFEU’s framework

Mechanics

  1. “Back-to-Back” market finance to participating states so cash in/out matched - for absolute simplicity and transparency, thus the very plainest of `plain vanilla’ structures.
  2. The  decision-making structure: Board of Governors = Finance Ministers (who are accountable to their national Parliaments)
  3. Capital structure: modest, callable capital
  4. Rules for limits to prevent members shortening their maturity profile excessively:
  5. I: Average life of debt to be more than [7] years.
  6. II: Maximum % of the debt under two-year remaining life– target of [25]% and cap of say [35]%
  7. NOTE: The existing provisions of the SGP and TSCG will enable the cash value of these rules to be monitored and enforced. The exposure limits would be fixed so that no state would have an exposure greater than the remaining lending capacity of the ESM.
  8. Exclusion from TEF:triggered by SGP sanctions and then coupled with an `invitation’ to take an ESM Programme to pay off the bills. Risk to guarantors is no greater than existing ESM liability.
  9. Highest credit quality in the Euro area  - so no requirement for a Credit Rating
  10. Bills to be sold to financial institutions, businesses (and individuals as soon as practicable) by ensuring there are no regulatory impediments.

Possible Outcomes:

  1. Safe, liquid and highly marketable asset so reducing the doom loop between banks and their sovereign – by at least one third.
  2. Improving this element of the credit quality of banks lowers their funding costs and enable the ECB’s single monetary policy to be transmitted more smoothly throughout the euro area.
  3. TEF bills become a natural asset for banks/insurers to hold: zero risk-weighted and no limit on large exposure - but this system must be reviewed soon to restore the credibility of the `no bail-out rule’.  Current regulations leave financial institutions little alternative but to roll maturing national bills into TEF Bills.

Consider the “golden scenario”:  

(In light of the positive experience of collective economic governance, a Debt Redemption Fund could be launched.)

But we should also consider a `black scenario’ of failure.Markets would be extremely aware if a particular state were failing to maintain its commitments and was on a trajectory to exclusion from the TEF. The [70% or more] of its debt not in the TEF would be priced to reflect the logical results of its policy failure and its eventual exclusion from the TEF would be merely another symptom of the national failures – NOT their cause.

I believe that a plan along these lines is completely feasible - both as a simple insurance policy against future storms that remain all too likely, and as a series of small, but reversible, steps towards deeper integration.

*****


© Graham Bishop