Tuesday, September 25, 2012

25/9/2012: Some questions on foot of latest ESM statement


From today's Joint Statement of the Ministers of Finance of Germany, the Netherlands and Finland (link here):
"Specifically, we discussed the governance, independence, decision making and accountability of the new Single Supervisory Mechanism involving the ECB. The new framework has to ensure that the ECB can continue to conduct effectively and independently its current tasks, and it has to take into account the concerns of non euro area Member States regarding governance of the new supervision. This requires appropriate governance structures and a clear division of responsibilities between a new ECB Supervisory Council, which may include representatives from all Members States, and the Governing Council of the ECB. To ensure the accountability of the new Supervisory Council, it should report on the stability situation and its decisions to European Finance Ministers (Ecofin Council or Eurogroup ) as well as provide reports to the European Parliament and national Parliaments."

Key points in my view are:

  • Core problem is the coordination of regulatory systems for euro area banks and non euro area banks is now further fractionalized into the space of 'supervised Euro area banks', 'non-supervised Euro area banks' (assuming the new Single Supervisory Mechanism (SSM) applies only to systemically important banks), 'non-Euro area banks in countries under mechanism', 'non-Euro area banks outside mechanism but inside the mechanism-covered countries', 'non-Euro area banks in countries outside the mechanism'.
  • The role of the Supervisory Council vis-a-vis the Governing Council of the ECB
  • The extent and nature of reporting by the Supervisory Council as well as the extent of the Ecofin / Eurogroup and EU Parliament oversight (if any) over the Supervisory Council activities.

"Regarding longer term issues, we discussed basic principles for enabling direct ESM bank recapitalisation, which can only take place once the single supervisory mechanism is established and its effectiveness has been determined. Principles that should be incorporated in design of the instrument for direct recapitalization include: 
1) direct recapitalisation decisions need to be taken by a regular decision of the ESM to be accompanied with a MoU; 
2) the ESM can take direct responsibility of problems that occur under the new supervision, but legacy assets should be under the responsibility of national authorities; 
3) the recapitalisation should always occur using estimated real economic values; 
4) direct bank recapitalisation by the ESM should take place based on an approach that adheres to the basic order of first using private capital, then national public capital and only as a last resort the ESM."

Points of note here are:

  • ESM recapitalization of the banks can only take place after the SSM is both established and proven in its effectiveness. Time scale for this? Anyone's guess. While time scale for Spanish economic meltdown is pretty well in front of our eyes.
  • Full and formal MoU will be required - a political no-go territory for some countries, though in fact the EU can fudge this requirement by simply re-printing as an MoU already ongoing 'reforms' processes.
  • Legacy assets should remain under the responsibility of national authorities, which means there is no coverage under the ESM for crisis-related assets. One can interpret this, possibly, as a de facto no to any removal of the Irish banks assets off the hands of the Irish state. One can also read this as a potential for restructuring some of the Irish Government liabilities relating to banks, but only to the extent of altering the cost of funding these liabilities (e.g. ESM loan with no change in actual liability risk, so that Irish banks-related debts will remain Irish Government liability).
  • Point (3) implies no 'future economic value' in computing ESM-available funding. In other words, losses incurred will not be covered. Which opens the question - who will cover the losses?
  • Point (4) is clear with respect to equity holders (these take the hit first, then the state owned equity is wiped out, only after that - ESM), but what about lenders to the banks (private bondholders and official lenders, including ECB)?


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