meaningful results



OMT and the ECJ

Ultimately a country like, for example, Greece has to finance itself by issuing bonds to a private sector (commercial banks and other investors) who will be wary of Greece’s ability to pay its debts and want a high interest rate to compensate for the risk that they won’t get back the amount they’ve invested. Of course Greece can’t afford to pay a high interest rate, but the risk to investors – and so the interest rate Greece has to pay - can be reduced by the prospect of bailout funding from other member states with a better credit rating if things turn bad.

In these ‘bailouts’ the money comes from other member states, not the European Central Bank (ECB). But that also means that however large the fund, it is actually limited, and might not be enough to fend off speculative pressure and keep borrowing costs down on bonds issued by Greece by enough for the bailout to work.

Now because the ECB can create as much of its own currency as it likes its own funding capacity is unlimited, and so when its head Mario Draghi has promised to do ‘whatever it takes’ he means that if borrowing costs for a country that is being bailed out come under pressure the ECB will produce as much money as necessary and buy as many bonds issued by that country as necessary to keep that country’s borrowing costs down. This is called the Outright Money Transactions (OMT) scheme.

The rather large fly in the ointment is that the ECB isn’t actually allowed to finance member states, so cannot simply give Greece money in return for its bonds. So the ECB is saying to the private sector that if they invest their money in Greek bonds issued with a riskily low interest rate, then the ECB will take them off their hands at a price that will ensure they don’t lose any money.

This has been challenged before the German Constitutional Court, who has asked the European Court of Justice (ECJ) whether this cunning plan in fact breaches the ban on the ECB financing member states. The ECJ’s Advocate-General has now given his Opinion here on the questions raised, and the ECJ usually follows this Opinion in its judgements.

One of the main issues of substance before the court is that if this meant the ECB promising to take the bonds off the original buyers as soon as they bought them (which is about the only way of guaranteeing they won’t have to bear any risk) this would be just the same as if the ECB bought them directly in the first place. The Advocate General makes clear that this would be illegal, but to make it legal the ECB just has to wait for the bonds to settle to a ‘market price’ and it looks as though only a day or two might be an acceptable delay. Obviously there will be some risk for the original buyers that a cataclysmic event might occur during that period (like just happened when the Swiss stopped paying a guaranteed price for euros!) and while that make a bit of difference to the price, it doesn’t look as if that would be a show-stopper.

The second main issue is that the ECB is only allowed to conduct monetary policy and not economic policy. However, the ECB intends to use OMT to buy bonds issued only by member states who are already being bailed out in a financial assistance programme. That is, they are being helped out by the other member states in return for agreeing to ‘structural reform’. As structural reform is usually a euphemism for ‘cut public spending’ that could clearly count as conducting or directing economic policy. The Advocate-General makes clear that this is not on, and if OMT were put in place, the ECB would immediately have to stop its own involvement in the original financial assistance programme where it would previously have been a key player. It could not take an active part even in monitoring the progress of the programme.

In real-world terms, it’s a bit like saying that a bank will only give a mortgage to the person who is going to live in the property, and so your parents (who could get a lower interest rate because of a better credit-rating) can’t take out the mortgage on your behalf. But the bank will lend you the money at the lower rate if your parents guarantee the repayments. Your parents might have said they would only do this is you don’t waste your money on drinking and clubbing, and you agree to show them what you’re spending each week so they can keep an eye on things. But if the guarantee is called upon, and the parents actually have to start funding the payments themselves, then they won’t be able to check what you’re spending your money on anymore, and they will have to rely on what other relatives or your neighbours tell them is going on.

So in summary the Advocate-General’s Opinion is that the ECB could legally buy bonds itself to help with bailouts so long as it does so on the open market rather than directly from the country being bailed out, and at the same time removes itself from any involvement in the ongoing bailout.

Presuming that the ECJ follows the Advocate-General’s opinion, does that deal with the legal challenge then? Well only if the German Constitutional Court actually accepts it.

Article 267 of the Treaty on the Functioning of the European Union says

"The Court of Justice of the European Union shall have jurisdiction to give preliminary rulings concerning: (a) the interpretation of the Treaties; (b) the validity and interpretation of acts of the institutions, bodies, offices or agencies of the Union; Where such a question is raised before any court or tribunal of a Member State, that court or tribunal may, if it considers that a decision on the question is necessary to enable it to give judgment, request the Court to give a ruling thereon.

So where a court has to take into account EU law, it can ask the European Court of Justice to make a judgement on the point of EU law first. The ECJ’s decision is called a ‘preliminary ruling’ only because it is made before the national court’s decision, not because it is any way tentative or uncertain or capable of being over-ruled by the national court. Once the national court has the ECJ’s ruling on the effect of the EU law, it can then go ahead and make its decision. But the ruling on the EU law points are binding on the national court. That’s the idea, anyway.

However in this particular case, there is an awful suspicion that the German Constitutional Court might not feel bound to do as the ECJ says. In referring the matter to the ECJ, the Germans said only they would treat its ruling as ‘in principle … a binding interpretation of EU law’ because at issue is ‘the ‘constitutional identity’ of the Federal Republic of Germany ... because of the consequences which the contested act is said to entail for the national constitutional body which is first and foremost responsible for expressing the will of the citizens.’ The will of the German citizens is of course presumably that they shouldn’t end up being responsible for other countries debts. In the ECJ proceedings, the Spanish, Dutch and Italian governments were so concerned about the wriggle-room provided by that ‘in principle’ that they argued that the German court shouldn’t even be able to ask for a ruling because it suggested that there was at least a theoretical possibility that they might not treat the ruling as binding.

The Advocate General worries about this too, noting that if the German Constitutional Court can determine the inviolable core of constitutional identity and to review whether the measure (as interpreted by the Court of Justice) encroaches on that core’ (para 56 of his Opinion) then it would become ‘an all but impossible task to preserve this Union, as we know it today, if it is to be made subject to an absolute reservation, ill-defined and virtually at the discretion of each of the Member States, which takes the form of a category described as ‘constitutional identity’ (para 59). And further ‘a clearly understood, open, attitude to EU law should in the medium and long term give rise, as a principle, to basic convergence between the constitutional identity of the Union and that of each of the Member States.’ (para 61). Some might say that this is essentially saying that actually one member state should not be able to say that its people don’t want to be responsible for other people’s debts if that’s what ‘the Union’ wants. Which presumably might not go down well with the German Constitutional Court and in fact lead them to reject the ECJ’s decision if that’s they thought it meant.

Recognising this tension, the Advocate-General rather agonises about what to do about it, and plumps for encouraging everyone involved to recognise everyone else’s concerns on the basis of a principle of sincere co-operation. ‘In the first place, substantively, that principle requires the Court of Justice to respond in the greatest spirit of cooperation possible to a question which has itself been referred to it in the same spirit; there cannot be the least doubt about that. In particular, if the national court, in explaining the extent to which the act in question causes it to have serious doubts as to validity or interpretation, has been particularly plain-spoken, that will have to be interpreted as an expression of its level of concern in that regard. I understand that that is the sense of the German Government’s appeal for ‘constructive’ treatment of the present case. (para 65) 

This rather seems to be saying that the ECJ should try as hard as possible to give a decision that would not be likely to be rejected by the German Constitutional Court, and that then ‘In concrete terms, that means that the Court of Justice … would in fact trust the national court — once it has considered the answer provided by the Court of Justice to the question raised and without prejudice to the exercise of its own duties — to accept that answer as decisive in the proceedings before it. Sincere cooperation involves an element of trust...’

So the legal issues around the ability of the ECB to go ahead with OMT haven’t actually been settled yet. Firstly, the ECJ has still got to make a formal judgement. If it follows the Advocate-General, it’s clear that OMT would have to be carried out differently from what might have been originally planned – that is, the ECB must wait for a market price to be established and remove itself from bailout involvement. That might create some difficulties in implementation. But secondly, we don’t know yet whether this will address the concerns of the Germans who have challenged it. Nor, if it doesn’t address their concerns sufficiently, do we know whether the German Constitutional Court will accept the ECJ judgement.

Some uncertainties remain ...