Overview : The ESM: The First Building Block?

This week, the European Stability Mechanism (ESM) issued its first long-term bond, exactly a year after starting up operations. Until now, it had solely raised cash trough short-term notes, 3 and 6-month instruments. With this inaugural bond issue, the ESM placed €7bn in 5-year bonds on financial markets, at a rate of 1.9%. As expected, the ESM was able to raise funds somewhat cheaper than its predecessor, the European Financial Stability Fund (EFSF). This is mainly because its capital structure, which consists in EUR 80bn in paid-in capital and EUR 620bn in callable capital, is expected to be more solid than that of the EFSF, which only benefits from member country guarantees. ESM issues are bound to grow in importance in the quarters ahead, notably as it will be necessary to roll-over the notes to the Spanish banking sector as part of the recapitalisation programme1. At this point, the funding programme of the ESM amounts to EUR 9bn in 2013 and EUR 17bn in 2014.

As a support facility for member states and as their new arm for preserving the stability of the eurozone, ESM already benefits from a very complete toolbox. First, it can make direct loans to ailing states, either to finance a full macroeconomic adjustment programme, as it already does for Cyprus, or to finance a programme designed solely to recapitalise the banking sector, as it already does for Spain. A third option is to open a precautionary credit line for a country so that it can either continue financing itself on the markets, in case it ever encounters difficulties, or to prepare for its return to the financial markets, a case Ireland is seriously considering. Lastly, it can intervene directly in the sovereign markets, with primary market purchases (as part of an adjustment or a precautionary programme) or with secondary market purchases (for any member country, whenever the ECB deems the financial stability of the Eurozone is threatened). Currently, the ESM’s capacity for future action is still largely intact since the Spanish and Cyprus programmes, at EUR 41.3bn and EUR 9bn, respectively, only require 10% of its total lending capacity of EUR 500bn2.

Destined for greater things? Some hope so…
One thing can be said for sure, the European Stability Mechanism is here to stay as part of European construction. Although it was designed as a response tool for the current crisis, its stakeholders, the Eurozone member states have decided to make it a permanent institution, unlike the EFSF. Many are predicting that one day it will have a much bigger role to play, together with much higher financial resources.

The Europeans have taken a new step recently by accepting that the ESM could directly recapitalise distressed banks in the future. Contrary to what happened for Spain, the support provided would not be written as a liability for the member state, i.e. would not increase its public debt. This will only be possible once the ECB’s Single Supervision Mechanism is operational, under very strict conditions and as a last resort3. Although the probability of such an intervention remains low (especially since the main eurozone banks will have to demonstrate that they are sufficiently capitalised before they are transferred to ECB supervision), some want to see this option as the first step towards real risk-sharing within the eurozone.

The most fervent supporters of greater eurozone integration – far greater than what is currently being designed – hope to go much further. In the fiscal field, for example, advocates of a mutualisation of European debts via Eurobonds or Eurobills would like to see the ESM transformed into a genuine European Treasury, responsible for issuing shared debt and for the distribution of the proceeds4. Turning to the banking union, Michel Barnier, the European Commissioner for the internal market and services, proposed this week that the ESM could ultimately take on the role of the Single Resolution Mechanism, a forthcoming institution that is currently a subject of fierce debate between the European Commission and member states5.

Several of the European Stability Mechanism’s characteristics make it the natural vehicle for greater integration. In addition to its permanent status and its ability to raise market funds, we must also keep in mind its governance. The ESM has a Governing Council comprised of eurozone finance ministers.

Although unanimity is still the name of the game, some decisions can be made, under exceptional circumstances, by a qualified majority. In this case, the vote of each governor is weighted according to the Member State’s equity stake in ESM, roughly similar to its weighting within the eurozone. This surely foreshadows some of the characteristics of the democratic pillar of the “genuine Economic and Monetary Union”, should it see the light of day in the future6. Without it, it is inconceivable that the large countries of the Eurozone envision a real transfer of sovereignty. Several other obstacles remain, beginning with the fact that a broader role for the ESM would almost certainly require revising the European treaties. In addition, there are certainly numerous opponents to the idea of federalism in the Eurozone. Dreaming is one thing, turning it into reality is another.

BY Frédérique CERISIER