14 January 2015

What are the key findings of the ECJ Advocate General (AG) opinion?

Ultimately, the opinion finds that the ECB’s Outright Monetary Transactions (OMT) programme is in line with EU law:

The OMT programme decided upon by the ECB…does not infringe the principle of proportionality and may be considered lawful, provided that, in the event of the programme being implemented, the obligation to state reasons and the requirements deriving from the principle of proportionality are strictly complied with.

ECJ Advocate General Cruz Villalón, Opinion, 14 Janaury 2015

Importantly the opinion notes that the ECB must be given significant discretion on monetary policy matters:

ECB must have a broad discretion when framing and implementing the EU’s monetary policy, and the courts must exercise a considerable degree of caution when reviewing the ECB’s activity, since they lack the expertise and experience which the ECB has in this area.

ECJ Advocate General Cruz Villalón, Opinion, 14 Janaury 2015

This could be an important legal precedent and may be seen as a veiled message to the German Constitutional Court (GCC). Ultimately, it suggests that the ECJ and GCC should be wary of ruling on monetary policy issues. However, this then raises the question of the level of oversight of the ECB. While it is independent, it should still be subject to oversight, especially since it has taken on a very active role in the crisis, amassed significant power and influence as well as taking on new roles such as financial supervision.

What conditions does the opinion lay out for the ECB using the OMT?

  • “The ECB must…refrain from any direct involvement in the financial assistance programme that applies to the State concerned”. As we know, the OMT can only apply to countries currently on the markets, but a bailout programme has to be launched in conjunction with OMT to provide conditionality. The ECB will now no longer be part of the Troika for said bailout. This does raise questions about the future of the EU/IMF/ECB Troika as a whole (a construct which many, including the European Parliament, are keen to do away with). However, since the OMT is increasingly less likely to be used, this may never come to pass.
  • “ECB must give a proper account of the reasons for adopting an unconventional measure such as the OMT programme”. Again this is not a particularly onerous condition, since the ECB would likely have had to explain its position somewhat anyway. Furthermore, with the new release of ECB accounts/minutes, the logic behind big decisions (such as launching an OMT programme) will be much better explained and more public.
  • Purchases must also be on the “secondary markets” and should allow a “market price” to form. Essentially this means that the ECB can buy bonds but there is an unspecified limit in terms of a market impact. There must be sufficient liquidity and private sector trading left in the secondary market for a clear price to be formed, absent the influence of the ECB. This is a more interesting condition but has again already been hinted at by the ECB since it is well aware that it cannot completely purchase the outstanding market for government bonds of a country.
  • Ultimately, these conditions seem largely superficial and are not particularly onerous for the ECB. They confirm and enshrine an approach which the ECB was already largely likely to take in a de facto sense.

Has the ECJ answered the key questions referred to it by the German Constitutional Court (GCC)?

  • It is hard to imagine that the GCC will be satisfied by this opinion and by the ruling if it follows it closely (which is often the case).
  • There seems to be little discussion over some crucial issues raised by the GCC including – whether bond purchases can be unlimited or not, and whether the ECB is should be senior to other investors if it ever came to a restructuring of bonds purchased.
  • The dismissal of the OMT as a form of economic policy is also likely to be an issue for the GCC, which suggested in its ruling that the programme is ‘ultra vires’ (suggesting the ECB has exceeded its mandate). It was never really down to the ECB’s role in the Troika that the OMT was seen as economic policy but more because it is a targeted programme designed to aid the economic circumstances of member states.
  • The one point which the GCC may take some solace from is the comment on market pricing. This could be interpreted as a clearer limit on what section of a market the ECB can buy and therefore may act as a de facto limit on the size of purchases. However, the opinion does not lay down any metrics for judging the market impact and it will likely be left to the ECB’s discretion.

What happens next?

This is just the opinion of the ECJ’s Advocate General Cruz Villalón, the Court as a whole will issue a final ruling in the coming months. The issue will then be sent back to the GCC which will have to decide on its final ruling on the original case brought against the OMT in light of the ECJ ruling. It seems likely the ECJ ruling will follow the AG opinion closely due to the technical and controversial nature of the case.

How might the German Constitutional Court respond?

If the ruling does follow the same lines, the GCC will be in a very tough situation.

  • It is clear from its original findings that it believes the OMT to be illegal. It did say it could foresee approving the programme if conditions were applied, but these conditions are unlikely to suffice. For one, the ECB is not senior in a debt restructuring, a point the Court explicitly mentioned as necessary. Furthermore, the prospect of unlimited purchases remains.
  • The GCC cannot rule on EU law and must accept the final ruling of the ECJ. However, as it pointed out in its original response to the case, if it feels the OMT is illegal, then it has an obligation to “refrain from implementing it” at least for German “constitutional organs”.
  • It would face a stark choice then of dropping its objections almost entirely or asking for the Bundesbank not to participate in any OMT programme. The latter could be enforced by the Bundestag refusing to approve any bailout linked to the OMT and could well therefore make the OMT invalid. This is less of an issue economically since the OMT is soon likely to be replaced by purchases of sovereign bonds under QE. But such a legal and political dispute between the largest EU member and the ECJ could be a huge problem. It seems likely the ECB would challenge the prohibition of the Bundesbank taking part in OMT at the ECJ – thereby setting up a direct conflict between the ECJ and GCC. These discussions and rulings will be of crucial importance for German sovereignty and as a legal precedence in the EU.
  • Similarly, if the GCC does overturn its concerns, it could de facto be seen as having given into the ECJ. This could again set a precedent for the ECJ trumping national constitutional courts.

 Does the opinion have any implications for the structure of Quantitative Easing (QE)?

  • Since the conditions are not particularly stringent the implications are likely to be limited. It confirms that purchases must be on the secondary market and must be proportional.
  • The market impact condition is probably the most important. If the ECB conducts QE based on the capital key of the ECB, it could find itself purchasing significant amounts of debt in small countries or those countries with lower debt levels (such as the Baltics). This would amount to a significant distortion of the debt markets in these countries and therefore may raise questions over monetary financing.
  • Tackling this issue is tricky because it would be difficult to exempt any countries from QE and yet still see it as blanket monetary policy, without targeting specific problem countries. One option would be to start the purchases off slow and stagger them in monthly interventions so the market impact is more mundane. Of course, this then limits the effectiveness of the policy itself. This is not a brand new problem for the ECB and it has largely always worked in the knowledge that it cannot intervene to the extent that it completely dominates a single sovereign debt market.