On July 8, 2015, the new Greek Finance Minister Euclid Tsakalotos submitted a request for a third loan package to the European Stability Mechanism (ESM). The ESM was set up in 2012 as a permanent intergovernmental organization under public international law to issue debt instruments in order to finance loans and other forms of financial assistance to euro-area member states in financial distress. The euro-area member states are the 19 European Union (EU) countries that have adopted the euro as their currency. The Greek request was forwarded by the Chairperson of the ESM Board of Governors Jeroen Dijsselbloem to the European Commission and the European Central Bank (ECB). The European Commission and the ECB prepared an assessment of the potential risk to the financial stability of the euro-area, the sustainability of public debt, and the financial needs of Greece. This assessment served as the basis for the decision of the euro-area member states of July 12, 2015, to agree in principle to start negotiating a third loan package. As a precondition for a new loan package from the ESM, the euro-area member states demanded that Greece also apply for continued International Monetary Fund (IMF) support.
In this post, I take a look at the structure and legal status of the ESM rescue mechanism, its capital structure, the decision making process, and the procedure for a loan request. In my next post, I will look at systems put in place to ensure compliance with the terms of a loan agreement; the difference between the ESM and its predecessor the European Financial Stability Facility (EFSF); previous financial assistance facility agreements with Greece; and the relationship between the ESM and the IMF.
1. What is the European Stability Mechanism (ESM)?
Article 136, paragraph 3 of the Treaty on the Functioning of the European Union (TFEU) provides that euro-area member states “may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro-area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.” In 2012, the then 17 member states of the euro-area signed an intergovernmental treaty to set up such a stability mechanism, the European Stability Mechanism (ESM). As noted above, the ESM is a permanent intergovernmental organization under public international law. (ESM Treaty, art. 1.) Although established by euro-area member states, it is not an EU institution.
The purpose of the ESM is to mobilize funding and provide financial assistance to an ESM member which is experiencing, or is threatened by, severe financing problems. (Id. art. 3.) The granting of financial assistance is subject to strict conditionality. (Id. art. 12, para. 1.) Strict conditionality means that financial assistance is only provided in exchange for macroeconomic reforms or other pre-established eligibility conditions. The terms of the conditions are fixed in a memorandum of understanding (MoU).
To fulfill its purpose, the ESM is entitled to raise funds by issuing financial instruments (bonds) or by entering into financial or other agreements or arrangements with ESM members, financial institutions or other third parties. (Id. art. 3.) The ESM’s initial maximum lending capacity is €500 billion. (Id. art. 39.)
2. How is the ESM’s capital structured?
The ESM has an authorized capital stock of approximately €705 billion divided into shares with a nominal value of €100,000 each. The capital stock consists of paid-in capital (€80 billion) and callable capital (€625 billion). All the euro-area member states subscribe to the shares of the ESM according to an initial contribution key. (Id. art. 8, para. 1; Annex I.) The contribution key is based on the key for subscription of the ECB’s capital (id. art. 11, para. 1) and reflects the respective country’s share in the total population and gross domestic product of the euro-area. (Statute of the ESCB and of the ECB, art. 29.) The countries with the largest contribution are Germany (26.96%), France (20.25%), Italy (17.79%), and Spain (11.82 %). The liability of each ESM member is limited to its portion of the authorized capital stock at its issue price. (ESM Treaty, art. 8, para. 5.)
At the end of April 2014, the 17 original ESM members transferred the last tranche of the paid-in capital of €80 billion.
Paid-in capital may not be used for loans. It is invested in high quality liquid assets in accordance with the ESM Guideline on Investment Policy. The paid-in capital also serves as a security buffer for the bonds that the ESM issues. The proceeds from bond sales are used to finance loans to ESM members. (ESM Treaty, art. 3.)
3. How is the ESM governed and how are decisions made?
The ESM has a Board of Governors and a Board of Directors. (Id. art. 4, para. 1.) For both bodies, a quorum of two-thirds of the members with voting rights representing at least two-thirds of the voting rights must be present in order to take decisions. Decisions are taken by mutual agreement, a qualified majority, or a simple majority as specified in the treaty. (Id. art. 4, para. 2.) Decisions by mutual agreement require unanimity of all members present, but abstentions do not count. (Id. art. 4, para. 3.) The adoption of a decision by qualified majority requires 80% of the votes cast (id. art. 4, para. 5), whereas a simple majority requires a majority of the votes cast (id. art. 4, para. 6). The voting rights of each ESM member are equal to the number of shares allocated to it in the authorized capital stock of the ESM. That means that Germany (26.96%) or France (20.25%) individually could block a decision that requires a qualified majority of 80%.
The Board of Governors is the highest governing body of the ESM. It consists of the ministers of finance of the euro-area member states as voting members and the European Commissioner for Economic and Monetary Affairs, the ECB president, and the president of the Euro Group as non-voting observers. (Id. art. 5, paras. 1 & 3.)
Important decisions of the Board of Governors must be unanimous. (Id. art. 5, para. 6.) These include the decision to grant the request for financial assistance of an ESM member and to establish the choice of instruments and the financial terms and conditions. (Id. art. 5, para. 6(f).) If the European Commission and the ECB decide that a failure to urgently adopt a decision to grant or implement financial assistance would threaten the economic and financial sustainability of the euro-area, an emergency voting procedure can be employed. (Id. art. 4, para. 4.). Instead of unanimity, only 85% of the votes are needed for this decision.
The Board of Directors makes all the decisions that are not specifically reserved to the Board of Governors. (Id. art. 6, para. 6.) For the Board of Directors, each governor selects one director and one alternate director “from among people of high competence in economic and financial matters” as voting members. (Id. art. 6, para. 1.) As with the Board of Governors, a member from the European Commission for Economic and Monetary Affairs and the ECB may observe the meetings as non-voting members. (Id. art. 6, para. 2.) Decisions are taken by qualified majority unless otherwise specified in the treaty. (Id. art. 6, para. 5.) One important decision made by the Board of Directors is the disbursement of the individual tranches of an approved loan. (Id. art. 13, para. 5; art. 15, para. 5; art. 16, para. 5.)
4. What is the procedure for a loan request from the ESM?
Article 13 of the ESM Treaty in conjunction with the ESM Guideline on Loans delineate the procedure for granting “stability support.” Stability support is the term used for the requested financial assistance for member states. A euro-area member state in need of financial assistance from the ESM sends a request to the chairperson of the ESM Board of Governors. (ESM Treaty, art. 13, para. 1.) As stated above, Greece sent such a request for financial assistance in the form of a loan with an availability period of three years to the ESM on July 8, 2015. Under the ESM Treaty, the chairperson forwards the request to the European Commission and the ECB. The current Chairperson Jeroen Dijsselbloem forwarded Greece’s request on July 8, 2015.
The European Commission and the ECB assess the existence of a risk to the financial stability of the euro-area as a whole or of its member states (TFEU, art. 136, para. 3), the sustainability of public debt, and the financing needs of the ESM member making the request. The assessment of whether public debt is sustainable must be conducted together with the IMF. (ESM Treaty, art. 13.)
The decision, in principle, to grant financial assistance to the requesting ESM member is made by the Board of Governors taking into account the request and the assessment from the European Commission and the ECB. (Id. art. 13, para. 2.) This decision does not entail the conclusion of a final loan agreement, but can be qualified as an agreement to negotiate an agreement. The finance ministers of the euro-area member states decided on July 12, 2015, to start negotiations with Greece on ESM financial assistance.
The Board of Governors then mandates the European Commission and the ECB and, wherever possible, the IMF, to negotiate a memorandum of understanding (MoU) detailing the conditions and envisaged reforms in exchange for the loan (conditionality). (ESM Treaty, art. 16, para. 2.) In addition, the Board of Governors instructs the ESM Managing Director to prepare a proposal for a loan agreement, called a “Financial Assistance Facility Agreement.” (Id. art.13, para. 3.)
The proposal for a Financial Assistance Facility Agreement is circulated to the ESM Board of Directors, which decides whether to approve the terms and to disburse the first tranche of the loan. (Id. art. 13, para. 5.) Before the directors can approve an agreement, they need to obtain permission according to their respective national procedures. In Germany for example, the German representative can only approve an agreement if the German Bundestag (parliament) has authorized the person to do so. (ESM-Finanzierungsgesetz, § 4, para. 1.)
5. How long does the loan approval process take? Will there be bridge-financing for Greece?
The process to agree to the final terms of a Financial Assistance Facility Agreement for Greece from the ESM will take around 2-4 weeks. It depends on several factors, in particular how long some of the national approval procedures will take.
At the Eurogroup meeting on July 12, 2015, the finance ministers of the euro-area member states also discussed options for bridge-financing for Greece so that it can meet its financial obligations until the final agreement is concluded. They decided to set up an ad hoc working group of experts to explore all possible options. On July 14, 2015, the euro-area member states agreed to provide Greece with a short-term loan of three months in the amount of €7 billion to be disbursed in one installment and linked to economic policy conditionality. The loan will be given out by the European Financial Stabilisation Mechanism (EFSM) and will be repaid once the agreement with the ESM is finalized.
On June 30, 2015, Greece missed a first payment to the IMF in the amount of €1.5 billion and another payment of €456 million on July 13, 2015. Its arrears to the IMF therefore total around €2 billion to date.
Stay tuned tomorrow for my second post on the financial assistance processes currently being implemented in Europe.