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24th March 2020
Banking & Finance Covid-19

Analysis: “Fighting the fallout: the ECB adopts a purchase programme in response to the coronavirus” by Marijn van der Sluis

Things are moving fast in the Eurozone. On Wednesday night, after an emergency session of the Governing Council, the ECB announced the Pandemic Emergency Purchase Programme (PEPP). Through the PEPP, the ECB will buy 750 billion euros worth of securities before the end of 2020. PEPP is an addition to other measures announced on 12 March 2020 that also aimed to counter the destabilising economic effects of the coronavirus. These measures included an increase in the monthly purchases through the Assets Purchases Programme (APP) and were analysed by Christy Ann Petit here. Moreover, last week, the Commission decided to activate the ‘general escape clause’ of the Stability and Growth Pact, and Prime Minister Conte of Italy stated that the ESM should be activated. Many EU Member States also announced unprecedented fiscal measures to counter the economic effects of the struggle against the coronavirus.

This post will describe some key characteristics of the PEPP and, in order to analyse its legal characteristics, compare it with the Public Sector Purchases Programme (PSPP) and the Outright Monetary Transactions (OMT) programme. For an analysis of the broader context of PEPP, also see the analysis by René Smits here.

 

The setup of PEPP

The first thing to note about the PEPP is the lack of available detail. This is no coincidence, as it reflects a key attribute of the PEPP itself, namely the flexibility in the setup and constraints. Not only does the programme have significant flexibility built in, the announcement ends with the statement that self-imposed limits might be revised, when necessary. The lack of detail is apparent in the very short press release for the PEPP. The blog that ECB President Lagarde posted on the topic contains few additional details (on a side note: this is the second post on the ECB Blog, which is a new mode of communication for the ECB).

The purchases through PEPP will continue at least until the end of 2020, and will then only cease when the Governing Council finds that the coronavirus crisis phase is over. The timing of the purchases over the coming months is not determined ex ante, allowing the ECB to ‘manage the staggered progression of the virus and the uncertainty about when and where the fallout will be worst’. The official aim of the programme is to counter ‘risks to the monetary policy transmission mechanism and the outlook for the euro area’.

The securities that can be bought through PEPP are the same as under the APP, which covers several programmes and includes securities from both public and private actors. The group of eligible securities is furthermore broadened by waiving eligibility requirements for Greek government bonds. Also relevant is that in the announcement for PEPP, the eligibility requirements for CSPP were broadened, in order to include short-term debt instruments.

For the purchases of government bonds (including those of regional authorities), the capital key of the ECB will be the guiding benchmark, meaning that purchases will be distributed among the euro area Member States. However, there is flexibility here again, as the distribution of purchases among jurisdictions may fluctuate over time. This allows the ECB to focus, temporarily, on the situation in a specific Member State.

What is not clear from the announcement, is how the PEPP is executed in terms of decentralisation. For the Public Sector Purchases Programme (PSPP), it was clear that National Central Banks would make 92% of the purchases, leaving 8% for the ECB itself. For PEPP, it is unclear if the ECB will also make purchases. Moreover, for PSPP it was also clearly indicated that for 80% of the purchases, there would be no risk sharing: the risks would remain at the NCBs. For PEPP, no mention is made of the risk-sharing regime. Although Article 32(4) of the ESCB/ECB Statute (attached as a protocol to the Treaties) indicates that loss sharing is exceptional, losses under the Third Covered Bond Purchase Programme will be shared. This is a matter to be clarified.

The announcement made no explicit reference to purchase limits, such as those in place under PSPP. Under PSPP, the ESCB is subject to a 33% issue share limit and a 33% issuer limit. This should prevent the ESCB from acquiring a blocking position for possible restructurings of sovereign bonds or becoming a dominant creditor. Although the purchase limits apply to PSPP, and apparently not to PEPP, the limits are nevertheless relevant, as purchases of bonds under the PSPP have also been ramped up since last week. PEPP purchases might thus lead the PSPP to run into its self-imposed boundaries.

Perhaps the most relevant part of the PEPP announcement is thus the one at the end, where it states that the Governing Council will reconsider some self-imposed limits to the extent that they hamper action that stands in the way of the fulfillment of the ECB mandate. Although this most obviously relates to the purchase limits, it might also cover other aspects of the setup of the programme, such as the eligibility criteria.

 

PEPP: a bit of OMT, a bit of PSPP?

This legal analysis of the PEPP starts with the cautionary note that the many legal issues that surround PEPP will probably be seen in a different light, as the crisis develops. It is worth remembering that the two seminal cases of the first euro-crisis (Pringle and Gauweiler), only arrived at the CJEU after a significant set of policy reforms (from the EFSF to ESM and from SMP to OMT). For example, if Italy receives financial assistance through the ESM, this might lead the ECB to activate OMT. This would probably shift the spotlight away from PEPP to OMT.

How then, does PEPP compare to OMT and PSPP? PEPP shares characteristics with both. At first sight, this appears to confirm the legality of PEPP, since both measures were approved by the CJEU, but the merging of characteristics leads nonetheless to some legal issues. First, there is the aim of PEPP, namely protecting the monetary policy transmission mechanism and to counter the serious risks to the outlook of the euro area. The former part is reminiscent of OMT. In Gauweiler, the CJEU approved the protection of the monetary policy transmission mechanism as an objective of monetary policy. However, for OMT the cause for the disturbance of that mechanism was the fear of euro area disintegration, affecting specific countries. Except for the economic response to the unfortunate remarks by ECB President Lagarde that the ECB is ‘not there to close spreads’, it is not clear that such a threat is present at the moment. Moreover, even if there is such a threat with regard to a specific Member State, it is not clear why OMT is insufficient to protect the monetary policy transmission mechanism from that particular threat.

The current crisis is different, according to Lagarde in her blogpost, as the shock that the Eurozone now faces is exogenous and affects all Eurozone Member States. Hence, as OMT can only be targeted at individual MS, a new programme is necessary. This specific need for intervention with regard to the monetary policy transmission mechanism was also discussed in the blogpost by Executive Board Member Lane.

The question is, however, whether PEPP will effectively supersede OMT for the time being, or under what circumstances OMT and PEPP might run simultaneously. To delineate the boundaries of PEPP, it is necessary to separate the economic effects of the shock induced by the pandemic, from the underlying, pre-existing economic issues of the different Member States. Where the economic crisis starts to affect a single Member State individually based on pre-existing economic conditions, rather than as part of the Eurozone economic shock as a whole, PEPP would be an inappropriate tool. In such a case, the OMT would be the appropriate measure. It will, however, be extremely difficult to make such a clear distinction in practice. Nonetheless, if PEPP would replace the OMT in effect, for the time being, the accusation is easily made that PEPP is OMT, just without the conditionality. This brings it one step closer to the red line of the prohibition of monetary financing.

In other ways, PEPP more closely resembles PSPP, the purchases programme for government bonds in place since 2015, especially with regard to the use of the capital key for the allocation of purchases among jurisdictions. Although there will be flexibility in the application of this benchmark, PEPP is not a selective instrument that allows the ECB to focus on a specific Member State for a longer period of time, at least for now. Ultimately, there must also be purchases of other Member State bonds. Although Lagarde mentioned that the current crisis affects all the Eurozone Member States, it is unclear whether the coronavirus crisis will indeed affect the transmission mechanism in a similar way across jurisdictions. For PSPP, the use of the capital key to allocate purchases was justified by the desire to raise inflation across the Eurozone. As we are currently in the midst of draconian measures to combat the coronavirus and the economic effects are far from certain, it is unclear if the Member States are going to be affected similarly. However, the purchases of securities must in the end align with the capital key. It is therefore not clear whether all purchases are then truly necessary, and hence, whether the measure is proportionate in this sense. Perhaps here the second part of the objective of PEPP plays a role, although its meaning is, if possible, even less clear. ‘Protecting the outlook of the euro area against serious risks’ is a catch all-phrase for any form of economic harm that might ultimately affect price stability.

To avoid confusion, the issue is not whether the ECB should or should not intervene, but that the stated objectives, means of intervention and the chosen restrictions must form a coherent whole that satisfies the appropriate legal tests. In the current circumstances, and in respectful disagreement with René Smits, that cannot yet exhaustively be determined.

Beyond the mere issue of legality, PEPP also has significant ramifications for ongoing debates about the governance of the euro area. For example, the connection in OMT between support and financial assistance measures was about more than economics, it also protected the ECB from becoming (even more) involved in political debates. By requiring a bailout package in place before intervening, the ECB required political agreement about the way forward. Member States seeking assistance could be redirected by the ECB to the European Council and Eurogroup. Even if financial assistance will now be provided with minimal or no conditionality, the ECB would still be able to ‘hide’ behind the consensus in the Eurogroup. By letting go of the requirement of a bailout package, and by possibly suspending the purchase limits, the ECB is going to enter extremely fraught terrain. There are already signs that PEPP reintroduced disagreement among the euro area Member States and in the Governing Council. The calls to bring the ECB under tighter political control have been growing over the last years, as the political nature of central banking was repeatedly confirmed during the crisis. PEPP is sure to intensify that debate.

Lastly, the sizeable intervention by the ECB to restore the monetary policy transmission mechanism displays a great overlap with another task, left explicitly to the Member States, namely that of Emergency Liquidity Assistance (ELA). Throughout the euro-crisis, the use of ELA has been a matter of controversy, as it is provided at the risk of the NCBs, but can be halted by the Governing Council. Especially after the creation of the Banking Union, keeping ELA as a national responsibility has been seen as inconsistent with the overall setup of the EMU. PEPP once again shows that in crisis situations, (emergency) liquidity is a responsibility of the ECB. ELA is an anomaly.

To conclude, the legal debate of PEPP is likely to evolve over time, as more national fiscal measures, and perhaps some European economic measures are adopted. Much will depend on how PEPP is implemented. The success of OMT lay in part in the fact that it did not need to be used. Its effect lay in its announcement. For PEPP, the ECB does not have that luxury, and it can only be hoped that it will succeed in minimising stress in the financial markets, thereby helping Member States and the EU to fight the pandemic.

 

Dr. Marijn van der Sluis is Assistant Professor in Constitutional Law at Maastricht University. He writes on constitutional law, European integration and economic law. In 2017, he defended his thesis at the European University Institute: ‘In Law We Trust: The role of EU Constitutional Law in European Monetary Integration’. Recent publications include a case note of the Weiss-case (available here) for Legal Issues of Economic Integration and a working paper on the ongoing negotiations of the Eurozone budget (the Budgetary Instrument for Convergence and Competitiveness) for the Maastricht Working Paper Series, available here

 

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