Eurobonds: a possible and legally feasible remedy against liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone?

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Master Thesis Law & Finance

Eurobonds

A possible and legally feasible remedy against liquidity problems and

excessive spreads on sovereign debt instruments in the Eurozone?

Diederik van den Bogaerde Student number: 12853410 Supervisor: prof. dr. René Smits Word count (excl. front page, table of contents, bibliography, and abstract): 17896

of which 3524 are annotations Date: 17 July 2020

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ABSTRACT

This thesis discusses whether Eurobonds are a feasible and legal remedy against liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone. It shows that the introduction of Eurobonds comes with several advantages. These advantages include the provision of a safe asset that could break the bank-sovereign (doom) loop, enhanced fiscal discipline and risk-sharing, and the improvement of the monetary policy transmission mechanism. Furthermore, Eurobonds’ disadvantages, in particular moral hazard, have been discussed. Subsequently, an overview of the legal compatibility of Eurobonds with treaty law and (German) national constitutional law is provided. It follows that article 125 TFEU (no bail-out clause) and German constitutional law are incompatible with proposals that include a

joint-and-several guarantee. To allow for these proposals, a treaty change and amendments in the

German constitution would be necessary. Due to the political infeasibility of these changes to allow for fiscal risk-sharing, the proposals that include a joint-and-several guarantee cannot be regarded as a feasible and legal remedy against liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone. Contrastingly, proposals without a

joint-and-several guarantee, like the SBBS-proposals and ESBies, are compliant with treaty law and

(German) national constitutional law. Despite the fact that these proposals suffer from some flaws in their design that need further attention, these proposals can be regarded as (politically) feasible and legal remedies against liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone.

Keywords: Law & Finance; Eurobonds; EMU; No Bail-out Clause; Risk-Sharing; SBBS; ESBies; Safe Assets; Sovereign Bonds; Eurozone.

ACKNOWLEDGEMENTS

I want to thank my supervisor, prof. dr. René Smits, from the University of Amsterdam very much for his great and very committed guidance throughout the whole process of this master’s thesis.

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LIST OF ABBREVIATIONS

BVerfG Bundesverfassungsgericht (The German Constitutional Court) CJEU Court of Justice of the European Union

DMO Debt Management Office

EC European Commission

ECB European Central Bank EDA European Debt Agency EDP Excessive Deficit Procedure

EFSF European Financial Stability Facility

EFSM European Financial Stabilization Mechanism EJBs European Junior Bonds

EMU Economic and Monetary Union ERF European Debt Redemption Fund ESBies European Safe Bonds

ESM European Stability Mechanism ESRB European Systemic Risk Board

EU European Union

GDP Gross Domestic Product NCB National Central Bank

SBBS Sovereign Bond Backed Securities SPE Special Purpose Entity

SSM Single Supervisory Mechanism SRM Single Resolution Mechanism

TFEU Treaty on the Functioning of the European Union U.S. United States

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1. INTRODUCTION

Recently, in the light of the corona crisis, the discussion about European debt instruments has re-emerged.1_{The discussion concerning these measures was first started in the aftermath of the}

financial crisis of 2007-08 when the European sovereign debt crisis materialized.2_Several

countries were hit extra hard by the crisis; particularly those which (often) had already large budget deficits in the years before the crisis started. As governments of these countries suffered from liquidity problems, they could no longer afford to finance their growing budget deficits on the markets, and their financial situation worsened. The interest rates (hereafter: yields) on their sovereign bonds increased, since investors recognized these possible liquidity or even solvency problems. Eventually, several countries within the Eurozone had to be bailed-out;3

either through financial assistance from other member states or (in)directly through funds like the European Financial Stability Facility (hereafter: EFSF), the European Financial Stabilization Mechanism (hereafter: EFSM),4_{or the European Stability Mechanism (hereafter:}

ESM). Due to differences in yields, the so-called ‘spread’, between sovereign bonds of several countries within the Eurozone, the effectiveness and singleness of the monetary policy -the transmission mechanism- was affected. To maintain price stability -the primary objective of the European Central Bank (hereafter: ECB)-,5_{the ECB announced extraordinary measures. The}

most notable of which arguably was purchasing sovereign debt on secondary markets to address the liquidity problems and reduce the high yields on sovereign bonds of (in particular) these suffering countries.6

Ultimately, after the former president of the ECB, Mario Draghi, spoke the famous words:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the Euro. And believe

1_{Rankin, The Guardian 26 March 2020.}

2_{Darvas, Bruegel 10 November 2010.}

3_{Greece received bilateral loans from the other Eurozone countries on a bilateral basis in 2010. Ireland (2011),}

Portugal (2011), and Greece (2012) received assistance through funds of the EFSF, and later Spain (2012), Cyprus (2013), and Greece (2015) received further help through funds of the successor of the ESFS: the ESM. For further reading, see European Stability Mechanism 2020-1.

4_{Regulation (EU) 407/2010.}

5_{Artice 127(1) of the Treaty on the Functioning of the European Union; see also: CJEU 16 June 2015, C-62/14,}

ECLI:EU:C:2015:400, par. 127 (Gauweiler).

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me, it will be enough.”,7_{and further expanded the bond purchase program,}8_{the markets finally}

calmed down and stabilized.9

Currently, amid the Corona crisis, again, spreads between (mostly) the northern, and southern countries have increased, despite the extensive purchase programs of the ECB.10_{The question}

has been asked whether these purchase programs of the ECB are the (definitive) solution to the re-occurring problem. These doubts are supported by the recent objections of the German Constitutional Court (hereafter: BVerfG) against the PSPP program due to an alleged lack of balancing the benefits of the PSPP against its influence on non-monetary matters.11_{Also, future}

lawsuits against other purchase programs are being prepared in Germany.12_{Furthermore, a}

recent statement made by the current president of the ECB, Christine Lagarde, stating that “the

ECB is not here to close the spreads. This is not the function or mission of the ECB. There are other tools for that, and there are other actors to actually deal with those issues.” reinforced

these thoughts.13

As an additional or alternative response to these purchase programs, and to address both the liquidity problems and to stabilize and reduce the spreads between sovereign bonds, the common issuance of debt in the Eurozone,14_{so-called ‘Eurobonds’, has been suggested by}

scholars and European authorities in several different proposals.15_{Yet, Eurobonds remain}

highly controversial. Some member states, in particular the ‘frugal four’,16_{resist the proposals,}

as they are afraid that the introduction of Eurobonds -a possible mutualization of debt within the Eurozone- might lead to higher borrowing costs for them, fiscal indiscipline, and a permanent cashflow from the fiscally sustainable (mostly northern) countries, to the less fiscally sustainable (mostly southern) countries.17

7_{European Central Bank 2012-1.}

8_{Outright Monetary Transactions (OMT) replaced the former Securities Markets Programme (SMP). However,}

OMT was never activated. See European Central Bank 2012-2.

9_{Copelovitch, Frieden & Walter, Comp. Political Stud. 2016, 49(7), p. 816.}

10_{Van Kuppeveld, het Financieele Dagblad 18 April 2020.}

11_{BVerfG 5 May 2020, 2 BvR 859/15, ECLI:DE:BVERFG:2020:RS20200505.2BVR085915, par. 138 (Weiss et}

al. / Bundesbank).

12_{OMFIF 2012.}

13_{European Central Bank 2020-1. However, this statement was corrected the next day. See European Central}

Bank 2020-2.

14_{This has happened before with the issuance of the ‘New Community Instrument’ (‘Ortoli Bonds’). See}

COM(78)26 final; Regulation (EEC) 397/1975.

15_{See chapter 5.}

16_{Adler & Roos, The Guardian 31 March 2020.}

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The question which therefore arises is whether Eurobonds are a feasible and legal remedy against the liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone. Hence, the following research question will be discussed in this thesis: “Is it possible

and legally feasible to introduce Eurobonds in the Eurozone as a measure to combat liquidity problems and excessive spreads on debt instruments of different Member States in the Eurozone, and if so, which proposal fits best in the current legal system?”

To be able to answer this research question, this thesis will start in chapter 2 by discussing what caused budgetary problems in the Economic and Monetary Union (hereafter: EMU). This will be reviewed from three phases: first, the situation in the EMU before the sovereign debt crisis, secondly, the development of the crisis, and thirdly, policy responses that have been proposed as a response to the crisis. The 3rd_{chapter analyzes Eurobonds as a general concept, and in}

particular its strengths and weaknesses. Thereafter, chapter 4 will give a detailed review of the legal framework Eurobonds would have to comply with. The discussion of the legal framework will cover both European Union law and (German) national constitutional law. Furthermore, the 5th_{chapter provides a comparative analysis of six} _{Eurobond proposals:}_{Blue Bond / Red}

Bond, Eurobills, European Safe Bonds, European Debt Redemption Fund, and two proposals on Sovereign Bond-Backed Securities. All these proposals will be reviewed on how they function, and on their legal compliance. Finally, this thesis will be concluded in chapter 6 by answering the research question, based on the previous chapters.

1.2. Methodology

This research will be conducted from a legal and financial approach within both monetary European Union law and national constitutional law. Considering the limited scale of this thesis, national constitutional law will only be assessed from a German perspective, as it is among the most prominent courts to formulate objections against further European integration. Furthermore, it won’t be possible to discuss all the Eurobond proposals that have been suggested in the literature. Therefore, the scope of this thesis will be restricted to the six proposals mentioned in the previous section. These six proposals have been selected based on their differences in terms of a possible joint-and-several guarantee, their functioning, and how much they have been discussed in the literature. The table in Annex I will provide further insight into my choices which proposals to discuss, and how they relate to each other. Based on this

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research, a conclusion will be drawn on whether Eurobonds should be introduced in the Eurozone, and if so, what proposal will fit best in the legal system as a measure to combat liquidity problems and excessive spreads on debt instrument of different member states in the Eurozone.

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2. BUDGETARY PROBLEMS IN THE EUROZONE

2.1. Introduction

In this chapter, a short introduction will be provided on the history of the EMU and its problems. The following chapters will build on this and show how Eurobonds could address these problems. In section 2.2. the foundation of the EMU, the Maastricht Treaty, will be discussed together with the Stability and Growth Pact, and in particular how the convergence criteria tried to prevent possible future imbalances within the Eurozone. During the crises, it became clear that the latter framework was not effectively functioning. This will be discussed, together with its effect on the Eurozone, in section 2.3. As a response to the flaws in the framework, several measures were proposed, which will be discussed in section 2.4.

2.2. Prior Crisis: Maastricht Treaty and Stability and Growth Pact

In 1992, a little over 40 years since the first steps were made in regard to economic integration,18

the Maastricht Treaty was signed. The Maastricht Treaty was a start towards a single European currency, which was regarded as complementary to the Single European Market which was fully established in 1992.19_{One of the goals of the Maastricht Treaty was to establish the}

EMU.20_{Membership to the currency union was made conditional to the so-called ‘convergence}

criteria’ to sustain the European Union (hereafter: EU) in the future.21_{These criteria include:}

1) an average inflation rate that is no more than 1.5% higher than the average of the three best performing member states in terms of price stability to ensure low inflation; 2) a government deficit that must not exceed 3% of its Gross Domestic Product (hereafter: GDP), and its public debt must not exceed 60% of GDP to ensure sound public finances; 3) to secure stable exchange rates countries’ currency must have normal fluctuation margins for two years provided by the Exchange Rate Mechanism; 4) to ensure low interest rates the average long-term interest rate

18_{The European Coal and Steel Community originated in 1951, which in 1957 transformed into the European}

Economic Community.

19_{The Single European Act (1987) gradually established the Single Market over a period up to the end of 1992.}

See European Central Bank 2010; European Economy 1990, p. 1; Official Journal of the European Communities 1987, p. 1.

20_{Article B of the Maastricht Treaty.}

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must not exceed that of the best three performing member states by more than 2%;22_{and 5) the}

compliance of national law with the law of the EMU.23_{After accession to the currency union,}

member states are still required to comply with the sound budget policy requirements and the legal convergence criterion.24

In 1997, the Stability and Growth Pact was adopted to further stipulate member states’ obligation to avoid excessive government deficits as agreed in the Maastricht Treaty.25_This

was done by providing details for multilateral surveillance (‘the preventive arm’),26_{and the}

excessive deficit procedure (‘the corrective arm’).27_{In short: when EU member states have a}

current or planned budget deficit over 3% of GDP they could end up in the excessive deficit procedure (hereafter: EDP), where they receive binding recommendations to correct for the fiscal imbalance.28_{If no effective actions are taken, non-interest bearing deposits can be}

required and ultimately fines can be imposed.29_{In 2005 some amendments were made to the}

SGP which made the preventive arm a little more stringent and brought more flexibility and discretion in the corrective arm.30

2.3. Global Financial Crisis and Sovereign Debt Crisis

During the decade before the financial crisis started, growing imbalances, risks, and non-compliance with the convergence criteria within the EMU did not result in big spreads between sovereign debt instruments, as they were very close to zero.31_{Until then, capital flowed from}

fiscally sustainable to fiscally unsustainable countries, as investors were attracted by investment opportunities and deemed low risk effectively compressing sovereign bond spreads.32_{It was}

only in 2007 when the spreads started to show the imbalances by diverging notably. This was accelerated after the bankruptcy of Lehmann Brothers at the end of 2008. It was argued that as

22_{Article 109 J of the Maastricht Treaty; Axfentiou, BJWA 2000, VII(1), p. 249; Lipińska, ECB Working Paper}

Series 2008, 896, p. 7. See also Artice 126(2) jo. article 140 TFEU jo. Protocol No. 12 (excessive deficit

procedure) jo. Protocol No. 13 (convergence criteria).

23_{Article 140(1) TFEU. This law of the EMU in particular includes the statutes of its national central bank, and}

Articles 130 and 131 and the Statute of the ESCB and of the ECB.

24_{See article 126 TFEU jo. article 140(1) TFEU and Resolution (European Council) 97/C 236/01.}

25_{Resolution (European Council) 97/C 236/01; Van Riet, ESRB Working Paper Series 2008, 35, p. 3.}

28_{De Haan et al., SJES 2013, 149(2), p. 206, 207.}

29_{De Haan, Berger & Jansen, IF 2004, 7(2), p. 237.}

30_{De Haan et al., SJES 2013, 149(2), p. 209.}

31_{De Haan, Berger & Jansen, IF 2004, 7(2), p. 239-241; Muellbauer, Economic Outlook 2014, 38(1), p. 32, 33.}

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a result of the lower borrowing costs than they previously had, fiscally less sustainable countries could borrow at a lower cost causing wage inflation, a housing bubble, and credit boom.33

Eventually, this led to a crisis, and as a result of that, investors sought safety and a ‘capital flight’ occurred from the (mostly southern) fiscally less sustainable countries to the (mostly northern) fiscally sustainable countries. Hence, the borrowing costs of the less sustainable countries soared, as the financial markets recognized the increased default risk of these countries.34_{By December 2011, this had evolved in the bank-sovereign doom loop,}35_which

eventually resulted in the sovereign debt crisis.36

Figure 1: 10-year bond spreads vs Germany for fiscally Figure 2: 10-year bond spreads vs Germany for less sustainable countries.37 _{fiscally sustainable countries.}38

2.4. Policy Responses

2.4.1. Six Pack, and Two Pack, Fiscal Compact

As a response to the crisis, European policymakers came to an agreement on a set of new regulations: ‘Six Pack’,39_{‘Fiscal Compact’, and ‘Two Pack’}40_{. These were designed to further}

monitor the macro-economy and public finances of the member states (and in particular the Eurozone), which could help to further manage the crisis and prevent crises in the future.41_It

was argued that it would also (partly) solve the shortcomings of the SGP.42_{The six pack}

33_{Muellbauer, Economic Outlook 2014, 38(1), p. 32, 33.}

34_{Brunnermeier et al., ESRB Working Paper Series 2016, 21, p. 5, 6.}

35_{See section 3.2.1.}

36_{Muellbauer, Economic Outlook 2014, 38(1), p. 33.}

37_Ibid.

38_Ibid.

39_{Six Pack includes six legislative pieces: Regulation (EU) 1175/2011; Regulation (EU) 1177/2011; Regulation}

(EU) 1173/2011; Directive (EU) 2011/85/EU; Regulation (EU) 1176/2011; and Regulation (EU) 1174/2011. Regulation (EU) 1173/2011 and Regulation (EU) 1174/2011 apply to the Eurozone only.

40_{Two Pack includes two regulations: Regulation (EU) 473/2013; Regulation (EU) 472/2013, which both apply}

to the Eurozone only.

41_{Laffan & Schlosser, J. Eur. Integr. 2016, 38(3), p. 237; De Haan et al., SJES 2013, 149(2), p. 210, 211.}

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regulations were aimed at reinforcing the corrective and the preventive arm of the SGP. In particular, the EDP faced less hurdles, increasing the chance that sanctions would (earlier) be imposed, and subjected member states to a more profound scrutiny by the European Commission.43_{In 2012, the Fiscal Compact was introduced outside the EU framework in an}

intergovernmental treaty signed by (then) all EU-members except the United Kingdom and the Czech Republic and aimed to address of the shortcomings of the SGP and to strengthen the Eurozone’s fiscal governance framework.44_{Its two most important elements are the}

strengthening of the EDP and a balanced budget rule including an automatic correction mechanism.45_{Furthermore, the two pack regulations followed in May 2013, which}

complements the six pack regulations, and incorporated some of the elements from the Fiscal Compact directly into EU law. In particular, the two pack regulations included a further centralization of fiscal powers to the European Commission and aimed to strengthen surveillance mechanisms in the EMU to prevent contagion and spillovers.46

2.4.2. Banking Union

In 2011, attempts were made to address the bank-sovereign (doom) loop by means of a fiscal union, including Eurobonds as a safe asset. This failed due to fierce political resistance, which therefore designated the so-called ‘Banking Union’ to solve the doom loop.47_{Its goal is}

eliminating national competitive distortions tying banks to the creditworthiness and political idiosyncrasy of the sovereign where it has its headquarters: the bank-sovereign (doom) loop.48

The banking union would do so through a framework which aims at supervising banking from a (mostly) European level by the ECB, pooling its policy at a European level and centralizing (most) of the decision-making process for the resolution of non-viable banks. Beforehand, the framework was mostly national.49

At the same time, purchase programs were announced, showing the ECB’s willingness to buy enormous amounts of sovereign bonds of fiscally less sustainable (‘weak’) countries, thereby

43_{De Haan et al., SJES 2013, 149(2), p. 210; Laffan & Schlosser, J. Eur. Integr. 2016, 38(3), p. 240, 241.}

44_{The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union; European}

Central Bank 2012-3, p. 101, 102; Laffan & Schlosser, J. Eur. Integr. 2016, 38(3), p. 243.

45_{De Haan et al., SJES 2013, 149(2), p. 210.}

46_{Laffan & Schlosser, J. Eur. Integr. 2016, 38(3), p. 241-243.}

47_{Véron, Bruegel Essay and Lecture Series 2015, p. 16.}

48_{Ibid., p. 12; see also: section 3.2.1.}

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ensuring the effectiveness of monetary policy in the Eurozone.50_{This resulted in better access}

to the markets for these countries, being able to fund their banks if necessary. Additionally, a Eurozone fund, the ESM, was set-up to recapitalize banks directly under specific conditions.51

Despite these measures taken, the bank-sovereign (doom) loop has still not been banned out due to a lack of safe assets. In fact, the current combination of member states issuing bonds to finance national stimulus packages providing financial support to businesses due to the COVID-19 lockdown, and the ECB buying these sovereign bonds under the asset purchase programs PEPP and PSPP, reinforces the bank-sovereign (doom) loop. Furthermore, some member states still suffer from semi-illiquid sovereign bonds and (relatively) high yields, despite the purchase programs of the ECB.52

The question thus follows whether Eurobonds would have solved this problem, which will be addressed in the next chapters.

50_{Véron, Bruegel Essay and Lecture Series 2015, p. 14.}

51_{Ibid., p. 16.}

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3. AN ANALYSIS OF EUROBONDS

3.1. Introduction

In this chapter, several arguments in favor of and against Eurobonds will be examined. Section 3.2., regarding the arguments in favor, will consecutively elaborate on the bank-sovereign loop and how to break it, the need for the provision of a safe asset, enhanced fiscal discipline, and risk-sharing. Furthermore, the improvement of the monetary policy transmission mechanism will be discussed, and how that could help to reduce the borrowing costs within the Eurozone. In section 3.3. the arguments against Eurobonds will be reviewed. These include moral hazard, the weakening of fiscal discipline and fiscal reforms, the increasing interest rate for fiscally sustainable countries, and lastly the unnecessity of Eurobonds due to already existing euro-denominated assets and private solutions.

3.2. Arguments in Favor

3.2.1. Breaking the Bank-Sovereign Loop by means of a Safe Asset.

Chapter 2 discussed that one of the several factors that contributed to the financial crisis is that the euro area lacked several institutional features which are necessary for a monetary union to succeed. Among these features were emergency funding for sovereigns and common banking supervision.53_{Despite the fact that some of these issues have been fixed by the introduction of}

the European Banking Union,54_{still a pivotal element is missing: the euro area as a whole does}

not yet have a safe asset. Safe assets are assets that are highly liquid (high-volume market), carry minimal or no credit risk and enjoy a high degree of market stability (no or very low volatility risk).55_{Therefore, they are especially very valuable in times of financial crises,}

because they typically maintain their nominal value, while other assets often decrease in

53_{Brunnermeier et al., ESRB Working Paper Series 2016, 21, p. 1.}

54_{The Banking Union introduced two mechanisms: the Single Supervisory Mechanism (SSM) and the Single}

Resolution Mechanism (SRM). The SSM is a European supervisor to which the powers of the national supervisors to grant and withdraw banking licenses and related supervisory duties have been transferred. The SRM mostly centralizes the decision making for the resolution of non-viable banks. Furthermore, a common euro-area fund was created: the European Stability Mechanism. See Véron, Bruegel Essay and Lecture Series 2015, p. 10-16. See also section 2.4.2.

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value.56_{Safe assets allow market participants to transfer risks, for example liquidity risk or}

market risk, without creating new risks as counterparty credit risk. When complying with the liquidity regulations as imposed by the Basel III standards, banks need to hold a certain amount of high-quality liquid assets, so safe assets, which they can use to meet their cash-outflows in times of a stress scenario.57

In the United States (hereafter: U.S.), the most widely held safe assets are U.S. Treasury bills and bonds. However, in the euro area, there is no such EU-wide safe asset, but only bonds issued by member states which respectively differ in risk and liquidity characteristics. Currently, when calculating liquidity and capital requirements, government bonds issued by countries within the Eurozone get a preferred treatment as a zero risk-weight is assigned to them, regardless of the current creditworthiness of the issuing government.58_{Although this zero}

risk-weight applies to any government bond issued by any government within the Eurozone, banks tend to hold government bonds of their sovereign, especially during times of crisis. In the literature, there is a general consensus that this is the case because of banks’ risk-shifting incentives.59_{Banks are incentivized to hold domestic sovereign debt as the risk of default}

increases, because equity holders expect to earn a positive pay-off from these bonds which can be reinvested in high-value projects. Simultaneously, the downside risk is shifted to others, as it either gets a bail-out from the government which is funded by taxpayers, or, if the government does not consider the bank important enough to provide a bail-out, the downside risk is shifted to the banks’ creditors.60_{Albeit, this problem is (partly) addressed by the Bank Recovery and}

Resolution Directive by means of a bail-in.61

This home-bias in holding sovereign bonds results in strong intertwining between banks and their national governments, eventually creating a diabolic loop between sovereign risk and bank risk.62_{For example, in case of a shock in investors’ expectations, the marked-to-market value}63

of sovereign bonds falls, resulting in banks’ book and market equity value to be reduced.64_Due

56_{Habib, Stracca & Venditti, ECB Working Paper Series 2020, 2355, p. 2; Brunnermeier et al., ESRB Working}

Paper Series 2016, 21, p. 2.

57_{Brunnermeier et al., ESRB Working Paper Series 2016, 21, p. 2; Armour et al. 2016, par. 15.3.1.}

58_{Véron 2017, p. 30; Kamerstukken II 2019/20, 21507-07, no. 1651, p. 1.}

59_{Alogoskoufis & Langfield, ESRB Working Paper Series 2018, 74, p. 3.}

60_Ibid.

61_{De Nederlandsche Bank 2017, p. 1-3; see also Directive (EU) 2014/59.}

62_{Véron, Bruegel Essay and Lecture Series 2015, p. 14-16.}

63_{Marked-to-market is the practice of revaluing an instrument to reflect the current values of relevant market}

variables. See Hull 2015, p. 831.

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to the reduced equity value, leverage goes up in relation to the equity value. This has two implications. Firstly, due to the banks’ increased leverage, the probability that the home sovereign will bail-out the bank is increased, provided that the bank is considered to be too important or politically connected to fail. Secondly, the bank wants to bring down its leverage ratio back to the initial leverage ratio and often does so by selling assets, which include cuts in loans to firms and households. Consequently, this credit crunch reduces economic activity, which lowers tax revenues for the government and increase the bail-out costs.

Concluding, concerns about sovereign risks translate into banks’ risks. In case a bail-out is needed, this again creates concerns about the risk of the sovereign. This is the so-called ‘diabolic loop’ or ‘bank-sovereign (doom) loop’.65

Figure 3: the diabolic loop or bank-sovereign (doom) loop.66

By providing a safe asset in the Eurozone like Eurobonds, the links between the banks and their respective national sovereign could be weakened.67_{Because these banks don’t hold huge}

amounts of national government bonds anymore, but (mainly) have Eurobonds on their balance sheet, an increasing default risk of its respective sovereign does not necessarily translate into an increasing default risk of the bank and vice-versa. Furthermore, the introduction of a European safe asset like Eurobonds would also enhance the banks’ ability to fund themselves

66_{Ibid., p. 5.}

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and intermediate credit, preventing the weakening of the economy due to a credit crunch. This would, on its turn, also prevent the sovereign debt risk from increasing.68

3.2.2. Provision of a Safe Asset

Currently, in situations of financial stress, investors tend to invest in government bonds of individual sovereigns in the Eurozone which are as liquid as possible, have high credit quality, and are very stable. An example is the German government bond (hereafter: German Bund). In case of the provision of a safe asset in the Eurozone (Eurobonds), the supply of safe assets would increase and would enhance liquidity (as safe German Bunds are relatively scarce in supply).69_{This could reduce the risk of investors flying to quality (safe, stable, and liquid}

bonds) in case of a financial shock or change in ratings.70_{Also, it would prevent large spreads}

from existing on government bonds between countries deemed to be safe, and those which are considered to be risky.71_{Therefore, it prevents the borrowing costs of the non-vulnerable}

countries from dropping below the level justified by fundamentals due to an enormous amount. On the other hand, it prevents the borrowing costs of vulnerable sovereign countries from increasing enormously.72_{Furthermore, the introduction of Eurobonds would prevent the}

cross-border capital flows which otherwise occur, and also prevent the funding problems this would impose on banks and other financial institutions.73

Other benefits can be derived from the introduction of common euro debt too. So far, the U.S. benefits from the relatively low liquidity (‘safe haven’) premium74_{on its safe asset (U.S.}

Treasury bills and bonds), due to its good liquidity and safeness.75_{The euro-area would benefit}

from such a (low) liquidity and safeness premium too,76_{as it would have the advantage of a}

reserve currency.77_{That way, it would help improve financial stability at a European level.}78_In

68_{Claessens, Mody & Vallée, IMF Working Paper 2012, 12(172), p. 7.}

69_{Favero & Missale 2010, p. 13.}

70_{Jones, Funcas SEFO 2017, 6(5), p. 6.}

74_{Liquidity premium will be asked by financial investors in the situation when a security cannot easily be}

converted into cash for its market value. Hence, investors will require compensation for an asset it is illiquid, due to an increase in risk. See Krishnamurthy & Vissing-Jorgensen, J. Political Econ. 2012, 120(2), p. 239.

75_{Krishnamurthy & Vissing-Jorgensen, J. Political Econ. 2012, 120(2), p. 235; Pisani-Ferry, Bruegel 20 July}

2012; Jones, Funcas SEFO 2017, 6(5), p. 9; Leandro & Zettelmeyer, Working Paper PIIE 2019, 18(3), p. 7.

76_{It is argued that the Eurozone would profit up to 30 basis points from a lower liquidity and safeness premium.}

See Depla & Von Weizsäcker, Bruegel 2010, 03, p. 5.

77_{A reserve currency is a currency that is very frequently used in the international monetary system. See Tovar}

Mora & Mohd Nor, IMF Working Paper 2018, 18(20), p. 4.; Kamerstukken II 2019/20, 21507-07, no. 1651, p. 4.

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addition to that, it is suggested in the literature that even countries with high-quality government bonds, for which the gains from further integration have always thought to be small, could benefit from greater liquidity a Eurobond would provide if it could compete with the U.S. treasures in the search for a safe investment for investors.79

It is key to note that the advantages of a safe asset will only hold, if it also meets the criteria of high credit quality. Whether this is the case, will depend on the proposals discussed in chapter 5. Factors that key to determining this are: first, insofar each issuer is liable for its own share and its credit rating, and secondly, whether the Eurobonds will be backed by joint guarantees (or issued by an EU institution).80

3.2.3. Fiscal Risk-sharing and Enhanced Discipline

The introduction of mutual European debt will to some extent create a fiscal union. Fiscal unions in practice consist of three pillars. First, there need to be fiscal rules or similar institutional tools which provide frameworks for discipline. In the EU, the Maastricht Treaty and SGP provide these rules.81_{The second pillar consists of risk-sharing mechanisms to}

conduct macroeconomic management by means of automatic or discretionary stabilizers.82_The

third and last pillar consists of a way to correct more permanent differences in initial conditions, which allows for some degree of income equalization. Together, these pillars stand at the basis of risk-sharing features of common debt issuance. These features do so in two ways: ex ante they can provide for transfers as some sovereigns benefit from lower spreads (and thus borrowing costs) than in the situation without mutual European debt, and ex post, they could incur (default) transfer mechanisms in case one of the member states is not able to meet its financial obligations.83

As will be discussed more extensively in section 3.3.1., fiscal risk-sharing may be prone to moral hazard as some countries may free ride. Consequently, the introduction of Eurobonds requires powerful mechanisms that closely monitor and enforce fiscal discipline of member states.84_{One of the measures advocated for is ex ante surveillance, due to a more important role}

79_{Favero & Missale 2010, p. 13, 14.}

80_{Ibid., p. 14.}

81_{See section 2.2.}

82_{An example of this is the proposed European Unemployment Benefits Scheme (EUBS). See Beblavy, Marconi}

& Maselli, CEPS 2016, 119.

83_{Claessens, Mody & Vallée, IMF Working Paper 2012, 12(172), p. 5-7.}

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for price signals, since the current mechanisms have proven to be less effective.85_{If successful,}

this would improve fiscal discipline, and thus address the problem of moral hazard. Also, it has been argued that a euro-level safe asset might be useful to help strengthen fiscal discipline in the Eurozone through two channels. First, when restructuring sovereign debt,86_{it can do so by}

lowering the economic costs. Secondly, it can increase the marginal borrowing costs when issuance exceeds certain levels.87

Some Eurobond proposals address the risk of moral hazard,88_{as member states have to keep}

some skin in the game. For example, member states are solely responsible for the amount of debt over 60% of GDP and face possible much higher interest rates on these bonds (Blue Bond / Red Bond proposal), or have to pay premiums if they exceed these levels (Eurobills proposal).89_{These forms of Eurobonds might induce these member states to at least bring down}

their debt levels, as it lowers their interest rate.90

3.2.4. Improvement of the Monetary Policy Transmission Mechanism

The last advantage that the introduction of common European debt such as Eurobonds would offer, is the improvement of the monetary policy transmission mechanism. The monetary policy transmission mechanism is a term used to describe the several instruments through which monetary policy affects output and prices. It includes two broad stages: first, changes in the policy interest rate or in monetary base lead to changes in financial market conditions which reflect in the market interest rates, the exchange rate, general liquidity, credit conditions, and asset prices in the economy. Second, these changes in financial market conditions which lead to changes in nominal spending on services and goods by firms and households, which can affect the general price level.91

During the past several years, and especially in times of crisis, great differences arose between several countries within the Eurozone, as credit rating and interest rates differed significantly along national lines. Hence, the monetary policy transmission mechanism was impaired by

85_{Claessens, Mody & Vallée, IMF Working Paper 2012, 12(172), p. 6, 7. See also section 2.4.}

86_{This can be done through Collective Action Clauses. See Economic and Financial Committee 2020}

for the current regime, and European Stability Mechanism 2020-2 for the envisaged regime.

87_{Leandro & Zettelmeyer, Working Paper PIIE 2019, 18(3), p. 8.}

88_{This will be discussed in more depth in section 3.3.1.}

89_{See sections 5.2. and 5.3.}

90_{Kamerstukken II 2011/12, 21501-07, no. 844, p. 4.}

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financial instability, which means that the interest rate policy as centrally set by the ECB did not result sufficiently into the local funding and lending conditions as was originally aimed for, despite its continuous efforts to do so.92_{As explained in more detail in section 2.3., these}

differences originate from concerns about the credibility of national sovereigns, and also in relation to the credibility assessment of the sovereigns’ banks.93

So far, the ECB tried to restore the proper functioning of the monetary policy transmission mechanism through the implementation of several non-conventional policies.94_{Despite the fact}

that these programs predominantly minimized the most severe consequences of the crisis, they were not able to bring the financial conditions back to what was regarded before the sovereign debt crisis, when there was hardly any market segmentation or fragmentation between member states across the credit spectrum.95

The introduction of a form of commonly issued debt within the Eurozone, such as Eurobonds, would offer an advantage over the current situation, as it could contribute to better functioning of the monetary policy transmission mechanism and restore financial markets’ functioning, as it provides a for a deep and unified market for euro sovereign securities. This eventually results in one of the biggest advantages of the introduction of Eurobonds, as it reduces the aggregate borrowing costs within the Eurozone. This follows from the fact that deep and unified markets (with large volumes traded) reduce transaction costs, as the liquidity premium and interest rate asked by investors decreases by the volume traded.96_{Also, the weighted average of the interest}

rates of all countries within the Eurozone without the introduction of the Eurobond would probably be higher than the interest rate on Eurobonds itself, as investors will attach a lower risk and liquidity premium to the Eurozone, resulting in a lower interest rate for the Eurozone on average.97_{All member states that are part of the Eurozone will profit from this lower risk}

and liquidity premium, but in particular, the fiscally less sustainable countries will profit from this, as the interest rate against which they can borrow money is much lower in case of Eurobonds than in case they would have to borrow against the market conditions when they would still issue their own sovereign bonds.

92_{The ECB consistently refers to the need that monetary policy translates in all jurisdictions in the Eurozone.}

See European Central Bank 2020-3.

94_{These non-conventional policies include asset purchase programs such as OMT, PSPP, PEPP.}

96_{Favero & Missale 2010, p. 10.}

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3.3. Arguments Against

3.3.1. Moral Hazard

Despite the upside as elaborated on under section 3.2., the introduction of Eurobonds also brings some urgent moral hazard concerns. Due to the issuance of a joint euro bond, the governments who maintain a more loose budgetary policy and possibly also face high spreads (compared to the Bund) will have fewer incentives to comply with sustainable fiscal policies.98_{In other}

words: these member states may be tempted to free ride on the legal obligations of other member states to assume its debt in case they default.99

Currently, without the existence of commonly issued euro debt, fiscally less sustainable countries are disciplined by higher interest rates on their government bonds on the market. In the event that these countries are (close-to) defaulting, they cannot be bailed-out by other governments.100_{In case Eurobonds would be introduced, countries maintaining a less tight}

budgetary policy will be disciplined less or even not at all. This lack of market pressure might induce them to continue or even relax their already unsustainable fiscal discipline and weaken their incentives for fiscal reforms. As the interest rate on Eurobonds will be lower (and consequently cheaper for the fiscally less sustainable countries) than the interest rate would have been on their sovereign bonds, these countries can take on more debt. Consequently, they would also loosen the pressure to comply with the convergence criteria.101

Additionally, the introduction of (some forms of) Eurobonds with mutual guarantees102_will

undermine the no bail-out clause,103_{and thus increase the chances of moral hazard. However,}

this statement is nuanced in the literature, as there is skepticism as to whether governments would adhere to the no bail-out clause in the future, due to the risk of contagion in the euro area as a result of close economic and financial ties.104

98_{De Grauwe & Moesen, CEPS 2009, p. 4; De Ferra & Romei, ADEMU Working Paper Series 2018, 118, p. 2.}

99_{Favero & Missale 2010, p. 17; Wyplosz et al. 2011, p. 44.}

100_{This is due to the no bail-out clause as defined in article 125 TFEU and CJEU 27 November 2012, C-370/12,}

ECLI:EU:C:2012:756 (Pringle); see section 4.3.2.

101_{See section 2.2.}

102_{See chapter 5.}

103_{Article 125 TFEU and CJEU 27 November 2012, C-370/12, ECLI:EU:C:2012:756 (Pringle); see section}

4.3.2.

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3.3.2. Governance

The looser pressure to comply with the convergence criteria may at a later stage lead to great budgetary and macro-economic imbalances, which eventually could result into invoking possible joint-and-several guarantees of all participating member states. If several countries loosen the pressure to comply with the convergence criteria, the question then arises whether these countries will exert a lot of pressure to generally loosen the convergence criteria by raising the thresholds for the maximum government deficit (3% of GDP) and public debt (60% of GDP). This will especially be the case for Eurobond proposals which include mutually guaranteed debt up to 60% as agreed upon in the convergence criteria, and debt higher than 60%, which will need to be solely financed by the member state responsible.105_{In these cases,}

it is questionable how the markets will react to these indebted member states, and disproportional amounts of pressure could be exerted in terms of very high interest rates, as it is clear that other member states will not be a mutual guarantor for the debt levels over 60% of the GDP.106

Furthermore, mutualizing debt up to a certain threshold, for example up to 60% of GDP, will also reduce the incentives (of the fiscally more sustainable countries) to reduce or maintain their debt below the threshold of 60%, as this does not result in the ‘reward’ of a lower interest rate since the debt is mutually guaranteed.107

3.3.3. Increasing Interest Rate for Fiscally Sustainable Countries and

Possible Compensation

Without further adaptions, the issuance of a form of common European debt will lead to lower interest rates for the Eurozone on average,108_{but it will most likely increase the interest costs}

for member states whose creditworthiness is a lot higher than the average of the Eurozone. For example, Germany and the Netherlands, who are both viewed as very creditworthy countries,109

will probably pay a higher interest rate after the introduction of Eurobonds, than that they currently do on their sovereign bonds.110

105_{Depla & Von Weizsäcker, Bruegel 2011, 02, p. 2.}

107_{Ibid., p. 5.}

108_{See section 3.2.4.}

109_{Credit ratings of the Eurozone can be found on Trading Economics 2020.}

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It is put forward in the literature that a possible compensation mechanism should be introduced to mitigate this problem. However, this leads to several problems, as this mechanism is expected to require high administrative costs due to its complicatedness and fluctuations in time. However, if this compensation will also be applied onto the (risk) premium, then Eurobonds won’t benefit from the advantages as described under section 3.2.: in that case, less fiscally less sustainable countries will have to pay the same (relatively high) interest rates as they currently have to do (despite the still existing mutual guarantee). Also, the question arises how high this compensation should be, and how ‘rigid’ these compensation mechanisms are in case a member state is (close to) defaulting since all the (direct and indirect) costs are mutually borne by the members of the Eurozone.111

3.3.4. Pre-existing Alternatives

It is argued, especially by fiscally sustainable countries, that there is no urgent need for a European safe asset like Eurobonds. Nonetheless, they do recognize that safe assets can contribute to the effective and efficient working of financial markets.112_{They name three}

possible alternatives to Eurobonds. First, they name several alternatives like €STR113_which

would function as an interest rate benchmark or reference rate.114_{However, I fail to see how an}

interest rate benchmark would replace a safe asset. The second alternative they propose is that several euro-denominated assets like Dutch government bonds or German Bunds could function as a benchmark interest rate curve. Albeit, it is questionable whether these bonds would suffice as a safe asset, as they are not as liquid as Eurobonds, and will not break the bank-sovereign (doom) loop. Thirdly, they state that private parties have possibilities within the current legal framework to create relatively safe assets like covered bonds or asset-backed securities. It is possible to do so by for instance pooling several government and corporate bonds, or more illiquid assets like mortgages. Additionally, they note that an adequate way of supervising financial markets and a proper macro-economic policy of individual member states in the Eurozone will contribute to the increase of international use of the Euro (as a reserve currency),115_{and the enhancement of the number of safe assets.}116

113_{€STER is the Euro Short-Term Rate, a wholesale unsecured overnight borrowing rate replacing EONIA. See}

Campbell & Weaver 2019; BMO Global Asset Management 2018.

115_{European Central Bank 2020-4.}

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4. LEGAL FRAMEWORK

4.1. Introduction

In this chapter, the legal framework Eurobonds will have to comply with if introduced, will be discussed. Section 4.2. will elaborate on the explicit competence to introduce Eurobonds. In section 4.3. the compatibility of Eurobonds with EU law will be reviewed, where consecutively its compatibility with title VIII, chapter 1, the no bail-out clause of article 125 of the Treaty on the Functioning of the European Union (hereafter: TFEU), and its compatibility with the ESM Treaty will be discussed. Finally, section 4.4. will zoom in on problems that could arise on a national scale when introducing Eurobonds. In particular, several cases of the German Constitutional Court will be discussed in section 4.4.1.

4.2. Explicit Competence to Introduce Eurobonds

Before elaborating on the compatibility of Eurobonds with EU law or national constitutional law, it is necessary to assess whether the EU is competent to take legislative actions (if necessary) to introduce Eurobonds.117_{This is based on the principle of attribution as described}

in article 2 TFEU.118_{Currently, there is no specific article in primary EU law that explicitly}

allows for the introduction of Eurobonds. Albeit, several articles might provide for some flexibility which could form a legal basis for the introduction of Eurobonds.119

First, article 136(1) TFEU, which allows for the adoption of specific measures to coordinate and surveil Eurozone member states’ budget discipline and set out economic policy guidelines for them,120_{might offer a possible legal ground for the introduction of Eurobonds. Article}

136(1) TFEU is part of the Treaties’ chapter on the EU’s economic and monetary policy (including budgetary policy) and is thus limited to the EU’s competence regarding economic policies, which is limited to coordinating the economic policies of the member states.

117_{Amtenbrink & De Haan, 2011, p. 13.}

118_{The EU is only allowed to legislate and adopt legally binding acts when the treaties (TFEU and TEU) confer}

explicit competence in a specific area onto the EU. See article 2(1) TFEU.

119_{Amtenbrink & De Haan, 2011, p. 13.}

120_{A reference is made to articles 121 to 126 TFEU. Furthermore, the adoption of the two pack and part of the}

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Ultimately, member states remain sovereign in their budgetary and treasury functions and cannot be (partly or fully) replaced by the EU.121_{Imposed obligations resulting from fiscal}

discipline following from EU treaties leave this ultimate sovereignty of the member states in their budgetary and treasury functions unchanged.122_{As several Eurobond proposals include}

establishing a distinct legal entity from the member states and mutualizing (part of) their debt, this distinct legal entity could impose several constraints on national budget sovereignty including the right to issue government debt with a certain maturity, at a certain time, or above a certain level. Consequently, it follows that such a legal entity including several constraints on budget sovereignty exceeds the right of the EU to set economic policy guidelines for Eurozone member states.123

Article 136(3) TFEU may be another possibility. The article confirmed that member states in the Eurozone had the authority to activate a stability mechanism (ESM) if necessary, to safeguard the stability of the Eurozone as a whole. It further ensured that the financial assistance under the ESM is subject to strict conditionality,124_{while the article does not specify any further}

what this ‘strict conditionality’ further entails. Consequently, this leaves room to serve as a legal basis for the introduction of Eurobonds, as this new budgetary authority (which would manage these Eurobonds) might be considered to be a ‘stability mechanism’.125_{However, many}

authors believe this is not the case.126

The third option may be article 352 TFEU, which allows for the adoption of appropriate measures necessary for the EU to achieve the objectives set out in the treaties,127_{provided that}

there is no explicit competence in the treaties for such an action.128_{As one could argue that}

Eurobonds could contribute to the objective of sound public finances, this would be a third possibility. Such measures are subject to a unanimity decision in the Council of the European Union,129_{and the consent of the European Parliament. Hence, this option is in practice hardly}

121_{Article 2(3) and 5(1) TFEU.}

122_{Tumpel-Gugerell et al., 2014, p. 62.}

123_{Ibid.; Amtenbrink & De Haan, 2011, p. 13, 14.}

124_{CJEU 27 November 2012, C-370/12, ECLI:EU:C:2012:756 (Pringle), par. 72, 73.}

125_{Amtenbrink & De Haan, 2011, p. 13, 14; Mayer & Heidfeld, NJW 2012, 422, p. 5.}

126_{Mayer & Heidfeld, NJW 2012, 422, p. 5; Kämmerer, Rev. Law. Econ. 2016, 12(3), p. 600, 601. This will be}

discussed in more detail in section 4.3.3.

127_{See article 3 TEU.}

128_{Mayer & Heidfeld, NJW 2012, 422, p. 5; Tumpel-Gugerell et al., 2014, p. 62; Favero & Missale 2010, p. 19.}

129_{Informally known as the Council of Ministers. Its presence consists of (often) the responsible minister of this}

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unusable.130_{To make it even harder, the BVerfG judged that the use of article 352 is subject to}

two-third majority approval by both the German Bundesrat (which represents the federated states), and by the German Bundestag (parliament).131_{Another possible reason why this article}

may not be able to serve as a basis for the introduction of Eurobonds is that the European Court of Justice (hereafter: CJEU) expressed that any measure can only be adopted under this basis if it stays within the general framework of the treaties.132_{However, it cannot in substance lead to}

a modification of the treaties, which is necessary for some of the proposals discussed in chapter 5.133

Concluding, there is no explicit competence for the introduction of Eurobonds in the primary treaties, and the articles proposed to serve as a possible alternative legal basis for the introduction of Eurobonds. Either, they are practically impossible to use or seem to exceed the scope of the article. Hence, probably a new provision has to be adopted explicating the EU’s competence to issue Eurobonds. Alternatively, Eurobonds (and a possible public agency that issues them) can be established based on an intergovernmental agreement. However, these agencies do not constitute an EU body in that case.134

4.3. Compatibility with European Union Law

4.3.1. Compatibility with Articles 122-125 TFEU

To determine whether Eurobonds would be compatible with EU law, articles 122 to 125 TFEU on the EMU will be assessed. One of the principles behind these articles is that member states should finance their deficits according to market conditions.135_{In case of Eurobonds, it is}

questionable whether all member states (in the Eurozone) will do so, as especially the fiscally less sustainable countries then will face a lower interest rate than in the situation that they would still issue their own sovereign bonds. Hence, Eurobonds would breach the fundamental principles laid down in these articles. Contrastingly, it could also be argued that they still

130_{Amtenbrink & De Haan, 2011, p. 13, 14.}

131_{European Commission 2014-1, p. 3; see also BVerfG 30 June 2009, 2 BvE 2/08,}

ECLI:DE:BVERFG:2009:ES20090630.2BVE000208 (Lissabon-Urteil) par. 417. This has been codified in Article 8 of the Integrationsverantwortungsgesetz of 22 September 2009. For such cases, the German Constitution requires a two third majority in both the Bundestag and the Bundesrat.

132_{CJEU 28 March 1996, A-2/94, ECLI:EU:C:1996:140, par. 30, 35.}

133_{Tumpel-Gugerell et al., 2014, p. 62, 63.}

134_{Kämmerer, Rev. Law. Econ. 2016, 12(3), p. 590, 591.}

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finance their deficits according to market conditions, in case each borrowing member state pays a different interest rate based on its own economic situation.136_{However, this would take one}

of the main benefits away from Eurobonds, as (highly) indebted countries cannot profit anymore from the reduced aggregate borrowing costs.

To further assess these articles in more detail, article 122 constitutes the legal basis in the TFEU for the providence financial assistance on behalf of the EU to the member states in case of severe difficulties due to natural disasters or exceptional occurrences beyond its control.137

Consequently, this cannot serve as a consistent basis for the introduction of Eurobonds. Moreover, article 123, which contains the prohibition of monetary financing, does not form an obstacle to the introduction of most Eurobond proposals, regardless of whether they can be seen as a ‘credit facility’, as these ‘loans’ (the issuance of Eurobonds by a certain member state in the Eurozone) are not issued or directly purchased by the ECB or any National Central Bank (hereafter: NCB).138_{Besides, it is good to note that in the possible transition from national}

bonds to Eurobonds these national debt instruments cannot be purchased by the ECB or NCBs in the primary market, or on the secondary market if it would have an effect equivalent to that of a direct purchase on the primary market, as it would constitute a breach of this article.139_The

prohibition of privileged access, as laid down in article 124, will also not hinder the introduction of Eurobonds, as no privileged access to financial institutions is accessed by Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities.140

Article 125, the no bail-out clause, will be discussed in more detail in the next section.

4.3.2. Compatility with no Bail-out Clause

In the literature, there is a lot of discussion about the compatibility of the possible introduction of Eurobonds with article 125 TFEU. Article 125 comprises the no bail-out clause and provides that the Union nor the member states shall be liable for or assume the commitments of other member states. The past years, it is argued that this provision partly lost its credibility, due to the bilateral loans granted to Greece during the crisis, and the establishment of the EFSM,

136_{Amtenbrink & De Haan, 2011, p. 13, 14.}

137_{To mitigate unemployment risks due to the Corona-crisis, Resolution (European Council) 2020/672 (SURE)}

was adopted 19 May 2020. Its legal basis is Article 122 TFEU.

138_{An exception to this is the ERF. See sections 5.5. and 5.7.}

139_{CJEU 11 December 2018, C-493/17, ECLI:EU:C:2018:1000 (Weiss), par. 103, 104, 106, 107; CJEU 16 June}

2015, C-62/14, ECLI:EU:C:2015:400 (Gauweiler), par. 95, 97, 101. See also Amtenbrink & De Haan, 2011, p. 15.

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EFSF, and the ESM.141_{Legally speaking these ‘bail-outs’ do not constitute a breach, as they do}

not amount to actual commitments of taking on the liability to the debtor member state since new liabilities are created by providing a loan or guarantee to the beneficiary: the debtor member state.142_{In line with this argument, it could be argued that the introduction of}

Eurobonds does not constitute a breach of article 125, as the issuance of Eurobonds by an EU-institution (if jointly-and-severally143_{guaranteed by the participating member states) does}

imply the member states’ liability for the issuance by the institution, and not for each other’s commitments. One could base the introduction of Eurobonds on this argument, but it would clearly further stretch the meaning of article 125 and oppose the rationale behind articles 122-125,144_{as the member states effectively guarantee each other’s commitments when agreeing to}

the participation of other states in the mutual issuance of debt and hence.145

However, at the end of 2012, the CJEU established in Pringle that, when establishing the compatibility of the ESM with the EU Treaties, article 125 does not prohibit the granting of financial assistance to a member state as long as it “remains responsible for its commitments to

its creditors provided that the conditions attached to such assistance are such as to prompt that Member State to implement a sound budgetary policy”.146_{Furthermore, it stated that “the aim} of article 125 is to ensure that Member States follow a sound budgetary policy”, and “ensures that the Member States remain subject to the logic of the market when they enter into debt, since that ought to prompt them to maintain budgetary discipline”. This should contribute to

the higher objective of maintaining financial stability in the monetary union.147_Furthermore, Pringle addresses the fact that granting financial assistance may diminish the incentive of the

recipient member state to conduct a sound budgetary policy. Consequently, it states that “the

activation of financial assistance by means of a stability mechanism as the ESM is not compatible with article 125 unless it is dispensable for the safeguarding of the financial

141_{See sections 1 and 2.4.2.}

142_{Smits 2011, p. 1, 2; Amtenbrink & De Haan, 2011, p. 15; See also Mayer & Heidfeld, NJW 2012, 42, p. 5, 6.}

143_{A joint-and-several liability is a liability where a claimant may pursue an obligation against any other party as}

if they were jointly liable and it becomes the responsibility of the defendant to sort out their respective proportions of liability of payment. See Scheinert 2011, p. 5.

144_{It opposes articles 122-125 TFEU, since it doesn’t leave the assessment of the creditworthiness of member}

states to the financial markets these countries with a not so fiscally tight policy cannot be ‘punished’ by the market due to high-risk premia (and hence high interest rates). See Mayer & Heidfeld, NJW 2012, 422, p. 5, 6.

145_{Smits 2011, p. 2; Kösters, Inter Econ 2009, 44(3), p. 135-138.}

146_{CJEU 27 November 2012, C-370/12, ECLI:EU:C:2012:756 (Pringle), par. 137. See also Leino-Sandberg &}

Saarenheimo, ADEMU Working Paper Series 2018, 095, p. 18.

Eurobonds: a possible and legally feasible remedy against liquidity problems and excessive spreads on sovereign debt instruments in the Eurozone?

Master Thesis Law & Finance

Eurobonds

A possible and legally feasible remedy against liquidity problems and

excessive spreads on sovereign debt instruments in the Eurozone?

ABSTRACT

ACKNOWLEDGEMENTS

LIST OF ABBREVIATIONS

TABLE OF CONTENTS

1.

INTRODUCTION

1.2.

Methodology

2.

BUDGETARY PROBLEMS IN THE EUROZONE

2.1.

Introduction

2.2.

Prior Crisis: Maastricht Treaty and Stability and Growth Pact

2.3.

Global Financial Crisis and Sovereign Debt Crisis

2.4.

Policy Responses

2.4.1.

Six Pack, and Two Pack, Fiscal Compact

2.4.2.

Banking Union

3.

AN ANALYSIS OF EUROBONDS

3.1.

Introduction

3.2.

Arguments in Favor

3.2.1.

Breaking the Bank-Sovereign Loop by means of a Safe Asset.

3.2.2.

Provision of a Safe Asset

3.2.3.

Fiscal Risk-sharing and Enhanced Discipline

3.2.4.

Improvement of the Monetary Policy Transmission Mechanism

3.3.

Arguments Against

3.3.1.

Moral Hazard

3.3.2.

Governance

3.3.3.

Increasing Interest Rate for Fiscally Sustainable Countries and

Possible Compensation

3.3.4.

Pre-existing Alternatives

4.

LEGAL FRAMEWORK

4.1.

Introduction

4.2.

Explicit Competence to Introduce Eurobonds

4.3.

Compatibility with European Union Law

4.3.1.

Compatibility with Articles 122-125 TFEU

4.3.2.

Compatility with no Bail-out Clause