Download The plan 1 provides a concrete mechanism to

`Completing Economic and Monetary Union’
Graham Bishop’s Plan for a Temporary Eurobill Fund as a Stepping Stone to Stage 2
2 November 2015
The plan1 provides a concrete mechanism to:
 Bind the euro area into economic policy co-ordination and convergence; deepen the
financial integration inherent in CMU; and buttress financial stability.
 Be initiated in Stage 1 as a modest stepping stone; be scaled up in Stage 2 towards
becoming a de facto European Treasury with Communautaire political governance
– perhaps even providing a modest `fiscal capacity’.
 Be easily reversed (even to extinction) within two years.
The Five Presidents’ Report in June laid out a two-stage process to completing EMU, and the
Commission’s October Communication added much detail to the Report’s principles, which included
“the European Parliament should organise itself to assume its role in matters pertaining especially to
the euro area... However, as the euro area evolves towards a genuine EMU, some decisions will
increasingly need to be made collectively while ensuring democratic accountability and legitimacy… A
future euro-area treasury could be the place for such collective decision-making.”
The Report also proposed a fiscal stabilisation function for the euro area with guiding principles “It
should not lead to permanent transfers between countries… should not undermine the incentives for
sound fiscal policy-making … be tightly linked to compliance with the broad EU governance
framework… should not be an instrument for crisis management and should help to prevent crises making future interventions by the ESM less likely.”
The Temporary Eurobill Fund could be operational quickly and, in due course, the political governance
could reflect the Community method so that its European Treasury function could indeed become the
locus of European “collective decision-making” between the European Parliament and Eurogroup. The
revamped European Semester process could readily provide a mechanism to manage some of the
`European’ liabilities created by the TEF. Accountability to the European peoples, and corresponding
liability for `moral hazard’, would both be at the European level.
Beyond the direct benefits to financial integration and stability, this Eurobill plan can provide a
concrete mechanism state-by-state: (i) to reward good economic `homework’ (ii) penalise lack of
effort (iii) operate with the grain of the markets to graduate the carrot and stick incentives for each
state and (iv) minimise the eventual costs if a state insists on pursuing economic policies that are likely
to end `badly’. It could be operational in time to take over euro area `solidarity’ when the ECB’s QE
programme winds down and interest rates normalise.
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This Plan has been developed by Graham Bishop since 2012. Comments to [email protected]
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Contents
The story so far: ...................................................................................................................................... 2
Part I: What is the TEF and what could it achieve?................................................................................. 4
Part II: Governance and Political Decision-Makers (PDMs) .................................................................... 7
Part III: Scenarios .................................................................................................................................. 10
Scenario I: The Golden Scenario leads on to a European Treasury .................................................. 10
Scenario II: Black = Probationary Period Failed and TEF winds down .............................................. 10
Scenario III: A State heads towards Exclusion .................................................................................. 11
Part IV: Appendices ............................................................................................................................... 11
Graham Bishop’s Selected Extracts from DRF/Eurobills Expert Group Conclusions ........................ 11
TEF in a summary picture.................................................................................................................. 14
The story so far:
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The original Four Presidents Report in June 2012 said “In a medium term perspective, the
issuance of common debt could be explored as an element of such a fiscal union and subject
to progress on fiscal integration. Steps towards the introduction of joint and several sovereign
liabilities could be considered as long as a robust framework for budgetary discipline and
competitiveness is in place to avoid moral hazard2 and foster responsibility and compliance.
The process towards the issuance of common debt should be criteria-based and phased,
whereby progress in the pooling of decisions on budgets would be accompanied with
commensurate steps towards the pooling of risks. Several options for partial common debt
issuance have been proposed, such as the pooling of some short-term funding instruments on
a limited and conditional basis…”
The European Parliament insisted that these `options’ be examined properly. In February
2013, the Council confirmed agreement with the EP on the "two-pack" and, as Council
explained, “the compromise agreed with the Parliament introduces the following elements….
The Commission will set up a group of experts to analyse the possible merits, risks,
requirements and obstacles in relation to a partial substitution of national debt issuance by
joint issuance in the form of a debt redemption fund and eurobills. The group will be composed
of experts in law and economics, public finances, financial markets and sovereign debt
management. It will report back by March 2014 and the Commission will make proposals if
appropriate.”
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What is `moral hazard’? US economist Paul Krugman defined it, rather pithily, as ‘any situation in which one
person makes the decision about how much risk to take while someone else bears the cost if things go badly’.
The recent economic governance of Greece has epitomised the concept.
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Commission President Barroso set up an Expert Group in June 2013 to examine the
possibilities including eurobills3 and he appointed Graham Bishop to be a member.
The Expert Group Report was published in March 2014 but the impact was lost as Parliament
was dissolving and the `Barroso’ Commission felt that proposals should be left to the incoming
`Juncker’ Commission.
The Expert Group Conclusions were that that a pro-rata guarantee structure (analogous to
that of the ESM) for eurobills was possible without any change to the main Treaty – the
TFEU (See key extracts from the Expert Group Conclusions below)
Since the original Four Presidents report of June 2012, the inability of the EU banking sector
to fund economic growth has become a major source of concern and the concept of a Capital
Market Union has come to the fore as potentially a major contribution to growth. As the
Expert Group pointed out “The eurobills idea has been put forward with the primary objectives
of stabilising government debt markets by reducing Member States' rollover risk and of
fostering the integration of financial markets through the creation of a safe and liquid asset.
Such an asset would also contribute to reversing the trend towards market fragmentation and
support monetary policy transmission.”
The Five Presidents Report of June 2015 set some ambitious goals as well as a clear timetable:
o Stage 1 from July 2015 – June 2017 as a period of ‘deepening by doing’.
o Stage 2 (`completing EMU’) should run from July 2017 to 2025 at the latest and
include `concrete measures of a more far-reaching nature…for each euro area
Member State to participate in a shock absorption mechanism for the euro area.’ Thus
a fiscal stabilisation function for the euro area is envisaged and “the European
Parliament should organise itself to assume its role in matters pertaining especially to
the euro area... However, as the euro area evolves towards a genuine EMU, some
decisions will increasingly need to be made collectively while ensuring democratic
accountability and legitimacy… A future euro area treasury could be the place for such
collective decision-making”.
The “Communication on steps towards Completing Economic and Monetary Union” was
published in October 2015 and set out some concrete steps for achieving Stage 1.
This latest version of my plan for a Temporary Eurobill Fund proposes a stepping stone
in Stage 1 which would enable the TEF to be deepened into a “concrete measure of a
more far-reaching nature” - a European Treasury - during the course of Stage 2, if it
had delivered the hoped-for benefits during a full economic cycle.
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This concept builds on the ideas that the author has discussed widely in recent years. These originated in a
2011 publication by the European League for Economic Cooperation (ELEC) where he acted as Rapporteur.
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Part I: What is the TEF and what could it achieve?
Schematic cash flows of the TEF
(See Appendix for a summary picture of the mechanics and results)
The key Concepts
It would follow a similar legal structure to that of the ESM with pro rata callable capital - but with a
crucial difference: only euro states in `good standing’ (defined below) could borrow, thus excluding
those in the ESM `sin bin’. The economic structure would be the plainest vanilla. The Fund would
borrow from the markets - exactly matching quantities and maturities requested by borrower states
– for maturities ranging up to two years. The key step is that participants would bind themselves to
borrow all new funds in this maturity range only from the TEF (with the possible exception of very
short-term cash management facilities). In short order, there would be a genuine, single European
yield curve for this market sector – with a TEF size of €0.8 trillion (nearly 10% of GDP). Members would
also have the right to re-finance maturing bond issues by borrowing from the TEF – thus removing rollover risk and enhancing financial stability.
Political Governance: Consistency with the Five Presidents’ Report and `Completing EMU’
proposals
The quickest and simplest system of political governance for the TEF would be to replicate the ESM’s
tried and tested `inter-governmental’ arrangements. That could enable the Fund to be operating
within a year.
However, the Heads of State/Government accepted the Five Presidents Report with its more farreaching integration plans for economic governance. Commission President Juncker has now come
forward with his two-stage proposals to complete Economic and Monetary Union and these provide
much more detail to ensure that all elements of economic governance are tied together – with a much
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greater degree of decision-making involvement of the national and European Parliaments. This is the
`Community method’ and the political governance of the TEF could readily be adapted progressively
as these new systems come into operation during Stage 1. This would be a classic `deepening by
doing’.
The “political decision-makers” (PDMs - detailed discussion below) would also be empowered to
authorise the officials of the executive board to buy-in members’ bonds with a remaining life of less
than two years if the PDMs judged the margin above the TEF curve to be excessive - in the light of the
member’s performance of its commitments to the new economic governance measures (Six Pack, Two
Pack, Fiscal Compact, European Semester). If performance during the next, say, five years encouraged
PDMs to buy in all under two-year debt, the TEF could reach about €1.9 trillion in size (+/- 30% of euro
area public debt). It would then have many of the functions of a European Treasury.
But exposure to the TEF must be limited by rules to prevent a member shortening its overall debt
maturity `excessively’ – a term that could be defined as a `benchmark’ within the revamped Country
Specific Recommendations procedure. On the darker side, if performance discouraged PDMs, they
would scale back purchases progressively for any particular state, or perhaps even cease TEF bill
issuance altogether and it would run off entirely within two years. This drawn-out process would give
a significant adjustment period and avoid any `cliff’ effect.
Can it be done?
Yes – The Expert Group was clear that an ordinary Regulation of the European Union could set up the
operational platform although a separate Inter-Governmental Agreement would be necessary to bind
participants to decisions about the financial management of the fund: membership, size, maturity etc.
This IGA would expire after 5 years – unless renewed unanimously by all the participating Parliaments.
The key is that there would be no need to change the main European Treaty – the TFEU. The mechanics
are simple so the first bills could be issued after ratification of the Agreement. This timetable could
bring the TEF into operation as the ECB’s QE programme winds down – hopefully by end-2016.
If the main Treaty were going to be changed during Stage 2, then after a few years of successful
operations – especially if tested successfully in a recession - it would be a natural step to make the
Fund a full part of the EU as the vast majority of EU members could be in the Eurozone.
The Plan would be good for Europe because:
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Financial (i): Enhancing integration it would complete the integration of the euro area’s
money and short term bond markets, whilst providing an anchor for medium term bonds. For
equities, the removal of a significant risk of dis-integration of a part of the assets held by
financial institutions (themselves a significant proportion of the main equity indices) should
be a useful integrative impulse.
o Banking union would be re-enforced, as short term TEF bills would be the most natural
High Quality Liquid Asset (HQLA) for banks to hold to meet Capital Requirement
Regulation liquidity rules, as they would be the safest, most liquid asset in the euro
area.
o As part of Capital Market Union (CMU), the euro-denominated component would be
boosted as all financial institutions – insurance companies, pension funds,
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corporations and mutual funds – would have a `European’ asset to satisfy their
legitimate economic needs for holding short-dated safe and liquid securities.
o The existence of a yield curve for the safest and most liquid asset would naturally
encourage the markets to innovate products with somewhat higher credit risk, and
thus return. As the euro area economy recovers and interest rates move to `normal’
levels, such a yield curve will return to central importance and provide the foundation
for `good’ securitisation of, say, packages of loans to SMEs that would back
commercial paper issued by banks and non-banks – as envisaged in the Commission’s
Securitisation proposal, as part of CMU. The ECB’s easy money policy could then reach
SMEs across the entire euro area.
o A minor practical benefit - but perhaps looming larger in restoring public trust in
financial markets – is that a public authority would provide reference pricing based
on massive activity for all financial contracts that need to specify an interest rate for
any particular short maturity. That would include the variable interest rate on say
longer term mortgages and bonds.
Financial (ii): Ensuring stability
o If the Fund’s PDMs had authorised the `buying-in’ of a state’s bonds with a remaining
life of less than two years, then virtually all of a bond issue would be held by the Fund
as the issue came up for repayment. Permitting the state to roll that over within the
Fund entirely removes roll-over risk.
o The `doom loop’ between banks and their sovereign would be cut by more than a
third - at a stroke. This will make it much easier to tackle the remaining two-thirds of
longer-dated inter-linkage that is necessary to restore the credibility of the `no bail
out rule’. Having cut the doom loop so substantially, it would be essential to modify
the rules on `large exposure limits’ for financial institutions so that the discipline of
the capital market cannot be evaded in the future by `encouraging’ local banks to
purchase excessive quantities of bonds.
Political: the broadening of the `common interest’ of each EU member in the economic
policies pursued by fellow members would be accelerated. The Two-Pack has already given a
collective oversight of budgetary polices. The political decisions of the TEF about permission
to borrow from it would deepen that oversight substantially – via both the signalling effect
and cash implications. In due course, the minimum denomination of the bills should be
reduced so that individual citizens would invest their retirement savings, thus creating a
vested interest in the success of `Europe’ – a step towards a European demos.
Economic: it binds the participating euro area states into closer financial solidarity – thus
encouraging greater observance of the economic governance commitments. But the obverse
would be a correspondingly strong sanction. The Fund’s PDMs would authorise the purchase
of a maximum amount of a state’s bills during the year ahead. The natural flow of redemptions
would steadily reduce the Fund’s exposure to a state – unless the PDMs made a positive
decision to replace these redemptions with new purchases. The absence of such a decision
would send a clear message to the markets holding the other [70%] of the state’s debts.
Market participants have now learnt that the debts of a government consistently pursuing
unsound policies are very risky.
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Monetary policy: The ECB’s QE programme specifically excludes securities with a remaining
life of less than two years so the TEF is outside the current QE programme. In the future, TEF
bills would be a natural public asset to purchase as they would not represent monetary finance
of governments and the state-by-state exposure would already have been agreed by the
politically-accountable PDMs.
Part II: Governance and Political Decision-Makers (PDMs)
The `inter-governmental’ governance system created for the ESM was developed in the heat of the
crisis and gave the final say to the Finance Ministers of each state – each of whom is only politically
accountable to their own national Parliament. There would be substantial merit in using a similar
structure for the initial launch of the TEF so that it would be functioning swiftly. In the near future, the
Fund could then support:
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Capital Market Union by providing a safe, liquid asset and a publicly–set benchmark for
shorter-dated yields;
Financial stability by providing a mechanism to remove roll-over risk in public debt, as well as
sharply reducing the doom-loop between banks and their sovereign;
Monetary policy by providing a politically-neutral asset for any future QE operations and
obviating the need for OMT operations.
However, the `Completing EMU’ proposals open the way to a proper `Community method’ approach
in the medium term so that political accountability and financial liability are both at the European
level. In practical terms, there are two elements to the Fund’s operations:
1. A `European Debt Agency’ (EDA) would provide the operational platform for
issuing/redeeming bills. Its creation would be authorised by an ordinary Regulation of the
European Union (using the enhanced co-operation system to apply it only to euro–area
states).
2. A separate Inter-Governmental Agreement to bind participants to decisions about the
financial management of the fund: membership, size, maturity etc. This IGA would expire
after, say, 5 years unless renewed unanimously by all the participating Parliaments. (The
temporary aspect is necessary to maintain the rights of national Parliaments to control their
own budget). In Stage 1, this IGA could replicate the governance features of the ESM, acting
as a stepping stone so that it could be replaced during Stage 2 by a new IGA with whatever
Community-method arrangements had evolved. There would be no interruptions to the
operational functioning of the EDA. By the end of Stage 2, the political governance
arrangements could be folded into any major Treaty revisions.
In reality, the `Completing EMU’ proposals would extend the existing concept of co-decision making
from legislation fully into the economic governance of the euro area as a whole, and its member
states. Decisions on the overall size of the TEF – and its exposure to individual states – would
highlight the transformation.
“First practical steps have been initiated by the European Parliament to strengthen parliamentary
oversight as part of the European Semester. ‘Economic dialogues’ between the European Parliament
and the Council, the Commission and the Eurogroup have taken place in line with the provisions of
the ‘Six-Pack’ and ‘Two- Pack’ legislation. This has already been part of the last European Semester
rounds. … The timing and added value of these parliamentary moments could be further
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strengthened, in line with the renewed European Semester… In Stage 2, more far-reaching measures
should be agreed upon to complete the EMU's economic and institutional architecture. This will
involve sharing more sovereignty and solidarity and will have to be accompanied by strengthened
democratic oversight… To prepare the transition from Stage 1 to Stage 2 of completing the EMU, the
Commission will present a White Paper in spring 2017...”
The proposed revamping of the European Semester is the opportunity to bring economic governance
fully under the wing of the co-decision process and the TEF could easily play a powerful role in this.
“These measures will be complemented by steps taken with the European Parliament to
improve democratic accountability of the European economic governance system…
2. A REVAMPED EUROPEAN SEMESTER: Member States should make more progress on
implementing country-specific recommendations ….The European Semester should be
structured so that discussions and recommendations about the euro area take place first,
ahead of country-specific discussions, so that common challenges are fully reflected in
country-specific actions. …Discussions on euro area priorities should take place within the
Council and the Eurogroup, as well as with the European Parliament. “
Bishop analysis: Crucial decisions for the euro area on the size of the TEF (and thus its exposure
to individual States) would naturally involve a form of co-decision between Parliament and
Eurogroup. As Parliament took up its full responsibilities within the Country Specific
Recommendation process, the time would be ripe for the IGA governing the TEF to be modified
to switch to making the Political Decision Makers into a co-decision process between
Parliament and Eurogroup.
“2.3. Promoting convergence by benchmarking and pursuing best practices: The Five
Presidents' report emphasises the use of benchmarking and cross-examining performance in
order to achieve convergence and reach similarly resilient economic structures throughout
the euro area. …. Starting with the 2016 European Semester, the Commission will
progressively suggest benchmarks and cross-examination exercises across policy or thematic
areas...”
Bishop analysis: Public debt management should become a focus of best practice analysis, with
benchmarks set for maturity distribution. The benchmark should set a maximum proportion of
debt eligible to be purchased by the TEF – i.e. with less than two years remaining life. The
benchmark proportion should be sufficiently low so there would be enough headroom beneath
an absolute cap for a state to roll-over maturing debt within the TEF in the event of a renewed
crisis.
“2.4. More focused support to reforms through EU funds and technical assistance: To
support structural reforms in line with the common economic priorities set at EU level, the
Commission will seek to enhance the use of the European Structural and Investment Funds in
support of key priorities highlighted in the country-specific recommendations, including
through the use of the measures linking effectiveness of these Funds to sound economic
governance. ... The reform of Cohesion Policy in 2013 has introduced the principle of so-called
macroeconomic conditionality to all five European Structural and Investment Funds.”
Bishop analysis: This is a key linkage between political accountability and financial liability at
the European level. The Commission is now empowered to request amendments to economic
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policy and finally propose to [the co-legislators in the future?] a suspension of payments in the
event of non-compliance. If payments had to be suspended, then the un-disbursed funds could
be used to pay off that State’s maturing obligations to the TEF. The Country Specific
Recommendations could be used – at least in some cases - to ensure that a state’s obligations
to the TEF broadly corresponded to the flow of EU funds to it. As Member States are already
liable to provide `Europe’ with these funds, they would provide the euro area with its share
to meet some liabilities to the TEF that might flow from the co-legislators’ decision on
suspending payments. When the offending State becomes compliant again, the funds used
for redeeming bills can be replaced by new TEF bill issuance that can be paid over to the State
as its `EU funds’. (If the State failed to repay its obligations to the TEF then it would be `offered’
an ESM programme – see Scenario III.)
“3. IMPROVING THE TOOLBOX OF ECONOMIC GOVERNANCE - 3.1. Improving
transparency and reducing complexity of the current fiscal rules: First, the Commission will
ensure the consistency of methodology between the debt rule of the Excessive Deficit
Procedure and Member States' structural budgetary target, known as the Medium Term
Budgetary Objectives. The recent strengthening of economic governance has translated the
debt criterion of the Excessive Deficit Procedure into a simple rule for the reduction of
government debt in excess of 60% of GDP.”
Bishop analysis: This existing process under the Fiscal Compact already provides the raw
material for monitoring actual cash flows of public debt to match ”% of GDP”-style
obligations. Thus the Country Specific Recommendations can be used to specify in cash
terms how much debt can be financed at the cheapest possible rates from the TEF. There
is a natural corollary: any over-run from agreed deficit targets will have to be raised from
more expensive longer-term debt markets. This gives an incentive to meet agreed fiscal
targets and an automatic penalty for breaching them – binding a State tightly into the
revised economic governance process.
“3.2. A stronger Macroeconomic Imbalances Procedure: Second, the Commission will ensure
appropriate follow-up to the identification of excessive imbalances. …The Commission will
stabilise the categories, clarify the criteria guiding its decision, and better explain the link
between the nature of imbalances and how they are addressed in the country-specific
recommendations. The Commission will engage with Member States… on how best to address
the imbalances and put in place a strong and time-bound system of specific monitoring to
support implementation. The Excessive Imbalances Procedure … will be used in case of severe
macroeconomic imbalances that jeopardise the proper functioning of the economic and
monetary union, like those that led to the crises. The Commission will also invite greater
Council involvement in the specific monitoring of countries with excessive imbalances for
which the Excessive Imbalances Procedure is not activated.”
Bishop analysis: This procedure is designed to catch overall economic problems and not just
public finance difficulties - which fall into the Stability and Growth Pact procedures. If the
imbalance becomes sufficiently severe and the State fails to implement agreed measures, then
the natural result should be that Europe progressively reduces the exposure which results from
the State’s obligations to the TEF. The State would have to refinance in the longer term debt
markets both the run-off of TEF funding and any overrun in fiscal targets. Markets would
undoubtedly recognise the rising risk of `Private Sector Involvement’ (a polite term for default)
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and market discipline might kick-in abruptly and significantly – imposing severe penalties for
perceived economic policy failures.
Part III: Scenarios
These scenarios were written in early 2014, with debt data and timetable correct at the time. These
should now be regarded as only illustrative of the process.
Scenario I: The Golden Scenario leads on to a European Treasury
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TEF launched in late 2016 at €0.8 trillion minimum size because:
o `Two-pack’ is working well and governments respond fully to the call for adjustments
o For the euro area as a whole, the cyclically-adjusted balance – the Medium Term Objective
–and the 1/20th debt reduction rule are both set to be met in 2017.
o Sixth European Semester in 2016 demonstrates major improvements in competitiveness
After starting small, the PDMs decide to expand the TEF progressively – Semester by Semester.
They authorise the purchase of bonds with a remaining maturity of less than [six months] for those
states meeting fiscal rules, so not in the Excessive Deficit Procedure nor subject to Excessive
Imbalance Procedures. This rewards `good homework’. The other states see an interest rate
spread that is a clear indicator of market sentiment and a small penalty for poor performance
The TEF’s size rises in graduated steps for exposure from minimum of say 10% of debt at under 2
year original maturity. (10% was around the maximum proportion of any members in the 2014
analysis.)
After the Seventh Semester, 2017 TEF investment plans include purchasing [all] participants’
bonds given their economic performance. The maximum spread from the TEF’s cost of funds is set
at a low level and the TEF buys in 1-year remaining life debt. It expands to over €1 trillion.
After the Eighth Semester, 2018 TEF investment plans call for even lower spreads and TEF buys-in
all under 2-year remaining life debt. Size reaches €2 trillion - de facto a European Treasury,
especially if there is some funding of a modest euro area `fiscal capacity’ to on-lend to members.
2020: National Parliaments unanimously vote to make the TEF permanent – but review every [five]
years. The TEF is folded into the main TFEU before the end of Stage 2.
Scenario II: Black = Probationary Period Failed and TEF winds down
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TEF launched in 2016 at minimum size
Several significant states subsequently miss MTO targets
Debt ratios static – at best
As a direct consequence of this disappointment, PDMs postpone setting any target spread for
buying-in operations. TEF remains at €0.8 trillion
(OR later, having expanded TEF initially, PDMs recognise reality of economic governance failure
and allow the flow of redemptions to shrink the TEF over a period of years back to the initial €0.8
trillion)
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2017: several major states fail to improve competitiveness
Financial market tensions return – exacting a sharp penalty from those states
2018: clear that the experiment in collective economic governance is failing to resolve lack of
competitiveness in some states
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Given high debt levels, markets fear debt re-structuring with major PSI in these states
National Parliaments decline to renew TEF mandate and it ceases new issuance
National DMOs resume short term borrowing in own name
Major financial crisis in uncompetitive states
Doom loop drags down many banks over-exposed to PSI in these failing states – contagion spills
across EU
Scenario III: A State heads towards Exclusion
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State X enters the TEF as it is not subject to the Excessive Deficit or Excessive Imbalance
Procedures and so it builds up to the normal [25%] maximum of its total debt being purchased by
the TEF.
A new government is elected with a mandate for pursuing risky policies. The Commission analyses
these polices as part of the European Semester and issues Country Specific Recommendations to
desist. These CSRs are approved by Eurogroup and the European Parliament in co-decision.
PDMs lower the investment limits for State X obligations by, say, reducing buying-in to one year
of remaining life. (NOTE: this step should also be associated with a change in the risk
weighting/large exposure rules for financial institutions holding State X’s debt)
Financial markets observe the operation of the `teeth’ of euro area economic governance and the
over-one year yield curve for State X steepens – applying a modest, public, annual penalty but one
that lasts for the life of the bonds issued.
The government of State X continues to ignore subsequent Country Specific Recommendations.
Accordingly, the PDMs foresee higher risks and correspondingly reduce the TEF’s purchases –
exposure falls rapidly back to the minimum of [10%] of that State’s debts.
Financial markets build in a significant interest rate premium – thus applying market discipline to
90% of the state’s debts. For a state with a debt/GDP ratio of say 100% (close to the average!),
that could easily cost an extra 2% of GDP (= to 4% of public expenditure) – so a very substantial
penalty that will last for the lifetime of the bonds.
If State X still declines to pursue sound economic policies, then it should not be entitled to `solidarity’
from other euro area states and should be excluded from the TEF entirely. By this stage, payments
from EU funds would have been suspended and the euro area’s contributions used to pay off maturing
obligations to the TEF – if the State refused to honour its obligations. An ESM programme would be
offered to pay off any outstanding obligations to the TEF. So the TEF would not create any extra
liability for euro area states as payments would be covered by the existing commitment to the ESM.
(The ESM programme may also have to cope with the probability that State X had already lost access
to financial markets.)
Part IV: Appendices
Graham Bishop’s Selected Extracts from DRF/Eurobills Expert Group Conclusions
(The full Report of the Expert Group4 is here)
Possible objectives of schemes of joint issuance of debt
 The eurobills idea has been put forward with the primary objectives of stabilising government
debt markets by reducing Member States' rollover risk and of fostering the integration of
4
Graham Bishop was a member of this group.
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financial markets through the creation of a safe and liquid asset. Such an asset would also
contribute to reversing the trend towards market fragmentation and support monetary policy
transmission.
 Introduction of any scheme of joint issuance could only be one step contributing to financial
market integration, amongst other possibly needed steps, including those aiming at
structurally strengthening Europe's banking sector. It should also be noted that no asset is
completely risk-free. Creating a jointly issued government security that will be regarded as a
safe asset for investors will thus imply some residual risk to governments participating in joint
issuance.
Assessing eurobills: Design, merits, risks
 Eurobills could contribute to promoting financial integration and financial stability. To the
extent they create a safe and liquid instrument, eurobills could be a step towards diversifying
sovereign debt holdings in bank balance sheets and thus reducing the bank-sovereign
feedback loop. Market fragmentation might also be reduced and monetary policy
transmission could be made easier; however, sustainable financial integration requires
structural reforms of the real economy and the financial sector.
 To the extent issuing limits are not reached, eurobills could lower the roll-over risk in particular
in case of sudden changes in the perception of the markets, contributing to more stable
government debt markets. Only a large eurobill fund is likely to provide this benefit in full. In
normal times, when spreads on short-term debt are small, the effect on Member States'
financing costs would probably be limited and would depend on the size of issuance and the
liquidity premium.
 The extent to which these objectives are attained depends on the design variants, which have
not only legal dimensions but also mark trade-offs linked to financial risk-sharing and
containing moral hazard.
 Setting up a eurobills scheme only temporarily and which would lapse unless renewed, i.e. as
a “test run”, is an option that might offer some advantages. However, there is some
uncertainty as to market acceptance of a temporary scheme and particularly to whether the
unwinding option is really credible and without stability risks. In any event, most of the
benefits for which eurobills have been conceived could only be obtained if the scheme was
set up on a permanent basis (subject to regular votes in national parliaments on concrete
liabilities assumed, [see point 35 of the Conclusions of the Expert Group].
 Robust mechanisms to contain moral hazard should be part of any scheme of joint issuance.
These could include prior conditions (a period of probation and restricting eligibility for
participation), reinforced competences of the European level over Member States’ fiscal and
economic policies in case of non-compliance, financial incentives and sanctions (e.g. markups) and ensuring that market discipline will still be felt.
 Given the still very limited experience with the EU's reformed economic governance
framework, it may be considered prudent to first collect evidence on the efficiency of this
governance and, if deemed necessary, further strengthen this governance framework, before
any decisions on introducing joint issuance are taken.
Legal requirements and limits for introducing … eurobills
 While the current EU Treaties do not allow any schemes of joint issuance of debt resting on
joint and several liability of Member States, they may allow guarantee structures based on
pro rata commitments and in particular a capital structure analogous to that of the ESM.
 The current EU Treaties do not grant sufficient competence to the EU to set up a DRF/P or a
eurobills scheme (even if based on pro rata) through EU legislation. At most, absent Treaty
change one could argue that it is possible to set up a temporary eurobills scheme through a
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combination of an Article 352 regulation (in enhanced cooperation) with an
intergovernmental agreement.
 If a DRF/P or a eurobills scheme was established on a purely intergovernmental basis, legal
limits would have to be taken into account. The EU's political institutions could not exercise
any decision-making powers. The EU's economic policy coordination should not be
undermined.
 National constitutional laws pose pronounced limits to the possibilities of Member States to
participate in a scheme of joint issuance of debt (see the example of Germany). There might
be possible ways to respect those limits. A scheme could the more likely be found in line with
those limits, the more clearly it were legally ensured that the maximum of a Member State's
liability is in advance limited, that there is a possibility for regular votes in national parliaments
on concrete liabilities assumed (on top of information rights and rights to influence) and that
there are strict conditions and safeguards designed to ensure fiscal discipline.
Overall conclusion
Both a DRF/P and eurobills would have merits in stabilising government debt markets, supporting
monetary policy transmission, promoting financial stability and integration, although in different
ways and with different long term implications. These merits are coupled with economic, financial
and moral hazard risks, and the trade-offs depend on various design options. Given the very
limited experience with the EU’s reformed economic governance, it may be considered prudent
to first collect evidence on the efficiency of that governance before any decisions on schemes of
joint issuance are taken. Without EU Treaty amendments, joint issuance schemes could be
established only in a pro rata form, and - at least for the DRF/P - only through a purely
intergovernmental construction raising democratic accountability issues.
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TEF in a summary picture
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