ESM in the context of the Coronavirus Crisis – a Much Needed Lifejacket or Another Lead Blanket?

Starting as a local outbreak, the COVID-19 has rapidly transformed into a global public health emergency spurring the global economic turndown and facilitating an unpredictable global and EU economic crisis. The reaction from the EU in terms of attempting to mitigate the effects of economic shock was not long in coming – for example, a comprehensive package of monetary policy measures has been recently announced by the ECB, whereas the Commission has already formulated an impressive amount of legislative proposals aiming at addressing economic difficulties experienced within various sectors affected by the COVID-19 pandemic. The current recession has raised questions regarding potential recourse to any funding available for Eurozone Member States, among which is the European Stability Mechanism (ESM). What can the ESM offer under the extreme circumstances of COVID-19 crisis and would the financial assistance under its auspices be desirable?

The Origins of the ESM

The ESM was established following the Eurozone sovereign debt crisis as a continuing facility to provide financial assistance to euro-area Members States experiencing economic distress. The predecessors of the ESM either lacked adequate funding (such as EFSM, whose maximum availability resources amounted to €60 billion only) or were temporary in nature (such as EFSF, established in June 2010 as a private entity under Luxembourgish law). The ESM is by contrast a permanent and ‘constitutionally engraved’ stability mechanism with strict conditionality at its core. The European Council agreed to establish the ESM in October 2010, whereas an amendment of Article 136 TFEU, which allowed the Eurozone Member States to establish a mechanism safeguarding the stability of the Euro-Area, provided the constitutional foundation for the ESM.

The ESM is formally an intergovernmental agreement, operating outside the EU legal framework, though it allocates tasks to such Union institutions as the Commission and the European Central Bank. Before entering into force, the complexity of the mechanism was reviewed by the Court of Justice in a seminal case Pringle. Mr Pringle, an Irish parliamentarian, challenged the creation of the ESM as incompatible with various Treaty provisions, constituting a breach of the ‘no bail-out clause’ and an encroachment on the exclusive competence of the Union in the field of monetary policy. The Court upheld the establishment of the ESM in Pringle and the ESM became operable July 1, 2013. As of the 16^th of March, 2020, the unused lending capacity of the ESM amounts to €410 billion.

The Toolbox of the ESM

The lending facility of the ESM consists of several tools: loans granted within a macroeconomic adjustment programme (Article 16 of the ESM Treaty), loans for indirect bank recapitalization, direct recapitalization of institutions (Article 15 of the ESM Treaty), primary and secondary market purchases (Articles 17 and 18 of the ESM Treaty respectively) and precautionary credit lines (Article 14 of the ESM Treaty). Throughout the history of the ESM only the first two instruments have been used, in the context of the Euro-Area crisis. In general, there are two possible scenarios for a Member State to draw funding from the ESM – a Member State whose economic and financial condition is sound (precautionary credit lines) or a Member State that is experiencing financial difficulties which  threaten the financial stability of either the Euro-area as a whole or of its Member States. According to Article 13 of the ESM Treaty a Member State, willing to receive the financial aid from the ESM, is required to submit its request to the ESM Board of Governors. This governing body then charges the Commission and the ECB with an evaluation of the existence of a risk to the financial stability, sustainability of the public debts and the financing needs of the ESM Member. On the basis of this assessment, the Board of Governors decides if a financial assistance facility is to be granted to the ESM Member and, if such an assistance is accorded, the Commission, the ECB and the IMF (together, the Troika) are to negotiate with the applicant the conditions of the Memorandum of Understanding that stipulates the requirements of the conditionality attached to the ESM financial assistance facility. The Troika is afterwards assigned to monitor the compliance of the receiver of the ESM loan with this conditionality.

Possible Legal Issues Raised by Invocation of ESM Assistance by a Distressed Member State

In the context of the public health emergency triggered by COVID-19  . Any grant of funds by the ESM is dependent on the conclusion of the Memorandum of Understanding between the Troika and an ESM Member and fulfillment of its conditions by the recipient of the financial assistance. These conditions have contained specific reform agenda, including, inter alia, ‘austerity measures’ that the Member State at hand needs to implement, such as, for instance, restructuring of primary expenditure in Cyprus, stemming from the conditionality attached to a 3-year ESM programme. An overwhelming public health crisis that depletes a Member State’s financial resources and severely damages its economy may not suggest a need for specific national reforms. It is not clear how the requirement of conditionality should be met in the context of the COVID-19 crisis that tests the viability of both the public healthcare system and the general economy of the Member States. A COVID-19 induced recession could not have been foreseen by the Member States and did not result from the structural deficiencies of their policies.

Moreover, the existence of ‘underlying conditions’ in some Member States also needs to be taken into account. Even though some Member States, such as Italy, advocate the use of precautionary financial assistance from the ESM in the form of the Enhanced Conditions Credit Line (ECCL) without any conditionality, their pre-COVID-19 state of economic affairs should not be completely disregarded. Italy’s intense economic recession was reflected in June 2019 in the report of the Commission, which revealed that Italy’s general government debt amounted to 132.2% of GDP (i.e. above the 60 % of GDP reference value). This report indicated the troublesome state of the Italian economy long before the state quarantine and the shutdown of aviation and tourism industries that occurred in February 2020. These questions, among others, are currently being discussed at the European level, following the latest video-conference on a coordinated crisis response that was held by the Eurogroup on the 24^th of March 2020. Klaus Regling, ESM managing director, indicated the suitability of the ESM as one of the institutions capable of providing its experience and capacity for combatting the crisis, highlighting that differentiating circumstances for triggering ESM financial assistance might call for use of different instruments (and distinct conditionality as well). In this context it can be concluded that the chances of the usage of the ESM funds are high, whereas such a development could become one of the myriads of tools employed in a battle against economic consequences of the COVID-19. The key element though that would define the usefulness of the ESM for certain Member States would be negotiated conditionality – it is difficult to imagine that the preexisting conditions in some Member States would be completely disregarded, especially since some Member States, such as Austria and the Netherlands, as opposing to Italy and Spain,  have already expressed their strong stance regarding this issue. The possible solution could be the introduction of the differentiated conditionality that would take into consideration the economic state of an applying Member State prior COVID-19 crisis – the more fragile it was before the outbreak, the more stringent the conditionality imposed could potentially be with a possibility of delayed adherence to the conditions stipulated in the MoU (triggered by the end of the public health emergency in the context of the EU). In this case ESM Member States might reach an equilibrium between expressing mutual solidarity under the circumstances of the extraordinary crisis and, at the same time, respecting the principle of sound public finances. Depending on the chosen regime of conditionality, ESM funding could either become a ‘lifejacket’ that could facilitate the recovery of a Member State from an unexpected crisis or serve as a ‘lead blanket’ providing a partial solution to stagnated economy at the expense of restructuring the distressed sectors of the state economy that in any way seems to be unavoidable. The employment of the ESM, though, remains to be discussed, whereas only  time will tell what kind of consensus, if any, the Eurogroup will reach in the near future – next videoconference of the Eurogroup is scheduled on the 7^th of April 2020.