Questionable legality: is the ECB's new bank supervision role in trouble?

• Author: Engelen, Klaus C.

The largest bank health check ever undertaken in terms of the number of banks, their overall size, and their geographical reach is keeping thousands of bankers, supervisors, and auditors in overtime this summer in preparation for the launching of the European Central Bank as the eurozone's lead bank supervisor at the beginning of November. The legality of this most ambitious European integration project since the introduction of the euro at the beginning of 1999 is still being questioned.

Once again, the legal challenges are coming from Germany. The outcome of that legal challenge remains open. As the saying goes, "Before the courts and high seas, we are in God's hands." Ever since European leaders opened the door to European banking union at their June 2012 EU summit in Brussels, the legal battles have been raging, particularly from a German perspective. It is useful to recall what the EU leaders agreed to at that fateful Brussels summit:

We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) TFEU for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific, or economy-wide and would be formalized in a Memorandum of Understanding. A letter from Germany's chief banking union negotiator, Wolfgang Schauble, finance minister since 2009, to then-EU Commissioner Michel Bamier, written July 11,2013, sheds light on Berlin's legal battles with the Club Med-dominated EU Council and EU Commission over the sound legal foundations of the three-stage European banking union.

Haunted by using the questionable Article 127, paragraph 6, of the Treaty on the Functioning of the European Union to enable the ECB to become the eurozone's lead bank supervisor, the German coalition government under Chancellor Angela Merkel insisted--against strong opposition from the European Parliament's majority--on intergovernmental agreements as legal foundations for the Single Resolution Mechanism and the Single Resolution Fund. "Germany has made clear that under the current treaties, the Commission does not have the competence to run such a central authority or act as a resolution body," said Merkel. "If we want new competences then they must be linked to treaty changes."

Merkel may have learned her lesson. To the horror of most German-speaking EU law experts, she took the position, advanced by the French, the EU Commission, the ECB, and Club Med leaders, that Article 127(6) TFEU would do as a legal basis for transferring national bank supervisory powers to the ECB. By simply ignoring the problem with the legal basis for the Single Supervisory Mechanism, Merkel signaled to her party followers and a docile German bureaucracy to keep quiet about its illegality. A debate over breaking EU law by transferring bank supervision and a large hunk of German sovereignty to the ECB might have unsettled the German public with national elections looming on the horizon. Also, the major opposition parties, the Social Democrats and the Greens, did not raise this legal issue for fear of being attacked as anti-European on the campaign trail.

The main thrust of the Schauble letter centers on the reasons why Germany can never accept using Article 114 TFEU as the legal basis for a centralized European bank resolution mechanism and fund, with their enormous fiscal implications for the financially and economically strongest eurozone member state. It also explains why the Berlin government sees the urgent need for treaty changes in order to expand Article 127(6) TFEU as a sound legal basis for enabling the ECB with the Single Supervisory Mechanism.

ENTER THE EUROPOLIS "GROUP OF FIVE"

On July 28, 2014, the reliable guardian of global investors, the Financial Times, sounded the alarm: "EU banking union challenged. German court case creates uncertainty--policy seen as vital response to crisis."

This followed a long report in the weekly Welt am Sonntag on the details of the constitutional complaint lodged at the Karlsruhe Federal Constitutional Court challenging the legal basis for transferring bank supervision, bank resolution, and resolution financing from the national to the European level. "Kerber doesn't let loose--Berlin's professor Markus C. Kerber again is marching before the Federal Constitutional Court. Again he is about to topple a mega-project of the euro rescuers."

The plaintiffs challenge the use of Article 127(6) TFEU as a legal basis. This section allows the EU Council to delegate "specific tasks" to the ECB in connection with prudential supervision of banks.

The Europolis group, a euroskeptic think tank headed by Kerber, argues that the Single Resolution Mechanism exceeds the remit of Article 127(6) by a wide margin, especially since the ECB assumed the power to put every single bank in the eurozone under its supervision. The plaintiffs also point to the inherent conflict of interest of the ECB's Governing Council, which under the TFEU is legally the only decision-making body of the ECB. The treaty stipulates only that the Governing Council must follow a price stability objective, which would conflict with a bank supervisory role. Although the ECB is trying to circumvent this conflict through a bank supervisory board, the Governing Council remains ultimately responsible. Furthermore, the plaintiffs take the position that a banking union would have required a change in the European treaties, something that member states avoided, fearing that they would not get the support of a majority of their citizens. Therefore, the plaintiffs accuse governments of trying to hide the risks, since banking union constitutes an indirect form of fiscal transfer.

The Welt am Sonntag article draws attention to a seventy-nine-page legal opinion on the constitutional and European legal limits of monetary and banking union by Udo di Fabio, a respected German former constitutional judge, commissioned by Stiftung Familienuntemehmen, a lobby group for small--and medium-sized private enterprises. Di Fabio comes to the conclusion that banking union would indeed require treaty changes.

Says Kerber, a finance professor at Berlin Technical University who was party to other major suits against the European Stability Mechanism, "Schauble deceives German taxpayers about the risks of the banking union." In the ESM case, supported by 37,000 backers, the Federal Constitutional Court ruled that the European Stability Mechanism was legal as long as the German parliament had enough control to protect German taxpayers. But in the recent high-profile complaint, the court in Karlsruhe separately referred a different part of the case relating to the ECB's plan to purchase the government debt of eurozone countries through "Outright Monetary Transactions" to the European Court of Justice. (See "Draghi's German Nightmare." TIE, Winter 2014). This complaint has not yet been finally adjudicated.

In a press release, Kerber and his euroskeptic think tank experts argue, "In view of the German governmental and parliamentary consent to banking union which goes far beyond the authorization by Article 127 TFEU, the Europolis group has lodged a constitutional complaint at the Federal Constitutional Court. As soon as the regulation for the single resolution mechanism and the single resolution fund enters into force the constitutional complaint will be enlarged. The banking union project compared...