The Eurozone Debt Crisis and the European Banking Union: 'Hard Choices,' 'Intolerable Dilemmas,' and the Question of Sovereignty

• Author: Emilios Avgouleas - Douglas W. Arner
• Position: Chair in International Banking Law and Finance, University of Edinburgh and Member of the European Banking Authority Stakeholder Group. - Professor of Law and Director, LLM in Compliance and Regulation Program, University of Hong Kong.
• Pages: 29-67

The Eurozone Debt Crisis and the European

Banking Union: “Hard Choices,” “Intolerable

Dilemmas,” and the Question of Sovereignty

E

MILIOS

A

VGOULEAS

*

AND

D

OUGLAS

W. A

RNER

**

I. Introduction***

The 2008 global financial crisis spread to most of the developed

economies, including those of the European Union. Unfortunately, despite

decades of effort to build a Single Financial Market, almost all EU

jurisdictions lacked proper crisis resolution mechanisms, especially with

respect to the cross-border dimensions of a global crisis.

1

This led to a

threat of widespread bank failures in EU countries and near collapse of their

financial systems. Today, in the wake of the Eurozone financial crisis and

the recent Brexit vote, the EU is at a critical crossroads. It has to decide

whether the road to recovery runs through closer integration of financial

policies to follow recent centralization of bank supervision and resolution in

the European Banking Union (EBU) or whether to take the path of

fragmentation with a gradual return to controlled forms of protectionism in

the pursuit of narrow national interest, although the latter is bound to

endanger the single market. Therefore, the policy dilemmas facing the EU

and contemporary institution building within the Eurozone provide a key

window into the future of both global and regional financial integration.

The complexity of the financial integration process and its significance

means that it is impossible to understand contemporary developments within

the EU leading up to the EBU without a discussion of the different forms of

* Chair in International Banking Law and Finance, University of Edinburgh and Member of

the European Banking Authority Stakeholder Group.

** Professor of Law and Director, LLM in Compliance and Regulation Program, University

of Hong Kong.

*** This article builds on the authors’ earlier framework of analysis on modalities and risks of

financial integration initially presented in Emilios Avgouleas & Douglas Arner, The Broken Glass

of European Integration: Origins and Remedies of the Eurozone Crisis and Implications for Global

Markets, in I

NTERNATIONAL

E

CONOMIC

L

AW

A

FTER THE

G

LOBAL

C

RISIS

: A T

ALE OF

F

RAGMENTED

D

ISCIPLINES

72-106 (C. L. Lim & Bryan Mercurio eds., 2015) and Emilios

Avgouleas & Douglas Arner, Ch. 10 Regional financial arrangements: lessons from the Eurozone crisis

for East Asia, in G

LOBAL

S

HOCK

, R

ISKS

,

AND

A

SIAN

F

INANCIAL

R

EFORM

377 (Iwan J. Aziz &

Song Shin eds., 2014). Though those earlier publications covered different ground we draw

here on some (limited) text and references from this published work. The authors gratefully

acknowledge the financial support provided by the Hong Kong Research Grants Council

Project: Enhancing Hong Kong’s Future as a Leading International Financial Center.

1. See E

MILIOS

A

VGOULEAS

, G

OVERNANCE OF

G

LOBAL

F

INANCIAL

M

ARKETS

: T

HE

L

AW

,

THE

E

CONOMICS

,

THE

P

OLITICS

261-347 (2012).

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30 THE INTERNATIONAL LAWYER [VOL. 50, NO. 1

integration and the history of financial integration in Europe. It is

important to draw a distinction between economic, monetary, and political

forms of integration before looking at the specific properties of EU financial

integration. Economic integration normally refers to integration of national

commercial and economic policies and elimination of trade barriers and

obstacles to foreign direct investment (FDI).

2

Monetary integration refers

to formal currency alignments and interest rate cooperation between states

supported through a variety of institutional mechanisms.

3

It could take a

stronger or a weaker form, depending on the nature of arrangements.

4

The

stronger form refers to an unequivocal decision between more than one

jurisdiction to share a common currency and a single monetary and foreign

exchange policy, as a result of a bilateral or multilateral agreement between

interested states. It entails the establishment of a common central bank and

shared responsibility for joint monetary policymaking.

5

The weaker form of

monetary integration essentially refers to exchange rate alignments, like the

Bretton Woods system of fixed exchange rates, or even adoption of another

country’s currency policy by means of currency board arrangements. In

terms of sovereignty concessions the stronger form means abolition of the

2. For R ¨opke the free and reciprocal flow of trade between the various national economics is

what defines economic integration. See W

ILHELM

R

¨

OPKE

, I

NTERNATIONAL

O

RDER AND

E

CONOMIC

I

NTEGRATION

72 (Gwen E. Trinks et al. trans. 1959) available at https://mises.org/

system/tdf/International%20Order%20and%20Economic%20Integration.pdf?file=1&type=

document. Wilhelm R¨opke was a “proponent of the Austrian School.” Shawn Ritenour,

Biography of Wilhelm R¨opke (1899-1966): Humane Economist, M

ISES

I

NST

. (Aug. 1, 2007), https://

mises.org/library/biography-wilhelm-r%C3%B6pke-1899-1966-humane-economist. Thus, he

was suspicious of other forms of integration such as political integration and attendant

consolidation of political power. Id. He was one of the first economists to highlight “the

connection between culture and economic systems,” and, uncharacteristically for an “Austrian,”

he “explored the ethical foundations of a market-based social order.” Id. His ideas had

significant influence over West German post-war economic development. See id.

3. “Monetary arrangements that supplement trad[e] relationships have existed for centuries.”

Ellen E. Meade, Monetary Integration, H

ARVARD

I

NT

’

L

R

EV

. (Mar. 21, 2009), http://hir.harvard

.edu/rethinking-financemonetary-integration/. In the Eastern Roman Empire, “for example,

the solidus coin—a money whose metallic content was stable—circulated widely” for more than

seven hundred years. Id. Its predecessor, the denarius, was undermined by emperor

Diocletian’s (284 – 305 AD) debasing of the metal content of the coin to cover the penury of

the Roman treasury at the time due to continuous defensive wars. See Martin A. Armstrong,

Diocletian – 284-305 AD, A

RMSTRONG

E

CON

., https://www.armstrongeconomics.com/

research/monetary-history-of-the-world/roman-empire/chronology_-by_-emperor/tetrachy/di

ocletian-284-305-ad/ (last visited Oct. 24, 2016). “This type of monetary arrangement was not

a true monetary union but rather a common-currency-standard area, because each country’s

monetary policy was separately rooted in a commodity—such as gold or silver—and the union

did not establish a common monetary authority or currency.” Meade, supra note 3. Thus, they

can hardly compare with the EMU. See id.

4. See generally Samuele Rosa, D

EFINITION OF

C

URRENCY

U

NION

, IMF C

OMM

.

ON

B

ALANCE OF

P

AYMENTS

S

TATISTICS

C

URRENCY

U

NION

T

ECH

. E

XPERT

G

ROUPS

(2004).

5. See also M

AREK

D

ABROWSKI

, M

ONETARY

U

NION AND

F

ISCAL AND

M

ACROECONOMIC

G

OVERNANCE

6 (2015), available at http://ec.europa.eu/economy_finance/publications/eedp/

pdf/dp013_en.pdf.

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2017] EUROZONE DEBT CRISIS & EUROPEAN BANKING UNION 31

national currency and of member states’ ability to set interest rates. Yet

weaker forms like currency boards also entail—in exchange of currency and

economic credibility—loss of sovereignty over exchange rate setting and

inflation targeting since the currency board country essentially imports the

low or high inflation policies of the country of the reference currency.

On the other hand, financial sector integration refers to the elimination of

restrictions to cross-border capital flows that may involve transactions

concerning loans, debt, and equity securities, and of barriers to cross-border

market access and operation by financial intermediaries. It could extend to

rights of establishment for foreign firms. The market for a given set of

financial instruments and/or services is fully integrated if all potential market

participants with the same relevant characteristics deal with a single set of

rules, when they transact in financial instruments and/or provide financial

services within a certain geographic area or region. Moreover, firms and

consumers must have non-discriminatory access to such financial

instruments and/or services. Regulatory oversight arrangements within

integrated markets are non-discriminatory.

6

Finally, political integration is

equally important. It involves the voluntary sharing/pooling of sovereignty,

whether in commercial and financial affairs, trade-policy cooperation/co-

ordination, or in relation to justice and national security.

7

Thus, given the

sovereignty concessions, integrated markets require a lack of political

integration that can hinder the flow of benefits emanating from monetary

and financial integration.

A central idea of this article is that the design of institutions underpinning

international financial integration has to be a step-by-step process. In the

EU market integration took several decades, starting with the European

Coal and Steel Community and the European Economic Community

(EEC)

8

and from there to the EU and ultimately to the European Economic

and Monetary Union (EMU) and the introduction of the single currency.

9

6. See L

IEVEN

B

AELE

, A

NNALISA

F

ERRANDO

, P

ETER

H

¨

ORDAHL

, E

LIZAVETA

K

RYLOVA

&

C

YRIL

M

ONNET

, M

EASURING

F

INANCIAL

I

NTEGRATION IN THE

E

URO

A

REA

7 (2004), available

at https://www.ecb.europa.eu/pub/pdf/scpops/ecbocp14.pdf?b767d42e5483e5b763fa75031702

5ed4.

7. For the main tenets of political integration in an intergovernmentalist rational bargaining

framework, see generally Andrew Moravcski, Preferences and Power in the European Community: A

Liberal Intergovernmentalist Approach, 31 J.

OF

C

OMMON

M

ARKET

S

TUD

. 473 (1993), https://

www.princeton.edu/~amoravcs/library/preferences1 .pdf.

8. The EU traces its origins to the European Coal and Steel Community (ECSC) and the

European Economic Community (EEC). See Matthew J. Gabel, European Union (EU),

E

NCYCLOP

æ

DIA

B

RITANNICA

, https://www.britannica.com/topic/European-Union (last

updated Oct. 17, 2016). The ECSC was established in 1951; it was a six-nation international

organization serving to abolish trade barriers in the areas covered by the treaty between the

democratic nations of Western Europe, as the Cold War had divided the geographic area

covered by European nations through the so-called “iron curtain.” See id. The ECSC was the

first purely European organization in the postwar era to be based on the principles of supra-

nationalism. See id.

9. The Maastricht Treaty established the European Union (EU) in 1993. See Gabel, supra

note 8. The same Treaty introduced the charter of the European Monetary Union. See id. The

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