SOurce:ESM

9 FEBRUARY 2012

Parliament passed the bill yesterday ratifying the TREATY establishing the European Stability Mechanism (ESM), signed on February 2, 2012 by Euro area Members and following March 25th 2011 European Council conclusions, and signatory countries « committed to ensure the financial stability of the Euro area ».  The TREATY will enter into force when ratified by its Members and when no less than 90% of total subscriptions is paid by Members. Target date July 2012.

ESM DECIPHERED

KEY DATES:
March 25th 2011: amendment of article 136 of the Treaty on the Functioning of the European Union (TFEU): « The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality".
21 July 2011: EuroGroup ministers agree to increase the flexibility of the European Stability Mechanism (ESM) « linked to appropriate conditionality".
9 December 2011: Euro area Member states adopt a Fiscal Compact under the new Treaty on Stability, Coordination and Governance in the Economic and Monetary Union ("TSCG").  This Treaty along with ESM are complementary.

Role of the ESM: successor of the current bail-out fund, the European Financial Stability Facility (EFSF), effective from July 1st 2012 with the aim to provide «  where needed » financial assistance to Euro area member states. The ESM intervenes when a Euro area member state's « access to market financing is impaired or is at risk of being impaired ». To bail-out a Member in need of financial assistance, a qualified majority with  80% of the votes cast is necessary. Euro area member states membership of ESM is compulsory. Close cooperation between the ESM and the International Monetary Fund (IMF) in « providing stability support » is systematic. A member state requiring assistance under ESM will also seek support from the IMF. Non Euro area member states will be invited to participate as observers in case of financial assistance request from a Euro area member state. They may seat at the ESM Board meetings as observers.
Watchdogs: The European Commission (EC) and the European Union Council are in charge of a post-program surveillance as per Article 121 and 136 of the TFEU. Internal, external auditors, as well as the European Court of Auditors, will be in charge of the ESM financial accounts verifications .

ESM legal status: a private company headquartered in Luxembourg with  an authorized capital stock of €700 billion, divided into seven million shares. Its initial total paid-shares stands at € 80 billion, and its initial maximum lending capacity at € 500 billion, based on member states capital contribution « including the outstanding EFSF stability support ».
ESM lending capacity review is scheduled to take place every five years. Property, funding and assets of ESM have full immunity. Premises, archives and documents are inviolable. Members of the Board of Governors and staff are subject to professional secrecy regarding classified data, « even after their duties have ceased ». Immunity applies to the Chairperson of the Board of Governors, Governors, alternate Governors, Directors, alternate Directors, as well as the Managing Director and other staff members. Immunity may be waived. As authorized by the Treaty, ESM assets, income, property  operations and transactions shall be exempt from all direct taxes.  Indirect taxes or sales taxes will be remitted when applicable. Are import tax free, all goods necessary for ESM exercise of its official activities. Staff salaries and extra are exempt from the national income tax, but will be subject to an internal tax. 
 
ESM Governance: a Governor (revocable at any time) and a Board of Governors. The Board of Governors is Chaired by the President of the Euro Group (currently Mr. Jean Claude JUNCKER).
Board Meetings may include as participants: the European Central Bank President, (ECB) a member of the European Commission (EC) in charge of Economic and Monetary Affairs, and a IMF representative. Non Euro area representative may join in Board meetings as observers. 
Each ESM Member must designate its Governor within two weeks of the TREATY entry into force.

ESM mechanism: Each Member contribution shall be payable in five annual installments of 20% each of the total amount due. The first installment will be due within 15 days of the first day of the Treaty entry into force. The remaining payments will be paid annually. ESM must constantly dispose of a minimum 15% paid-in capital so as to guarantee a minimum combined EFSF/ESM € 500 billion lending capacity. 
Under the terms of the TREATY, a Euro area Member may request financial assistance to the ESM Board of Governors.
1. The Board entrusts the European Commission (EC) and the European Central Bank (ECB) with the Member's assessment taking into account the Member's public deficit potential impact on the Euro area financial stability.
2. The Member country public debt sustainability is also evaluated and in conjunction with the International Monetary Fund (IMF), an assessment of the financial package requested is produced.
3. Negotiation of a Memorandum of Understanding (MoU)  is undertaken with the Member state concerned if a decision is taken by the Board, in conjunction with the EC, the ECB and the IMF, the tri-partite known as « the Troika ». The MoU details financial instruments chosen and weaknesses to be addressed by the Member country.
4. The European Commission signs the MoU on behalf of the ESM.
The terms and conditions of the financial agreement are prepared by the Managing Director of the ESM.
5. The Board of Directors approves the agreement, and sets disbursement of the first tranche. 
6. The ESM establishes a warning system to ensure that reimbursement by a Member state concerned is made in due course.
7. The TROIKA monitors compliance with the financial assistance granted.

An emergency voting procedure to provide financial assistance to a Euro area country, through the ESM Emergency Reserve Fund, is feasible as long as 85% of votes are cast. The Emergency Reserve Fund is made of the net income generated by the ESM operations, and sanctions provided under the surveillance program (0.1% of GDP of a member state above its public debt target). Transfer from the fund to a Member in an emergency situation constitutes a « dedicated buffer ».  

ESM Members Voting rights : are equal to the number of shares allocated to a Member in capital stock of ESM (Germany, France, Italy are largest contributors). They are forsaken by any ESM member who has not paid in its contribution, or has failed to reimburse financial assistance. In such case, a voting threshold  shall be recalculated « accordingly ». 

Under the TREATY, Precautionary Assistance may be granted to a Member: this form of financial assistance shall be applicable for the purpose of a Member's own financial institutions recapitalizations. The procedure is simplified with the implications of the Board and the Managing Director, based on a report produced by the European Commission. The Board decides on disbursements following a first tranche.
 
ESM and Financial flows: to provide financial assistance to a Member state upon its own request, the ESM Board decides to initiate operations under the form of loans, or bonds issuance on the primary market. Based on recommendations from the ESM Managing Director, the Board may decide to initiate operations on the secondary market. The ECB's intervention on the secondary market is based on an analysis and « exceptional financial markets circumstances« .  Private Sector Involvement (PSI), « in accordance with IMF practices« will be requested to participate in a bail-out process (as is already the case with Greece).

Borrowing operations: the ESM may borrow on the capital markets from banks, financial institutions, or other persons or institutions based on volatilities determined by the Managing Director. Appropriate risk management tools must be used and reviewed regularly by the Board. Dividends may be paid to ESM Members when the reserve fund or paid-in capital are in excess of the level required to maintain its lending capacity. If the ESM has not provided any financial assistance to a Member state, proceeds shall be returned to its members, provided that its lending capacity is fully available.