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Plain Sailing for the ECB? Look out for the rocks!

As Britain’s ‘mortgage prisoners’ seek help to see them through the difficulties of rising interest rates, the UK’s internal problems may prove to be small beer by comparison with UK exposure to Eurozone debt. Here Barnabas Reynolds considers the irregular arrangements under which the European Central Bank operates, and the steps needed to protect the UK from a future fallout.

The European Central Bank recently celebrated its 25 th birthday with French music, mango flavoured cake and a blue carpet, at a party in the Bank’s glass towered Frankfurt home. But the celebrations may be misplaced. High levels of debt pose serious challenges for the Eurozone and its creditors. Any assessment of the ECb’s performance over this time must not only consider that debt, but also the unique framework which gives rise to it. Moreover, steps should be taken to protect the UK outside the Eurozone from the repercussions arising from any future mishaps. “So far so good” is often the commentary, the suggestion being there have at least until now been no disastrous consequences. This is clearly inadequate.

The ECB portrays itself as a normal central bank. It is tasked with managing interest rates and implementing monetary policy for the Eurozone. It also carries out the other day-to-day functions of a central bank. Its public statements revolve around these tasks, and commentators often see it as successful, implying performance no worse (overall) than the Federal Reserve (in the US) and the Bank of England (in the UK). The Euro is the second most significant currency in the world after the US dollar. The EU has even aspired to make the Euro the world’s next reserve currency.

There are of course grumbles amongst member states about the ECB’s performance. The ECB sets interest rates at levels that are often too high for the successful states of the northern Eurozone, but too low for the southern states. This over-suppresses inflationary pressures in the north whilst failing to curb inflationary pressures in the south. Yet these complaints are generally seen as entirely natural and inevitable compromises arising from living and operating within a wider zone where individual economies vary significantly.

But it is the portrayal of the ECB as a normal central bank, the more mundane picture, that masks something disturbing: the EU’s aspirations for the Euro and the ECB run far ahead of reality. That reality is that the legal arrangements underpinning the ECB’s operation mean it cannot behave like the Federal Reserve or Bank of England.

The underlying problem is the half-complete legal structures of the Eurozone under which monetary matters are centrally controlled by the ECB, whereas fiscal matters are conducted at a member state level. Member states have relinquished (to the ECB) their ability to control their own central banks, so they can no longer guarantee they will be able to print more money to repay their debts. Instead, they rely on their own tax base, with the limitations inherent in that. The reason for this situation is political: Eurozone member states have so far refused to accept mutual liability and pool significant resources. They wish to have the benefits of a single currency but without creating common liabilities with a common tax base, which makes them differ from the US and UK.

The ECB’s mission is far more complex than that of the Federal Reserve or Bank of England, and it is forced to navigate legal and political obstacles unknown to those organisations. In seeking to achieve its goals under EU law, the ECB, under its head, Christine Lagarde, a former lawyer, makes highly delicate and dangerous manoeuvres. One false move, or a series of smaller errors taken together, could destabilise the EU financial system, with serious repercussions for the EU and other economies around the world. Even though the dialogue surrounding the ECB is ostensibly economic, it rests on and often conceals factors which are uniquely politico-legal.

The implications of this unique schism in matters of financial sovereignty are profound.

The fudge has led the EU to make consequential changes to its law and to take decisions of extreme gravity. It has adopted rules which breach international regulations and accounting methods. Its arrangements disguise Eurozone indebtedness – ECB operations are permitted which have the effect of financing member states (and their financial and other companies) in a manner which exacerbates the political problem. Its laws reduce the ability for the market to identify and respond to the risk. And it operates in breach of WTO standards for trade, creating trade distortions and unnatural trade dependencies for the UK. Each choice exacerbates the riskiness of the zone, both within the EU and internationally, and creates significant rocks which the ECB must avoid – and which need to be considered when assessing its performance. The main ways in which the EU has rendered the Eurozone system opaque and unnecessarily risky are discussed here (1-5) full publication

This issue is of concern to other countries and the global markets. It is of particular concern to the UK. The UK continues to run a direct exposure to the EU, under provisions in the Withdrawal Agreement 2020, to the tune of EUR 200bn. 1 Moreover, there are other displacement effects specifically to the UK’s detriment. The UK’s debt-GDP ratio at the end of 2021 was the same as Germany’s, at 102.8 per cent. Yet Germany’s debt was AAA rated by Standard and Poor, and the UK’s rating was AA. The UK seems to have been penalised in its perceived creditworthiness and performance relative to the Eurozone and EU.

Against this complex and potentially fraught backdrop, the ECB’s functions are anything but normal. Any assessment of the performance of the ECB since its birth 25 years ago needs to be tempered by a proper understanding of the dangers of its entire operation. There is a lot to be grateful for. The ECB has managed to avoid (so far) a calamitous collapse which the above debt levels might imply. Nonetheless, any discussion of the ECB's performance cannot be normalised by a superficial comparison with the Federal Reserve and Bank of England. We cannot ignore the implications of the risks of the Eurozone and must now take action to protect ourselves from the untoward seepage of those risks. We should minimise our Eurozone exposures; reject post Brexit overtures to move business to the Eurozone; remove contractual liability for the consequences of Eurozone risk – the UK needs urgently to renegotiate or nullify the Withdrawal Agreement arrangements which give rise to EUR 200 billion financial exposure to the Eurozone – that agreement can, and should, under international law, now be set aside, on the basis it was temporary, and circumstances have changed; and the UK (with the US and other states) should consider levying countervailing duties at its borders on goods from the northern Eurozone to remove the abnormal trade dependencies.

In the meantime, whilst the UK must, with the US, seek to navigate the rocks and monitor the ECB’s progress in doing so, we can only hope that the next 25 years of its operations will be as quiet on the surface as the last. Above all this country must work to ensure that any financial ripples can b contained by the ECB, within the territory of the EU, in a way that avoids unrest or worse. The ECB’s task is extreme. Congratulations are in order for making it thus far. We can only wish the ECB every success for the future.


1 We are exposed to EUR 159bn through the EU itself, of which only a third has a natural, scheduled run-off date.
The rest is either evergreen or, in the case of InvestEU, has equity stakes behind it and guarantees whose end date is unclear
(and may not exist). That is on top of EUR 39bn through EIB which, in case of InvestEU, presents the same problems with
no run-off date. There is then about EU 1bn through the ECB as well.

*This blog is an extract from the longer publication, Plain Sailing for the ECB? Look out for the rocks, which is published by Politeia today. The full text can be read here

Barnabas Reynolds is a partner at Shearman & Sterling LLP and Global Head of the Financial Services Industry Group. His Politeia publications include Restoring UK Law: Freeing the UK’s Global Financial Market (2021), Free Trade in UKEU Financial Services: How Best to Structure a Brexit Free Trade Deal (2018), A Template for Enhanced Equivalence: Creating a Lasting Relationship in Financial Services between the EU and the UK (2017). He coauthored The Lawyers Advise: UKEU Trade and Cooperation Agreement (2021) with Martin Howe, David Collins, James Webber and Sheila Lawlor and Managing Euro Risk: Saving Investors from Systemic Risk (2020) with David Blake and Bob Lyddon.


Barnabas Reynolds

Barnabas Reynolds is Global Head of Financial Institutions and Financial Services Advisory & Regulatory Group at A&O Shearman. He is the author of Restoring UK Law: Freeing the UK’s Global Financial Market, (2021), The Lawyers Advise: UK-EU Trade and Cooperation Agreement – Unfinished Business? (2021), and Politeia’s new publication, Rules for the Regulators: Regulating Financial Services after Brexit.

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