On 6 September, the European Central Bank announced the technical details of the Eurosystem's programme for the purchase of sovereign bonds by means of Outright Monetary Transactions ("OMTs") in the secondary markets.
The purpose of this advisory is to examine those details and their consistency with the legal framework applicable to the Eurosystem.
Objectives of OMTs
The OTM programme is designed to contain the increasing cost of borrowing for euro area Member States that have had to seek assistance in the form of a financial bailout. This will be achieved by outright purchases of sovereign bonds in the secondary markets which will have the effect of increasing demand and, hence, reducing yields.
When introducing OMTs, Mario Draghi, the ECB President, stated that the new arrangements will enable the ECB to address severe distortions in government bond markets which have resulted in very high interest rates on debt issued by troubled Member States. He also emphasised three further points of principle in relation to OMTs, namely:
- the ECB acts strictly within its mandate to maintain price stability over the medium term;
- the ECB acts independently in the determination of monetary policy; and
- the euro is irreversible.
OMTs will in some respects be a successor to the ECB's Securities Market Programme introduced in 2010, under which the ECB conducted periodic interventions in both the sovereign and the corporate bond markets.
Technical Features of OMTs
The ECB's Press Release of 6 September sets out the core features of OMTs, including the following:
OMTs will only be considered for the sovereign bonds of euro area Member States that are subject to a macroeconomic adjustment programme or a precautionary programme within the European Financial Stability Facility/European Stability Mechanism ("EFSF/ESM") including strict and effective conditionality. This is clearly a crucial area for the ECB because, as noted below, in order to ensure consistency with its mandate, it sees OMTs as a mechanism for ensuring the proper transmission of monetary policy, as opposed to a form of monetary financing or "bailout". In an effort to reinforce this position, it is stated that OMTs will be terminated "... when there is non-compliance with macroeconomic adjustment or precautionary programme …".
OMT's will be concentrated on sovereign bonds with shorter maturities in the range of one to three years. Crucially, the OMT programme is uncapped – or, as the Press Release more drily expresses it, "No ex ante quantitative limits are set on the size of Outright Monetary Transactions".
- Creditor treatment
The Press Release confirms that bonds purchased by the Eurosystem through OMTs will rank equally with bonds held by private or other creditors. This confirmation is of some importance: if the ECB had sought to claim senior treatment, then this would effectively inhibit the return of the relevant Member State to the bond markets at a later stage.
The Press Release confirms that the liquidity credited by OMTs will be fully sterilised. In other words, the Eurosystem will conduct operations that are designed to re-absorb the liquidity fed into the market through OMTs. These operations are designed to ensure that the new programme does not affect the neutrality of the ECB's monetary policy stance.
The value of OMTs and certain other information will be published at periodic intervals.
- Securities Market Programme
Securities currently held by the ECB within the portfolio created by the Securities Market Programme will be held to maturity but, subject to that, the Programme has now been terminated.
Inn a separate Press release also issued on 6 September, the ECB announced measures "… to preserve collateral availability for counterparties in order to maintain their access to the Eurosystem's liquidity-providing facilities…" In essence, until further notice:
- minimum credit rating thresholds will not be applied where the collateral consists of a sovereign obligation of a Member State that is eligible for OMTs or which is complying with the conditionality attached to an EU-IMF programme; and
- subject to appropriate "haircuts", euro area securities denominated in US dollars, sterling or Japanese yen will be treated as eligible collateral. This may be seen as a logical step and a necessary measure to support the financial system in the euro area as a whole and, more particularly, for banks located in those peripheral Member States that have sought EU-IMF assistance.
Mandate and Treaty Issues
As was the case with the Securities Market Programme and earlier relaxations of collateral requirements, the consistency of OMTs and the suspension of the collateral criteria with the ECB's mandate may be the subject of some controversy.
It is well known that the primary objective of the ESCB is to maintain price stability, which refers to a medium term inflation rate below, but close to two per cent. It is also required to act independently of Member States in the implementation of that policy. In this context, the ECB is clearly conscious of the challenges that OMTs pose to the scope of its mandate and its independence at the heart of monetary union.
As a result, the 6 September Press Release describes OMTs as a necessary step "…to safeguard the monetary policy transmission mechanism in all countries of the euro area …" and "…to presence the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area …" OMTs will thus enable the ECB "… to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro …". OMTs are therefore intended to form "… a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area …".
In addition, similar measures that had been taken in connection with the Securities Market Programme were challenged by a German individual on the basis that they contravened Articles 123-125 of the Treaty on the Functioning of the European Union, which prohibit (i) the monetary financing of a Member State's debt, (ii) privileged access to the facilities of a financial institution and (iii) the assumption of responsibility for the debts of another Member State (the so-called "no bailout" clause). The case was dismissed on procedural grounds but is currently the subject of an appeal to the European Court of Justice. It may well be that a similar challenge could be mounted to OMTs and the other arrangements discussed above.
Other Legal Challenges
It may be noted in passing that other aspects of the steps taken to combat the eurozone crisis have also been the subject of legal challenge.
The legality of the recently-established European Stability Mechanism has been challenged in Pringle v The Government of Ireland, where it has been argued that the ESM is contrary to the "no bailout" clause noted above. Various issues arising from that case have been referred to the European Court of Justice for decision.
In addition, on 12 September, the German Constitutional Court is due to give its long awaited decision on the compatibility of the ESM with that country's Grundgesetz (or Basic Law).
The measures announced by the ECB on 6 September may be wholly justified in the context of the current crisis, although some may dispute that view. Certainly, in the short term, those measures have brought significant respite to troubled financial markets.
However, OMTs may pose longer term difficulties for the ECB itself. For example, it may terminate OMTs in relation to any Member State that is not complying with the conditionality attached to its macroeconomic adjustment programme. In some cases, this may involve a highly subjective judgment and the ECB would, in practice, come under pressure to maintain OMTs wherever possible. But a relaxation of the "conditionality" requirement would make it difficult for the ECB to maintain that OMTs are consistent with its monetary policy mandate, and may prejudice the ECB's much-prized independence.