The Opinion of the Advocate General on the Announced Bond-Buying Program of the ECB

Never before has an opinion of a European Advocate General had such a severe impact on Switzerland as the one published on the request for preliminary ruling in the so-called OMT case, a government bond-buying program announced by the ECB in 2012. Only one day after the Advocate General basically rejected the legal concerns of the German Constitutional Court that had asked for preliminary ruling, the Swiss National Bank withdrew its previously made promise concerning the maximum exchange rate of the Swiss Franc vis-à-vis the Euro. The European Court of Justice has now ruled in the same direction as the Advocate General had recommended in its opinion.

by Peter Sester (Reference: CapLaw-2015-34)

An interim judicial act has rarely ever had such a severe impact on international financial markets as the opinion of the Advocate General (AG) published on 14 January 2015. One of the most acute reactions was the paradigm shift by the Swiss National Bank (SNB) only the day after the legal opinion of the AG Cruz Villalón was released. This opinion concerned the request for the preliminary ruling from the German Constitutional Court (Bundesverfassungsgericht (BVG)) (Case C 62/14). The SNB abandoned the currency ceiling; and subsequently the Swiss Franc appreciated substantially.

Certainly, the SNB had a number of reasons for taking this decision to stop interfering with currency markets. One of these reasons was to fulfill its previous promise not  to allow the Swiss Franc to further appreciate vis-à-vis the Euro to a ratio higher than 1.20 CHF to 1 EUR. However, it was clear from the outset that the an unlimited government  bond buying program such as the European Central Bank’s (ECB) Outright Monetary Transactions (OMTs) program would force the SNB to buy Euros to an unlimited extent. For the SNB, these forced purchases entailed all inherent risks for the Swiss monetary and economic policy in general. Obviously, the governing body of the SNB was not willing to take this risk, and decided to withdraw the described promise to save its credibility and to create room for maneuver.

Case C 62/14 is peculiar in many ways. First of all, the published opinion of the AG is not a legally binding act or a decision by an authority. It is only a press release setting  out the basic features of the program for purchasing government bonds. The formal adoption of the legal instruments regulating the program was postponed and those instruments have still not been adopted until today. For the first time in history, the German BVG requested the European Court of Justice (ECJ) for a preliminary ruling. However, the BVG did not signal that it would question the constitutionality of the participation of Germany in the OMTs, if the ECJ would come to the conclusion that the announced OMTs can be carried out as intended by the ECB without any legal boundaries and/or conditions. Consequently this case is, among others, another battlefield in the framework of a war for the ultimate judiciary power in Europe between three courts: national constitutional courts (such as the BVG), the ECJ in Luxembourg, and the European Court of Human Rights in Strasbourg. Last but not least, the case in question is a superb example for the never-ending task to draw an appropriate line between adequate judiciary control and the necessity to grant governments or monetary authorities (here the ECB with regard to monetary policy) room for non-controllable discretionary decisions. And the key difference between the position of the AG and of the BVG lays exactly therein. They have drawn different lines. The AG tends to favor discretionary powers when it comes to highly technical tasks such as defining the proper monetary policy, which is necessarily based on a forecast of the overall  economic future panorama. On the other hand, the BVG sticks to its rather dogmatic approach and ever growing tendency to intervene in political decisions.

The content of the announced bond buying program, as outlined in the ECB press release of 6 September 2012, was summarized by the AG as follows: “The ECB gave notice of its intention to purchase on secondary markets, subject to certain conditions, government bonds issued by States in the euro area. In brief, the ECB made application of the program conditional upon the States concerned being subject to a financial support program of the European Financial Stability Facility or the European Stability Mechanism, provided that such a program included the possibility of primary market purchases. It was also announced that transactions under the OMT program were to be focused on the shorter part of the yield curve, with no ex ante quantitative limits
being set, and that the Eurosystem accepted the same (pari passu) treatment as private creditors, whilst an undertaking was given that liquidity created would be fully sterilized.”

The argument of the ECB for its competence to launch OMTs is that this program is the proper instrument to deal with exceptional circumstances. This is because this program aims at doing what has to be done in order to restore ECB’s ability to make efficient use of its monetary policy instruments. The program prioritizes this objective regardless of its unconventional nature and the risks it entails. Indeed the ECB refers to a number of articles in the Treaty on the Functioning of the European Union (TFEU). However, the most precise rule is article 18 of the Statute of the European System of Central Banks (ESCB), as laid out in Protocol No 4 of the TFEU. Article 18 states that the ECB and the national central banks may operate in the financial markets
by buying and selling outright (spot and forward) marketable instruments in order to achieve the objective of the ESCB and to carry out its tasks.

An important question is whether or not a communication strategy (as the AG calls it) in a press release of 6 September 2012 can be subject of a preliminary ruling by the ECJ. The AG takes the view that “in the specific case of actions of this kind by the ECB, in which acts of public communication assume special significance for the effectiveness of monetary policy, an act such as the one called in question by the Bundesverfassungsgericht constitutes – having regard not only to its content and the actual effects that it may produce but also to the circumstances in which the measure was adopted – an act which falls within the scope of article 267 TFEU.” To underline his position, the AG points to the announcement effects of statements made by a (creditable and powerful) Central Bank.

The centerpiece of the AG’s ECB-friendly position is his definition of the ECB’s status and mandate, combined with the AG’s practical and economical approach to the ultimate question on whether or not to save the common currency. The end goal of saving the common currency sustains, even if this requires an extensive and unconventional interpretation of the treaties. According to the AG, “the Treaties confer on the ECB sole responsibility for framing and implementing monetary policy, for which purpose it is given substantial resources with which to undertake its functions. On account of those resources the ECB also has access to knowledge and particularly valuable information, which permits it to perform its tasks more effectively whilst also,  over time, bolstering its technical expertise and reputation. Those features are essential for ensuring that monetary policy signals actually reach the economy since, as has previously been stated, one of the functions of central banks today is the management of expectations, and technical expertise, reputation and public communication are basic tools for carrying out that function. The ECB must accordingly be afforded a broad discretion for the purpose of framing and implementing the Union’s monetary policy. The Courts, when reviewing the ECB’s activity, must therefore avoid the risk of supplanting the Bank, by venturing into a highly technical terrain in which it is necessary to have an expertise and experience which, according to the Treaties, devolves solely upon the ECB. Therefore, the intensity of judicial review of the ECB’s activity, its mandatory nature aside, must be characterized by a considerable degree of caution.”

The AG qualifies the OMT in two ways: formally, as operations provided for in article 18.1 of the Status of the ESCB; and materially, as an unconventional monetary policy measure. By doing so, he basically adopts the argumentation line of the ECB. The AG explicitly states: “it is important to point out that the ECB’s monetary policy is implemented, as has been noted, through various ‘transmission channels or mechanisms’, by means of which the Bank intervenes in the market and fulfills its mandate of ensuring price stability. In order to carry out its monetary policy, the ECB controls the monetary base of the euro area economy, which it does by transmitting the appropriate ‘impulses’ or signals, chiefl y through the setting of interest rates, which will subsequently pass from the financial sector to firms and households. In this respect, to ensure the proper functioning of these transmission channels, the Statute of the ESCB and of the ECB confers on the ESCB an express competence to adopt a set of ‘monetary functions and operations’. The ECB defends the lawfulness of the OMT program on the basis that it is a measure intended to ‘unblock’ the Union’s monetary policy transmission channels (and not a hidden measure of general economic policy or forbidden monetary finance of tumbling Member States). As has been explained above, those monetary policy transmission channels do not function as mechanisms producing immediate effect but as a framework through which the ECB sends out a series of ‘impulses’ or signals with a view to them reaching the real economy. According to the ECB, monetary policy may be affected by factors external to the transmission channels, factors which are liable to disrupt the proper functioning of the signals sent out by the ECB: an international political or economic crisis, or a significant change in oil prices, amongst other factors, may severely interfere with the ‘impulses’ that the ECB sends out via the monetary policy transmission channels. When a situation of that kind occurs, the ECB considers it has competence to intervene using its own instruments with the aim of ‘unblocking’ those channels. In such a case the actions it takes are different from those which are part of the ECB’s normal practice, since they can be said not to involve so much a ‘standard’ operation but rather an operation to ‘unblock’ and subsequently restore monetary policy instruments properly so-called (…). Accordingly
I take the view that the objectives of the OMT program as they are explained by the ECB may be accepted, starting from the acknowledgement that, in announcing the OMT program, it was the ECB’s intention to pursue a monetary policy objective”.

Against this background, the AG concludes that the ECJ should answer the question referred for a preliminary ruling by the BVG so that the OMT program may be implemented as announced by the ECB. However, he establishes three restrictions, which are, however, either self-evident or already conferred by the ECB:

  1. Subject to the conditions established by the ECB, the OMT can only be activated with regard to sovereign bonds issued by Member States of the Eurozone that are subject to a financial support program of the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM). Due to this fact, the ECB must – as the AG emphasizes –refrain from any direct involvement in the financial assistance program to which the OMT is linked. Otherwise the line between monetary policy on the one side and general economic policy as well as state finance on  the other side would become unclear. Moreover, the OMT could no longer be clearly qualified as a measure of monetary policy only.
  2. Also, the AG insists on the ECB strictly complying with the obligation to state reasons and with the requirements deriving from the principle of proportionality. Both obligations “to state reasons” and “to act in a proportional way” are fundamental principles of EU law. The first obligation is explicitly addressed in article 296 TFEU and a fundamental precondition for transparency and effective judicial control. The second obligation is a product of case law developed by the ECJ (inspired by the BVG, among others).
  3. Finally, the AG states that the OMT is compatible with article 123 TFEU (ECB’s obligation not to engage in monetary finance). This is acceptable provided that the timing of the program’s implementation permits the actual formation of a market price in respect of the government bonds. Again, this is a self-evident “restriction”, because otherwise the argumentation chain would break down. Article 18 of the Statute of the European Central Bank only allows interference with secondary securities markets.

None of the three “restrictions” established by the AG poses a severe obstacle to the implementation of the OMT. Or to say it quite frankly, they can be considered a tribute to the BVG. This becomes particularly clear in one short sentence of the AG’s opinion: “I consider that the ECB, in announcing the OMT program, weighted up the benefits and costs appropriately.” As a matter of fact, the AG switched the signal to green. Consequently, at least in this respect, the SNB’s paradigm shift was based on the right conclusion. This is particularly true considering that there is little chance that the ECJ will substantially deviate from the AG’s proposal.

On 16 June 2015, the ECJ published its preliminary ruling in the OMT case. The judgement is, as it was to be expected, fully in line with the AG’s opinion outlined above; however, much shorter and even more favorable for the ECB’s position.

The ECJ points out that “the draft decision and draft guideline (on the OTM) produced by the ECB in these proceedings indicate that the Governing Council (of the ECB) is to be responsible for deciding on the scope, the start, the continuation and the suspension of the intervention on the secondary market envisaged by such a program. The ECB has also made clear before the Court that the ESCB intends, first, to ensure that a minimum period is observed between the issue of a security on the primary market and its purchase on the secondary market and, secondly, to refrain from making any prior announcement concerning either its decision to carry out such purchases or the volume of purchases envisaged. Inasmuch as those safeguards prevent the conditions of issue of government bonds from being distorted by the certainty that those bonds will be purchased by the ESCB after their issue, they ensure that implementation of a program such as that announced in the press release will not, in practice, have an effect equivalent to that of a direct purchase of government bonds from public authorities and bodies of the Member States.” Hence, the announced OMT program cannot be considered as circumvention of the objective of article 123 (1) TFEU, since it is designed in such way that it will not weaken the impetus of the Member States concerned to follow a sound budgetary policy.

Last but not least the ECJ states that “it should also be borne in mind that a central bank, such as the ECB, is obliged to take decisions which, like open market operations, inevitably expose it to a risk of losses and that article 33 of the Protocol on the ESCB and the ECB duly provides for the way in which the losses of the ECB must be allocated, without specifi cally delimiting the risks which the Bank may take in order to achieve the objectives of monetary policy.”

by Peter Sester