Assessing EU Economic Governance Reforms

The Economic Governance reforms sought by the Prime Minister seem anodyne next to red cards and emergency breaks. Yet the issues raised in the negotiations go right to the heart of the UK and EU problem. The immediate aim is to pacify Euro sceptics, but the coherence of the arrangements will eventually be judged on financial markets.

All Member States accept that an effective economic and monetary union requires deeper financial integration across the Eurozone. But integration in finance is much harder than for other industries. As we know, financial institutions can go wrong. And the economic consequences can be so serious that taxpayers become the ‘ultimate backstop’ to the financial system.[1]

As the Eurozone pursues deeper integration with greater risk sharing between nations, the distinction between jurisdictions becomes less relevant. A single rulebook, single supervisor and single resolution mechanism involving taxpayers from member states naturally follows.

But there are two problems. First, the UK is host to a significant part of the Eurozone’s financial system and, second, having (at least) two sets of rules, two regulators and two taxpayers’ pools sits uneasily with the idea of a single market when capital flows so easily across borders.[2]  

This is where Economic Governance come in. For EU legislators the solution is to harmonise regulation across the whole of the EU. But this limits the UK’s ability to pursue its own financial stability objectives which, according to the Bank of England, is ultimately a ‘national responsibility’. Any inconsistency between these positions will eventually be exploited by markets.

The proposed New Settlement sets out to ensure mutual respect between all EU member states, whether in the Eurozone or not. The rights of non-Eurozone countries are to be respected and any reasoned opposition to further integration will be heard by the European Council. But there will be no effective veto on further integration of the Eurozone. Mutual respect is welcome, but priority is deeper integration of the Eurozone.

The New Settlement affirms that there can be no discrimination against non-Eurozone countries with regard to Euro currency activities. This harks back to the European Central Bank’s (ECB) failed attempt to require clearing houses carrying out Euro business to be located within the Eurozone. The settlement states that ‘any differences in treatment must be based on objective reasons’ so it is hard to see how this constitutes progress.

The New Settlement clarifies that non-Eurozone countries will not have budgetary responsibility for crisis measures to safeguard the Eurozone. This relates to the use of Eurozone Financial Stability Funds (which the UK contributes to) for an emergency bridging loan to Greece last year.[3] Clarification is welcome but UK taxpayers in practice are always exposed to the Eurozone as long as UK banks engage in cross-border banking. Consider how much of RBS’s losses in 2008 arose from its Dutch bank ABN Amro.[4]

Finally, the New Settlement raises the possibility (no stronger) of greater flexibility around prudential regulation.[5] This usually refers to the type and quantity of capital that financial institutions must hold and is harmonised across the EU. The Bank of England has long made the case that this may not be an optimal arrangement. And given that so much Euro financial activity takes place in the UK it is unclear this will stay a possibility or be developed while keeping the primacy of financial stability.

The New Settlement has high level principles and helpful clarifications on the co-existence of Eurozone and non-Eurozone states within the EU. But the hard issues of two major currencies, two sets of regulations and different backstops within a single market remain.


[1] Bank of England, 2015, EU Membership and the Bank of England, p80.

[2] For example, according to the Bank of England almost half of the world’s largest financial institutions have their European headquarters in the UK.

[3] The UK was insulated against any losses.

[4] The UK government’s concessionary loan to Ireland was also made of its own volition.

[5] There is also a re-statement that macro-prudential regulation, supervision and resolution is for national authorities if the member state remains outside of the banking union.

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