EU summit measures slightly exceeded expectations
Following long, thought-provoking discussions at a two-day summit in Brussels, EU leaders reached an agreement on June 29 that will take Europe forward on the following issues:
1) Supervisory mechanism for banks
By the end of 2012, the European Commission will present to banks a supervisory mechanism that will involve the European Central Bank (ECB). Certain regulatory tasks will be assigned to the ECB. A single banking regulator for euro-zone banks should be positive for the EU, and should help it move toward a closer banking union and fiscal union.
2) Direct recapitalization of banks by the ESM
Once the supervisory agreement is established, the European Stability Mechanism (ESM) will have the option to recapitalize banks directly. Previously, bank bailout funds were channeled through state governments, which added to sovereign debt imbalances—particularly in Ireland and Spain. Ireland’s 2010 financial sector bailout and adjustment program will be reexamined.
3) No seniority status on ESM loans provided to Spain's banks
The €100 billion needed for Spain's banking sector will be provided by the European Financial Stability Facility (EFSF) until the ESM becomes available, at which point it will be transferred to the ESM without gaining seniority status. Previously, in the case of default, ESM loans had priority status, which weakened the claims of private-sector investors and increased the perceived riskiness of Spain's banks.
4) Flexible use of EFSF and ESM to ensure stability in financial markets for member states
Funds provided by the EFSF and ESM can be used to purchase the debt of euro-zone member countries, which should help decrease borrowing costs for Europe’s struggling sovereigns.
5) A €120 billion "compact for growth and jobs"
Additional capital will be available for the European Investment Bank (EIB), for infrastructure financing and for EU structural funds. The "compact" includes a number of long-term measures:
- Growth-friendly fiscal consolidation
- Promoting competitiveness
- Tackling unemployment and addressing the social consequences of the crisis
- Modernizing public administration
6) A genuine move toward a true "Economic and Monetary Union"
- Coordinating tax policy and improving labor mobility
The President of the European Council set out four essential building blocks and asked to develop a time-bound roadmap for:
- An integrated financial framework
- An integrated economic policy framework
- An integrated budgetary framework
Allianz Global Investors' View
- Strengthened democratic legitimacy
The measures announced at the EU summit surprised bearish investors. In principle, the announced decisions were in line with Allianz Global Investors' base-case scenario, which calls for an extended period of difficult negotiations around keeping the euro together and working toward a true European Union. Additional decisions and timelines—as well as political changes and parliamentary procedures—will take time and will offer the potential for disappointment.
There are still problems to solve, ranging from "moral hazard"—in the form of less commitment to reforms once aid is provided—to the ultimately limited resources of the ESM. To provide a clear vision, the "road map" also needs to be formulated in a credible way with a fixed timeline.
Overall, we anticipate continued volatility with a more optimistic outlook for risky assets.