The EMS is an intergovernmental organisation created to provide financial assistance to Eurozone Members States in difficulty. It was introduced by the European Stability Mechanism Treaty signed on 2 February 2012. How does it work? How does it operate? What are ‘Dual limb CACs’?

1. THE EUROPEAN
STABILITY MECHANISM
What it is, howit works and
why we keep talking about it
January 2020

2. THE EMS
The ESM is an intergovernmental organisation created to provide financial assistance to Eurozone
Members States in difficulty through the issuance of debt instruments. In particular, the ESM:
• grants loans as part of a macroeconomic adjustment programme;
• purchases debt securities on the financial markets;
• provides financial assistance in the form of lines of credit;
• finances the recapitalisation of banks and financial institutions through governments loans.

3. Creation of the ESM
Active since July 2012, the ESM was introduced by the
European Stability Mechanism Treaty signed on 2 February
of the same year by the Eurozone Member States.
It replaced the European Financial Stability Facility (EFSF)
and the European Financial Stabilisation Mechanism (EFSM),
two instruments that had been set up since 2010 in order to
maintain stability in the Euro area by dealing with the sovereign
debt crisis of some of its Members States (mainly Greece).

4. How it works
The shareholders of the ESM are the Members States of the
Eurozone. The shares are allotted based on the key for subscription,
by the national central banks of ESM Members, of the ECB’s capital
(Art. 11 of the Treaty establishing the ESM).
THE CAPITAL
Its authorised capital is about €700
bn, of which only €80 bn have been
paid in by the Member States.
Italy’s share is about €14.3 bn.
The remaining €620 bn can be
collected – if necessary – through
specific bond issues on the market
guaranteed pro quota by the States.
THE shareholder
countries
The first five shareholder
countries are:
1. Germany (27.1%)
2. France (20.4%)
3. Italy (17.9%)
4. Spain (11.9%)
5. The Netherlands (5.7%)

5. Governance
The ESM is managed by the Board of Directors.
Each Governor appoints a Director. The European
Commissioner in charge of economic and monetary
affairs and the President of the ECB can appoint one
observer each.
The Board of Directors:
• adopts decisions by qualified majority;
• manages the ordinary administration and the
functions delegated to it by the Council of Governors;
• is presided over by the Managing Director.
The ESM is governed by the Board of Governors.
It’s made up of the financial ministers of the Euro area.
It has exclusive competence over various functions,
including the granting of financial assistance and the
identification of economic policy interventions that are
conditional.
Decisions normally require the unanimity of voting
participants. This threshold goes down to 85% of capital
if there is an urgent request for intervention by the
European Central Bank and the European Commission.
Appoints the Board of Directors and the Managing
Director.
Management

6. How it operates
When a Member State requests financial support (Art. 13), the ESM
issues loans (granted at fixed or variable rates) and purchases bonds
on the primary and secondary market.
LOANS
are granted upon the signing of a
Memorandum of Understanding
(MoU) between the Member State
and the ESM, on the basis of which
the financial assistance provided
is subject to ‘strict’ conditionality
that ‘may range from a macro-
economic adjustment programme to
continuous respect of pre-
established eligibility conditions’
(Art. 12).
Sanctions
may be implemented when
Members States do not
respect repayment deadlines,
also including the suspension
of the incompliant State’s
voting rights in the Council of
Governors.

7. The Council of Governors can decide to activate two lines of credit
to provide precautionary financial assistance to Members States
that request it:
• Precautionary Conditioned Credit Line (PCCL);
• Enhanced Conditions Credit Line (ECCL).
Precautionaryfinancial
assistance:twolinesofcredit

8. 2018
Conditions for eligibility for financial assistance
The Council of Governors may decide to grant financial assistance on the basis of an assessment by the European
Commission, in concert with the ECB:
• of the existence of a risk to the financial stability of the eurozone;
• of the sustainability of the public debt of the Member State requesting financial assistance.
The conditions the Member State must fulfil in exchange for financial assistance are laid out in the MoU the Member State
negotiates with the European Commission, in liaison with the ECB and the IMF (also referred to as the Troika).

9. The ESM and the banks
The Council of Governors may decide to grant financial assistance with the specific aim of recapitalising a
Member State’s financial institutions (Art. 15).
What is more, the ESM can make deals with banks and financial institutions to obtain support in providing
assistance to States in difficulty.

10. The threat of debt restructuring
In exceptional cases, the Treaty provides for an
adequate and proportionate
form of private sector involvement
which is just a roundabout way of saying that financial assistance
provided by the ESM to a Member State in difficulty may be conditional
on the restructuring of its public debt.
To expedite the restructuring procedure, for all new sovereign bond
issues with maturity above one year starting from 2013 the Treaty
provides for the so-called ‘Collective Action Clauses’ (CACs).

11. WHAT ARE ‘Dual limb CACs’?
CACs are included in the bonds of all ESM Member States, whether
they have requested financial assistance or not.
CACs are meant to enable agreement, where necessary, between a
State and its creditors on the restructuring of a sovereign bond issue
through only two votes:
• a majority vote of all the bondholders;
• a majority vote of the bondholders of each individual issue.
This is why the CACs set out in the Treaty are called ‘dual-limb’ CACs.

12. THE REFORM
The aim of the revision of the Treaty is to introduce three substantial changes into how the ESM works.
It draws a neater distinction
between the two lines of credit
clearer (PCCL and ECCL): the first is
no longer conditional on signing an
MoU but is only available to States
that satisfy very strict criteria.
It introduces the possibility for
the ESM to finance the Single
Resolution Fund (SRF) for up to
€55 bn, financed by European
banks in order to help financial
institutes in difficulty.
Backstop
Precautionary financial
assistance
All Members States must
introduce ‘single-limb’ CACs into
sovereign bonds issued starting
from 2022, allowing debt to be
restructured with one majority
vote of all bondholders.
Debt restructuring

13. The Member State must also prove that:
• it doesn’t have any excessive macroeconomic
imbalances;
• it has access to international capital markets under
reasonable conditions;
• it has a sustainable external position;
• it doesn’t have any particularly serious vulnerabilities
in the financial sector.
Practically speaking, none of the Members States with a
high debt would be eligible for the PCCL.
The Member State must have satisfied the Fiscal Compact
criteria over the previous two years:
• deficit doesn’t exceed 3% of GDP;
• structural budget balance (i.e. taking into account
the economic cycle);
• public debt doesn’t exceed 60% of GDP or,
alternatively, 1/20 annual reduction in the amount
of debt exceeding 60% of GDP.
new eligibility criteria
for the PCC

14. A closer look at the eligibility
criteria for the ECCL
In the event that a Member State fails to satisfy the PCCL eligibility
criteria, the State may be eligible for the ECCL if:
• its public debt is considered ‘sustainable’;
• it signs an MoU setting out the conditions for eligibility for
financial assistance.
Compared to the previous version, the Managing Director of the
ESM plays a more important role in the negotiation of the MoU
than the European Commission.

15. The negotiations
Since 2017, two opposing positions emerged during the negotiations
on the revised Treaty:
• Members States from northern Europe have proposed making the
eligibility conditions for credit lines less flexible because easy
access to assistance would deprive Members States with a high
sovereign debt of the incentive to reduce it swiftly (s.c. ‘moral
hazard’);
• Members States with greater debt exposure have pushed for the
conditionality attached to loan-granting not to include either automatic
restructuring or the mandatory adoption of economic reforms that
could potentially trigger a recession.

16. Where we’re at in the process
In the Eurogroup meeting the Ministers of Finance of the Eurozone approved the draft of the revised Treaty.
5 dECEMBER 2019
The Eurogroup decided to postpone the approval of the revised Treaty, also because of the political debate sparked in some
Member States. However, on various occasions Eurogroup President Mario Centeno stated that the text (not including the
technical annexes) cannot be modified because it has obtained the consensus of all the Eurozone Member States.
13 JUNE 2019
Their agreement was confirmed in the Euro Summit.
The negotiations continued over the following months regarding the technical documents that must be
annexed to the Treaty.
21 JUNE 2019

17. The philosophy inspiring
the reform…
The revised Treaty approved by the Eurogroup reflects the idea
that Eurozone Members States should be forced by market
discipline to comply with those rules laid down by the Fiscal
Compact Treaty that so far have remained a dead letter. In fact:
• no Member State will be eligible for the PCCL if it doesn’t
respect the rule regarding structural balancing and the one on
reducing debt exceeding 60% of GDP by 1/20 annually;
• eligibility for the ECCL will also be conditional on a debt
sustainability analysis;
• in the event of a negative analysis, the only path left for a
Member State with difficulty placing their bonds on the financial
markets would be restructuring.

18. …and the criticisms
According to the critics, this framework:
• increases the likelihood, albeit implicitly and without any
automatic mechanisms, that Members States in difficulty will be
forced to restructure their debt;
• increases the risk for sovereign bondholders to be imposed a
reduction in the value of the bonds they hold because with the
‘single-limb’ CACs there will only be one majority vote among all
bondholders;
• consequently provides an incentive for financial operators to ask
for higher returns on sovereign bonds to protect themselves against
this risk, resulting in an increase in financing costs precisely for
the States that are already more exposed and with the risk of
triggering a vicious cycle.

19. Could begin leaning towards the bonds of less exposed
countries, even though they offer lower returns (‘flight to
quality’) to avoid the risk of restructuring.
By selling the bonds of more exposed countries, they
would end up increasing the likelihood that those
countries will have to restructure their debt.
The critics also claim that making the ESM’s rules stricter
could result in asymmetrical consequences within the
Eurozone in the event of external shocks (e.g. the
deterioration of the global economy or a banking crisis) or
in the event that the ECB adopts a less accommodating
monetary policy (higher interest rates).
Beyond the Treaty:
What are the consequences?
INVESTITORS
So all the Treaty would do is improve Germany’s position to the detriment of the Mediterranean countries.

20. Italy’s position: the first Conte government…
The Five Star Movement – Lega majority, which backed the first Conte government, expressed many concerns about the
proposal to revise the Treaty.
18 JUNE 2019
The majority approved the resolution committing the Government to:
• opposing legal frameworks that 'end up forcing some countries onto paths of predefined and automatic restructuring';
• not approving changes in the ESM Treaty that penalise Members States with a greater need for reform and
investment;
• promoting the joint assessment of the ESM revision along with the other elements of the reform of the economic and
monetary union, the Budgetary Instrument for Convergence and Competitiveness (BICC) and the Banking Union (the
s.c. ‘package approach’).
But former Minister Tria had already given the green light to the revision of the Treaty
during the 13 June Eurogroup meeting!

21. … and the second Conte government
In the new majority, the Democratic Party and Italia Viva were very convinced in their backing of the Treaty revision,
whereas the Five Star Movement and the Left (Liberi e Uguali) kept a more critical standpoint.
11 DECEMBER 2019
The new majority approved a resolution committing the Government to continuing EU negotiations on the basis of
two fundamental criteria:
1. sticking with the package approach;
2. excluding all mechanisms entailing the automatic restructuring of public debt (an automatic mechanism which is
not set out in the current reform, in any case).
This is a compromise which, however, fails to resolve the problem that the agreement
reached among the EU bodies cannot be changed.

22. After signing the reform, it must be ratified by all the Eurozone Member States.
In Italy, it is Parliament that authorises the ratification of international treaties by passing a law.
Therefore, the reform of the ESM will be debated again in Parliament.
RATIFICATION

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