Daniel Mark Azzopardi
An article by Daniel Mark Azzopardi fully exploring some of the issues in the post below appeared in the first edition of the European Law Students’ Association (ELSA) Malta Law Review, a student-edited law review published by ELSA Malta, a student organisation at the University of Malta.
In witnessing the spectacle of the euro crisis and the inevitable collapse of the European model as we know it, one cannot help but feel a sense of déjà vu, like a football match that’s already been played. Only this time, the players are slightly different. Instead of securitised mortgages, we have sovereign coupons. Instead of overleveraged financial institutions, we have overleveraged governments. Instead of falling share prices, we have falling bond prices. Instead of employees made redundant, we have…well, unemployment. Sound familiar?
And yet equally, there are many similarities – heavy borrowing, profligacy, hubris, uncertainty, toxic debt and above all, an unflinching and unapologetic belief in a single idea – that the model does not, and cannot, fail. History has already shown us how this fanatical, almost superstitious, reliance on a model – a formula – that can supposedly outsmart the market, had already undone the investment bank (Bear, Lehman, take your pick), the insurance company (AIG) and the hedge fund (does anyone remember LTCM?). But those institutions were evil. Surely the same fate could not befall the supranational institution that stood, morally un-ambivalent, firm in the fight against the sinister by-products of modern-day capitalism? Surely the European Union would prevail.
To understand what led to the debacle currently threatening the very existence of the European Union (EU) as we know it, one has to examine the formula that its founding fathers relied upon. The formula is one based on the notion of forming a European bloc for three main strategic reasons, all interconnected. On the back of two world wars fought for primarily economic reasons, the belief was held that economic union was the only way to restrain the European powers from a seemingly insatiable desire to destroy each other. Political stability was therefore the first. The second was to facilitate trade among one another. The third was based on the Aristotelian assumption that economic integration would lead to a collective growth that would outpace the members’ individual progress.
Although initially slow off the blocks, the integration project gained momentum in the last decade of the twentieth century through two main initiatives. The first, and most obvious, was monetary union, which was partly (not everyone signed up) achieved through the establishment of the European Central Bank (ECB) and the euro. The second would be driven by the Union’s main engine, the European Commission. This came in the form of legislation, and lots of it. The idea was that by creating a pan-European body of rules for the finance industry, investors would be convinced that they were in fact dealing with a unified economic and legal entity; that Spain was in fact no different from Sweden, and Greece no different from Germany. The EU formula therefore looked something like this:
Monetary union * Uniform body of law = Economic integration = Political stability + Collective economic growth > Sum of individual member economic growth
And for the longest time, the formula worked. In the ten years following the introduction of the Financial Services Action Plan (FSAP), the Commission issued scores of directives and regulations aimed at harmonising the financial services sphere of the Union. The euro grew to becoming the second largest reserve currency, second only to the US dollar (a title it still holds). European cross-border trade hit record highs, the dispersion of cross-country equity returns decelerated and sovereign bond yield divergences narrowed. The descendants of the founding fathers – our modern-day Eurocrats – basked in a mood of vindication and self-congratulation. They pressed ahead with further reform with a renewed zeal and conviction and, with a new quasi-constitutional treaty finally in place, they could claim the legitimacy to do it.
Nor did the onset of the 2008 financial crisis stay their hand. Rather, it encouraged it. Buoyed by growing anti-capitalist sentiment, they bemoaned the lax regulatory environment that allowed morally-flexible investment banks and ‘locust’ hedge funds to bet against markets they created. Economically ravaged and outside the euro club, the largest exponent of smaller government within the Union – the UK – was left voiceless as the champions of centralised regulation, France and Germany, forged on with vim and vigour. An entirely new supervisory architecture for the EU’s financial services sphere was formulated. Three previously obscure Level 3 Committees (don’t ask) were pumped up on steroids and suddenly enjoyed a wide range of competences to take far-reaching decisions in the banking, insurance and securities industries without requiring them to be corroborated through previously lengthy consensus-requiring procedures. The Alternative Investment Fund Managers (AIFM) Directive came next, aimed at reining in the hedge fund industry. Short-selling, derivatives and credit rating agencies were next to follow. Nothing was beyond reach.
So what went wrong? Simply put, the markets retaliated. In an ironic turn of events, it was the markets’ turn to reveal the frailties in the European model that had hitherto seemed infallible. In fact, like all the other foolproof models dreamed up in pseudo-laboratories by financial alchemists claiming to beat the market, its stumbling block was its inability to continue to hold sway in an environment it was not designed to exist in – one where it no longer enjoyed the confidence of its subscribers.
What the Eurocrats in fact failed to realise was that the integration that was taking place was less the product of a fledgling currency and legislative initiative but more an optimistic outlook by global investors that believed in the stability of the Union and the conviction of national governments to continue to support its existence. Once the cracks started to appear in national balance sheets, the façade of European integration that had hitherto seemed implacable began to show blemishes of its own. Investors were quick to pounce, and individual member states that had borrowed too much and had too little in reserve quickly came under the spotlight. National governments were slow to come to each other’s aid. European institutions were confused and helpless. Meeting after meeting produced much hyperbole but little substance. What resulted since then has been the largest discrepancy in European bond yields since the creation of the euro. The credit rating of every eurozone country has since been put on the discussion table. This has not only highlighted economic disunity, but political disunity as well. So strong have the economic forces been that they pushed the Franco-Germanic team (known to friends as ‘Merkozy’) to admit that no member is guaranteed a place in the club, even though there is no clause in any EU treaty that entertains the possibility of a member being compelled to exit the Union (the Lisbon Treaty only mentions unilateral withdrawal). By doing so, they have only served to reaffirm investors’ fears that there is nothing they can believe in, and that anything can happen at any given time. What a long way we have come.
To a legal scholar interested in understanding the development of the sui generis institution we call the EU, this latest crisis has raised serious questions about the role of law in driving its economic and political integration. For one thing, the markets have shown that aesthetically pleasing substantive harmonisation can do little to conceal economic fragmentation along national lines, especially if not supported by the conviction of politicians to put their weight behind the values and ideals glossing the preambles of European texts. That is not to say that legislative reform is not necessary – it is. However, its role should be limited to acting as a complementary tool to true economic integration, rather than expecting it to be its catalyst.
A sober regime for legislative reform would focus purely on the laws that are necessary on a pan-European level, leaving sufficient room for the nuances that invariably inhabit the legal systems of member states. In fact, the only supranational laws that should be implemented are ones that guarantee the free movement of capital and services and ensure that investors enjoy a minimum standard of protection wherever they are based. Rather than attempting to draft embryonic ‘one-size-fits-all’ codes of law, the European model should leave enough flexibility to allow member countries the freedom to style the regulatory environment of their market in order to give them a competitive advantage and give market participants the benefit to choose the regime that best suits their interests.
Today, the European Union is facing a ‘sink or swim’ dilemma. The immediate solution to assuaging the markets is to give the European Central Bank (ECB) unlimited power to ring-fence solvent but illiquid national economies, capitalise large European banks with a dangerously high level of exposure to southern debt, and organise a structured default of economies that have failed (Greece). However, this will only provide temporary respite from the question that Europe’s politicians have so far failed to address. Assuming that they want the Union to survive, they have to face the reality that they cannot continue to have an arrangement that entrusts monetary union to a centralised body while keeping fiscal policy within the national ambit.
For too long, governments have been living in denial about the Union – they claim to support its ambitions but are unprepared to surrender the sovereignty necessary to achieve them. As the latest round of talks in Brussels has shown, some of the oldest members of the Union cannot seem to agree what the EU is and what it stands for. And just like the road fatality that finally prompts the local council to install traffic lights on a dangerous street, so it takes an economic crisis of epic proportions to get European leaders to sit down and finally take on the elephant in the room. Unfortunately for the Union, the solutions put forward could not be in starker contrast, with Team Merkozy advocating deeper integration, and the UK openly questioning the rationale behind integration in the first place. Even the Franco-Germanic proposals are feeble and myopic – constitutional amendments and fiscal discipline may provide temporary respite, but in the long-term, they will fail to convince investors that pan-European debt carries the same level of risk across the board. They may have wished to go further, but with Merkel under intense pressure at home and Sarkozy facing an election year, they simply do not have the political capital or democratic mandate to go further. That therefore leaves only two possibilities on offer – another seemingly endless period of half-baked reform, or a break-up of the Union as we know it. Either way, recession seems sadly inevitable.
The creation of the ECB and the euro was probably one of the bravest moves made in the history of the EU. In hindsight, it now appears rushed and poorly conceived. Years from now, once the dust has settled, European political and economic analysts might sit down and speculate over what could have been done differently. Perhaps they may come to the conclusion that Europe was not, and perhaps never will be, ready for true economic integration. And perhaps that’s not a bad thing. After all, the European Union did manage to facilitate cross-border trade. It also managed to keep its members so busy trying to figure out what all the acronyms meant that they didn’t have the time to kill each other. Two out of three ain’t bad.
Daniel Mark Azzopardi wrote his doctoral thesis entitled ‘A Fully Integrated European Securities Market: Where have we got so far and where are we going?’ on the impact of European legislation on economic integration in the securities industry. He currently works for HSBC Group on the European Executive Management Programme and is presently based in the United Kingdom.