Courtesy of Pietro Fazzini and Federico Urbani
The German Constitutional Court’s Ruling on the PSPP: An Introduction
The already fragile political stability of the European Union has been radically shaken by the adoption of the long-awaited and disruptive ruling from the Second Senate of the German Constitutional Court (Bundesverfassungsgericht or GCC) on the validity of the ECB’s Public Sector Purchase Programme (PSPP). Under the PSPP, the Eurosystem has conducted purchases of public sector securities for a cumulative net amount of approximately €2.3 trillion so far.
In their ruling on 5 May, 2020, the GCC came to the momentous conclusion that the PSPP violates the principles of conferral and democracy under the EU Treaties. Therefore, the Bundesbank shall refrain from taking part in the programme, unless the ECB provides adequate evidence that its actions under the PSPP abide by the principle of proportionality.
Unfortunately, the GCC’s decision shakes the one EU institution that has proven to be the most effective. Moreover, the decision’s unfortunate timing amid the COVID-19 pandemic might exacerbate frictions in the talks between member states on how to support the post-virus recovery (the GCC decision did not address the legitimacy of the recently announced €750 billion Pandemic Emergency Purchase Programme (PEPP) nor the €120 billion temporary increase to the Expanded Asset Purchase Programme, both launched to tackle the COVID-19 crisis). Although the judgement is provisional, if confirmed, it might disempower the ECB’s traditional quantitative easing (QE) toolkit at the very moment when member states are finally starting to discuss an upgrade of the EU’s powers in matters of economic and fiscal policy.
The Current Architecture of ECB Purchase Programmes in the Public Sector
To fully understand the arguments and the implications of the GCC’s decision we should examine it in the context of the ECB’s QE framework, namely the Expanded Asset Purchase Programme (EAPP). The EAPP is part of a package of non-standard monetary policy measures launched by the ECB in mid-2014 to support the monetary policy transmission mechanism and ensure price stability. The EAPP consists of four main different purchase programmes, covering corporate bonds (CSPP), asset-backed securities (ABSPP), covered bonds issued by financial institutions (CBPP), and public sector securities issued by euro area governments as well as by recognized agencies, international organizations, and multilateral development banks located in the EU (PSPP). The PSPP was first introduced in March 2015 and then underwent several successive rounds of recalibration, which, inter alia, extended its original duration.[1]
The PSPP represents the main pillar of the EAPP from a quantitative perspective, accounting for approximately 80% of the overall purchases and corresponding to around 25% of the eurozone’s GDP. As such, it played a major role in stabilizing the price of public securities issued in the Eurozone in the aftermath of the 2011-2012 sovereign debt crisis. Despite the ECB’s more limited freedom in structuring its QE programme compared to other non-EU Central Banks, the PSPP led to tighter spreads between poor performing southern EU countries and the benchmark German bund. The PSPP still plays a major role today in helping the ECB achieve its main institutional objective of price stability by promoting a bounce back of inflation expectations on short- and medium-term maturities (at least until the very recent, unexpected, developments).
The PSPP incorporates some unusual safeguards compared to other non-EU Central Banks’ QE programs. These safeguards limit the programme’s effectiveness but are necessary to comply with the legal constraints contained in the EU Treaties and the ECB’s statute, particularly the prohibition of monetary financing contained in Art. 123(1) of the Treaty on the Functioning of the European Union (TFEU). “Monetary financing” is defined as running a fiscal deficit (or a higher deficit than would otherwise be the case) that is not financed by the issue of interest-bearing debt, but rather by an increase in the monetary base, i.e. of the irredeemable fiat, non-interest-bearing, monetary liabilities of the government or central bank. This would typically be in the form of deposit money in the government’s own current accounts, which would then filter into the economy through tax cuts or increases in public expenditure.
The first safeguard is that only secondary market purchases are allowed under the PSPP, thus preserving financial markets’ ability to form prices for securities free from direct government involvement. Second, aggregate purchases are limited to an overall monthly basis of €80 billion for the whole EAPP. Moreover, in order to avoid monetary financing, there is an aggregate purchasing limit of 33% of each issuer’s total outstanding debt (taking into account all consolidated holdings in all portfolios of the Eurosystem central banks) and a limit of 25% per international securities identification number (i.e. per each single issue/tranche of securities). The rationale for such limitations comes from the 2013 Treaty Establishing the European Stability Mechanism (ESM), which requires EU sovereign bonds to include collective action clauses (Euro CACs). Such clauses allow creditors to agree on debt restructuring, and therefore to a haircut for all creditors, upon the favorable vote of at least two-thirds of the outstanding debt.[2] This puts a creditor holding at least one-third of the overall outstanding debt in the position of hold-out creditor. Since securities are purchased under the PSPP pari passu with private creditors, the ECB would be subject to a potential sovereign debt restructuring. In such a scenario, any holding in excess of the above thresholds would force the ECB into a position to decide either to derail the restructuring of a EU country’s distressed debt, or to vote in its favor and thereby likely impinge in a violation of the prohibition of monetary financing.
Third, the PSPP permits very limited risk-sharing of the purchased sovereign debt. Currently, of the total securities purchased under PSPP, 90% shall be issued by governments and recognized national public agencies and 10% shall be issued by eligible EU international organizations. Out of the share allocated to sovereign debt, 90% shall be purchased by National Central Banks (NCBs), each bank purchasing only securities of its own jurisdiction (e.g. the Bundesbank will purchase German bunds while the Bank of Italy will purchase Italian BTPs). Only the remaining 10% will be purchased by the ECB and thus be subject to mutualization across all EU countries. Both the ECB and the competent NCBs can purchase securities issued by a certain EU country within the limit of the share represented by that country’s capital key in the ECB with respect to the aggregate purchase monthly cap (e.g. Italian BTPs could be purchased on aggregate within the 13.8% (of 90%) of the overall monthly cap).
The absence of a cross-country risk-sharing mechanism in the PSPP—the consequence of a then-necessary political compromise—is an uncommon feature, even for the ECB. Ordinary monetary policy operations in the eurozone are mainly carried out by NCBs, but all income generated, and any credit losses incurred, in these operations are distributed among all of the ECB’s shareholders, regardless of the country that caused such an effect. The PSPP’s anomaly is strongly criticized for the prospect that it may prove ineffective and counter-productive in the event of a new eurozone sovereign default. In such a scenario, it would likely bankrupt the relevant NCB and force the Eurosystem’s other participants to take aggressive action to prevent a deflationary spiral. At the same time, because the PSPP lacks a cross-country risk-sharing mechanism, the direct economic consequences of the GCC’s decision on the eurozone member states (other than Germany) should be quite limited, at least in the short-term.
A Critical Review of the Court’s Legal Arguments
The GCC reviewed both the PSPP and the related Court of Justice of the European Union (CJEU) decision in Weiss, which upheld the validity of the PSPP within the mandate of the ECB and Art. 123(1) TFEU. Notably, in the Weiss case, the CJEU issued its preliminary ruling (under TFEU Art. 267) upon the direct request from the GCC to examine the validity of the PSPP under EU law. The latter now openly disregards the former’s solicited decision—a gesture that may be interpreted as an act of war against the CJEU.
The GCC’s Competence
The GCC first addressed the issue regarding their competence. The Court was obliged to do so since they could not ignore that the CJEU—the competent court on EU law and hierarchically superior to national courts—had already issued a final and binding ruling on the matter. The GCC reasoned that national courts are legally entitled to conduct autonomous judicial “second review” of any legislative act adopted by EU institutions, bodies, offices and agencies “where an ultra vires [i.e. beyond powers] review or an identity review raises questions regarding the validity or the interpretation” of such act [§118]. In this respect, it is irrelevant that the Treaties vest the CJEU with the exclusive competence over the validity and interpretation of such acts (consistent with the case law developed in Honeywell), as national courts may still express their opinion “where the interpretation of the Treaties [put forth by the CJEU] is simply not comprehensible and thus objectively arbitrary” [§112, 113, 118].
According to the GCC, where a national court reasonably suspects that an EU legal act, or even a CJEU ruling, had been adopted ultra vires, it shall be competent in conducting an independent review, acting as an ultimate ‘gatekeeper’ over the application and interpretation of EU law, even though such a role is not recognized under the EU Treaties. The Court believed that reasoning otherwise would amount to a violation of the principle of conferral, which stipulates that “the Union shall act only within the limits of the competences conferred upon it by the Member States in the Treaties to attain the objectives set out therein.”
Lack of proportionality and insufficiency of safeguards
The German judges carried out an independent, substantive, and profound second review of the validity of the PSPP, in which they granted themselves overriding power over the CJEU’s ruling. The Court identified two issues of primary concern.
First, the GCC found that the ECB acted ultra vires when establishing the PSPP because they failed to conduct a suitable proportionality test of weighing and balancing the objectives of monetary policy against the economic and fiscal effects [§165]. In particular, the PSPP contains a de facto risk-sharing mechanism of member states’ sovereign debt by creating conditions that favor moral hazard by the less rigorous countries which count on the ECB’s support in times of financial hardship. This creates a negative externality on German (and other states’) taxpayers as a result of a decision solely taken by a third party (i.e. the ECB). Therefore, in the absence of any validation by the democratically-appointed national bodies, the PSPP violates the principle of democracy.
Second, the Court found that the CJEU’s Weiss ruling was rendered ultra vires as well, insofar as it failed to closely scrutinize the safeguards built into the PSPP and to conduct a suitable proportionality assessment [§184]. In failing to apply the “recognized methodological principle” of proportionality, the CJEU did not fulfill its institutional duty to verify whether the PSPP fell within the ECB’s statutory mandate, and thus violated the fundamental principle of conferral set out under Art. 5(1), first sentence, and 5(2) of the Treaty on European Union (TEU). In essence, the GCC held (somewhat paradoxically) that the CJEU confirmed the validity of the PSPP without performing the strict scrutiny required by the Treaties, and instead simply relied upon the ECB’s motivations. This holding comes despite the fact that Weiss is consistent with the CJEU’s general methodological approach.
On these grounds, the GCC concluded that the CJEU’s ruling is “not comprehensible” and “arbitrary from an objective perspective,” as it “lack[s] the minimum democratic legitimation” [§112, 142] under the German Constitution (Grundgesetz or Basic Law). A combination of the broad discretion afforded by the ECB, together with the limited standard of review applied by the CJEU “fail[ed] to give sufficient effect to the principle of conferral […] and pav[ed] the way for a continual erosion of Member State competences” [§156]. The GCC go even further to self-proclaim its legitimation due to the apparent need to halt the EU to become too strong vis-à-vis the member states.
The GCC’s review improperly addresses the merits of both the PSPP and the legal arguments in Weiss. In concluding that any shortcomings of EU institutions will be rigorously scrutinized by the German Constitutional Court, the judgement comes off as a general denunciation of the EU legal system’s decision-making processes.[3] Even though the GCC formally claim that it will only exercise this kind of review when a process violates the “recognized methodological principles” of member states’ constitutional legal traditions, the extent of such a review is unpredictable in application, as the principles are vague and open-ended, and are not consistently interpreted and applied across European legal systems.
As one commentator notes, the GCC’s behavior in extending the principle of proportionality to the EU context, in the shape that has been developed by German case law, is a clear and unacceptable attempt of “cultural dominance.” Applying a nationally-developed standard of review to foreign or supranational courts severely prejudices the rule of law and leads to inconsistent outcomes. Moreover, given the intrinsically vague scope of the principle of proportionality, such a standard deprives the ECB of almost any business judgment over monetary policy that naturally overlaps with fiscal policy. This kind of deprivation violates the EU Treaties and the independence of the ECB.
Notwithstanding its severe criticisms to the PSPP and Weiss, the GCC concluded quite surprisingly that, despite failing to properly apply the principle of proportionality, “the decisions on the adoption and implementation of the PSPP ultimately do not amount to a qualified violation of Art. 123(1) TFEU” [§197]. The GCC then granted the ECB three months to either prove that a suitable proportionality test had already been carried out for the purposes of adopting the PSPP, or conduct a new proportionality test in order to reach a final decision on the matter (even though the GCC do not have the power to impose this kind of obligation on the ECB).
The Legal, Economic, and Political Implications: A Push Towards a More Democratic Central Bank?
The Short-Term Implications
The GCC’s decision has faced a cold reception from EU institutions (not to mention from other member states). The leitmotiv tends to reassert the ECB’s autonomy from national law (established in Art. 130 TFEU) and the supremacy of the CJEU, despite the remarks made by the GCC on this point. Therefore, the argument goes, the ECB will continue its operations under the PSPP, given the CJEU’s go-ahead in Weiss.
Similar frictions are not a novelty throughout the EU integration process. Nonetheless, in the short-term, we may expect one of a few alternative scenarios, mostly depending on how the GCC and the other institutions involved will sort out the issue.
In one scenario, the ECB might accommodate the GCC’s request by providing evidence that a suitable proportionality test was conducted, both at the time the PSPP was established in 2015 and when it was restarted in 2019. To this end, the GCC assigned the German Federal Government and Parliament (Bundestag) to ensure that the ECB delivers such response. The Federal Government and the Bundestag shall also communicate their legal view to the ECB or take other steps to ensure that conformity with the Treaties is restored. Should the GCC find the outcome of this process satisfying, it would confirm that the PSPP is in fact compliant with the EU constitutional architecture (and, indirectly, with German Basic Law). As a result, the Bundesbank would be formally allowed to take part to the PSPP again.
In an alternative scenario, the GCC might maintain that the PSPP was adopted ultra vires. In such case, it will need “not to be applied in Germany, and [will not have] binding effect in relation to German constitutional organs, administrative authorities and courts.” [§§234-35]. In this case, the Bundesbank would not be allowed to carry out any further purchases under the PSPP. In addition, it would be required to sell off the German bonds it purchased under the programme.[4] In this respect, it is uncertain whether all purchases under the PSPP would be held illegitimate or whether the GCC would establish a grace period (presumably, the first period of implementation of the PSPP), where the purchases were justified by reasons of emergency.
In any case, the GCC leave another window open: a case where the ECB adopts a new decision based on proportionality, demonstrating “in a comprehensible and substantiated manner that the monetary policy objectives pursued by the ECB are not disproportionate to the economic and fiscal policy effects resulting from the programme” [§235]. If so, the Bundesbank would be allowed to participate to the PSPP.
In each of the scenarios above, the ECB is likely to be weakened, perhaps from a legal standpoint (more in the second than in the first case), but certainly from a political one. There is, instead, a third-order of alternative scenarios where the ultimate balance would be the outcome of deep political negotiations. This is the most uncharted territory and difficult to predict, yet it may be the most fruitful one.
From a political standpoint, the GCC’s decision is no doubt a complex issue for the whole EU. The ECB will likely respond to the GCC’s request to provide the proportionality assessment, even though this sets a dangerous precedent for similar requests by national courts in the future.
At the same time, the decision might bring about political consequences to Germany’s detriment. The GCC’s ruling might well constitute a breach of EU law, in the sense that a member state’s institution failed to fulfil an obligation under the EU Treaties, in this case by denying full effect to EU law as interpreted by the CJEU. Although nobody seems to like the idea, challenging Germany with an infringement procedure might end up being a last-resort measure to protect the EU institutional framework from a possible flood of similar lawsuits. The opening of an infringement procedure, regardless of the outcome, would lead the EU into a no-man’s-land politically and legally, but it would most certainly deepen the political fracture already created by the decision made in Karlsruhe. The procedure has only rarely been used against judicial decisions from national courts and must be brought with caution. However, given the novelty and magnitude of the issue, an effective solution can hardly be achieved by means of pure legal solutions, and an infringement procedure may be very useful. The President of the European Commission already stated that such option is still on the table, and that “The final word on EU law is always spoken in Luxembourg. Nowhere else.”
Finally, from a monetary policy standpoint, the short-term landscape under a Bundesbank withdrawal looks like a lose-lose situation. First, the effects of the GCC’s decision on the German economy should not be underestimated. As a matter of law, the GCC cannot interfere with the purchases made by other NCBs under the PSPP, which would continue unaffected. Therefore, removing the Bundesbank from the PSPP would be felt most acutely within German national boundaries. Notably, the cumulative net purchases made by the Bundesbank under the PSPP as of April 2020 amounted to about 23.3% (€534 billion) of the cumulative net purchases made under the programme. Being forced to step out of the program may be quite burdensome, even for an economy as robust as Germany’s, especially in these particularly troubled times. In addition, while the PSPP might not be impaired in the short-term from losing its first funding provider from a strict accounting and financial perspective, the loss would surely decrease the overall firepower of the programme (and possibly that of future ECB monetary initiatives).
The Long-Term Implications
The emerging narratives on the GCC’s decision that depict a disastrous impact on the ECB’s power and EU policy seem overly pessimistic. Nonetheless, there is a risk that the political aftermath, if not properly managed, will weaken the ECB. The time is not yet ripe for making any prediction in a long-term perspective, thus we only try to sketch out some potential implications.
First and foremost, if the GCC’s ruling goes unquestioned (legally, politically or both), it might limit the freedom of the ECB’s future QE initiatives. The ECB might be de facto forced to conform to the GCC’s demands in order to avoid further lawsuits. The recently enacted PEPP might become a dangerous test bench. As mentioned earlier, neither the PEPP nor the temporary amendments made to the EAPP in connection with the COVID-19 crisis fall within the scope of the GCC’s present decision, but should the GCC stick to its current course of action, the programmes are likely to be subject to its scrutiny eventually. Compared to the original PSPP, the PEPP provides additional flexibility and purposefully features a larger extent of risk-sharing in order to tackle the asymmetric effects of the pandemic on the EU economies. However, after the GCC’s decision it is hard to predict whether this would be enough to satisfy the proportionality test in the fashion conceived therein.
A second issue is the cost of uncertainty that may arise from the GCC’s decision. In recent years, the ECB resorted to QE programmes as a practical tool to tighten the spreads among the eurozone’s sovereign debts. This goal links only indirectly to the ECB’s institutional objectives, since it is instrumental to maintaining price stability throughout the EU and ensuring that the cost of debt is kept as uniform as possible among its member states. Yet the market impact of future QE measures could be weaker if investors are uncertain whether the ECB’s measures may be challenged by national courts. The danger is particularly substantial if the GCC can dismantle the purchases retroactively. In other words, the German precedent could pave the way for a flood of lawsuits in different EU countries, each one trying to advance its own national interest. This could happen more easily in those countries like Germany and Spain where single individuals are allowed to bring direct constitutional complaints in front of the national court.
Furthermore, if monetary policy is to be strictly separated from fiscal policy as the GCC state, then QE measures can legally be allowed only so long as inflation levels warrant it. This may not be a concern in ordinary times, but extraordinary circumstances like the pandemic might lead to deflation while also accelerating a new sovereign debt crisis. In such circumstances, the responsibility of setting up a comprehensive plan should in principle rest upon member states and the European Council. Nonetheless, in recent crises, including the current one, the ECB proved far more effective than any government.
On the bright side, the GCC’s decision can be interpreted as a call for further political integration across the EU. In many recent occasions, the ECB has done the “dirty work” that governments were not willing to take responsibility for but quietly celebrated. Such action may or may not have been within its legal boundaries (according to either the CJEU or the GCC) but it might have helped to “save the Euro” in its darkest hours. If the ECB stretched the law to pursue such goals, it was to compensate for political idleness. Therefore, if member states want to stick to this road, the GCC say that it is up to their political bodies to start taking greater ownership and stop hiding behind the ECB. It is unclear whether EU member states are ready for this; even pro-European politicians are struggling to speak frankly with their electorates about the EU political integration agenda. If not, the GCC might have pushed the eurozone to the edge of a cliff.
Conclusion
The reasoning of the GCC’s decision raises serious doubts and questions. The GCC delegitimize the autonomous existence and operations of the ECB and the autonomy of the whole EU legal framework by refuting, even if to a limited extent, that the CJEU is a superior court on matters regarding EU law.[5] Indeed, willingly or not, the GCC put a crack in the EU’s foundation by weakening the principle of uniform interpretation of EU law. Similar lawsuits might rapidly follow against the ECB and the issue may pour into other fields of EU law.
Such effects are magnified by the fact that the ruling comes from the constitutional court of the state that effectively lays at the heart of the European architecture. The GCC seem to want the ECB to be confined to a narrower institutional role, based on a strict legal interpretation of its mission. We can argue whether this is what the law really commands, yet EU politicians, including the German ones, might agree in principle but not be ready for this in practice. Nonetheless, member states, with Germany on the front-line, shall find a solution to such impasse. Only time will tell whether such decision has ignited the spark of EU next-level integration, fatally drowned it, or changed nothing at all.
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[1] For the ease of reference, the terms and conditions described herein are those currently applying.
[2] Such quorum refers to the majority required pursuant to the Euro CAC to approve a resolution on a reserved matter (concerning the important terms and conditions of debt securities – which would be likely triggered in the event of a debt restructuring) by means of a written resolution. Such required majority is even higher in the case the resolution is to be taken by means of a bondholders’ meeting (in such case it must be approved by a 2/3 majority of the outstanding bonds and 75% of bondholders represented at the meeting).
[3] A similar disappointment in the CJEU decision-making process occurred in Gauweiler, concerning the ECB Outright Monetary Transactions (OMT) programme, in which the GCC however confirmed that no ultra vires acts had been adopted.
[4] Notably, should the GCC confirm that the PSPP is a violation of the German Basic Law, the Bundesbank shall ensure that the bonds already purchased under the PSPP and held in its portfolio are sold based on a – possibly long-term – strategy coordinated with the ESCB [§235].
[5] See Katharina Pistor, Germany’s Constitutional Court Goes Rogue; Diana U. Galetta, Karlsruhe über alles? The reasoning on the principle of proportionality in the judgment of 5 May 2020 of the German BVerfG and its consequences; Jacques Ziller, The unbearable heaviness of the German constitutional judge. On the judgment of the Second Chamber of the German Federal Constitutional Court of 5 May 2020 concerning the European Central Bank’s PSPP programme; Peter Meier-Beck, Ultra vires?: ‘a judgment that is wrong or perhaps only inadequately reasoned must also be accepted if the legal system does not (any longer) provide for an appeal against it, and this applies to decisions of a local court as well as to those of Federal Court of Justice, the Federal Constitutional Court and the European Court of Justice’.
