Opinion & analysis

Policy Insight | The power surplus. Brussels calling, legal empathy and the trade-regulation nexus | CEPS

The EU may not be a superpower but it holds a ‘power surplus’ when it comes to the trade-regulatory nexus. The strategic challenges posed by the deployment of this power surplus are the subject of this paper, which argues that in order to be a responsible regulatory power and positively influence the multilateral agenda, the EU needs to develop a coherent overall approach to the external dimension of its regulatory policies.

In this spirit, and in most cases, the EU would be ill advised to project itself as a model or to seek to ‘weaponise’ its regulatory powers in pursuit of unrelated foreign policy goals. Instead, it should wield this power to enhance the regulatory compatibility between its own and others’ jurisdictions through cooperation rather than relying on the passive market-based influence of the so-called Brussels effect. This is simply a way to be faithful to its core defining philosophy of legal empathy.

The CEPS Policy Insight by authors Ignacio Garcia Bercero and Kalypso Nicolaïdis offers a typology of different forms of external EU regulatory impact, a discussion of the risks of either underuse or overuse of the regulatory power surplus, and considers the ‘good global governance’ model implied by a principled geopolitical role. It moves on to discuss a unifying conceptual framework to encompass this approach, under the umbrella of ‘managed mutual recognition’ as the operationalisation of legal empathy. It concludes with six specific suggestions as to how the EU can best exercise its regulatory power through a closer integration of trade and regulatory policies.


Download the full publication here


This paper can also be found at the European University Institute as a School of Transnational Governance Policy Report.

Can responsible investing encourage retail investors to invest in equities? by M. Brière and S. Ramelli | European Capital Markets Institute (ECMI)

On 16 March, the European Capital Markets Institute (ECMI) published a commentary by Marie Brière and Stefano Ramelli, named Can responsible investing encourage retail investors to invest in equities? which acknowledged that the low participation of retail investors in the equity market is a concern for many countries. It is a necessary condition for the development of capital markets in Europe and a key factor for funding post-Covid economic recovery. Recently, savers’ appetites for responsible investment has grown, but little is known about the consequences of this development on individual investment decisions. 

Employee savings plans constitute a unique laboratory for studying these choices. In a recent research article (Brière and Ramelli, 2021), the impact of introducing responsible funds into the investment choices of more than 900,000 French employees was analysed. The addition of a responsible option to the menu of funds led to a 7% increase in the equity allocation of new investments. Given that the average equity allocation is around 13%, this increase is substantial and represents an encouraging result for retail investors’ participation in the equity market. The role of social preferences further explains this phenomenon.

Download the full publication here

About the authors

Marie Brière is Head of Investor Research Center at AMUNDI, Affiliate Professor at Paris Dauphine University, Senior Associate Researcher at Université Libre de Bruxelles, and Member of the ECMI Academic Committee.

Stefano Ramelli is PhD Candidate at the Department of Banking and Finance, University of Zurich.

What next for Angela Merkel’s CDU after two regional election defeats? | Europp – LSE Blog

Featured image credit: European Council

Disappointing results in two regional elections on 14 March have raised doubts about the potential for the CDU to remain in power at Germany’s federal election in September. John Ryan writes that with the party suffering from accusations of corruption and growing public dissatisfaction over its handling of the Covid-19 pandemic, it is no longer unthinkable that an alternative coalition without the CDU could form the next German government.

The Christian Democratic Union (CDU), the ruling party of German chancellor Angela Merkel, has been dealt bitter blows in two important state elections. While the results are in part a reflection of regional politics, they also function as a practical indicator ahead of September’s federal election. The results also raise questions for the new leadership of the CDU and for the selection of the party’s next chancellor candidate.

Record low vote shares

In Baden-Württemberg, the Greens won 32.6% of the vote (up 2.3%), while the CDU, junior coalition partner to the Greens until now, reached only 24.1% (down 2.9%) when compared to the last state election in 2016. In Rhineland-Palatinate, the Social Democrats (SPD) came first again with 35.7% (down 0.5%) ahead of the CDU, which led there in opinion polls until last month but secured only 27.7% (down 4.1%). This means that in both regions, the CDU received record low vote shares.

The SPD has managed to maintain its numbers in Rhineland-Palatinate, in part thanks to the popularity of state premier, Malu Dreyer. In Baden-Württemberg, the extremely popular Winfried Kretschmann has been in office for ten years. He is the only Green party member to serve as a state premier in Germany.

The elections on Sunday came at a delicate time for Armin Laschet, the new leader of the CDU. The poor performance by the Christian Democrats has undermined his authority and weakened his bid to run as the CDU/CSU’s joint candidate for chancellor in September’s federal elections. Various polls taken in the last few months, before a series of corruption scandals emerged and before the poor regional election results, found voters preferred the CSU’s Bavarian state premier Markus Söder as their future chancellor by a wide margin. While traditionally the position of party leader would have automatically placed Laschet into the chancellor candidate role, the election results and polling signals mean that Söder is now the favourite to become chancellor candidate.

German media reported that as many as a third of those eligible to vote in Baden-Württemberg had already cast their ballots before the corruption scandals broke. In Rhineland-Palatinate, the figure was even higher, at almost 37 percent. Due to the Covid-19 pandemic, many voters chose to cast their ballots by mail this year ahead of Sunday’s election date. With less lead time, the results could have been even worse for the CDU.

Both regional election results open the way for potential regional alliances of the Greens, SPD and the liberal Free Democrats (FDP). That coalition construct, also known as a traffic light coalition due to the official colours of the three parties involved, was already the governing coalition in Rhineland-Palatinate following the 2016 elections. CDU leaders now fear the same constellation of parties could gain enough support to leave their party in opposition in Baden-Württemberg and at the national level following September’s federal vote.

Corruption accusations and Covid-19

The CDU/CSU has seen its support decline significantly in recent weeks due to the fallout from the corruption scandals and growing dissatisfaction with the government’s handling of the Covid-19 pandemic. Germany’s comparatively slow vaccination programme has been described as a “debacle” and a “Covid nightmare.” Yet as damaging as this has been, it was the accusations of corruption that constituted the biggest blow before Sunday’s elections.

The scandals centre on allegations of profiteering in mask procurement deals and foreign donations. They have already led to the resignation of two CDU members and one CSU member of the Bundestag. Nikolas Löbel, a now former MP for the CDU, bowed to pressure after revelations that his company earned commissions of about €250,000 for brokering protective mask sales contracts, while Georg Nüsslein, from the CSU, faces accusations he received €600,000 to lobby for a mask supplier.

Meanwhile, the magazine Der Spiegel reported that CDU parliamentarian Mark Hauptmann was paid €16,744 by the Azerbaijani embassy in Berlin to advertise a shopping weekend in Baku in a local newspaper that Hauptmann publishes in the state of Thuringia. According to the report, the payment was made after Hauptmann had worked for years to establish cordial ties with Azerbaijan, consistently siding with the country despite its controversial human rights record. The governments of Taiwan and Vietnam also paid for ads in the newspaper, according to Der Spiegel. Axel Fischer, a CDU MP from Baden-Württemberg, has also had his parliamentary immunity suspended amid a criminal investigation into whether he accepted bribes from Azerbaijan. He denies any wrongdoing.

On 12 March there was a deadline set for lawmakers from Germany’s governing conservative bloc to declare in writing that they had not profited from the Covid-19 pandemic. This is the CDU/CSU’s “worst crisis” since a campaign-financing scandal at the end of the Kohl era that brought down the leadership, ushering in Merkel. The scandals are already morphing into a broader examination of MPs’ extra-parliamentary income, and such scrutiny seems likely to trigger more uncomfortable revelations.

The end of the road for the CDU?

As of now, most observers are betting on a tie-up between the Christian Democrats and the Greens following September’s federal elections. A continuation of the current coalition between the conservatives and the Social Democrats is likely to be a mathematical option after the election, but it is not a constellation either side is eager to renew after governing together for most of the past decade. A three-way coalition between the Greens, Social Democrats and Die Linke would not currently have enough support. There is however a chance over the next six months that the Greens, SPD and FDP could build enough momentum to form a traffic light coalition. Upcoming opinion polls may show that these three parties gain more support.

Given the corruption accusations and Covid-19 vaccination delays, trust in the chancellor and her cabinet is weakening. For several weeks now, public approval of the government’s pandemic management has been sliding. This is hardly surprising in view of the many glitches in the vaccination and testing drives, the broken promises, the resurgent number of infections and a chancellor who is no longer able to assert herself against powerful state premiers. Merkel’s party has announced a ten-point plan to tighten regulations on lobbying and bribery in the Bundestag. The plan foresees the prohibition of paid work on behalf of third-party interests in the Bundestag. But this may be too little too late.

The realisation after these two elections is the very real prospect that Germany may emerge from the September elections without the CDU/CSU being part of the government. The CDU/CSU is still the most popular party in Germany for now, but one federal poll showed its support at only 29 percent (the party’s lowest ever), raising questions over whether it will get enough votes to form a coherent government. The regional elections affirmed the national trends that the slow rollout of vaccines and the recent accusations have left the CDU/CSU struggling to contain the damage. The level of Covid-19 infections in Germany remains stubbornly high. The availability of vaccinations remains low. Patience is also wearing thin over endless lockdowns.

Armin Laschet as the party’s leader – but not as their chancellor candidate – has seen his popularity diminish over his handling of Covid-19. In comparison, Markus Söder, the CSU leader, has remained cool headed during the pandemic. The CDU/CSU had agreed to choose their chancellor candidate in May, but as results and opinion polls are showing a negative outcome, the decision to appoint their candidate may have to be brought forward. Angela Merkel’s CDU needs to rethink fast. As the long-serving chancellor bids farewell, her party faces the real prospect of losing its grip on government altogether.

Policy Insight | It’s time to rethink the EU’s Russia strategy | CEPS

Anti-regime protests in Belarus and the poisoning of Alexey Navalny have brought EU-Russia relations to their lowest point since the 2013-14 Ukraine crisis. High Representative Josep Borrell’s trip to Moscow last month, aimed at re-establishing common ground, instead led to the expulsion of three European diplomats and a joint press conference in which the EU was accused of being an “unreliable partner”.

Borrell has concluded that Russia is no longer interested in constructive dialogue with the EU. Even the more dovish member states will now face pressure to adopt a more assertive stance towards Russia. In developing a more robust approach, however, member states must remain conscious of the fragile state of continental security in Europe.

The five guiding principles: between toughness and engagement

The Foreign Affairs Council (FAC) of 22 February discussed how the EU’s relations with Russia could evolve within the context of the five “guiding principles” laid out by Borrell’s predecessor Federica Mogherini. Following the Ukraine crisis, which marked the failure of the Lisbon-Vladivostok vision of a ‘Greater Europe’, these principles aimed to carve out a new equilibrium between toughness and engagement with Russia. This equilibrium now appears to have collapsed. Although they will not be jettisoned, changing circumstances point to the need to de-emphasise certain principles and firm up others.

Two of the principles – demanding full implementation of the Minsk agreements as a precondition to lifting sanctions and cooperating selectively with Russia where interests align – were evidently rooted in the lowest common denominator among member states that favoured engagement and those that preferred a more hawkish stance. Borrell’s more recent calls for a European “language of power” have failed to transcend this reductionist approach, as the term can satisfy both those who interpret it as a push for more autonomy from the US and those who see it as calling for a firmer approach towards Russia.

These intra-EU divisions have damaged the cause of Europe’s strategic autonomy. The Minsk agreements, the German Nord Stream 2 pipeline, and Emmanuel Macron’s proposed Russia reset have solidified the attachment of many smaller member states to NATO. The result is a vicious circle: Moscow continues to believe that the EU has effectively outsourced its security to Washington and therefore prioritises the dynamics of its rivalry with the US, which in turn has a deleterious effect on EU-Russia relations. This trend has also reinforced the illusion that Moscow can pursue cooperative relations with individual member states without engaging with the rules-based framework that ties those states together.

It has become increasingly difficult to square the other three principles – pursuing closer relations with Russia’s post-Soviet neighbours, enhancing EU resilience to Russian threats, and increasing support for Russian civil society – with selective engagement. As great power relations have worsened and Russia has drifted towards authoritarianism, ties between Brussels and Moscow are in danger of becoming fully adversarial, on a par with the US-Russia relationship. A prolonged confrontation, while undesirable from the standpoint of preserving a stable European security order, is now perhaps inevitable. With little prospect (or appetite) for meaningful strategic engagement with Moscow for the foreseeable future, member states should recalibrate their collective approach to Russia in a manner that balances toughness and restraint.

Towards a new approach: balancing toughness and restraint

For the first time, ministers at the recent FAC agreed to make use of the EU’s Global Human Rights Regime to impose restrictive measures against individuals responsible for prosecuting Navalny and repressing the protests that followed his arrest. (The US followed up with measures of its own.) This move allows Brussels to claim a win without imposing more wide-ranging sanctions that might have invited a more serious reprisal from the Kremlin. Yet while human rights promotion will remain part of the EU’s DNA, reflexively resorting to sanctions has become a poor means of addressing the problem of Russia’s divergence from European norms.

With the liberal international order seemingly in crisis, Russia has come to view Western humanitarian measures and pronouncements not as expressions of universal values, but rather as weapons aimed at destabilising its regime. Moreover, a survey released by the German database Statista last month shows that Vladimir Putin remains the most trusted public figure for 29% of the Russian population, compared with just 5% for Navalny. Although support for Putin has declined from its post-Crimean high in 2014, the regime remains resilient and the legacy of the disorderly 1990s has not yet faded from public memory. Taking aim at what Moscow sees as its internal affairs will only convince Russian authorities that they have little to lose by cracking down further on protestors and perceived opponents. It also risks escalating the regional security dilemma when paired with a US-led Euro-Atlantic security order that Moscow perceives as exclusionary and threatening.

Moreover, the EU’s demand that the Minsk agreements be implemented as a precondition for restoring ‘business as usual’ reinforces the misperception that the pre-2014 status quo was rosy. EU-Russia ties throughout the post-Cold War era suffered from a fundamental asymmetry of aims, with Brussels envisaging a rapprochement based on shared values and Moscow emphasising its desire to be treated as an “equal”. The latter embodies a centuries-old tendency in Russian foreign policy and should not be derided as a mere feature of the Putin ‘system’, which in any case pursued a relatively liberal foreign policy in the early 2000s. Russia’s initial desire to join the West after the Soviet Union’s collapse was more a reflection of a brief turn in European and global history than a permanent shift in how Russia interprets its interests. In short, the conflict over Ukraine is a symptom and not the cause of the European security order’s current malaise.

A more strategically minded approach would focus on buttressing the other two non-engagement-related principles. Working with Washington to enhance resilience to external challenges is an obvious interest that the EU shares with the Biden administration. That said, with Brexit and Donald Trump in the rear-view mirror, the EU’s deteriorating relationship with Russia will become an even more central driver of European strategic autonomy over the coming four years. This threatens to deepen existing fault lines between the transatlantic alliance and the Sino-Russian entente, which would undermine the EU’s efforts to strengthen the rules-based foundations of interstate relations.

Member states must therefore demonstrate that a more robust EU approach towards Russia will balance transatlantic cooperation with a strong autonomous component. To that end, the forthcoming EU Council meeting should launch a process aimed at exploring forms of differentiated integration for Ukraine, Georgia and Moldova that would include some of the benefits of membership. Such a move would add a political and strategic dimension to the Commission’s goal, expressed in last month’s Trade Policy Review, of supporting the greater alignment of these three countries with the EU’s regulatory model. With no resolution to the Donbass conflict in sight, this could also provide a path for the EU to enhance its commitment to Ukraine while simultaneously reducing the Ukraine-centrism of its Russia policy.

Placing emphasis on the neighbourhood rather than on developments within Russia would send a balanced signal to Moscow. By providing greater incentive for the Association Agreement countries to deepen their alignment with the EU’s political and legal criteria, member states would affirm that the EU regulatory order is an established fact of Europe’s security architecture and should not be derided as a mere economic arm of NATO. At the same time, it would make clear to Moscow that the door remains open to cooperation on areas of shared interest. If Russia comes to see the EU as a more sovereign actor, then this may open space not only for sharper adversity but also more effective dispute resolution.

Strategic inaction is not an option. Moscow will likely remain able to sustain lofty geopolitical ambitions for decades, despite its economic and demographic challenges. Alternative sources of liquified natural gas and the gradual greening of Europe’s economy threaten to remove one of the few remaining areas of complementarity in EU-Russia relations – oil and gas imports – leaving military deterrence and coercion as the primary means for Moscow to advance its interests in Europe. Simply waiting for the Kremlin to crack is not a recipe for ensuring the EU’s security.

Since the Ukraine crisis, the EU and Russia have appeared content to live indefinitely with the reality of a fragmented European security order. Moscow sees the liberal international order as undergoing an existential crisis, while the West believes that Russia is in irreversible decline, leaving neither side prone to compromise. It was naïve to assume that such a situation could continue indefinitely without a sharper breakdown in relations. Seven years after the annexation of Crimea, it is no longer possible to continue muddling through.

Follow this link to the original publication

Policy Insight | What can the ECB achieve in a lockdown recession? | CEPS

The honest answer is, very little.

The economy of the euro area might well chalk up another quarter of negative growth in Q1 2021 as governments are prolonging social distancing measures due to the continuing winter wave and the slow pace of vaccination.

While the euro area economy remains weak, the US economy is poised to accelerate. A number of short-term indicators point to double-digit growth in the near term and stronger medium-term growth as lockdowns are lifted and US consumers start spending their accumulated savings, supported by further transfers from the $1.9 trillion package instigated by President Biden.

In this context, it is not surprising that US long-term rates have increased, already returning to their pre-Covid level.  Given the global nature of capital markets, rates in the euro area have also increased.  The benchmark German bond yield has risen by 20 basis points – hardly a major move, even though the ECB has felt it necessary to declare its willingness to increase the pace of its bond buying to support the economy.

But what could the ECB hope to achieve? It should not react to a recession in the usual way because this one is different, certainly very different from the last one.

There is broad agreement that lockdowns should be considered as a mixture of sectoral supply and demand shocks that directly affect travel, tourism and other contact-intensive services such as restaurants. These shocks are then transmitted via input-output linkages across sectors, which propagate these sectoral shocks (both demand and supply) to the entire economy.

A key consequence of the sectoral and externally imposed nature of these shocks is that attempts to stimulate aggregate demand have little impact on the overall economy as long as the sectoral restrictions of the lockdowns persist.

As an example, Farhi and Baqaee (2020) study supply and demand shocks in a general disaggregated model with multiple sectors. They conclude that “aggregate demand stimulus is only about a third as effective as in a typical recession”. This finding applies to monetary policy, in particular because monetary policy can only attempt to stimulate aggregate demand. In contrast to fiscal policy, it cannot be targeted at those sectors in which demand or supply are affected by the lockdown.

Lowering interest rates via monetary policy instruments is usually thought to induce households to bring consumption forward, to consume more today and less tomorrow. However, this mechanism works less well when households today cannot afford their normal consumption basket.

A concrete example can illustrate this proposition. Consider a person who wants to buy new sports equipment to be used on a vacation abroad. Normally, a low interest rate would make it more likely that the entire consumption basket (e.g. vacation and sports equipment) is bought today. But if foreign travel is impossible today due to the pandemic, the sports equipment will not be bought. No amount of interest rate reductions will lead to higher sales.

The evidence for the differences across sectors is already clear at the level of large aggregates, such as services and manufacturing. Figure 1 below shows the confidence indicator for these two macro sectors. In 2020 manufacturing confidence fell much more and was quicker to rebound than services. At present, in early 2021, manufacturing confidence is at a high level and industrial output is indeed expanding. However, confidence in services is much lower and declining again under the impact of the lockdowns imposed in late 2020. The difference between the two has reached an unprecedented level.

Figure 1. Eurozone Purchasing Managers Index (PMI) – 2018-21

Another piece of evidence for the reduced effectiveness of monetary policy is the fact that since the start of the crisis households have chosen to save a large part of their income. Figure 2 shows that household savings rates have more than doubled – not driven by interest rates, but by the fact that many services cannot be bought today. The aggregate data on household savings of course hide big differences in incomes across occupations. But these sectoral issues can only be addressed by fiscal, not monetary policy.

Figure 2. Household savings rates in the four largest euro area countries

The impact of lockdowns on spending is compounded by uncertainty about the course of the disease, with no end in sight as long as vaccination remains woefully behind schedule in the EU. This uncertainty also holds back investment in sectors such as hospitality if it is not clear when these sectors can reopen.

The conclusion is simple: monetary policy becomes ineffective in a recession that is caused by government-imposed lockdown. The minor reductions in interest rates that the ECB might hope to engineer by tweaking the asset purchases under the pandemic emergency purchase programme (PEPP) cannot have a significant impact on the sectors that are locked down. The rest of the economy is expanding anyway.

Finally, one should keep in mind that temporary variations in the pace of asset purchases within the given overall volume of the PEPP can at most have a second-order effect on interest rates.

Tweaking the path of bond purchases is thus unlikely to have a meaningful impact on the ultimate goal of the ECB, namely price stability. The ECB should keep its powder dry for the ‘day after’. Once the lockdowns have ended for good, monetary policy can once again become effective.

This Commentary draws on: A. Capolongo and D. Gros, (2020) “This Time is Different: The PEPP Might Not Work in a Sectoral Recession”, contribution to the Preparation of the European Parliament, Monetary Dialogue, and D. Gros and F. Shamsfakhr (2021) “Adjusting Support in a K-Shaped Recovery”.


Follow this link to the original publication

[Paper Series] Policy Insight | Avoiding the Main Risks in the Recovery Plans of Member States | CEPS

This is the first of a series of reports dedicated to the preparation and implementation of the Recovery and Resilience Facility of the EU. It sets out some of the main risks to the success of the recovery programmes, such as a lack of focus and mistargeting, maintaining unsustainable sectors, delays in implementation, and the lack of both a European dimension and the capacity to implement such a complex programme over and above the normal EU budget.

These risks can be mitigated or avoided, however. The report also presents a number of solutions to ensure that aspects critical to the recovery programmes – and the key objective of longer-term resilience – are implemented. It highlights the necessity for serious structural reforms in member states, better management and control systems at EU level, well-designed active labour market policies, and a clear framework for public private partnerships to ensure that they are used more effectively.

Download the full report here

Policy Insight | On the fringes: EU-UK financial services under the TCA | CEPS

The outcome of the Trade and Cooperation Agreement (TCA) for trade in financial services between the EU and UK deal was even more paltry than expected. The TCA does not even institute a dedicated financial services committee, but rather a general one for services. Nevertheless, there is a deal that provides for an umbrella, a governance structure, and a mechanism for dispute settlement and cooperation in a variety of fields, as might be expected for a former member and close neighbour. Joint actions have also been envisaged on money laundering (which remains problematic even within the EU), cybersecurity, and in financial programmes of the European Investment Bank (EIB). The agreement contains a long list of member states’ specific market access reservations, notably on financial data processing services – a clear sign that this is no longer a Union but a loose trade agreement. Only supervisory equivalence agreements between both parties covering some aspects of the free provision of financial services could somehow maintain the appearance of the frictionless trade of before.

From a once intense relationship in financial services, which was measured by the number of ‘passports’ or single licences used, capital flows and the high number of transactions in both directions, the TCA is a huge climbdown from the former close trade relationship. However, it was years in the making and thus allowed all providers to prepare for the new normal, which banks, insurance companies, financial infrastructures and related service providers have largely done.

The first working day of the new TCA, in its provisional form, saw no great change; there were no major hiccups and some businesses had already relocated to the EU with the new framework, often on platforms created by UK-based providers. But this likely heralds the beginning of the slow decline of the all-powerful City of London, whose rise coincided with the launch of the single market and expanded ever since thanks to passporting, and the renewed fragmentation of financial services over several European financial centres.

The agreement has a dedicated chapter on cross-border financial services and investment, following the (most favoured) national treatment and anti-discrimination rules (Section 5.37 of the TCA). But it provides for a prudential carve-out, as in other international trade agreements, allowing each party to adopt or maintain measures deemed necessary for consumer and investor protection or the stability of its financial system. This clause can easily be invoked in the financial services domain for protectionist reasons, and has never been challenged in international courts.

The City’s disappointment at the non-existence of a dedicated financial services committee in the TCA was understandable. The UK’s first draft of the Comprehensive Free Trade Agreement (CFTA) featured a financial services committee, which is obvious given the importance of this sector to the UK economy. This committee was supposed to function as a first-level dispute settlement entity and be composed of competent persons from each side. The draft also contained a specific annex related to the functioning of equivalence decisions. None of this is in the final TCA, as other issues seem to have taken priority, given their importance for the UK electorate. But the text had been kept among a close circle before the deal was formally announced on the 24 December 2020, hence the surprise at the change. Nevertheless, financial services will be dealt with in a generic services committee, and the respective EU supervisory and regulatory entities have announced several Memoranda of Understanding (MoUs) with their counterparts in the UK.

Other parts of the agreement and its various provisions are also important to maintaining market access for finance providers. Key parts in this regard are free cross-border data flows and the cooperation for cybersecurity.

  • Cross-border data flows (Part 2, Title III): the UK can be part of the EU data space, or a single data space, with no requirements for data or server localisation, and all this implies for business. This will require adequacy decisions between the EU and UK data protection rules, which still need some additional rulemaking on both sides, a GDPR-equivalent regime on the UK side, and an additional proposal by the EU Commission on data flows.
  • Cybersecurity (Part 4, Title II): the UK will also participate in the EU’s cyberspace, and both will cooperate on international fora to promote cyber-resilience. Moreover, the UK will be part of the EU’s Computer Emergency Response Team (EU-CERT), in the cooperation group of the Network Security Directive (EU/2016/1148), and in the EU Agency for Cybersecurity (ENISA) (subject to an appropriate financial contribution).

In addition, combating money laundering is a specific engagement of the parties in the TCA (Part2, Title X), with provisions regarding the exchange of information, mutual assistance and the transparency of beneficial owner registers, while there was only one reference to money laundering in the UK’s first draft. Furthermore, there is a requirement to provide information on bank accounts and transactions (Part 3, Title XI), and to assist with judicial prosecution in the case of money laundering.

Equivalence assessments of each other’s supervisory systems are not referred to in the FTA, but in a Joint Declaration that states: “the EU and the UK agree to establish structured regulatory cooperation on financial services, with the aim of establishing a durable and stable relationship between autonomous jurisdictions.” This includes: bilateral exchanges of views relating to regulatory initiatives; transparency and appropriate dialogue in the adoption, suspension and withdrawal of equivalence decisions; and enhanced cooperation and coordination, including in international bodies as appropriate.

So far, the EU concluded one agreement of importance, the equivalence of the supervision of UK clearing facilities, as contained in the 2014 European Market Infrastructures regulation (EMIR). This is far less than what the EU has concluded with other third countries so far, but is also less than the temporary relief which the UK has granted to EU service providers, as can be observed in this table. Although the European Commission has received the UK’s replies to the Commission’s questionnaires covering 28 equivalence areas, further clarifications are needed.[1] Decisions will be assessed only “when they are in the EU’s interest”.

As a step towards more equivalence decisions, but mostly to enhance supervisory cooperation, the EU, the member states and UK authorities have concluded a series of MoUs. The directorate general in charge, DG FISMA, and the UK Treasury plan to conclude an MoU on regulatory cooperation. However, this broad and non-binding commitment (more of an administrative than a policy tool), which is to be agreed by March, is noticeably different from the guaranteed single market access that UK financial service firms enjoyed until 31 December 2020.

The equivalence process should however not be seen as a unilateral process only. The UK itself will undoubtedly know where to go for equivalence, and where it should go its own way now that it can decide more quickly than as a member of the EU. The UK has already indicated that it will diverge in certain areas, such as on the settlement regime as contained in the central securities depositories regulation (CSDR), on the prudential regime for investment firms as contained in the investment firm regulation (IFR), or on the listing rules.

The strict EU bonus regime for financial services providers was never endorsed by the UK either, so change can be expected here. But the EU itself has already changed laws as well, as in the MiFID quick- fix amendments adopted in February 2021. These changes are certainly not to the liking of the UK authorities because they hinder equivalence in investment services.

The TCA sections on the level playing field (LPF), which mostly concern the manufacturing sector, will likely have no effect on financial services but could cause problems for the relationship overall. If there are significant divergences (e.g. on labour and social regulations, environment and climate, taxation levels of protection), that could have a material impact on trade or investment between the EU and UK. Rebalancing measures may be introduced to address the distortions, potentially ahead of an arbitration panel. The same applies for subsidies, where remedial measures could be requested.

The LPF debate demonstrates the EU’s fear of having a serious competitor following other rules at its backdoor, particularly one that is a significant competitor in financial services. Financial regulation is only one of the elements on which a financial centre competes; there is also human capital (expertise); a critical mass of players, activities and professions; infrastructure and interconnectedness; and reputation and proximity.

As a leading financial centre on all these aspects, the City of London – and more broadly the UK – will continue to play an important role in European and global financial services, until a true competitor emerges on the continent. But this competition is emerging – given the obligation to be established within the EU to provide certain services, such as share trading.

[1] In particular regarding how the UK will diverge from EU frameworks, how it will use its supervisory discretion regarding EU firms, and how the UK’s temporary regimes will affect EU firms.

Follow this link to the original publication

Policy Insight | Balkan and Eastern European Comparisons. Building a New Momentum for the European integration of the Balkan and Eastern European associated states | CEPS

This study, prepared by CEPS, brings us a comparative picture of progress among the Western Balkan and EaP EU associated countries. It reveals solid and converging similarities of development and achievements in the EU south-eastern and eastern neighbourhood region.

It raises new questions about EU policy convergence in the region. Are we ready to deploy EU Western Balkan integration instruments to the EaP countries that are ready to accept them? Will the EU be ready to respond in like manner and with the same policy instruments to the two very similar converging groups of countries aspiring to the same strategic goal of EU membership? Now is the time to answer these questions.

This study reveals the essential similarities between these groups of countries and offers bold new ideas for how the EU can incentivise Trio countries further with EU instruments. Incentives, or benefits, are suggested that can work not only for the Western Balkan region, but also for the Trio of EU-associated countries. A range of models for building a New Momentum for closer association and integration with the EU or, as I call them, the EU antechamber membership models, is discussed, along with related conditions and policy benefits. The EU has a historic and geopolitical obligation to assist our partners on their path towards full membership of the EU.

Find the full publication here


A brown or a green European Central Bank? by Dirk Schoenmaker | Bruegel

The European Central Bank portfolio is skewed towards the brown economy, reflecting a bias in the market. Can and should the bank deviate from the market allocation?

Climate change is a hotly debated issue in the European Central Bank’s ongoing strategy review. While ECB president Christine Lagarde and her colleagues at the centre favour robust tools to tackle climate change, most national central bank governors (like their colleagues at the US Fed) seem to be against including climate considerations in monetary policy. The core question is: should the ECB continue to accommodate the bonds and bank loans of carbon-intensive companies as assets or collateral, or should it reduce them?


In its quantitative easing programme, the ECB buys corporate bonds in proportion to their availability on the market. Carbon-intensive companies, such as oil and gas companies and car manufacturers, are typically also capital intensive and thus issue more corporate bonds. By taking assets proportional to the market, the ECB’s asset portfolio is skewed towards high-carbon companies relative to low-carbon companies. The carbon intensity (defined as carbon emissions divided by sales) of the ECB’s corporate bond portfolio is 57 percent higher than the average carbon intensity of EU companies. This large carbon bias makes the ECB a brown central bank.

By accommodating high-carbon corporate bonds, the ECB improves the liquidity of these bonds (just as it improves the liquidity of low-carbon companies’ bonds) thereby lowering the cost of capital for high-carbon and low-carbon companies equally.


Could the ECB address its carbon bias? There are broadly speaking three routes. First, the ECB’s primary mandate is price stability. If the ECB does establish that climate change has an impact on future inflation (eg through rising food prices due to droughts), it should be vigilant and prepare an appropriate monetary response to ease potential inflation pressures. Although the inflation impact of climate change seems to be remote, it is already part of the ECB’s monetary policy work to monitor this. Moreover, better modelling of the climate risk impact on monetary policy does not address the carbon bias in the ECB’s monetary policy operations.

Second, the ECB’s legal mandate states that it “shall support the general policies in the EU, without prejudice to price stability”. This refers to the ECB’s secondary goals. The transition to a low-carbon economy is a cornerstone of the EU’s general economic policies. The European Green Deal has a target of curbing carbon emissions by at least 55% by 2030.

The ECB can support the EU’s climate policy by cutting carbon emissions in its asset and collateral portfolio for monetary policy purposes. This second argument is the most compelling, especially were the European Parliament and Council to declare that the EU’s climate policy has priority within its general economic policies over the next decade(s).

Third, the ECB could include a climate risk assessment in its monetary policy operations. High-carbon companies are more exposed to rising carbon taxes, which increases the risk of write down for these companies. The haircut on collateral of high-carbon companies can then be increased. Again, risk assessment is already included in the ECB’s collateral framework. Moreover, climate risk is a major issue for the ECB’s supervisory and financial stability tasks. A climate stress test of the Dutch banking sector, for example, indicated that losses could amount to 4%-63% of core capital for a €100 to €200 per ton carbon tax.

In sum, the climate change debate in monetary policy is first and foremost about the ECB’s allocation of monetary reserves to high-carbon companies. The question is then which approach could reduce this allocation?


There are several ways to reduce the over-allocation to high-carbon companies. These range from excluding the most carbon-intensive companies or dealing exclusively with low-carbon companies to tilting the portfolio towards low carbon. We developed a methodology to tilt the asset and collateral base for monetary policy operations towards low-carbon assets. For assets, tilting would relate the relative share of a company’s securities inversely to its carbon intensity. The ECB would then over-weight low-carbon companies and under-weight high-carbon companies in its asset portfolio. For collateral, an additional haircut could be directly related to carbon intensity. The ECB would then apply an additional haircut to high-carbon assets in its collateral framework.

A medium tilting approach can reduce carbon emissions in the central bank’s corporate and bank bond portfolio by over 50%, offsetting the current carbon bias. Our paper shows how this can be done without unduly interfering in the smooth conduct of monetary policy. A key element of a tilting approach would be that the ECB would remain present in the entire market for eligible assets, which guarantees that monetary policy gets into “all of the cracks” of the economy. Tilting only increases the share of low-carbon assets at the expense of high-carbon assets, but does not exclude high-carbon assets.

So, a first step in tilting would turn the ECB from a brown central bank into a carbon-neutral central bank. A follow-up step could turn the ECB into a green central bank, aligned with the EU’s emission reduction targets.


If the ECB were to take on the challenge of greening its monetary policy operations as a secondary goal, it would be of utmost importance to do it fully independently. The ECB could adjust the eligibility criteria for assets and collateral in a general way, using a transparent and objective indicator, such as carbon emissions. The ECB should refrain from favouring specific projects or setting sectoral targets, which are issues for government policy.

Recommended citation:

Schoenmaker, D. (2021) ‘A brown or a green European Central Bank?’, Bruegel Blog, 24 February

Debt cancellation by the ECB: Does it make a difference? | Europp – LSE Blog

Featured image credit: European Central Bank (CC BY-NC-ND 2.0)

Earlier this month, several major newspapers published a letter from more than a hundred economists calling for the ECB to cancel the government debt it holds. Paul De Grauwe argues that even if the ECB did cancel this debt, nothing of substance would change economically for national governments.

The recent publication of a proposal made by more than a hundred economists to cancel the government debt held by the European Central Bank has reignited the discussion about the role of the central bank in supporting the government. The question that many ask themselves is whether this proposal is to be taken seriously. In order to answer this question, it is good to go back to the basics of fiat money creation.

When the central bank buys government bonds, say in the context of quantitative easing, it substitutes interest bearing government bonds for monetary liabilities (the money base typically taking the form of bank reserves). In the old days, these liabilities of the central bank were not remunerated. For around the last ten years, however, central banks have fallen victim to lobbying by the banks and have started to remunerate these bank reserves. Nothing in the statutes of the central banks forces them to do so, and they could quickly reverse this policy. In fact, over the last couple of years major central banks have been applying negative interest rates on these bank reserves, indicating how easy it is to reverse the remuneration policies.

At the moment when the central bank buys government bonds, it creates “seigniorage”. This is the monopoly profit arising from the creation of money. This “seigniorage” is transferred to the national government budget in the following way: the government pays interest to the central bank which now holds the bonds, but the central bank returns this interest revenue to the government. Thus, when the central bank buys the government bonds, de facto, the government does not have to pay interest any longer on its outstanding bonds held by the central bank. The central bank’s purchase of government bonds is therefore equivalent to debt relief granted to the government.

What happens when the government debt held by the central banks is explicitly cancelled? I will argue that economically nothing of substance happens.

As long as the government bonds are on the balance sheet of the ECB, these bonds do not exist anymore from an economic point of view. This is so because, as I argued earlier, when a government bond is on the central bank’s balance sheet, a circular flow of interest payments is organised from the national treasury to the central bank and back to the treasury. So, the burden of the debt for the national government has become zero. The central bank can cancel that debt (i.e. set the value equal to zero) thereby stopping the circular flow of interest payments. This would not make a difference for the burden of the debt. Put differently, the profit of the money creation has been transferred to the government at the moment of the purchase of the bonds by the central banks.

What happens when the bonds that are kept on the balance sheet of the central bank come to maturity? The ECB has promised that it would buy new bonds to replace those that come to maturity. Again, no difference with outright cancellation. Thus, as long as the government bonds remain on the balance sheet of the central bank, it does not make a difference from an economic point of view at what value these bonds are recorded on the balance sheet of the central bank. These can be recorded at their face value, their market value, or they can be given a value of zero (debt cancellation): from an economic view this does not matter because the government bonds on the balance sheet of the central bank cease to exist.

What matters is the size of liabilities of the central bank. This is the money base that has been created when the bonds were purchased. As long as the money base is kept unchanged, the value given to the government bonds on the balance sheet of the central bank has no economic consequence. If these bonds were to be set equal to zero (so-called debt cancellation) the counterpart on the liabilities side of the central bank would be a decline in equity (possibly becoming negative). But again, this is of no economic consequence. A central bank issuing fiat money does not need equity. The value of equity on the books of a central bank only has an accounting existence.

Thus, debt cancellation is fine, but it is equivalent to no-debt cancellation as long as the bonds are held on the balance sheet of the central bank. The problem may arise in the future if inflation surges and if the ECB wants to prevent the inflation rate from exceeding 2%. In that case it will have to sell the bonds, so as to reduce the money base (and ultimately the money stock). If the bonds are still on the balance sheet (because they have not been cancelled) the central bank will sell these. As a result, they will be held by the private sector and the burden of the debt of the governments will increase because the interest paid on the bonds will go to private holders who do not return it to the treasuries.

If the bonds have been cancelled, they cannot be sold anymore and the central bank will have to reduce the money base in another way. It could issue its own interest-bearing bonds in exchange for the outstanding money base. But this means that the central bank will have to pay interest in the future. As a result, it would transfer less profit to the treasuries. Again, no (or little) difference with outright cancellation.

The conclusion here is that if the ECB wants to keep inflation at 2%, it does not make a difference whether it cancels the debt or not today. In that case if inflation surges beyond 2%, it will have to reduce the amount of outstanding money base by either selling government bonds or issuing its own interest bearing bonds, thereby taking back the seigniorage it granted to the government when it bought the bonds.

Things would be different if the ECB were to allow more inflation in the future; in other words, if it decided that it will do nothing when inflation exceeds 2%. Then it would not have to sell the bonds (or issue its own bonds). In that case, the higher inflation would reduce the real value of the government debt that is not on the balance sheet of the central bank, and that was issued during the last few years at very low interest rates. The government would gain. But note again that this gain would accrue to the government whether or not the debt was cancelled.

Who would pay for this inflationary policy? The investors. Nominal interest rates would increase, thereby reducing the price of the long-term bonds that these investors were foolish enough to buy at negative or zero interest rates.

Two last comments. First, the hundred-plus economists proposing debt cancellation have created the illusion that debt cancellation reduces the debt and therefore allows governments, unburdened by old debt, to issue new debt to finance great projects. I have argued that the debt relief occurs at the moment of the bond purchases by the central bank and not when the central bank puts the value of these bonds equal to zero on its balance sheet. The illusion is to think that you can have debt relief of the same debt twice.

Second, except if at the moment of the debt cancellation governments force the ECB to cancel its commitment to an inflation target of 2%, future increases of inflation will necessarily force the ECB to reduce the amount of money base thereby undoing the debt relief it organised when it bought the debt. Thus, as long as the ECB remains committed to its inflation target, explicit debt cancellation is likely to only reduce the debt burden temporarily. Only if the ECB reneges on its inflation commitment will debt cancellation permanently lower the government debt burden. But somebody will then pay for the inflation tax. One may still argue, however, that some more inflation is worth the price for permanently reducing the government’s debt burden. Maybe this is what the hundred-plus economists had in mind.