Brussels blog

German chancellor Angela Merkel during a press conference Thursday

Our friends and rivals over at The Daily Telegraph have gotten their hands on an interesting document from the German government detailing its proposals for EU treaty change, and have helpfully posted it online (with an English translation by the Open Europe think thank).

Although the Telegraph focuses on its implications for Britain, there is a significant amount of detail on how Berlin would like to change eurozone economic governance, including yet another stab at enshrining bondholder “haircuts” in the EU treaties.

For those who haven’t followed the debate closely, there is now a closed-door fight going on about whether Greece really will be the only country that sees its bondholders pushed into losses – as the eurozone’s leaders have repeatedly insisted in their summit conclusions – or whether the bloc’s new €500bn rescue fund, which could come into place as early as next year, should allow for organised defaults.

Although almost all EU institutions – including the European Commission and European Central Bank – want to make explicit Greece was a one-off, the German paper makes clear they want to keep the door open.

The documents calls for turning the new rescue fund, called the European Stability Mechanism, into a “European Monetary Fund” which would have the power to take over much budgetary sovereignty from a country in a bail-out, far more power than the current rescue fund – the €440bn European Financial Stability Facility – has.

Under a section headed “The establishment of a procedure for an orderly default as part of the ESM”, Berlin makes clear that countries which are deemed to be insolvent – rather than just suffering a temporary loss of access to the financial markets – would be allowed, in effect, to declare bankruptcy and default on their bonds:

If [a debt sustainability review] is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared. In order to make sovereign defaults possible where they are unavoidable, the threat of instability in the financial system resulting from such a default must be able to be credibly excluded. A plan to maintain the stability of the financial system in the event of an orderly default needs to be developed in close co-operation with European banking regulators. This would determine which banks would be restructured and/or recapitalised, which will necessitate the drawing up of Europe-wide rules on bank restructuring.

Up until now, the only agreed on mechanism for a default are so-called “collective action clauses”, commonly used measures included in bond contracts that allows for a default if a supermajority of bondholders agree to it. But the German document says clear that a possible default through CACs “is not sufficient”.

The debate is hardly a theoretical one. Although the ESM was originally not supposed to come into effect until 2013, there is increasing consensus that it should be moved up as soon as the middle of next year so that the eurozone’s rescue effort is less reliant on the somewhat shaky foundations of the current EFSF.

When broader default powers were mooted for the ESM at this time last year in a much-discussed agreement between France’s Nicolas Sarkozy and Germany’s Angela Merkel in the French seaside town of Deauville, bond markets swooned, sending Ireland and then Portugal into bail-outs. Days later, during a G20 meeting in Seoul, Merkel was forced to back down. But the issue clearly hasn’t died.