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What role does the European Stability Mechanism play?



Based in Luxembourg, the European Stability Mechanism now has the task of contributing to the development of the eurozone banking union. Photo: Shutterstock

Based in Luxembourg, the European Stability Mechanism now has the task of contributing to the development of the eurozone banking union. Photo: Shutterstock

Pierre Gramegna’s candidacy to lead the European Stability Mechanism (ESM) is an opportunity to shed light on an international institution, based in Luxembourg, that is as important as it is little known.

Former finance minister Pierre GramegnaPierre Gramegna (DP) is officially in the running for the post of managing director of the European Stability Mechanism. The next MD will succeed Klaus Regling, whose term of office will end in October. Although it plays a key role in safeguarding the eurozone’s economy, this Kirchberg-based entity remains largely unknown to the general public.

Founded in October 2012, the ESM’s main mission is to assist eurozone countries in avoiding and overcoming financial crises. To this end, euro area countries have access, through the ESM’s programmes, to lower-cost financing, enabling them to strengthen their debt sustainability.

Although it existed before the ESM, the European Financial Stability Facility, created in June 2010, has not engaged in new loan financing programmes since July 2013. Since then the EFSF has remained active only for the purpose of rolling over its outstanding bonds. Ireland, Portugal, Greece, Spain and Cyprus are the five countries that have benefited from EFSF support. The latter still has an outstanding amount of €172.61bn. Its funding will run out in 2070.

€500bn capacity

Subsequently, the ESM continued the work done by the EFSF, concluding an agreement with Greece in 2015 ending in 2018 and with Cyprus in 2013 ending in 2016.

Unlike its big brother, the EFSF, which was incorporated as a private entity under Luxembourg law, the ESM has the status of an intergovernmental institution governed by international law. Its capital structure consists of €704.8bn subscribed by the 19 euro area countries. Its lending capacity is limited to €500bn. With €89.9bn outstanding, the ESM’s remaining financial strength is €410.1bn.

In addition to its usual financing capacity, the ESM has an additional financial weapon at its disposal, amounting to €624.25bn, in the form of callable capital. In this way, the managing director of the ESM can, for example, call on emergency funds to avoid a possible default on any of the institution’s obligations.

In November 2020, the Eurogroup decided to reform the ESM’s mission with the intention of making it contribute to the development of the banking union. Thus, the ESM manages the Single Resolution Fund, whose mission is to address the problems of failing banks. This fund is not financed by taxpayers’ money, but by contributions from the banking sector.

Support in times of pandemic

Following its reform, the ESM can also monitor macroeconomic and financial developments in all euro area member states. This allows the European Commission and the ESM to informally share their analyses in this respect and to assess macro-financial risks. The commission can even invite the ESM to collaborate in its economic policy coordination tasks and in the budgetary monitoring of states--with the agreement of the country concerned.

Apart from a few government debt support programmes, the ESM also participated in the European financial support of €540bn during the pandemic. Along with the EU and European Investment Bank, the ESM provided a €240bn safety net to support health and care costs and prevention measures related to covid-19. This funding is scheduled to run until the end of 2022.

The ESM finances its bonds on the basis of both a short-term and a long-term strategy. The loan issues are backed by a super guarantee mechanism from the six highest rated countries in the euro area, namely Germany, France, the Netherlands, Austria, Finland and Luxembourg.

Originally published in French by Paperjam and translated for Delano