I.    Judgement

On 5 May 2020, the German constitutional court (Bundesverfassungsgericht BVerfG“) decided in a landmark judgment about the compatibility of the Public Sector Asset Purchase Program launched by the European Central Bank (“ECB“) in March 2015 (“PSPP“)[1] with German constitutional law.

The BVerfG expressly excluded the EUR 750 billion Pandemic Emergency Purchase Program (“PEPP“) launched in March 2020 to mitigate the economic impact of the COVID-19 pandemic from its decision.

In brief, the BVerfG ruled that with the establishment of the PSPP in 2015 the ECB by far exceeded its competences and, therefore, acted ultra vires. The main reason is that the decision of the ECB lacks sufficient proportionality considerations due to insufficient balancing of the ECB’s monetary policy objective against potential effects on this policy.

More fundamentally, the judges of the BVerfG further ruled that they are not bound by the judgment of the Court of Justice of the European Union (“CJEU“)[2]. The CJEU decided upon submission by the BVerfG in 2018 that the ECB had the power to establish the PSPP. The BVerfG argues that while generally the interpretation and application of the laws of the European Union fall within the responsibility of the CJEU (so-called principle of uniformity and coherence of EU law), there are – under the established case law of the BVerfG – exceptional cases of substantiated ultra vires challenges where the BVerfG is not bound by judgments of the CJEU. According to the BVerfG, this follows from the legal structure of the European Union which has not yet passed the threshold to a federal state. The BVerfG rejects the principle according to which the Member States, via the acceptance of the EU Treaties, have given power to the EU institutions, in particular to the CJEU. According to the BVerfG, the Member States of the European Union are still “Masters of the Treaties”. The European Union does not have the power to determine its own competences (so-called ‘competence-competence’). As a consequence,  Member States are not bound by decisions of EU institutions which would effectively amount to a treaty amendment or an expansion of competences which would in turn imply the existence of a competence-competence of EU institutions.

The BVerfG also ruled that the decision of the ECB about the PSPP does not infringe the prohibition of monetary financing under Art. 123(1) of the Treaty of the Functioning of the European Union (TFEU).

The BVerfG defined the following legal consequences resulting from the ultra vires infringement:

  • As of the end of a three months period following the judgement of the BVerfG, Deutsche Bundesbank will no longer be allowed to participate in the implementation and execution of the ECB-Decision, unless the ECB describes by the end of that period in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects.
  • The German government and the German parliament (Bundestag) must take active steps against the PSPP in its current form, e. they are required to take steps seeking to ensure that the ECB conducts an improved proportionality assessment.

By way of background, the BVerfG has no legal power over institutions of the European Union. Accordingly, the ECB is not bound by the judgment of the BVerfG and, thus, not legally bound to implement its orders. Only German institutions (such as Deutsche Bundesbank, the German government and the German parliament) must observe the judgement of the BVerfG.

II.     Outcome

End of June 2020, the parties involved (ECB, German parliament, German government and Deutsche Bundesbank) finally found a solution: The ECB – through Deutsche Bundesbank – provided non-public minutes containing the required proportionality considerations. All parties are of the view that these minutes fulfill the requirements of the BVerfG judgement. This opens the way for Deutsche Bundesbank to continue participating in the PSPP.  However, this also means that, going forward, the ECB will have to provide more balanced proportionality considerations for comparable future bond purchase decisions.

Fortunately the second possible outcome where the ECB would have not provided the required proportionality considerations within the three months-period has not come true. The situation would have become very complicated, not only from an economic and political but also from a legal point of view: In particular, for the addressees of the judgement of the BVerfG (Deutsche Bundesbank, German government and parliament), it would have been unclear whether they must observe the CJEU judgment (PSPP is in line with EU law) or the dissenting court ruling of the BVerfG. As a reaction to the court ruling of the BVerfG the CJEU already stated on 8 May 2020:

In order to ensure that EU law is applied uniformly, the Court of Justice alone – which was created for that purpose by the Member States – has jurisdiction to rule that an act of an EU institution is contrary to EU law.

There is no provision or precedent – neither in EU nor in national German law – dealing with the situation where a judgement of a national constitutional court declares a CJEU ruling inapplicable due to an alleged infringement of the ultra vires-principle. This left the German institutions concerned in an uncertain situation as it is not entirely clear to them which ruling  ultimately prevailed. As shown, the CJEU claims that its judgement prevails, while the BVerfG claims that its judgement overrules the CJEU decision.

If the German institutions had followed the BVerfG, then Deutsche Bundesbank would have had to refrain from participating in the PSPP. The economic dimensions of such decision would have been immense and would have likely meant the end of quantitative easing in its current form. This could have proved catastrophic for the EU.

If Deutsche Bundesbank had followed the CJEU, ignored the BVerfG and continued participating in the PSPP, this would have caused a constitutional crisis and hugely damage the credibility and reputation of the BVerfG.

III.    Political Dimensions

For the first time in the history of the EU a national constitutional court in effect rejected the ruling of the CJEU on the basis of an ultra vires-infringement. Unsurprisingly, the reactions of national and EU institutions were not long in coming.

Some commentators (especially in Germany) support the verdict of the BVerfG saying that the judges wanted to make everybody aware of the fact that the Eurozone is not based on a fiscal union (in particular a lack of taxes on EU level) and, therefore, the ECB is not entitled  to conduct economic policy unless the Treaties are  changed accordingly.

However, most commentators (particularly from abroad) strongly criticize the judgment of the BVerfG. They especially raise the concern that the ruling may pave the way for other national constitutional courts to challenge the European legal order and the CJEU in other areas. The first Member States – Poland and Hungary – have already welcomed the judgement of the BVerfG. It is one of the main concerns that the judgement of the BVerfG has questioned the primacy of the legal system of the European Union and will give way to undermining the principle of “sincere cooperation” under Art. 4(3) TEU in other areas of law. The principle of “sincere cooperation” obliges Member States to refrain from any measure which could jeopardize the attainment of the EU’s objectives.

Especially in order to address these concerns, the President of the European Commission, Ursula von der Leyen, immediately after the publication of the judgement announced that the European Commission considers the opening of an infringement proceeding against the Federal Republic of Germany in accordance with Article 265 TFEU. In a publicly available letter she stated that the ruling of the BVerfG raises questions that touch the core of European sovereignty – without specifying  what “the core of European sovereignty” actually is or should be. It is the Commission’s intension and obligation to ensure the primacy of EU Law of national Member States’ law and to avoid that other Member States take the German judgement as an invitation to challenge other judgements of the CJEU claiming that the EU acted ultra vires. In response, one of the judges of the BVerfG in an interview with the Frankfurter Allgemeine Zeitung said that an infringement procedure against Germany “would trigger a significant escalation, potentially tipping Germany and other member states into a constitutional conflict that would be very difficult to resolve.”[3] While the President of the Commission is highly likely to want to avoid a constitutional clash, a show of strength is necessary to protect the credibility of the EU legal system.

The ECB’s initial reaction remained so far very generic by simply stating that it “takes note” of the German court ruling but “remains fully committed to doing everything necessary within its mandate”. The ECB as European institution and independent central bank of the Eurozone underlined with this statement its independence from the judgement of the BVerfG and in more general terms from national court rulings of any member state. More recently, Isabel Schnabel, Member of the ECB’s Board, indicated her sentiment that constructive ways may be found out of the dead-lock and Christine Lagarde said before the EU parliament that the ECB will support the Bundesbank in responding to the BVerfG which finally happened. However, the ECB demonstrated that it will not bow to the BVerfG by increasing the envelope for the current temporary Pandemic Emergency Purchase Program (“PEPP”) by €600 billion to a total of €1,350 billion.

Wolfgang Schäuble, the President of Deutsche Bundestag, has established a task force where all parties of the Deutsche Bundestag are represented in order to elaborate a solution how to deal with the judgement from Karlsruhe and how the German parliament may react.

Finally, no less than the German Chancellor Angela Merkel intervened in the discussion. Although she is concerned about the situation caused by the recent judgement of the BVerfG, she is of the view that the situation is “healable”. She suggested the following solution: The ECB shall provide the requested proportionality considerations through Deutsche Bundesbank which publishes these considerations as “agent” on behalf of the ECB. This procedure would be a compromise which allows all parties involved to save their face.

But Merkel is not likely to gamble with the credibility of the Euro by relying solely on this technical solution. The judgment has dented the credibility of  the Euro by indirectly questioning the practice of the ECB’s bond purchasing programs with the PEPP as important emergency measure. The judgement has also compromised the long-term credibility of the Euro by clashing with the primacy of EU law. It is generally considered  that the ECB has been the strongest pillar in supporting the credibility of the Euro by taking emergency measures when the Member States were reluctant to act. See, for example, ECB President Draghi’s “whatever it takes” remarks that framed  the spread on government bonds since 2012.

Politically speaking, the judgement has introduced a conspicuous uncertainty as to the Euro’s institutional as well as policy potential, going forward. In our reading of the political situation, now that the ECB may not be able to save the credibility of the Euro, the Member States may finally be forced to provide the much needed credibility through the completion of the fiscal union and more democratic legitimacy. We hence believe that the judgement of the BVerfG has contributed to the launch by the President of the European Commission of the Next Generation  EU Recovery Fund; a move that was fostered by the initiative of Chancellor Merkel and  President Macron of a plan for a European COVID-19 recovery fund which has – after long negotiations – finally been agreed by the heads of state of the European Union on 21 July 2020. This EUR 750 billion recovery fund will consist of EUR 390 billion in form of grants and EUR 360 billion in loans. While the next steps will prove highly complex they may represent a move in the direction towards a fiscal Union.

In addition, if other Members States were to  agree to pool  EU debts and grants, this would necessitates the push for more taxes and resources at EU level (“own resources”) to secure liquidity along the maturity curve and keep interest rates on EU-issued debt low. Popular proposals for EU level taxes include taxes on financial transactions, digital services, plastic waste, and expanding the emission trading scheme to air and sea traffic.

IV.     Summary

  • The BVerfG caused considerable uncertainty in Germany and the European Union. Although a solution for the PSPP has been found, the outcome and consequences of the judgment for the ECB, Eurozone, the Euro and the credibility of the legal system of the European Union cannot be predicted at present.
  • The Karlsruhe verdict may impact the future bond purchase programs of the ECB as well as on discussions about Eurobonds. For decisions about Eurobonds and other bond purchase programs may also be challenged before the BVerfG. While some might argue that the German government and parliament will carefully consider the principles set up by the BVerfG when agreeing such future financing measures on EU level, the recent increase of the Pandemic Emergency Purchase Program by EUR 600 billion demonstrates that the ECB is ready to continue to act.
  • Nevertheless, the political tension that the judgement has put on the ECB will likely force the Eurozone and the Member States to tread carefully with the balance between the ECB’s monetary policy and the role of fiscal policy at various levels and consider the need to provide solid political solutions instead of awaiting the ECB to act.
  • Last but not least, if the European Union does not find an appropriate response and a way to (re-)establish the primacy of EU law over national law, beyond the economic impact of the court‘s ruling, the principal consequence may well reside in the risk that the judgement might be picked up by constitutional courts of other Member States to challenge decisions by the CJEU but also from other EU institutions. This would be contra the duty of sincere cooperation and thereby undermine the core of the of the European Union.

The Covington Financial Services team will continue to monitor the situation and update you on any new developments.

[1] See Financial Times (May 13, 2020), “German judge warns EU over ‘very difficult to resolve’ legal crisis”, available here.

[2] ECB Governing Council’s Decision of 4 March 2015 (EU) 2015/774 as supplemented from time to time (“ECB-Decision“).

[3] Judgment of the CJEU dated 11 December 2018 – C‑493/17.

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Photo of Sophie Bertin Sophie Bertin

Sophie Bertin is a senior advisor to Covington in their Financial Services and Antitrust practice. Her current focus is on financial services topics, ranging from State aid, implementation of regulations, interplay between various regulations, including the new data protection rules; as well as…

Sophie Bertin is a senior advisor to Covington in their Financial Services and Antitrust practice. Her current focus is on financial services topics, ranging from State aid, implementation of regulations, interplay between various regulations, including the new data protection rules; as well as the impact of new technologies (like Blockchain) on the financial services business models and resulting competition challenges.

Sophie has over 20 years of professional experience and she has broad experience helping banking clients on their strategy, restructuring, reorganization, risk management, regulatory and compliance, back-office operations and automation, as well as, advising on various issues around banking regulation and competition law (most notably State aid).

Marco Brand

Dr. Marco Brand is an associate in Covington’s Frankfurt office and a member of the corporate team. His practice focuses on financial regulatory law, in particular banking and asset management regulation, as well as on corporate matters and debt capital markets. Mr. Brand…

Dr. Marco Brand is an associate in Covington’s Frankfurt office and a member of the corporate team. His practice focuses on financial regulatory law, in particular banking and asset management regulation, as well as on corporate matters and debt capital markets. Mr. Brand has also experience in advising FinTech companies and payment service providers.