"Don't underestimate how close the Court verdict is" is the warning that Morgan Stanley's European Research group sends out in a note today. In their view, there is a non-negligible risk that the German Constitutional Court will voice concerns about the ESM and, potentially, also the fiscal compact on September 12. Given that the EFSF is still in operation, given that the Court views the scope of the German constitution as being exploited already, and given its record of voicing concerns about European integration, MS sees a 40% chance that the Court bans Germany from ratifying the ESM treaty (with major repercussions for financial markets), at least for now, and while their base case is for ratification of both treaties, they believe the market is not priced appropriately for the downside tail-risk of a possible 'no' verdict (and the asymmetric scenarios below).
Morgan Stanley: Concerns about the German Constitutional Court?
Hoping for a go ahead for the ESM on September 12
When Germany’s Constitutional Court announces its initial verdict on several emergency injunctions regarding the ESM and the fiscal compact, the decision will be significant in two respects:
- First, the ruling could decide the fate of both treaties if the Court decides to grant the emergency injunctions and bans Germany from completing the ratification process until it has ruled. This is especially true for the ESM, which contrary to the fiscal compact cannot start without Germany’s participation.
Second, the verdict – either now or in the final ruling expected early next year – might set out additional boundaries for the German government when it comes to European policy initiatives.
Should the Court decide not to grant an emergency injunction, its president could sign both treaties into law, completing the German ratification process. Once Germany has deposited what are called ‘instruments of ratification’ in Brussels, it will be bound by the treaties under international law. Given the binding nature of the ratification, we expect the Court to weigh its decision very carefully and would assign a probability of up to 40% on the Court granting an emergency injunction against the ESM, forcing the government to hold off until the Court has given its final verdict sometime next year.
If the Court bans the German government from joining the ESM for now, this will likely have major repercussions for financial markets.
At the public hearing the Court held in July, the judges were probing several of the experts on the likely consequences of a delay in the ESM. By and large, the judges were assured, e.g., by Bundesbank President Weidmann and by representatives of the EFSF, that a delay would not cause major problems as EFSF support was still available. While this is certainly true, it seems to us that policy-makers, notably in Germany and Spain, favor bringing new support programs, especially if they concern sovereign support for Spain or even Italy under the ESM instead of the EFSF. As such, the decision of the Constitutional Court could therefore also affect the start of the new ECB’s bond buying program.
Constitutional Court watches over whether democratic decision-making is undermined by European integration. The Constitutional Court consists of two so-called Senates, which have eight judges each. The current President of the Court, Prof. Dr. Andreas Voßkuhle is also the chairman of the second Senate, which is in charge of the ESM and Fiscal Compact ruling. Each Senate is led by a chairman, which are usually the President and Vice-President of the Court. Decisions that involve basic rights or issues of particular importance are decided with a two-thirds majority. All other issues require an absolute majority. In an interview with the German daily F.A.Z., Judge Voßkuhle stressed that the parameters of Germany’s constitution, the ‘basic law’ (Grundgesetz), were close to being exhausted when it comes to further European integration.
Constitutional Court decision closer than many think
Overall, the decision is likely to be a close one. For starters, the Court has already signaled that it takes the issues very seriously by granting a public hearing on the matter (which is unusual for a decision on an emergency injunction). In particular, the Court already warned the government, in its verdict on the involvement of the Bundestag on EFSF matters, to not bend the rules of the constitution.
What the Court decides about on September 12
On September 12, the Court will only decide on the requests for so-called interim relief, i.e., an emergency injunction which puts the German ratification process on hold until the Court has decided on the cases in full. Such a final verdict is not expected before 2013. But the Court has chosen an unusual procedure, which makes it unlikely that the final verdict will deviate from its preliminary assessment in September.
Usually, the Court assesses a request for interim relief in two steps:
- The Court first looks at the validity of the complaint without ruling on the matter itself. Here the request for interim relief needs to be admissible on the basis of an immediate and direct danger to the constitutional rights of the claimant in question. This danger needs to outweigh the consequences of the delay of the government decision in dispute.
- In a second step – and provided the case itself is admissible – the Court would then decide on the constitutionality of the issue at a later stage, i.e., the Court needs to assess whether the complaint is justified on the grounds of the German Constitution, notably whether the sovereign rights of the German people are being infringed. For cases brought by individuals, the hurdle of admissibility is high, with the Court throwing out more than 97% of the cases.
In the present case, however, the Court has purposefully taken its time with its preliminary assessment of the emergency injunction, perhaps longer than expected by some. The Court is seemingly fully aware of the fact that if it would reject the request for interim relief, and hence would grant Germany permission to ratify the treaties (which would then become binding in international law), this would make it difficult to rule the treaties unconstitutional at a later stage.
Implications (click for large version):
Source: Morgan Stanley