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Lawyers claim that the latest EU treaty is still fraught with uncertainty and loopholes and some regulators are in legal denial over the implementation of some proposals.


Lawyers have told Euromoney that despite most of the national leaders from the European Union (EU) having established a working treaty to save the eurozone and the area’s currency, politicians and regulators are not only not equipped to deal with Europe’s sovereign debt crisis but are also in denial over the legal implementation of many of the proposals.

“Whilst the recent treaty and regulatory regime changes show us that eurozone financial institutions and banks are at least aware of the problems to a certain extent, a key issue is that the practical legal ramifications of the crisis have not yet been really considered,” says James Campbell, partner at law firm Pillsbury and past adviser to the Russian Federal Securities Commission and the Uzbek Centre for the Securities Markets. “Some regulators can be characterized as being in total denial over legal realities whilst financial institutions are reacting very slowly. Potentially, we could be facing a massive dislocation throughout Europe. If the damage is to be contained then regulators will need to step in and play an active role rather than just leaving the situation to politicians.”

Earlier this month France’s president, Nicolas Sarkozy, and Germany’s chancellor, Angela Merkel, unveiled a treaty that would affect all 27 EU member states in a bid to tackle the eurozone’s sovereign debt crisis and seek to stop a break-up of the currency.

Changes included more legal and financial powers for the EU authorities in Brussels, harmonized tax laws, including the financial transactions tax, and a “comprehensive agreement” on a new set of fiscal rules, in a bid to save the euro.

Proposals have also included tougher budgetary measures and moves to relax rules on the private sector taking losses on future eurozone bailouts.

However, UK prime minister David Cameron controversially vetoed the treaty as it “was not in Britain’s interests”, which is a move seen to reinforce the country’s unwillingness to accept more powers being assigned to Brussels.

However since the outset, market participants as well as legal experts have remarked on the lack of clarity in how the treaty would impose fines on countries for not adhering to set deficit levels or even if the EU decided to try to eject a country from the eurozone.

“I feel that it’s absurd to believe that you can successfully impose a system of fines on a sovereign basis,” says Simon Smith, chief economist at FXPro. “People can be fined, but not countries. What’s the stick? Pay up or leave the euro? That won’t be on the table because that would then leave countries open to speculative attacks.  In summary, fiscal union requires a degree of centralized taxation, spending and political decision-making; that’s the bottom line. Sarkozy and Merkel’s proposal falls short of this, which sets it up for failure.”

Legal experts also claim that the combination of the lack of preparedness from regulators and oversight, legally, has led to a conundrum should the EU decide to exclude certain countries from the euro.

“The issue is that regulators are not equipped for this role, and when the EU was created and the oversight bodies set up, no one envisaged them being faced with these types of challenges and certainly not a crisis of this magnitude,” says Pilllsbury’s Campbell. “Crucially, when the zone was set up, no system for member state expulsion from the euro was introduced. A sovereign is allowed to determine its own currency, so technically a country could make a legal argument that it can retain the euro, despite political pressures from other member states for expulsion. In this situation it is not yet clear whether a motion to force a member state out of the euro would be legally enforceable.”

Ronald Bornstein, a partner at Pillsbury who was previously a conseil juridique in France and a Ford Fellow at the Academy of International Law at The Hague and a Visiting Fulbright Professor at the University of Dakar, says that theory and practice are two different things.

“With the potential break-up of the euro and the dislocation of the eurozone, legal scholars have delivered a vast amount of recommendations on the legality of implementing changes,” he says. “However, many of these are more theoretical than practical. While recommendations have also been made by politicians and market participants, there is no clear strategic direction at the moment on how these can be executed or enforced.”

The EU treaty and various new regulatory proposals have caused concerns for market participants for some time.

If some of the proposals were to go ahead, critics say, a number of issues would arise, ranging from competitive disadvantages that would result from EU rules on clearing houses to regulatory arbitrage that would ensue if the mass of regulatory changes were to be implemented.

However, one of the overriding issues that arises is the possibility of the break-up of the euro.

The subject has garnered mixed reactions: some say that it is impossible to remove sovereign states, while others have said it is inevitable, with some banks even testing their systems in preparation for countries such as Greece, Italy and Spain re-adopting their original domestic currencies.

Legal experts argue that if countries such as Greece were to leave the eurozone the knock-on effect for financial markets might be deeper and more complicated than politicians and regulators expect.

“There are a number of practical issues that will need to be tackled if the euro does break up,” says Bornstein. “For instance, legally it could become extremely difficult or near on impossible to designate euro deposits or portfolios back into individual currencies. For example, on break-up, if Greece were to reintroduce the drachma, it would probably be heavily devalued. Any fund portfolio or deposit previously held in euros would lose a lot of its value when converted to drachmas, meaning that fund managers and institutions would be using any means at their disposal to ensure those funds and investments are pegged to stronger currencies. Unless there is an orderly process imposed, determining which actual currency the funds are redenominated in would likely become a nightmare and we could see a sharp rise in legal disputes across all ex-eurozone economies.”