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22 October 2021

Is Polexit possible?

Our main story is about how Polexit could happen; we also have stories about the timetable for a traffic light coalition; on the failure by EU's leaders to agree a common line on energy policy; on a warning from Ignazio Visco about troubled loans; on a Spanish dispute with the EU over labour policies; and, below, on the extreme sensitivity of the crypto industry to regulation.

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Today's free story

Estonia's crypto crackdown

Estonia’s Financial Intelligence Unit announced last week that it has now revoked 2000 virtual asset service provider licenses, Vasps, granted to crypto firms, the latest development in an ongoing crackdown that started in June 2020.

It kicked off when companies that had failed to launch operations within six months of licensure had their Vasps revoked – that wiped 500 off the board – and the FIU continued thinning the herd throughout 2020. By the end of the year, 70% of Vasps – 1808 in total – had been revoked, with FIU citing the growing risk of money laundering and terrorist financing.

The reasoning was a little different this time around. There were the usual concerns about money laundering, terrorist financing, scams and hacks, but Matis Mäeker, head of the FIU, also told Eesti Ekspress that the Estonian crypto industry contributes nothing significant to the country’s tax authorities, nor does it creates jobs. He called for stricter capital requirements for the industry, which could include a requirement to hold a minimum of €350,000 in cash or securities, compared to €12,000 at present.

More significantly, Mäeker called for a total reset of crypto regulations in the country, arguing the government should turn the regulation to zero and begin the licensing process from scratch.

The Estonian case is interesting because the country was once widely viewed as a crypto trailblazer, passing a series of laws aimed at encouraging development of crypto exchanges and initial coin offerings, or ICOs, in 2017. But as Cointelegraph reports, the regulatory landscape in Estonia has evolved since then, and the country’s Know Your Customer regulations are now more stringent than what is required under EU law.

This is a teachable moment, both for governments and the industry. It is becoming increasingly obvious that speed, agility, and reactivity will be essential to regulate such a fast-evolving industry. But revoking the licenses of an entire industry sends the wrong message and will damage investor confidence, as well as trust between the two sides.

On the industry side, many stakeholders are pro-regulation, but legitimacy will entail paying taxes. Much like the Gafa big tech companies, the crypto industry has been reluctant to do so. And we see a bigger problem looming on the horizon, in the space where crypto and big tech converge.

Earlier this month Fabio Panetta, an ECB executive board member, warned that Gafa companies’ fast-growing financial services pose a threat to the banking sector because their size, large customer base and access to user data makes them more relevant to global players in the market. He also highlighted the rapid growth of crypto assets and stablecoins, and warned that if the two industries should converge – that is, if big tech begins issuing stablecoins – it would alter the functioning of global markets. According to Panetta:

“As the assets managed by stablecoins increase, banks’ funding conditions could become more expensive and volatile. For instance, competition for liquid resources would make these more scarce, and thus increase their price, forcing banks to turn to more expensive forms of short-term funding.”

Opposition to the crypto and DeFi industries is justifiable under the argument that it will starve governments and the banking system of the resources they need to function. But as we’ve been arguing, regulating the industry will prove difficult because it is decentralised. Estonia could be the canary in the coal mine. It will be interesting to see what the FIU does in the event companies with revoked licenses continue operating.

21 October 2021

How to meet China on the road?

Global Gateway is the EU’s latest answer to China’s One Belt, One Road strategy. The name itself does not sound promising. China captures the imagination with a reference to the once mighty silk route that connected east and west between the 2nd and 18th century. Global Gateway sounds like a landing strip of an airport. With all the huffing and puffing about greener transport, air traffic is actually what they came up with.

But the geopolitical challenge is clear: China gives out loans to build infrastructure projects in developing countries, making them financially dependent and pliable to Chinese economic interests, at the same time bringing in Chinese suppliers and norms to build those projects. This is foreign policy pursued through economics. The European Union, long time resistant to meddling those two domains, is finally waking up to this new reality.

European member states increased the pressure on the European Commission to rewrite their rule book and come up with something that integrates strategic interests in EU grant giving. It makes no sense for the EU to build a road from a copper mine, owned by the Chinese, to a port, owned by the Chinese, conceded Ursula von Der Leyen. The big rethink is also happening in some countries, including Germany. Their view on China has been changing, as it takes a more aggressive stance and refuses to accept any criticism, and as the US is stepping up its counter push against China.

With Belt and Road, China is selling a concept: investing in large infrastructure projects in developing countries using Chinese companies to build them, and getting a foot into the regulatory and financial ecosystem there. They sell it as a win-win to its partners, but in reality the big win is for China, as it installs itself and its values for the long term on their territory. No military action needed.

Europe had hoped to export its norms to those developing countries, but how can this stand up to China showing up there with lots of cash? Les Echos quoted figures that even reveal that this is all smoke and mirrors: Between 2013 and 2018 China gave out €460bn in credits and €36bn in direct subsidies. The European Union, taking national and community level together, gave €410bn in direct grants, not credits, over the same period. Yet, everyone is talking about China, not the EU.

Will there be a turn of fate in the near future? Some of those developing countries already start to see that not all that glitters is gold. Montenegro ended up with a huge pile of debt for a motorway that no one needs. US-China relations are also cooling down the appetite for more China in Europe.

But the EU needs to change not only its geopolitical role, but the way it makes decisions on infrastructure projects. This is where the big rethink has to happen. The European Commission's procedures will have to change. What infrastructure does the EU want to support? With what partners? What is the long term strategy behind it? The EU used to respond in a technocratic way. At some point, the geopolitical reality is permeating through to the ground level. The European Commission will have to decide the extent to which it wants to take on a more active role.

20 October 2021

Crypto: a way around sanctions?

Discussions about economic sanctions usually focus on the politics behind them, and its knock-on effects. What is usually not questioned is the implicit assumption that sanctions are indeed enforceable. As long as the US dollar was the leading currency, and all transactions had at some stage a dollar component that linked it to the US finance system, sanctions were indeed enforceable.

But the global financial system is about to change, and with it the predominance of the dollar as a currency for clearing international transactions will change too. Hostile states and even allies are already rowing back the use of the dollar in cross border transactions, and there are new threats to the effectiveness of sanctions: crypto currencies. These are the findings of a report that the US treasury commissioned, out of concern about the role of the dollar, but also due to the increased use of sanctions over the past two decades. The number of sanctions against governments, government officials, personalities and companies has increased tenfold within 20 years, to a total of 9400, according to the FAZ. Secondary sanctions increased from only 2 in 2018 to 104 by the end of Donald Trump’s presidency.

In the light of these findings, the US government is renewing its sanctions approach. If sanctions prompt criminals to use crypto instead, they no longer seem an effective tool of coercion in foreign policy. The new mantra under the Biden administration is to coordinate better with allies, and test sanctions according to whether they meet a strategic target, as well as whether they are precise enough and keep collateral damage to a minimum. Backing down on sanctions over Nord Stream 2 seems just the beginning of the end of an era.

19 October 2021

Will EU sanctions stop Belarus?

EU foreign ministers are looking to impose sanctions on Belarus for flying in refugees from the Middle East and sending them in buses to the borders of Lithuania, Latvia, and Poland. Migrants end up trapped between borders, instrumentalised by Belarus against the EU, while EU countries ramp up border defences that include illegal pushbacks in Poland. Bordering EU member states, backed by Germany, want to levy sanctions on airlines that fly migrants from refugee-hosting countries to Belarus, Politico reports. Ireland, which is leasing out most of those planes, wants those sanctions to be limited to new leasing only, arguing existing ones are contractually binding. Some airlines already stopped the practice of flying in migrants from Turkey and Iraq, while new airlines entered the market, according to the Lithuanian foreign minister.

Since August there have been reports of Iraqis, Syrians, Iranians, Afghans and Yemenis who were lured to fly to Minsk by Belarusian authorities to reach the EU's external border with Poland and Lithuania. Advertisements in Arabic on Tiktok and Telegram promise a promenade at the Belarus border, just a swim away from the EU. This sounds attractive compared to a hazardous journey through the Mediterranean Sea, with the prospect of ending up in an overcrowded camp. Since Sunday, citizens from Iran, Pakistan, Egypt, Jordan, and South Africa can to travel to five other Belarusian airports without a visa, writes Der Standard. They must have already had a visa for the Schengen area or an EU country before. This will increase the numbers as it makes it easier for many people to enter Belarus. That is as long as there are flights.

What awaits them is not what they prepared for. Stripped of their valuables, the migrants are sent through border fences by the Belarusian military. Polish forces push them back with nowhere to go. Poland now wants to build a wall, while Lithuania is increasing its border controls. Photos and videos show how desperate the situation is at the borders. Seven people have died so far, and more deaths will come as the temperatures are dropping. This is a humanitarian crisis at the borders of the EU.

This is not the refugee crisis like we had 2015. But, what is at stake is overcoming the inability to define a dignified common EU strategy towards Belarus.

18 October 2021

A Hungarian surprise

The second round of a historic primary contest among Hungary’s opposition has concluded with a result that nobody would have thought possible even a month ago. Péter Márki-Zay, an independent candidate, has handily beaten Klára Dobrev, with 56.7% of the vote.

Dobrev is the leader of one of Hungary’s largest opposition parties, the centre-left Democratic Coalition, and a vice-president in the European Parliament. Márki-Zay is mayor of a small city in Hungary’s southeast with a population of 44,000.

We have spent the last several weeks following the various twists and turns of the primary, after the first round vaulted Márki-Zay into the runoff in the first place. The big question, for Hungary and the EU, is whether he can beat Viktor Orbán at the elections in April 2022.

Three factors will be crucial to Hungary’s united opposition, and their chances of success. The first is being able to stay together. Hungary’s electoral system, which Orbán put in place in 2012, allocates 106 of the Parliament’s 199 seats via first-past-the-post constituencies.

This has made it easy for Fidesz to win the two-thirds supermajorities it needs to amend the constitution at will, even with less than 50% of the vote in elections in 2014 and 2018. The united opposition and Fidesz are running neck-and-neck in the polls. So, any splits would seal their fate.

While a schism is still possible, Márki-Zay’s victory made it less likely. Dobrev attracted the ire of other opposition figures because of her links to a controversial former prime minister, Ferenc Gyurcsány. Some factions, like the liberal Momentum party, believed that Dobrev would have had no chance of victory at the helm. Márki-Zay winning averted their possible departure from the coalition.

The second is the opposition’s ability to mobilise supporters. This is essential for them given Orbán’s almost total control over the mainstream media in Hungary. The state-owned MTI news agency spent most of Sunday ignoring the primary. The opposition will almost definitely lose the air war, so they need to make up for it in the ground war.

Here, the picture from the primaries is more mixed. Since Márki-Zay does not come from an established party, he does not have much of a campaigning apparatus behind him personally. But the primary process itself could be a boon for him, driving opposition voter engagement. The question is whether they can sustain this enthusiasm for the next five months.

Finally, there is the economy. Orbán’s electoral success has been underwritten by economic growth. During his premiership, Hungary’s GDP per capita, in purchasing power parity terms, has gone from $21,700 to $33,000.

But this could change very quickly. Hungary is experiencing a nasty spate of inflation, which hit 5.5% in September despite tightening from the central bank. At its current trajectory, it could easily worsen. Even if this inflation is transitory, it could easily peak right before or during the election.

To prevail over Orbán, Márki-Zay is going to need both skill and luck. He has to find ways to keep his diverse coalition together, and energise grassroots supporters. And Orbán's reputation for delivering higher living standards will need to take a knock as well.

15 October 2021

Central banker, meet crypto!

We have been chronicling the Luddite tendency of central bankers with some concern, specifically when they hyperventilate about cryptocurrencies and cryptofinance. Our favourite line is Christine Lagarde’s characterisation of bitcoin as funny money. It ain’t funny.

We thought that Sir Jon Cunliff, deputy governor of the Bank of England, in charge of financial stability, got it right with the assertion that crypto is here to stay, and that it needs regulation. Crypto regulation is hugely complicated, as we have been writing before, because the crypto networks are physically impenetrable. Financial contracts in the Ethereum blockchain are technically enforced by algorithms, not by law courts. It is a world that is maximally incompatible with the world of central banking and financial regulation.

Sir Jon is a rare breed of central banker who is optimistic about crypto, because it promised genuine innovation. This is the transformation of financial services, essentially the prospect of a mass homicide of the unproductive middlemen that are so ubiquitous in the industry, like brokers, backroom operatives, and people who spend their time pontificating about financial regulations in quangos.

There is, of course, no way the world can regulate crypto in the way it regulates banks. But what it can do is regulate investments by large domiciled institutions. Sir Jon notes that unbacked crypto-assets make up 95% of the total, at present $2.3bn. Price movements of crypto assets are twelve times more volatile than the S&P 500. Phase one of the crypto craze has been occupied by techies. We are now entering a phase where traditional investors are showing interest. Banks are now to offer custodial services.

The nightmare scenario for regulators is the following where

...a severe fall in the value of cryptoassets could trigger margin calls on crypto positions forcing leveraged investors to find cash to meet them, leading to the sale of other assets and generating spillovers to other markets.

We are less optimistic than he is on the extent to which the cryptomarkets can be regulated once they start to crowd out existing financial service and become the dominant part of the financial system. Crypto might end up not only eating up the financial middlemen, but also the financial regulator. We are not naive about concepts such as self-regulation, a known oxymoron. But algorithms can replicate and enforce legal contracts, so there is no reason to think that they should not be able to enforce regulation too. We are currently in a stage of development where only the rudimentary infrastructure is operational: the blockchain and some services. For this to develop into a mature financial market will require decades of financial innovation.

14 October 2021

EU trade concessions on NI Protocol

The European Commission sent out its counter proposal, to improve the Northern Ireland protocol rather than replace it. From the EU’s perspective this is a matter of improving frictionless trade, while London sees it also as a constitutional question.

The Commission's offer would scrap 80% of all customs checks on British goods destined for Northern Ireland, and drop half of the customs formalities. It would allow medicines and national identity goods, such as sausages, to enter Northern Ireland from the UK without checks, and there would be fast-track lanes and formal structures to involve Northern Irish stakeholders and authorities in overseeing the arrangements. If the new proposals were to come into force, it would still require the UK to comply with other aspects of the protocol, such as sharing real-time customs data and building permanent border infrastructure.

Reception to the proposal was mixed. Industrialists in Northern Ireland welcomed them, saying they went further than expected, while the DUP warned that it is a long way short of what is required.

The Commission is silent on one of the main demands from London: that the Court of Justice of the EU has no jurisdiction in Northern Ireland, even if it is still part of the single market. London wanted to resolve difficulties through independent arbitration rather than the CJEU. The EU did not see this a crucial issue. For them it is all about frictionless trade.

The Commission put some real effort into the proposal, and pivoted on some rules despite reservations amongst member states. This and the UK text will be the basis for talks and negotiations in the coming weeks and months. 

13 October 2021

Steinmeier's second term

One of the indirect winners of the German elections has been Frank-Walter Steinmeier, Germany’s president, whose terms is up for renewal in March 2022. Steinmeier was formerly a social democrat. The German president is elected by the Federal Convention, a parliamentary assembly made up in equal parts by all 735 Bundestag MPs, and a matching number from the Bundesrat, the upper chamber. The prospective traffic light coalition, SPD, Greens, FDP, have a small hypothetical majority in the convention, 774 out of 1470.

The coalition negotiators are insisting that the election of the president is not part of the political horse-trading. Officially, that is certainly true. But it is inconceivable that the party leaders won’t talk about this. It is also inconceivable that the Greens and FDP would agree a coalition, and then vote for someone else in the Federal Convention. Right now, the exploratory phase of the talks is making good progress. Formal coalition talks could be agreed by the end of this week.

Yet, both small parties have reasons to be critical of Steinmeier. He was Gerhard Schröder’s right hand man in Lower Saxony, and later in the chancellory. He was instrumental in securing ties with Vladimir Putin. Steinmeier defended Nord Stream 2 as a moral obligation Germany had towards Russia. He is the quintessential representative of the Russia connection in German politics. This connection constitutes an important area of disagreement between the Greens and FDP on the one side, and the SPD and CDU on the other.

We doubt that the leadership of the Greens and the FDP will prioritise the presidential elections. But never underestimate the potential of a grassroots rebellion, especially in the Green party.

Our instinct is that the Greens will hold their nose and reluctantly support Steinmeier. Our radar screen would start beeping if that were not so.

12 October 2021

Italy's green pass: present and future

Italy’s green pass, mandating either vaccination or a recent negative test, is set to become compulsory for workplaces this Friday. Though other European countries have introduced mandates, Italy’s takes things much further: only Saudi Arabia has mandated something like the green pass for all workers.

Two stories about the pass have recently come to the fore. The first is the aftermath of violence that accompanied anti-green pass protests in Rome over the weekend. During the protests, an angry mob attacked the headquarters of the Italian general confederation of labour, the largest trade union in Italy. As a result, twelve people were arrested.

Among those arrested was Roberto Fiore, leader of the neo-fascist Forza Nuova. Subsequently, the Roman public prosecutor’s office launched an investigation into FN. And yesterday, the PD submitted a motion to the Senate calling for the party’s disbandment. As Corriere della Sera reported, Mario Draghi’s office is moving towards a similar conclusion, but more cautiously, and with a different legal basis.

Italy’s three mainstream right-wing parties rejected the motion, including Lega and Forza Italia. While distancing themselves from the violence itself, all three parties said that the PD’s motion went too far. FN’s constitutionality is, they claimed, for the courts to decide, not politicians.

The other story is an announcement, also yesterday, from Andrea Costa, Italy’s undersecretary for health, spelling out a possible wind-down of the green pass. According to Costa, this could come as early as the new year, on the condition that epidemiological data look positive. He also reiterated that there is no obligation for eligible Italians to take a third booster dose.

That Costa’s announcement followed the riots so closely cannot be a coincidence. And together, these two events say much about the limited shelf-life of the vaccine mandates that Italy and other EU countries are introducing.

One concern is something we have raised before: that a large minority who disagree with vaccine mandates will be drawn closer to fringe, extremist groups. A unit like FN engaging in violence is not a surprise. What should be more worrying is how they are able to latch on to a cause that draws a much wider base of popularity.

Another is that the mandates will become increasingly difficult to sustain, legally and politically, as the pandemic recedes. Vaccine mandates were relatively popular during a period of acute fear of a fourth wave in Europe. As these worries subside, so will backing for them.

This will be more so the case in Italy, where the green pass has already been dogged by administrative issues, especially for Italians who were vaccinated abroad. And data privacy rules would stop Italian businesses from storing employee health records, meaning that certificates will need to be reverified every day. Even if many support the green pass in theory, a botched roll-out to workplaces could dent confidence.

In short, one thing that Costa said in his statement is true: inevitably, the pandemic will at some point fade into the distance. And mandates like the green pass will with it.  

11 October 2021

Plot twist for Hungary's opposition

For the second time in as many weeks, our attention has turned to Hungary’s opposition primary elections. After we talked about cracks in the opposition last Monday, we did not expect to come back to the election campaign for some time.

But events intervened when Hungary’s opposition played host to one of the most surprising European political developments of the last week. On Friday, Gergely Karácsony, the mayor of Budapest, and pre-election favourite to lead Hungary’s opposition against Viktor Orbán, withdrew from the race with almost no warning.

As we discussed last week, the contest to become the prime ministerial candidate for a disparate coalition of opposition parties has two rounds. The first round eliminates all but three candidates, who proceed to a winner-takes-all runoff. Klára Dobrev, a centre-left MEP, and wife of former prime minister Ferenc Gyurcsány, won. Káracsony came second and Péter Márki-Zay, the mayor of a small city in Hungary’s southeast, came third.

Both runners-up oppose Dobrev’s candidacy, because of controversy surrounding Gyurcsány’s tenure as prime minister. They claim that the controversy, and Dobrev’s relationship with Gyurcsány, makes her unelectable. So, both insisted that one would have to drop out before voting began in the second round yesterday. But they couldn’t agree on who should.

Karácsony, the more high-profile of the two, answered that question by quitting. The decisive moment came on Thursday, when the liberal Momentum party threw their weight behind Márki-Zay. András Fekete-Györ, Momentum’s candidate, did not tally enough votes in round one to put Márki-Zay over Karácsony or Dobrev. But, since it’s likely that more Momentum supporters voted tactically in the first round, the shift probably spelled curtains for Karácsony.

Rather than dwelling on why Karácsony failed as a candidate, we want to look at what might happen if Márki-Zay becomes Hungary’s opposition leader. And the first question is whether he stands a chance against Orbán. On the face of it, his odds look tough: he has led of a city of 44,000 for three years. Orbán has led the country for more than a decade. Orbán has tried hard to tie the opposition to Gyurcsány, portraying them as his puppets. But, unlike Gyurcsány, Márki-Zay is a staunch right-winger. He is so much of an outsider, and so ideologically at odds with Gyurcsány, that he is hard to paint as the ex-prime minister’s tool. And he is strong on issues where Orbán is weak, like corruption, but can match Orbán’s more popular socially conservative positioning.

Another question is what a Márki-Zay government would look like, especially for Hungary’s relationship with the EU. Orbán is, of course, the EU’s original right-wing populist bête noire. Márki-Zay would chart a less antagonistic course on corruption and rule of law, and his coalition partners would probably stop him from picking fights with the EU over social issues. But at the end of the day, he’s much closer to Orbán on issues like LGBT rights or migration than the other major opposition candidates. So, anyone who’s waiting for Hungary to become Luxembourg probably shouldn’t hold their breath.