Bulgaria’s road to ERM II – current developments


Parallel to many of the socio-economic changes that have been taking place as a result of the various COVID-19 measures, the Bulgarian government hinted that it is reviewing its action plan regarding the country’s intention to join the Exchange Rate Mechanism II (ERM II). On 29 June 2018, Bulgaria’s intention to join ERM II together with the Banking union was communicated, where the country presented its Action Plan with measures in response to the Republic of Bulgaria’s intentions to join the ERM II and the Banking Union (the Action Plan).

The Action Plan in question contains seven measures, including: (1) the required steps for joining the Banking union; (2) Macro-prudential Supervision; (3) Supervision of the Non-banking sector; (4) Insolvency Framework;  (5) Anti  Money Laundering Framework; (6) Modernisation of the framework for management of state-owned enterprises in line with the best  international practices for corporate governance; and last but not least (7) Law Ratifying the Agreement on the Transfer and Mutualization of Contributions to the Single Resolution Fund; where the indicated timelines suggested that Bulgaria expected the decision for its accession to the ERM II and the Banking union to take place in Q2 2019 or early 2020.

The ERM II accession decision itself needs to be taken by the ministers of finance of the Eurozone countries and the European Central Bank (ECB) together with the minister of finance and central bank of Denmark (i.e. the only non-Eurozone  member of  the ERM II ) and it also needs to determine the central exchange rate between the euro and the Bulgarian lev. The decision in question is heavily dependent on the completion of the Action Plan and the convergence criteria, at the time of the potential accession. The ERM II members also pointed out another important element related to the Bulgarian accession – the successful implementation of the commitments made by Bulgaria under the European Commission’s Cooperation and Verification Mechanism in connection to the reforms in the judicial system and the fight against corruption and organized crime.

According to the information included in the Action Plan, Bulgaria already implemented all the measures in 2019, but it should be pointed out that some of those measures presuppose additional actions (e.g.  by the ECB or third parties), which could not be accounted for in the plan. For instance, the application and preparatory work relating to the Banking union membership presupposes the establishment of close cooperation between the Bulgarian National Bank (BNB) and the ECB, as part of the country joining the Single Supervisory Mechanism.

In order to establish the close cooperation arrangement, the ECB carried out a comprehensive assessment of six Bulgarian banks, comprised of an asset quality review (AQR), assessing the  carrying value of the banks’ assets, as well as a stress test that aimed at assessing the banks’ resilience in adverse micro-economic scenarios. Based on the ECB’s results, as announced on 26 July 2019, four of the Bulgarian banks did not face any capital shortfalls, and two are already making  progress on the required  strengthening of their capital positions.

Along with the various assessments and different activities, a number of legal amendments were also made as part of the Action Plan implementation (e.g. the changes made to art. 152 para.(1) of the Credit Institution Act in connection to the establishment of close cooperation between the BNB and the ECB, amending the general provisions for imposing sanction). Another part of the changes made relate to Bulgaria’s long-term objective and legal obligation to adopt the euro; namely those relating to the alignment of the national legal framework with the rules of the Economic and Monetary Union. The key legal amendments relating to Bulgaria joining the ERM II are also closely connected to those goals, where the amendments to art. 29 BNB Act, giving legal expression to the principal that the central exchange rate between the euro and the Bulgarian lev  should be negotiated as a result of the decision taken by the ERM II members regarding Bulgaria’s accession, faced wide public scrutiny. Nevertheless, there are no underlying reasons to expect the setting up of a central exchange rate different than the current one.

In the context of the various legislative changes and the public response that they were met with, the Bulgarian government indicated in early 2020 that it intends to postpone its official ERM II application. These plans were subsequently revised, however. Thus, on 10 April 2020, in view of the already implemented Action Plan and the expected successful recapitalization of the aforementioned two banks, the government signalled that Bulgaria will apply to join the ERM II and the Banking Union by the end of the April 2020. One of the main arguments that was brought up as a justification for this decision was the COVID-19 crisis and the fact that the Eurozone countries have access to significantly larger financial resources to deal with the situation, as all European Union Member States have access to the same funds and programs, but the Eurozone counties also have access to  the ECB asset purchase programme  of private and public sector securities with overall budget of EUR 750 billion – the Pandemic Emergency Purchase Programme.

It is important to note, however, that as per the current framework the ERM II membership alone does not guarantee access to the ECB’s financial programmes, considering that they are normally targeted towards the Eurozone countries only. In this regard, the successful establishment of close cooperation with the ECB would also not give access to financial or any other liquidity support, nor to ECB’s monetary policy framework, as this agreement signifies the change in the supervisory and resolution framework, leading to the harmonisation of the Bulgarian legislation with the rules of the Economic and Monetary Union. This framework may, nonetheless, be revised.

For instance, the BNB and the ECB agreed on the setting up of a swap line on 22 April 2020. The goal of this agreement is to provide euro liquidity, if needed, where the BNB will be able to borrow up to EUR 2 billion from the ECB in exchange for Bulgarian levs, with a 3 months maximum maturity for each drawing. It is important to note that this agreement is not a loan, but it  serves as an additional liquidity protection for the currency board, similar to the ECB swap line for Croatia – the other ERM II applicant, and the already existing Danish agreement that the ECB recently reactivated with 100% limit increase. It is currently envisaged that the Bulgarian swap line remains in place until the end of  2020, but, if needed, it could be extended,  although it is not expected that the country will make use of the swap line unless it is absolutely necessary.

In the meantime, the Bulgarian government hinted that Bulgaria, together with Croatia, is expected to join the ERM II in July 2020. This timeline is also in line with the indications given by the European Commission back in the summer of 2019, in the context of the ECB’s comprehensive assessment of the aforementioned banks.

Should you wish to learn more or require additional information please reach out to:

Kristina Dimitrova, Associate, Attorney-at-Law

Nikolay Bebov, Managing Partner, Attorney-at-Law