Euro zone finance ministers gather in Luxembourg today amid mounting expectation that a definitive decision on the application of the euro zone's ESM fund to AIB and Bank of Ireland could be delayed until the autumn of next year.

While the latest draft of proposals on the ESM direct recapitalisation instrument to be put to ministers today contains no mention of retroactivity, a senior euro zone source confirmed the principle of retroactivity would be discussed at today's meeting, the last under the Irish presidency of the European Council.

Retroactive
"The principles should be discussed, but there will be no specific decision. There are three possibilities – no retroactivity, full retroactivity, or a decision on a case-by-case basis."

If consent is given to consider requests for retroactive direct recapitalisation on an individual basis, no specific decision on Ireland is expected before autumn 2014 at the earliest. Direct bank recapitalisation by the fund will only become possible once the single supervisor is fully functioning, which is now expected to be in the second half of 2014. In this scenario, any consideration of Ireland's bid to secure debt relief on the State's investment in AIB and Bank of Ireland via the fund would most likely be made once the direct recap instrument is up and running.

While euro zone finance ministers could give blanket agreement to the principle of retroactive direct recapitalisation of banks at today’s meeting, resistance to the concept of retroactivity has been intensifying in Brussels and Berlin in recent months.

German officials said they saw no chance of using the ESM bailout fund to recapitalise banks rescued with Irish taxpayer money at the height of the crisis.

While the legacy and retroactivity issue would be on the table in Luxembourg, German officials were adamant that the issue would get nowhere because the principle is only supported by programme countries that have a vested interest in the matter.

Across the German political spectrum there is widespread agreement against opening up the ESM for legacy debt. As well as being politically unpalatable in an election year, German finance officials say such a move could empty the ESM overnight, removing the backstop for euro zone states and triggering a fresh wave of financial instability in the euro zone.

Contribution
Euro zone finance ministers are expected to agree to some of the key features of the direct recapitalisation instrument today, including the maximum amount available for direct recapitalisation, which is expected to be capped at between €60 and €70 billion. Member states' contribution to the fund is also expected to be finalised at somewhere between 10 and 20 per cent, after legacy assets are taken into account.

The ESM’s role in directly recapitalising troubled banks will also be informed by any decision on how banks are wound up in future.