03 February 2015

The Juncker Plan - A little bit of clarity please!

The confusion surrounding the plan's structure, resources and governance risks to amplify the growing controversy surrounding this emblematic initiative which should have been largely consensual, writes Paul Goldschmidt.

There is  a quasi unanimous recognition of the need to stimulate investment within the European Union. This explains the favourable reception of the Juncker Plan when announced as the priority objective of the newly installed Commission. However, the confusion surrounding its structure, its resources and its governance risks, unless the necessary clarifications are forthcoming rapidly, to amplify the growing controversy surrounding this emblematic initiative which should have been largely consensual.

In my recent paper dated November 24th concerning the “European Fund for Strategic Investments” (‘EFSI), I already drew attention to a number of unanswered questions. On January 13th, the Commission adopted a legislative proposal covering the creation of this new Fund. The commentaries surrounding its publication provided a number of answers though several key points remain ambiguous if not contradictory.
 
Let us summarise the basic facts:
 
The Structure: the Fund is a “partnership” between the Commission and the EIB. It operates under the latter’s umbrella and is subject, in particular as far as the approval of its interventions, to “the rules and procedures of the Bank”. The Fund is open in principle to contributions of third parties (Member States, private investors...).
 
The Fund’s resources: € 21 billion made up of an EU “budgetary guarantee” amounting to € 16 billion (half of which will be effectively paid in over 5 years) and € 5 billion credited to an account in its name on the books of the EIB and levied on the latter’s own resources.
 
Objectives: Create through a process of leveraging, a total investment capacity of € 315 billion over three years.
 
Instruments: Guarantees, loans, equity investments and other “innovative financial instruments”.
 
Governance: A Steering Committee composed of representatives of the Commission and the EIB (plus other investors in the Fund) who will be responsible for setting general guidelines including asset allocations, investment criteria and risk management. An Investment Committee of independent experts charged with the selection of specific projects. The Fund is subject to the oversight of the European Parliament and the European Court of Auditors.

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Let us review some of the important outstanding questions based on the texts published by the Commission: http://ec.europa.eu/news/2015/01/20150113 fr.htm.
 
 
Project eligibility: 
 
How will it be possible to reconcile the prescription imposing “greater risk taking” with the obligation to follow the ordinary approval rules and procedures of the EIB? How will one avoid conflicts of interest within the EIB (EIF) concerning allocating projects between its ordinary business the Fund?
 
Remuneration of the EFSI:
 
Are the guarantees provided by the Fund free? As the EIB will be the sole beneficiary (see hereunder), charging a fee would necessarily increase the cost of EIB’s intervention. If, on the other hand, they are free, it is difficult to see what interest potential third parties would have in investing in the fund (see further down).
 
The leverage factor:
 
With regard to the € 240 billion of loans financed by the Plan: 
 
“The role of the guarantee is to provide the EIB with additional risk-bearing capacity so that it can invest in projects with a higher risk profile without losing its triple-A rating”.
 
These guarantees (€ 16 billion) should allow the EIB to grant riskier loans for a total amount of € 48 billion (x3).On this basis, the EIB believes it can attract a further € 192 billion in financing from the private sector multiplying by 5 EIB’s contribution (to be compared with a multiplier of 18 for EIB’s ordinary loans) and multiplying the EFSI contribution by 15. These multipliers seem reasonable, at least to the extent that that the funds provided by the private sector are contributed by “partners” who have a vested interest in the completion of the projects rather than by the “financial markets”, who, unless particularly favourable terms are offered, should not show any great interest.
 
It should be noted that the entire guarantee capacity EFSI will have thus been allocated for the exclusive benefit of the EIB. Furthermore, when structuring the financing of each individual project, the question of the subordination of the EIB’s loan contribution will be raised because it benefits from a guarantee that is not available to co-investors.
 
Concerning the € 75 billion of the Plan allocated to instruments financing SMEs (up to 3000 employees):
 
The EFSI will provide the EIB with € 5 billion allowing the Bank to increase the funds available to the European Investment Fund (EIF) by € 15 billion (x3). This contribution will exhaust the entire contributive capacity of the EFSI to the Juncker Plan.
 
The EIF intervenes in the “risk capital” market in partnership with other investors through a variety of instruments: investments in risk capital funds, loan guarantees to portfolios of SME loans, etc.
 
If the objective pursued by increasing the EIF’s capacity to support selected projects by offering, for instance, first loss absorption (which is the equivalent of subordinating EIF’s position instead of its usual pari passu status), there is a considerable risk that private co-investors will merely transfer any further contributions towards the new instruments to the detriment of older ones. It becomes then highly debatable whether the anticipated leverage factor of 5 applied to the EIB’s investment in the EIF is achievable.
 
Third party contributions to the EFSI:
 
Private third party contributions (Sovereign wealth funds…), are hard to envisage unless there are identifiable financial benefits; if made available, these might, however, reduce the attractiveness of the Fund’s intervention (see above).
 
As far as contributions by EU Member States (or their respective Public Investment Banks), their interest seems conditioned on establishing a link between their potential contribution and the selection of projects in which they have a direct interest. However such a link is specifically forbidden by the Governance structure of the EFSI which establishes an independent Investment Committee whose mandate is to select projects based on objective criteria of financial and social returns, of their risk profile, their innovation capacity etc. The additional carrot, offered by the Commission to grant a favourable treatment to Member State’s contributions to the Fund when evaluating compliance with the Stability/Convergence Pact’s requirements, seems wholly inadequate to draw in contributions.
 
Under these circumstances, it does not seem reasonable to anticipate any direct contributions to the Fund from third parties. However, it would appear particularly appropriate to consider a framework encouraging co investment/financing of specific projects eligible for EFSI support.
 
Governance: 
 
One should consider whether it is rational that the selection of projects for the Plan is decided by a single Investment Committee. Indeed the characteristics of the two sets of projects envisaged are fundamentally different; the expertise needed to judge their conformity with the Steering Committee’s guidelines are not necessarily the same.
 
Suggestions:
 
The global capacity of the Juncker Plan is constrained by the availability of the EU budgetary contribution and the EIB’s initial investment in the EFSI. There are,  however means to increase its scope considerably.
 
Indeed, the great majority of selected projects will integrate a more or less important number of criteria (social values and/or financial risks) that, by their very nature, demand the direct support of the State in which projects are to be implemented. Thus a Government guarantee will normally be required (which is in line with the obligation of the EFSI to follow rules and procedures of the EIB).
 
However, for countries whose “sovereign signature” is satisfactory on a standalone basis, such a guarantee would duplicate, at EIB level, the guarantee offered by the EFSI. It follows that for such projects the intervention of the EFSI could be limited to the selection process on the one hand and, on the other, to providing a certification for “favourable treatment by the Commission (in its evaluations of conformity of Stability/Convergence criteria) to direct contributions as well as guarantees provided to the EIB and other co-investors to the project by the beneficiary State.
 
Three objectives would thus be achieved:
 
Provide a powerful incentive to Member States to support project selected by the EFSI.
 
Concentrate the guarantee capacity of the EFSI on projects selected in the more fragile countries thereby answering constructively a number of criticisms that have surfaced in political circles.
 
Allow all participants in the Plan to benefit from the expertise that will be provided by the EFSI, an advantage that was stressed by the Commission.
 
The total amount of the loan component  of the investments generated by the EFSI would be the sum of the € 240 billion benefitting directly from EFSI support and the amount of investments, certified by the EFSI who would benefit from the Commission’s “favourable” treatment during its stability/convergence evaluation process.
 
Conferring on an independent Community Authority the task of selecting projects benefitting from the Commission’s “favourable treatment” is an original response to those Member States who clamour for greater flexibility in the application of Community regulations while avoiding the pitfalls of ex post denials.
 
Conclusion:
 
It is of the highest importance that the Juncker Plan be an outright success. It is therefore urgent to bring additional clarifications to the points raised here above; they do not pretend to be exhaustive. The Commission is running the risk of carrying the blame if the anticipated results fail to materialise, in particular with regard to collaborating with Member States whose support is vital.
 
In the current political climate in which the relevance of the Union’s actions is constantly being challenged, the failure of the Plan could paralyse the capacity of the Commission to act and reinforce the credibility of the euro sceptics. Its success, on the other hand would be a demonstration of the compatibility of growth oriented “European policies” aimed at alleviating austerity with the self imposed rigor on the Member States resulting from the shared management of the single currency.

© Paul Goldschmidt