2017 ANNUAL REPORT 2017 ANNUAL REPORT ANNUAL EUROPEAN STABILITY MECHANISM STABILITY EUROPEAN ISSN 2443-8138 Europe Direct is a service to help you find answers to your questions about the European Union Freephone number (*): 00 800 6 7 8 9 10 11 (*) The information given is free, as are most calls (though some operators, phone boxes or hotels may charge you). Photo credits: Front cover: Illustration (flags), ©Shutterstock; euro symbol, ©Shutterstock Programme country experiences, banners: p. 24, Ireland: © iStock.com/Peter Hermus (note); p. 26, Greece: © iStock.com/Peter Hermus (note); p. 31, Spain: © iStock.com/Peter Hermus (note); p. 32, Cyprus: © iStock.com/Peter Hermus (note); p. 33, Portugal: © iStock.com/Peter Hermus (note). © European Stabiity Mechanism, Steve Eastwood: pages 6, 14, 15, 18, 20, 21, 23, 25, 28, 30, 34, 36, 38, 40, 42–45, 47, 49, 50, 54, 59, staff photo 61, 65, 66, 67, 69 Portrait photos: pages 12–13, 60–63 supplied by national Finance Ministries PRINT ISBN 978-92-95085-42-8 ISSN 2314-9493 doi:10.2852/890540 DW-AA-18-001-EN-C PDF ISBN 978-92-95085-41-1 ISSN 2443-8138 doi:10.2852/800884 DW-AA-18-001-EN-N More information on the European Union is available on the Internet (http://europa.eu). 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Printed by Imprimerie Centrale in Luxembourg printed on white chlorine-free paper 2017 ANNUAL REPORT 2017 ANNUAL REPORT | 3 Contents 5 Introduction to the ESM 7 Message from the Managing Director 10 Letter of transmittal to the Board of Governors 11 2017 ESM highlights 12 Message from Mário Centeno, Chairperson of the ESM Board of Governors 13 Message from Jeroen Dijsselbloem, former Chairperson of the ESM Board of Governors 14 The ESM: ready for the future 01 ECONOMIC DEVELOPMENTS 17 Macroeconomic and financial environment 22 Euro area bank performance improves but outlook uncertain 24 Programme country experiences 28 ESM cuts interest rate risk for Greece on loans, measures also reduce long-term debt burden 34 ESM follows up on independent evaluation recommendations 02 ESM ACTIVITIES 37 Processing the financial transactions of the ESM 39 ALM and Lending activities 41 ESM and EFSF lending fosters budget savings 42 Funding and Investor Relations 45 Major rating agencies affirm ESM’s high rating position 46 Investment and Treasury 49 Risk and Compliance 51 ESM deploys additional derivative instruments to manage financial risks 53 Transparency and accountability 54 The ESM strives to implement environmental, social, and governance best practices within its internal operations 03 INSTITUTIONAL FRAMEWORK AND ORGANISATION 55 The financial assistance toolkit of the ESM 57 Governance 58 Governance structure 59 Board of Governors 62 Board of Directors 64 Board of Auditors 66 Internal control framework 68 ESM organisational structure 69 5 years of the ESM 4 | EUROPEAN STABILITY MECHANISM 04 FINANCIAL REPORT 72 Balance sheet 73 Off-balance sheet 74 Profit and loss account 75 Statement of changes in equity 76 Statement of cash flows 77 Notes to the financial statements 05 EXTERNAL AUDITOR’S REPORT ON THE 2017 FINANCIAL STATEMENTS 06 REPORT OF THE BOARD OF AUDITORS ON THE 2017 FINANCIAL STATEMENTS ACRONYMS AND ABBREVIATIONS 2017 ANNUAL REPORT | 5 Introduction to the ESM The European Stability Mechanism (ESM) is a crisis resolution mechanism estab- lished by the euro area countries. The ESM’s mission is to provide financial assis- tance to ESM Members experiencing or threatened by severe financing problems to safeguard the financial stability of the euro area as a whole and of its Member States. The Luxembourg-based ESM raises funds by issuing debt instruments, which are purchased by institutional investors. The proceeds enable the intergovernmental institution, in operation since 8 October 2012, to provide its Members the following types of financial assistance: loans to cover their financing needs; loans and direct equity injections to recapitalise financial institutions; credit lines to be used as precautionary financial assistance; primary and secondary debt market purchases of Members’ national bonds. ESM provides financial assistance to beneficiary Members addressing weaknesses in their economies through reforms which are jointly agreed by that Member, the European Commission, in liaison with the European Central Bank (ECB) and, where applicable, the International Monetary Fund (IMF). The reforms are required to be consistent with the measures of economic policy coordination provided for in the Treaty on the Functioning of the European Union. More information about the ESM can be found on our website: www.esm.europa.eu. Note: The ESM 2017 Annual Report contains the audited financial statements as at 31 December 2017, together with the report of the external auditor in respect of their audit concerning these financial statements, and the report of the Board of Auditors in respect of these financial statements. The description of ESM policies and activities covers the 2017 financial year, except when stated otherwise. The information related to the composition of the Board of Governors (BoG) and Board of Directors (BoD) reflects their composition as of 15 May 2018. The economic development report (Chapter 1) includes certain information available up to 3 May 2018, but all historic financial data there set out is limited to the period to 31 December 2017. 6 | EUROPEAN STABILITY MECHANISM As a permanent institution, the ESM “ makes the monetary union more robust, and enhances the resilience “of its economy. KLAUS REGLING Managing Director European Stability Mechanism 2017 ANNUAL REPORT | 7 Message from the Managing Director The European Stability Mechanism was set up to protect the euro area against the worst blows dealt by an economic crisis. Such crises happen from time to time, and have done so for hundreds of years. They can spring up suddenly, seemingly out of nowhere, for reasons that may be poorly understood at first. The problems that cause a crisis often build up for a long time – but we do not always heed the warning signals. It was like that in the last financial crisis, a period from which the ESM was born. Several countries accumulated unsustainable misalignments during the first decade of monetary union, in the form of high debt levels, a loss of competitiveness, and growing current account deficits. In addition, the euro area was not well-equipped institutionally to deal with a serious crisis, and the monetary union threatened to break up. The rapid establishment of the ESM – and first the temporary European Financial Stability Facility (EFSF) – could not turn the clock back on the crisis. But these two institutions shielded Europe against a far worse outcome: the departure of one or more countries from the euro area. The ESM is now a permanent feature of the monetary union and of the global finan- cial safety net. It functions as an emergency system, which has helped to keep the euro together. Four of the five countries that were in EFSF or ESM assistance pro- grammes are clear success stories. Greece has a chance to join this group, if it continues to implement reforms, also after the end of its programme in August. As a permanent institution, the ESM makes the monetary union more robust, and enhances the resilience of its economy. These are not abstract concepts: it means fewer job losses, and less economic damage when the next crisis hits. But the euro area’s emergency defence system is still not as solid as it could be. That is understandable: Europe had to come up with a broad policy package very quickly at the height of the crisis. Setting up the ESM was only one part of that. And while the crisis response was very successful, not all risks have gone away. Remaining deficiencies should be fixed now, in order to better prepare for the next crisis. These steps, importantly, are relatively small in comparison to the work that has already been done. They do not represent a grand architectural design for new European institutions. I am a strong proponent of the principle of subsidiarity – taking decisions at the lowest possible level. Many things can be done better at the national or regional level. But there are a few tasks that countries simply cannot resolve on their own. Examples are control of the European Union’s external borders, the fight against terrorism and dealing with climate change. These are areas where Europe needs to be strong, and where it can bring something to its citizens that countries cannot. Defending the integrity of the monetary union – and the many benefits that the single currency brings – are also areas where cooperation leads to better results than individual countries’ actions. Now is a good time to work on these remaining reforms, because the economy is thriving. The euro crisis is behind us, and Europe has come out of it stronger than before. The economy has been expanding almost twice as fast as the potential growth rate. Growth is spread evenly, with some of the former programme countries showing among the highest growth rates in the euro area. Investors – whom we meet on the frequent roadshows the ESM does across the globe – are telling us that they are seeing Europe as a safe haven for their money in today’s world. This is a 8 | EUROPEAN STABILITY MECHANISM marked ­difference from a year ago, when many saw a number of elections in Europe as creating uncertainty. Of course the risk of political disruption never goes away. Constant debate is the basis of democratic decision-making – and that debate can sometimes be pro- longed and unruly. But I expect we can make real progress this year in those areas where it is most needed.