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The Many Faces of Eurobonds

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The Many Faces of Eurobonds 05 May 2020 Bond Watch: The many faces of Eurobonds Jan von Gerich Many kinds of Eurobonds already exist and many of them will be used more also during the corona crisis. It will be politically easier to utilise existing mechanisms and at the same time try to maintain an illusion of limited liability. • Despite the word being almost a taboo sometimes, many kinds of Eurobonds already exist, and their significance will once again rise amidst the corona crisis • European Investment Bank to mainly help companies in need • European Union will increase its activities significantly, possibly including the financing of the so-called Recovery Fund • European Stability Mechanism to help governments in need • European Financial Stability Facility remains an active issuer The general discussion about Eurobonds often disregards the fact that such debt instruments have existed for a long time. True, in a narrower definition, a Eurobond would be a debt instrument issued with a joint and several guarantee by the Euro-area member countries to finance either the entire Euro area or individual member states. During the past years, several dierent structures have been proposed. However, many kinds of bonds already exist, which rely on dierent kinds of support structures from either the countries of the European Union or the Euro area. At least the bonds issued by the European Investment Bank (EIB), the European Union (EU), the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF) are in many ways quite close to the idea of Eurobonds. Two of these issuers, the EFSF and the ESM, were created during the Euro-area debt crisis, so it is possible new structures will be created also in response to the corona crisis. However, the existing structures will probably be used first, and the EIB, the EU and the ESM already have a role in addressing the corona crisis, which means that a lot more issuance will be seen from these names. It seems clear that more EU/Euro-area level measures will be needed to secure an eective exit from the crisis. The political willingness for increased risk sharing looks low, at least in certain countries, but more risk sharing looks unavoidable, at least if the Euro area is to exit this crisis as a single monetary union. That is why many the Euro-area governments are trying to find solutions using existing tools, which is politically easier, and at the same time object to new bond types such as corona bonds. e-markets.nordea.com/article/57298/bond-watch-the-many-faces-of-eurobonds Many kinds of Eurobonds already exist e-markets.nordea.com/article/57298/bond-watch-the-many-faces-of-eurobonds A comparison of Eurobond issuers European Investment Bank to mainly help companies in need The EIB is the lending arm of the EU and was founded as early as 1958. It is by far the biggest of the four issuers mentioned above and is owned by the EU member states. The shareholders have paid in capital of around EUR 22bn and have committed to providing more than EUR 200bn of additional capital, if needed, which brings the lending capacity of the EIB to more than EUR 600bn. This structure has allowed the EIB to secure triple-A ratings from all the major rating agencies. The EIB is also the most active of the four, and its new lending operations totalled more than EUR 60bn last year. e-markets.nordea.com/article/57298/bond-watch-the-many-faces-of-eurobonds The EIB is already being used to tackle the corona crisis. It is creating a EUR 25bn guarantee fund which will be funded by direct contributions by the EU member states pro rata to their shareholding. With the help of the guarantee, the ECB will be able to provide up to EUR 200bn in support to companies. As part of this support involves guarantees given by the EIB, its own issuance needs should rise by much less. In addition, the EIB had already earlier announced potential financing of up to EUR 40bn to European companies in need, of which EUR 20bn consists of guarantees. The original issuance target of the ECB was EUR 60bn, but this will rise substantially due to the new support measures. European Union will increase its activities significantly Everyone knows the EU, but not everyone knows that it also issues its own debt. While the volumes have so far been quite low, only around EUR 50bn of bonds are currently outstanding, the EU has been providing financial aid to countries in distress. EU bonds are backed by the EU budget and member states’ obligation to provide the funds necessary to meet the EU’s legal obligations. In the past, the three forms of support provided by the EU have been the European Financial Stabilisation Mechanism (EFSM), the Balance of Payments (BoP) programme and Macro-Financial Assistance (MFA). • The EFSM has the goal of preserving financial stability in the European Union, with a maximum capacity of EUR 60bn (it was part of for example the Irish and Portuguese aid programmes). • The BoP programme provides support of up to EUR 50bn to non-Euro-area member states. • MFA is a financial aid programme to assist non-EU countries under an IMF programme. During the corona crisis, the European Union has already been tasked to provide funding for the EUR 100bn Support to mitigate Unemployment Risks in an Emergency (SURE) programme. SURE will provide financial assistance in the form of loans granted on favourable terms to member states to assist in addressing the sudden increases in public expenditure to preserve employment, resulting from for example national short-time work schemes. The EU is also in the centre of the discussions for the so-called Recovery Fund. The dierences of opinion between the countries remain substantial. It has been agreed that the fund must be of a sucient size, at least EUR 1000bn, and targeted towards the sectors and geographical parts of Europe most aected. The open questions include how such a fund should be financed, how big it should be, on what terms it should oer support, should the support take the form of grants or loans and who should bear the risks involved. One idea could be to use the EU budget and guarantees from EU member states for an initial pot, which could then be leveraged with the help of private money as was done with the so-called Juncker plan. Such a plan would need much less direct monetary contributions via the EU, but would then also rely on attracting e-markets.nordea.com/article/57298/bond-watch-the-many-faces-of-eurobonds a lot of private contributions, which would aect where and how the money could be used. Obviously, the exact form of the fund would have a huge impact on the issuance needs of the EU. In any case, it looks certain that the EU will increase its bond issuance significantly this year. European Stability Mechanism to help governments in need The ESM was founded in 2012 amidst the Euro-area debt crisis to provide assistance to Euro-area member states in need. Its tools include loans to governments, bank recapitalisations, primary market purchases, secondary market purchases and precautionary programmes. The ESM has paid-in capital of EUR 80.5bn from the Euro-area members states and commitments of additional capital worth EUR 624bn, if needed, giving it a maximum lending capacity of EUR 500bn. The biggest programmes the ESM has been involved in have been the aid facilities to Spain and Greece. Under the corona crisis, it has been agreed that the ESM will provide credit lines to member states of up to 2% of the member states’ GDP, or up to EUR 240bn. Such credit lines will be available until the COVID-19 crisis is over. The conditionality on these credit lines was a heated decision, since normally a credit line by the ESM would come with certain terms on how a member state would need to adjust its economy, but in the end it was decided that the only requirement to access the credit line would be that the credit is used to support domestic financing of direct and indirect health care, cure and prevention-related costs due to the COVID-19 crisis. The eventual use of the credit lines will most likely end up being considerably less than the theoretical maximum of EUR 240bn, since only a handful of countries is likely to utilise the credit lines. The ESM can naturally be used in other ways to address the crisis as well. The ESM had set a bond issuance target of EUR 11bn for this year, but this could easily increase manifold. European Financial Stability Facility remains an active issuer The EFSF was founded as a temporary response to the Euro-area debt crisis in 2010. Its mandate was to provide financial assistance to Euro-area countries in diculties in order to safeguard financial stability in Europe. It has provided aid for Ireland, Portugal and Greece. EFSF bonds are backed by guarantees from Euro-area countries. The EFSF will no longer provide any new financial assistance, but as the loans it has granted have an average remaining maturity of more than 35 years, considerably longer than for its bonds, it will continue to be an active issuer for a long time. The EFSF has a bond issuance target of EUR 19.5bn for 2020. Jan von Gerich Chief Analyst [email protected] +358 9 5300 5191 e-markets.nordea.com/article/57298/bond-watch-the-many-faces-of-eurobonds .
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