Annual Report 2018 2018 ANNUAL REPORT EUROPEAN STABILITY MECHANISM 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: © European Stabiity Mechanism, Steve Eastwood: pages 6, 17, 35, 37, 38, 40, 44, 51, 52, 55, 57, 58, 63, 66, 71, 73, 75 Portrait photos: pages 14, 17, 20, 23, 36, 39, 42, 46, 50, 51, 54, 56, 58, 63, 66, 67-70, 72, 73 supplied by national Finance Ministries PRINT ISBN 978-92-95085-59-6 ISSN 2314-9493 doi:10.2852/53320 DW-AA-19-001-EN-C PDF ISBN 978-92-95085-58-9 ISSN 2443-8138 doi:10.2852/427922 DW-AA-19-001-EN-N More information on the European Union is available on the Internet (http://europa.eu). Luxembourg: Publications Office of the European Union, 2019 © European Stability Mechanism, 2019 Reproduction is authorised provided the source is acknowledged. 2018 Annual Report 2018 ANNUAL REPORT | 3 Contents 5 ESM at a glance 7 Message from the Managing Director 9 Letter of transmittal to the Board of Governors 10 2018 year in review 11 The international role of the euro 01 ECONOMIC DEVELOPMENTS 13 Macroeconomic and financial environment 18 December 2018 Euro Summit marks new chapter for the ESM 21 Programme country experiences 23 Greek programme achievements 32 Resilience of countries that benefited from financial assistance 02 ESM ACTIVITIES 37 Processing the financial transactions of the ESM 39 ALM and Lending activities 42 Funding and Investor Relations 46 Major rating agencies affirm ESM’s high rating position 47 Investment and Treasury 50 Risk and Compliance 55 Focus on the Risk and Control Self-Assessment (RCSA) process 56 ESM: committed to public service, transparency, and accountability 03 INSTITUTIONAL FRAMEWORK AND ORGANISATION 59 The ESM financial assistance toolkit 61 Governance 62 Governance structure 63 Board of Governors 67 Board of Directors 70 Board of Auditors 72 Internal control framework 74 ESM organisational structure 4 | EUROPEAN STABILITY MECHANISM 04 FINANCIAL REPORT 78 Balance sheet 79 Off-balance sheet 80 Profit and loss account 81 Statement of changes in equity 82 Statement of cash flows 83 Notes to the financial statements 05 EXTERNAL AUDITOR’S REPORT ON THE 2018 FINANCIAL STATEMENTS 06 REPORT OF THE BOARD OF AUDITORS ON THE 2018 FINANCIAL STATEMENTS ACRONYMS AND ABBREVIATIONS 2018 ANNUAL REPORT | 5 ESM at a glance The European Stability Mechanism (ESM) is a crisis resolution mechanism established by the euro area countries. Since its inauguration in October 2012, the Luxembourg- based ESM has provided financial assistance 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. Euro area leaders decided to give the ESM, an intergovernmental institution, a stronger role in financial assistance programmes and agreed to changes in its toolkit. The leaders’ agreement foresees that: The ESM will provide a backstop for the Single Resolution Fund (SRF), a key element of banking union that is designed to resolve financial problems at systemic banks in an orderly fashion; ESM’s backstop loans will be granted as a last resort and be fiscally neutral over the medium term; The ESM will take a stronger role in designing, negotiating, and monitoring future programmes, in full respect of the European Commission and European Central Bank (ECB) competences; The ESM’s precautionary instruments will be reviewed to make them more effective. For more information on the new mandates, see ‘December 2018 Euro Summit marks new chapter for the ESM’. The ESM raises funds by issuing debt instruments, which are purchased by insti- tutional investors. The proceeds enable the ESM to provide its Members with the following types of financial assistance: loans to cover their financing needs; loans and direct equity injections to recapitalise financial institutions; primary and secondary debt market purchases of Members’ national bonds; credit lines to be used as precautionary financial assistance. More information about the ESM in general can be found on our website: www.esm.europa.eu. Note: The ESM 2018 Annual Report contains the audited financial statements as at 31 December 2018, ogethert 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 2018 financial year, except when stated otherwise. The information related to the composition of the Board of Governors and Board of Directors reflects their composition as of 7 May 2019. The economic development report (Chapter 1) includes certain information available up to 1 May 2019, but all historic financial data there set out is limited to the period to 31 December 2018. 6 | EUROPEAN STABILITY MECHANISM “The ESM reached two milestones in 2018: Greece exited its ESM programme successfully and European leaders decided on a package of measures to deepen Economic and Monetary Union, including steps to strengthen the ESM.” KLAUS REGLING Managing Director European Stability Mechanism 2018 ANNUAL REPORT | 7 Message from the Managing Director The ESM reached two milestones in 2018: Greece exited its ESM programme success- fully in August after more than eight years under financial assistance, and the Euro Summit decided in December on a package of measures to deepen Economic and Monetary Union (EMU), including steps to strengthen the ESM. Greece’s successful programme exit followed those of Ireland, Spain, Cyprus, and Portugal. With loans of almost €204 billion from the ESM and its temporary predecessor, the EFSF, Greece has benefited from the largest financial assistance in modern history, making the rescue funds the country’s biggest creditor by far. Thanks to our loans’ low interest rates and long maturities, Greece saved €13 billion in its 2018 budget alone compared to market financing, calculations for this Annual report show. This amount represents 7% of Greek GDP. Similar savings will be repeated over many years to come. This is an unprecedented act of solidarity by the other euro area member states with Greece. In a further gesture of support, the Eurogroup approved medium-term debt relief measures for Greece in June. They concern an abolition of step-up interest rate margins, a further 10-year deferral of interest and amortisation, and a 10-year extension of the maximum weighted average maturity, all related to EFSF loans. We estimate that this will lead to a cumulative reduction of Greece’s debt-to-GDP ratio of around 30 percent- age points until 2060. We also expect Greece’s gross financing needs to fall by around eight percentage points over the same time horizon. As a result of these medium-term measures, Greece will not start repaying most of its EFSF loans before 2033, and the new weighted average loan maturity has been extended to 42.5 years. All of this comes on top of sizeable short-term debt relief measures implemented in 2017 for Greece. Also for the longer term, Greece received reassurance on its debt sustainability. The euro finance ministers committed to reviewing in 2032 whether additional debt measures are needed to respect Greece’s agreed gross financing needs targets. There is also a contingency mechanism on debt, which could be activated should Greece be hit by an unexpectedly adverse scenario. If the Eurogroup were to activate the mechanism, meas- ures could include further re-profiling, and capping and deferral of interest payments to the EFSF to the extent needed to meet the gross financing needs targets. In return, Greece pledged to stick to the reforms agreed under the programme, among them to maintain a primary surplus of 3.5% until 2022 and to comply with EU rules, particularly related to fiscal and economic policies. In an effort to continuously improve the work of the ESM, Mário Centeno, the Chair- person of the ESM Board of Governors, and I have asked former European Commis- sion Vice President Joaquín Almunia to lead an independent evaluation of the finan- cial assistance to Greece. We are looking forward to an interim report of his work in December 2019 and to the opportunity to consider his results at the ESM Board of Governors’ Annual Meeting in June 2020. With Greece’s programme exit, the ESM accomplished its immediate mission to over- come the euro crisis and to safeguard financial stability in the euro area by providing loans in exchange for economic policy reforms. The ESM can now focus on implement- ing the December Euro Summit decisions to be better prepared for the next crisis. 8 | EUROPEAN STABILITY MECHANISM The year-end summit decisions illustrate both Europe’s determination to make the euro area more resilient and the political will to move EMU forward even without the threat of an existen- tial crisis. The decisions also show that the ESM has become a key pillar in the currency union’s institutional architecture. According to the Euro Summit, the ESM receives a broadened mandate and becomes the back- stop for bank resolution within banking union. This backstop will only be activated if the funds of the Single Resolution Fund are insufficient to resolve a bank in crisis. To repay its loans to the ESM within three-to-five years, the SRF would receive levies from European banks. As is the case with all country programmes, there will be no transfer of taxpayers’ money. By 2024 at the latest, the backstop will be fully operational. The ESM will also play a stronger role in future programmes in close cooperation with the Euro- pean Commission and in full respect of its prerogatives according to the EU Treaty.