It marks by far the EU’s most significant foray into the capital markets to date, bringing a critical mass to its debt issuance and giving its bonds the potential to become a new benchmark for interest rates on financial assets across Europe.
The aim is not only to allow Europe to recover from the COVID-19 pandemic, but to emerge stronger by investing the bulk of the proceeds in a green and digital transition for the region.
Such a sizable borrowing plan would need to be carefully and clearly explained to prospective investors — including the nature and timing of the rollout and, crucially, how the money will be paid back. While the EU has borrowed before, this supranational program, known as NextGenerationEU (NGEU), is unlike anything it has attempted before.
“For the first time, the EU [will] finance national investment and reform programs of common interest through the issuance of common debt,” said Alessandra Perrazzelli, Deputy Governor for Banca d’Italia, on a recent video hosted by the Official Monetary and Financial Institutions Forum (OMFIF), a think tank.
Scheduled to kick off later this month, the program will be carried out in a series of annual tranches worth around €150 billion — equivalent to the annual borrowing of France.
Marion Amiot, senior economist for EMEA at S&P Global Ratings, estimates in a report that the NGEU program could add as much as 4.1 percent to the EU’s gross domestic product over the next five years.
The sheer size of the program means that, if successful, it would be almost as much as the total borrowing by Germany in the five years before the pandemic struck in early 2020. Johannes Hahn, EU Commissioner in charge of budget and administration, recently referred to the NGEU in a press statement as “a game-changer in EU capital markets.”
Some analysts and bankers go further, noting that while the EU would not technically be a sovereign issuer, the NGEU’s many similarities with sovereign borrowing programs would nonetheless make the EU one of the world’s largest supranational borrowers. Almost one third of the new debt issued will be in green bonds, used to fund sustainable projects and digitalize public administration across the EU.
“This is clearly a new chapter in the world of sovereign borrowing,” says David Marsh, chairman of OMFIF.
The project’s ambition inevitably raises questions over whether it can be rolled out and managed successfully in the way its architects hope. The Commission’s initial stumbles in managing another pan-European initiative, the rollout of COVID-19 vaccines, might lead some to be skeptical.
Here, the Commission is taking no chances. It has worked hard at planning and managing the project, starting immediately after EU leaders in July 2020 agreed to back a landmark pandemic recovery fund.
The team in Luxembourg is headed by Niall Bohan, an Irish national and Commission official with long experience in banking and capital markets. It ultimately reports to Gert Jan Koopman, a Dutch national who is head of the Directorate General for Budget, and who previously spent eight years as deputy director-general for EU state aid.
The Commission has said a key element of this is pursuing a diversified funding strategy. The Commission has pledged to publish its funding plans every six months in materials on its website; develop structured and transparent relationships with banks supporting the issuance program; manage its liquidity needs and maturity profile; and use a combination of auctions and syndications “to ensure cost-efficient access to the necessary funding on advantageous terms.”
Finally, the Commission will set up a primary dealer network to facilitate an efficient auction and syndication process, support liquidity and ensure wide placement of the debt.
About 90 percent of the proceeds, €723.8 billion, will fund a “Recovery and Resilience Facility” (RRF), to be split between grants (€338 billion) and loans (€385.8 billion) for member states. The rest, €83.1 billion, will go toward six smaller projects.
Spain and Italy are by far the largest beneficiaries of those RRF grants, each set to receive about 20 percent of the proceeds, with France next at 11.6 percent, Germany at 7.6 percent and Poland receiving the fifth-largest amount at 7 percent.
“Given the volumes, frequency and complexity of the fund’s borrowing, the Commission is putting forward a debt management policy on a par with that of some of the most advanced EU sovereign borrowers,” Koopman told an OMFIF webinar in March.
Building the NGEU program from scratch would be a daunting task, even for a sovereign. But bankers point out that the EU has a decent track record as a borrower, with an established yield curve, and is therefore something of a known quantity in the capital markets.
This can be traced back to the creation in 2010 of the European Financial Stabilisation Mechanism (EFSM), which raised emergency funds in response to the last eurozone crisis. The EFSM was succeeded by the European Stability Mechanism (ESM).
Another programs is called SURE (an acronym derived from “support to mitigate unemployment risks in an emergency”), created last year to provide loans to member states for protecting jobs affected by the pandemic. By May this year, 19 member states had received a total of nearly €90 billion under SURE (see Figure 2). Those bonds were not only oversubscribed but also carried a social label to demonstrate to investors that funds raised will be used for social objectives.
Yu also believes that the sustainability element of the NGEU was deliberate. There is increasing pressure on investment managers to buy green bonds. “Reserve managers who want to diversify away from the U.S. dollar and also integrate environmental, social and governance strategies may welcome a large increase in the stock of jointly issued, and green, euro-denominated supranational assets,” he says.
The European Central Bank (ECB) also is widely expected to play a significant role as a participant. It will not itself buy NGEU bonds, but the national central banks of each member state that use the euro as their currency (the so-called euro area) will purchase them in the secondary market on behalf of the ECB.
While the Commission has clearly done its homework with investors, politics may yet influence whether the NGEU can achieve long-term success.
The idea of the EU borrowing through a common debt instrument, with liabilities to be shared among member states as the NGEU envisages, has been around for decades. But it has always met resistance from wealthier member states that are net payers into the EU budget.
That’s because of domestic political resistance to the idea of backstopping an instrument with an implied mutualization of debt, regardless of the fiscal strength of participating member states. Germany has led opposition to the idea, with its economics minister as recently as March 2020 dismissing the idea as “a phantom debate.”
The economic and social crises sparked by the pandemic led to a stunning reversal in the German position last year, however. After lengthy talks between EU leaders, Germany’s Angela Merkel and France’s Emmanuel Macron threw their weight behind the idea of a rescue plan, funded by borrowing in the capital markets. Thus the €750 billion recovery fund, or NGEU, was born and has since been revised upwards to account for latest prices.
Kay Swinburne, vice chair of financial services at audit and consultancy firm KPMG, and a former Member of the European Parliament, says support for the NGEU grew with the pandemic. “People had been talking about this for decades and suddenly, European solidarity was more important than trying to protect your own national treasury. So the stars were aligned,” she explains.
Yet while this was a victory for advocates of an EU-wide borrowing exercise to fund the recovery, the initiative received a setback. In March 2021, a group of German eurosceptics — led by Bernd Lucke, an economics professor at the University of Hamburg and one of the founders of the right-wing Alternative für Deutschland (AfD) party — issued a lawsuit challenging the NGEU’s legality in a bid to stop the German parliament ratifying it. Member states ratified the NGEU in May, allowing the borrowing to move forward.