Source: EU Commission
FUNDING STRATEGY: AN OVERVIEW
What did the Commission decide on 14 April 2021 and why is it important?
NextGenerationEU – at the heart of the EU’s response to the coronavirus pandemic – will be funded by borrowing on the capital markets. We will raise up to around €800 billion between now and end 2026.
This would translate into borrowing volumes of on average roughly €150 billion per year, which will make the EU one of the largest issuers in euro. All borrowing will be repaid by 2058.
While the Commission has been borrowing before – to support EU Member States and third countries – the volumes, frequency and complexity of the NextGenerationEU borrowing have called for a fundamental change in the approach to capital markets.
A diversified funding strategy will respond to the new needs. It will reconcile the different demands and constraints of the NextGenerationEU funding, and deliver all funds as required on the most advantageous terms for the EU Member States and their citizens.
On 14 April, the Commission took a number of decisions, which will enable it to implement a diversified funding strategy. In addition, the Commission is setting up a robust governance framework, which will guarantee a coherent and consistent execution. Finally, the Commission is ensuring a clear allocation of responsibilities within the institution for the implementation of relevant processes.
The new funding strategy is critical to ensure that the Commission can mobilise the financial means as and when needed for the implementation of NextGenerationEU.
This package thus helps the Commission to set up the operational framework under which it will use a new and more flexible approach to raise NextGenerationEU funds in capital markets, in line with the approaches used by other large and frequent issuers, including Member States.
Why do we need a new approach?
Under the back-to-back approach used so far, the Commission issued bonds and transferred the proceeds directly to the beneficiary country on the same terms that it received (in terms of interest rate and maturity).
This method has successfully addressed small funding needs. It has reached its limits with the SURE programme where 19 Member States are being served by a single funding programme. It could not ensure financing of much larger NextGenerationEU volumes to be issued on a regular basis over the next years and under changing conditions.
The size and complexity of the NextGenerationEU programme require the Commission to introduce the use of issuance methods employed by large and frequent issuers.
With a maximum borrowing of up to around €800 billion (or on average roughly €150 billion per year), by the end of 2026, and a complex disbursement schedule to Member States and EU policies, a diversified funding strategy is the only viable way for the EU to successfully carry out the issuance programmes ahead.
What is a diversified funding strategy and what is its added value?
A diversified funding strategy combines the use of different funding instruments and funding techniques with open and transparent communication to market participants.
In this way, the issuer facilitates the market absorption of its funding programme, while being able to react quickly and decisively to changing funding requirements or changing market conditions.
The diversified funding strategy of the Commission would combine:
- Communication of annual borrowing volumes and 6-monthly funding plan’s key parameters, to offer clarity on Commission issuance intentions notably to investors so that they can plan their investments;
- Structured and transparent relations with banks that support the programme through the organisation of transactions (via a Primary Dealer Network);
- A combination of auctions and syndications as methods for structuring the transactions, to ensure cost efficient access to the necessary funding on advantageous terms;
- Multiple funding instruments (medium and long-term bonds, some of which will be issued as NextGenerationEU green bonds, and EU-Bills) to maintain flexibility in terms of market access and to manage liquidity needs and the maturity profile.
The borrowing operations will be embedded in a robust governance framework, which will ensure coherent and consistent execution.
In its work, the Commission will continue to coordinate with other issuers, including the EU Member States and supranationals.
What tools and techniques will the Commission use for the borrowing and lending under NextGenerationEU?
To be able to place the full size of NextGenerationEU under optimal conditions, the Commission will use a variety of tools and techniques both on the borrowing and on the lending side of the NextGenerationEU instrument.
On the borrowing side, the Commission will use a diverse set of instruments and techniques to be able to take full advantage of favourable funding opportunities as they arise. It will allow the Commission to minimise possible risks of funding shortfalls, to ensure optimal conditions and enable it to raise all the necessary funding under NextGenerationEU as and when required.
Multiple instruments with EU bonds and EU bills
To be able to place the full size of NextGenerationEU under optimal conditions, the Commission will use bonds with varying maturities as well as short-term debt instruments – to be known as EU-Bills.
Issuing bonds through benchmark maturities (3, 5, 7, 10, 15, 20, 25, 30 years) is the principal way for an issuer to implement its funding plan. With SURE, the instrument to finance employment schemes across the EU, the Commission has already issued benchmark bonds with different maturities (from 5 to 30 years). The NextGenerationEU issuance programme will give the Commission the opportunity to consolidate a regular presence on all parts of the yield curve with as liquid as possible EU-Bonds. Rather than issuing new bonds with new maturities, the Commission will, where possible, augment the amount of already issued bonds. By doing so, the outstanding amount of the bond will make these bonds more liquid in the secondary market trading and hence more attractive to investors.
The Commission will also start to issue securities with a shorter maturity – below one year – to be known as EU-Bills. These will give the EU access to the deep and liquid money market. This will offer the EU the flexibility to determine the size of each transaction based on the actual liquidity needs. To issue EU-Bills, the Commission will rely on auctions, in line with standard market practice.
Multiple issuance techniques with syndications and auctions
The use of a variety of funding techniques will enable the Commission to attract the necessary funding, even under difficult market conditions, enlarge the investor base and reduce funding costs. To achieve all of this, the Commission will combine syndications and auctions, and will use several funding techniques.
For syndicated transactions, the Commission works with a group of underwriters, usually banks whose role is to place the debt with investors. Syndications are the traditional technique for debt issuance by supranational issuers. The Commission has used syndication exclusively in the past and will continue to rely on it for a substantial part of the future NextGenerationEU and other bond issuances.
Auctions are a funding technique in which the Commission will offer its debt to a group of financial institutions (primary dealers) which can acquire the debt by submitting bids via an electronic platform. They are a cost-effective way of issuing debt and the only format for issuing EU-Bills. Auctions are the favoured issuance technique used by large EU sovereigns like Germany and France (for more than 90% of their volumes). NextGenerationEU bond auctions will be conducted by a best-in-class auction platform to ensure a cost-effective execution of these new funding operations.
On the lending side, the new approach will allow the offer of attractively priced and structured loans to Member States. The NextGenerationEU funding strategy will allow long-term loans to Member States to be priced on appealing terms, as they will be funded by highly-rated EU debt with a lower average maturity.
What is the importance of the annual borrowing decision and funding plan in implementing NextGenerationEU?
The annual borrowing decision and the funding plan are key elements to ensure sound financial management, accountability and transparency vis-à-vis the European Parliament and the Council in the implementation of the NextGenerationEU debt management operations (cf. Article 5(3) of Decision (EU, Euratom) 2020/2053). The two items are complementary.
The annual borrowing decision as defined in the Commission Decision on Governance will set a maximum ceiling for the planned borrowing operations over the planning period of one year. It will also set a range for maximum issuance amounts of long-term and short-term funding, the average maturity of the Union’s long-term funding and a limit for the amount per issuance.
The 6-monthy funding plan will map the borrowing to be undertaken in the coming 6 months, within the boundaries set by the annual borrowing decision. The purpose of the funding plan is to ensure that the necessary funds are available to cover the relevant payment needs.
Key elements of the funding plan will be communicated to market participants in order to offer the needed predictability. In particular, the Commission will publish on a regular basis:
- The targeted amounts to be financed by bonds;
- The target auction dates for bond and bill issuances;
- Indications on the expected number and aggregate volumes of syndicated operations.
When will the Commission communicate the first annual borrowing decision and funding plan under NextGenerationEU?
The Commission will adopt its first annual borrowing decision and publish a funding plan before the start of the NextGenerationEU borrowing, expected this summer. The exact timing will depend on the approval of the Own Resources Decision, the piece of legislation that will enable the Commission to borrow for NextGenerationEU, by EU Member States.
The borrowing operations can then start as soon as the Own Resources Decision will enter into force. Later on, funding plans will be updated semi-annually.
PRIMARY DEALER NETWORK
What is the EU Primary Dealer Network and why is it needed?
Primary dealers are financial institutions appointed by sovereign issuers to buy, promote and distribute government debt. They are financial intermediaries, usually banks, that facilitate the smooth market absorption of debt at the time of the initial issuance (primary market) and support trading in secondary markets.
In line with established market practice, the Commission will set up a Primary Dealer Network to facilitate the efficient execution of auctions and syndicated transactions, support liquidity in secondary markets and ensure the placement of our debt with the widest possible investor base.
To raise funds for NextGenerationEU, the Commission will be resorting to the capital markets on a large scale and with a high frequency.
The Primary Dealer Network will reinforce the Commission`s capacity and ensure transparent relations with banks that support the placement of the EU borrowing.
How are you going to select the banks within the Primary Dealer Network?
The Commission Decision on the Primary Dealer Network – adopted on 14 April 2021 and to enter into force following its publication in the Official Journal – describes the selection process in details. The eligibility criteria to join the EU Primary Dealer Network are as follows:
- Being a legal entity established and having its head office in the Union or in a European Economic Area country;
- Being a credit institution authorised in the EU and supervised by an EU competent authority;
- Being a primary dealer for another European issuer;
The eligible credit institutions will have to commit to buy a minimum of 0.05 % of the volume to be auctioned.
The Commission will seek to work with banks active in supporting bond issuance and placements to ensure the success of its EU-Bonds and EU-Bills.
The application form and the General Terms and Conditions for participation will be published shortly.
The Commission will be selecting the banks for subsequent syndicated transactions from the members of the network.
How did you decide on the criteria for the Primary Dealer Network?
In line with best market practice and as per the experience of other big European issuers, the Commission decided to open up membership to all established primary dealers in the EU or the European Economic Area (EEA). This will guarantee a strong pan-European reach of the network and ensure access to all Member States’ investor communities.
When it comes to the participants in each individual transaction, the Commission will make sure that the selected banks will be able to support secondary market trading. This will support good absorption and increase the attractiveness of EU borrowing.
Are non-EU banks also eligible to take part and why?
The members of the Primary Dealer Network that the Commission will be setting up must be banks that are authorised in the EU and supervised by an EU competent authority.
This will guarantee that the primary dealers are capitalised in line with the EU rules, and subject to direct control of EU competent authorities.
EU bank subsidiaries of non-EU parented financial or banking groups are eligible to be members of the Primary Dealer Network if already a member of a national or supranational primary dealer group. Such entities already form an active and important part of national and EU supranational primary dealer groups. They can add value to the EU Primary Dealer Network inter alia through their access to investor distribution capacities in other parts of the world.
Will there be some kind of a rotation mechanism to ensure turnover in the primary dealers supporting transactions?
The selection of banks for syndicate transactions will be based on rigorous application of quantitative and qualitative criteria that focus on the quality of bank services and the assessment of the offer submitted for the transaction in question.
This will be complemented by the application of a rotation factor to ensure the same banks are not always mandated. The objective is to recognise the commitment of each eligible bank to the network and to cultivate a broader group of capable partners to sustain this issuance programme along its duration.
What is an auction platform and why is it important? How will this platform affect the efficiency and cost of the NextGenerationEU issuance?
An auction platform is a system used by sovereign issuers to auction their bonds and bills to a group of banks (most often referred to as primary dealers).
In this way, the issuers can ensure cost-efficient execution of the transactions. Access to a robust, easy-to-operate and safe auction platform will therefore be a powerful asset for the completion of the NextGenerationEU funding programme.
How will the Commission select its auction platform?
The Commission has undertaken an extensive examination of main auction platforms used by national debt management offices in EU Member States.
On this basis, the Commission will select the provider of the auction platform that best matches the specific needs of NextGenerationEU funding operations.
These needs encompass functional requirements like the management of large volumes and multiple tranches, and the ability to take on-board a large primary dealer group in the next months, ahead of the first auctioning operations under NextGenerationEU.
The Commission is also carefully assessing the robustness of the IT infrastructure and the compatibility with the systems that the Commission uses for the settlement of the auctioned securities.
When will you reveal your auctioning platform?
The process for selecting an auction platform is still underway. The decision on the identity of the auction platform will be revealed as soon as the process has been completed.
Will you use the auctions both for bonds and for bills?
The auction platform that the Commission will select will be used for both bonds and bills. While syndications remain an important tool for the issuance of bonds, bills will be exclusively issued via the auction platform.
START OF BORROWING
When will the Commission start borrowing under NextGenerationEU? Why has it taken so long to get to this point?
For the Commission to be legally authorised to borrow under NextGenerationEU, all Member States must approve the Own Resources Decision in line with their constitutional requirements.
In the meantime, the Commission is working hand in hand with Member States in their work to put together their Recovery and Resilience Plans. These would enable them to access the funding under the Recovery and Resilience Facility, the instrument under which 90% of the NextGenerationEU funds will be allocated.
Once the plans have been approved, the Commission will be able to start disbursing the first funds.
The Commission will start borrowing under NextGenerationEU as soon as all the necessary legal preconditions are in place.
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