May has seen some positive news on both tackling the health and social impact of COVID-19 as well as agreement on the recovery in Europe. Further concrete developments on the shape, breadth and length of the Recovery Fund (officially the EU Recovery and Resilience Facility) were announced on May 27, following both a French-German proposal and a counterproposal from Austria, Denmark, The Netherlands and Sweden (our analysis on that here) that are often dubbed the “Frugal Four”. 

The EU’s plans for the budget and the Recovery Fund goes beyond those proposals and marks a historic step in addition to the 540 billion euro already committed in the Spring 2020 relief measures such as the ESM’s Pandemic Crisis Support, EIB Guarantee Fund and SURE which we covered here. The plan, officially entitled “Next Generation EU” is accompanied by an amended Work Program for 2020. We will be presenting further “deep dive” analysis on the EU’s plan, Member States’ reactions and opportunities for market participants but in the interim here are the headline terms: 

• Overall financial firepower of 1.85 trillion euro comprised of the EU’s budget for 2021 – 2027 and 750 billion euro through in the Recovery Fund, which would start operation on January 1, 2021, by which point 11.5 billion euro will already be made available by reallocating the current 2014-2020 budget. Earlier on in May MEPs had passed a resolution calling for a global package of 2 trillion euro. When the current measures are added to the existing 540 billion the overall package runs to 2.4 trillion euro
• Next Generation EU i.e. the Recovery Fund will raise money by temporarily lifting, on an exceptional and temporary basis, the own resources ceiling from the current ceiling of 1.4% to 2% of EU Gross National Income, allowing the EU to issue bonds (backed by the strength of the budget). These bonds will be repaid over a long period of time throughout future EU budgets but not before 2028 and not after 2058. The EU has also announced that it will, in addition to streamlining and simplifying its existing revenue sources, introduce gradual reduction of rebates and that it will consider new own resources i.e., revenue streams that fit in with the EU priorities on climate change. These include: 
  • extension of the Emissions Trading System-based own resources to the maritime and aviation sectors to generate 10 billion euro per year
  • a carbon border adjustment mechanism to raise 5 billion to 14 billion euro per year including possibly taxes on non-recycled plastics
  • an undefined tax on “operations of companies that draw huge benefits from the EU single market, which, depending on its design, could yield around 10 billion euro per year”
  • a digital tax on companies with global annual turnover of above 750 million euro to generate up to 1.3 billion euro per year.
• The Recovery Fund will allocate 500 billion euros as grants to EU Member States while the remaining 250 billion euros are to be available as loans. Some Member States will likely profit more than others in terms of grants they receive. Green and ESG objectives will be pre-conditions for grants and loans to deliver on the EU’s Green Deal and aims to become carbon neutral by 2050 

In many ways, the EU’s Commission President von der Leyen has taken an important step forward to deliver on “whatever it takes”. In any event the overall package marks a first step to greater borrowing and tax revenue collection at the EU-level. The announcement also is a compromise amongst what had been a divided camp of north v south and west v east on core issues of whether to Corona Bond or not. 

President von der Leyen will now need to secure the backing of all EU-27 Member States, hopefully as soon as in three weeks’ time. This leaves some time to convince the more conservative corners across national capitals even if there is no disagreement on the need of a recovery fund backed by bond issuances in particular given the gloomier economic outlook of the pace of recovery. The ECB has already warned of COVID-19’s contribution to rising NPLs as well as threats to financial stability in the wake of the immediate stress. It has equally warned that Eurozone GDP will likely fall 8 to 12% this year compared to a 4 to 5% drop during 2008 and the Great Financial Crisis. France’s economy could contract as much as 20% in the second quarter 2020 according to the national statistics agency and Germany is working on an additional stimulus package worth between 50 billion and 100 billion euro. 

While most Member States have welcomed the announcements, the recent rumblings out of Karlsruhe (which we set out in our Thought Leadership) and what that means for the role of the Bundesbank plus the ECB, will likely carry on through to resolution during the Summer and ultimately July when Germany takes over the rotating presidency of the Council of the EU before handing over to Portugal and then Slovenia. The Council is the body where ministers from EU countries discuss and adopt legislative provisions i.e., set the overall agenda. Germany has already begun to align its priorities for the helm of the Presidency in line with the trio presidency program, which is to be finalized by June, as well as the EU’s overall strategic agenda. 

Germany will thus also play a role in guiding the Recovery Fund through the negotiations with national capitals regarding the start of operations. Much will now be in the hands of Chancellor Merkel to assuage concerns from the Finnish capital to see whether it will join the Frugal Four or instead proactively work to include perhaps some further checks and balances on the conditionality of grants and possible repayment terms. As all of this is to be financed largely by bond issuances, these details do matter. 

We hope you enjoy this month’s edition.