The European Parliament and the Council have reached an agreement on the legislative proposal presented by the Commission to set up the European Fund for Strategic Investment.

The (virtual) investment “offensive”

As you may remember, the Juncker Commission started its mandate presenting what they called the “investment offensive“.The idea was to set up a fund to reinvigorate the investment firepower of the EU and lift the Member States out of a seven-years-long stagnation. The Communication was followed in January this year by a proposal for a Regulation on which the European Parliament and the Council of the EU found an agreement at the end of May.

The Council and the EP should give their final green light to the Regulation by the end of June and the EFSI is expected to become fully operational by autumn this year. The Fund will be managed by the European Investment Bank in partnership with the European Commission and will be complemented by an European Investment Advisory Hub to provide technical assistance and by an European Investment Project Portal with real time and transparent information on the projects that are being considered.

Following the agreement between the institutions, it appears that the allocation of money within the fund will not be fundamentally changed with respect to the initial proposal of the Commission. The Fund will have a EUR 21 bn. guarantee (16 coming from the EU Budget and 5 from the EIB). However only EUR 8 bn. are expected to be put in an actual guarantee fund while the remaining EUR 8 bn. would be deployed only if the guarantee is called.

In other words half to the guarantee (hence the Fund itself) is “virtual”, unless it will have to be used. Furthermore the guarantee fund will not be “new” money, instead it will be coming from existing EU budget lines:

• €2.8bn from CEF and €2.2bn from Horizon 2020;
• €3bn from unused margins over the period 2016-2020.

On top of the EU-level guarantee, Member States can participate with additional commitments. So far only 6 Member States have pledged to contribute: Italy, Poland, Germany and France (EUR 8 bn. each), Spain (EUR 1.5 bn) and Luxembourg (EUR 80 mn.). It is not fully clear whether the national contributions would constitute additional guarantees or if they will be mobilized to actually finance projects. Either way, the agreement on the EFSI foresees that regardless of their contribution Member States will not have any privileged role in the selection of the projects.

Where should the real money come from…

The EFSI is therefore for the time being more of a hypothetical fund than a real pot of money that can be deployed to finance investments. The core idea is that with the guarantee of the EU budget and the EIB, private investors would be lured into financing risky projects that would otherwise not be done. The expectation of the Commission is to have a multiplier effect of about 15, thus carrying out investments for about EUR 300 bn. over the next three years.

In this sense the position expressed by the European Parliament is clear: “Projects financed or guaranteed by EFSI should (…) be ineligible for EU budget or European Investment Bank (EIB) finance”. These projects in other words should be additional with respect to the ones that can already be financed by the existing EU funds.

The main reason to attract private capital in order to carry out such projects is, as the Commission puts it, to raise the level of investments without increasing the public debt. However, recall that the EU and EIB have pledged to guarantee the investments; this means that they will absorb first losses up to EUR 21 bn.

The fund will therefore create additional contingent liabilities for the Member States and the EU institutions. Should the projects fail, public money will have to be used to cover the losses. The EFSI is therefore providing an implicit subsidy to the investments that may or may not lead to an increase of public debt, depending on the outcome of the project. Note that this is basically a one way bet for the private investors: if things go well they can reap the benefits, if things go bad, the losses will be transferred to the public sector.

…And where should the money go

The Commission and the EIB have explained that eligible projects will have to be within the following areas:

• Strategic infrastructure (digital, transport and energy investments in line with EU policies)
• Education, research and innovation
• Investments boosting employment, in particular through SME funding and measures for youth employment
• Environmentally sustainable projects

And they must meet the following criteria:

• EU–added value (projects in support of EU objectives)
• Economic viability and value – prioritising projects with high socio-economic returns

As some commentators have noticed, there can be more than one doubt about such approach.

First of all, investments in the above-mentioned areas are already covered by numerous EU initiatives: the Connecting Europe Facility for energy, transport and ICT; the Structural Funds; Horizon 2020 and various environmental programmes. But recall what the European Parliament said: the EFSI projects must not be the ones eligible under the existing EU funds. One is therefore left to wonder how to find projects with ‘EU value added’ that cannot be already financed through the various existing channels; not mention the risk of confusion that the multiplication of funds may cause.

Secondly, if private operators have to be attracted, this means that the projects must be able to generate a cash flow with which to remunerate the capital invested. This is easier said than done, especially if one of the 2 criteria is to prioritize “socio-economic returns”. Socio-economic returns may well be what Governments seek when they make public investments but it is hardly what private investors are interested in. This is incidentally why public investments are normally needed in those circumstances where societal returns are higher than private returns. The lack of profit expectations discourages private investments causing what economists call “market failures”. This approach is therefore potentially dangerous because if Governments try to extract high private returns from the projects in order to attract investors they may end up generating “rents” and therefore reduce the overall aggregate welfare impact of the investments.

A final criticism that can be made relates to the fact that with record-low interest rates, private operators would already have plenty of opportunity to invest. If they are not doing so already it is mostly because the crisis has left a deep scar in their balance sheets in the form of debt overhang. The prolonged recessions has also reduced their income expectations, therefore lowering their appetite for further investments. How the EFSI is going to overcome these barriers remain to be seen. Historical evidence seems to suggest that during downturns, public investments are needed to kick-start the economy and only after growth resumes private investments pick up again.

Only time will tell whether these doubts are justified or not. For the time being we can only wait and see what happens.