Le blog du CEPII

The euro area urgently needs a Federal Investment Fund (not a budget)

The decline in investment rates in the euro area following the global financial crisis has been sharp. And it looks as though it will not reverse significantly. Rebooting investment and channeling investable funds to the right places on the continent is therefore a major challenge for policy makers.
By Natacha Valla
 Post, April 9, 2014

Unfortunately, financing investment is adversely affected by two headwinds: financial fragmentation, which still prevails in both wholesale and retail markets, and the drastic reduction of bank funding, which leaves holes in the way Europe finances growth. If they persisted for too long, financial fragmentation and bank deleveraging would hinder any pick-up in investment and eventually lower potential economic growth.

The situation is serious, but the case for investment is not lost. In fact, the financial fundamentals of the euro area are sound: the area has savings in excess (and a significant current account surplus), its aggregate fiscal capacity is sound, and many potential investors would put money on the table if they were given the tools and rules to operate at a pan-European scale.

These mixed circumstances should be seen as an opportunity for policymakers to proactively kickstart investment. One way to do so would be to create a Federal Investment Fund (let us call it Fede Fund, in homage to the upcoming Italian EU presidency in the Summer 2014), a pan-European financial capacity established by Treaty to invest over the euro area wide geography.

A Fede Fund would have political and institutional merits. After all, the future path for European integration is still very much uncertain. The crisis had created an impressive institutional momentum to safeguard the euro (macroeconomic governance, banking union). But economies remain feeble, heterogenous, and countries collectively hesitate about the way forward for European integration. One of the “integration options” on the table is fiscal federalism, with a common countercyclical budget. But its political acceptability is all but there – Germany shows reluctance to it, and perhaps rightly so - and the economic case to finance countercyclical policies with pooled taxpayers’ money can be challenged. But this debate about a common budget is benign: many even want to dismantle the euro!

We see the current polarized context as being particularly favourable to the creation of a Fede-Fund. It would be a way to pool financial resources across euro area member states. But it would not aim at financing short term countercyclical policies. Instead, it would finance structural, long-term, growth-enhancing, and stability-promoting public and private investment. As such, it would resonate with recent recommendations by the IMF or the Australian G20 presidency (warning against the generalized decline in investment ratios in the aftermath of the crisis - IMF (2014) - and arguing for a revival of public-private investment to support global growth - G20 (2014)).

Such a fund would counter fragmentation “from the supply side” of financial markets. And as a pan-European institutional vehicle, it would foster the development of pan-European capital markets to substitute for waning bank financing. As a truly pan-European investor, it would also foster progress in a number of areas where the need for improvement has already been well identified by the industry and policy makers. If we were to quote just one, that would be the development of high-standard, safe, simple instruments for securitization.

Additional “mechanical” improvements in the cross-border financing of investment would also stem from a Fede-Fund: the passporting of assets, to make them acquirable cross-border, and the reduction of barriers to invest in them (tax, regulation, legislation); the “single market” passporting of investment vehicles themselves, in particular EU loan funds (so that they can generate investment also via the asset side of their balance sheet by acquiring assets / supplying credit on a cross-border basis); the development of labeling initiatives to increase transparency and standardization; the development of new pan-European financial instruments to foster European integration. In these areas, a Fede-Fund could act as a catalyst.

What would be the purpose of a Fede Fund? As said, it would aim to mobilise funding for public and public-private investment to finance jobs and growth in Europe. To do so in an economically sustainable and financially profitable way, it would need to grant access to its funding subject to conditionality. Concretely, the financing of activities in the public sphere should be made conditional on growth-enhancing structural reforms and economic policies, when needed. Fede-Fund financing should also generally integrate high environmental and social standards, as well as strong and politically independent governance.

Where and in what would it invest? Investments conducted by the Fund would fulfill one or several of the following criteria, but not in a mutually exclusive way: be long-term, have a strategic dimension, foster European integration, be a stabilization tool for non-investment grade countries, act as a substitute for banks (in particular for SMEs), and assist countries with impaired socio-economic environments (by providing quasi-aid when poverty looms).

Last but not least, an appropriate governance is needed for such a Fund to achieve these goals. As a core principle, all Euro area Member States would be expected to become Fede-Fund members. So would EU institutions be, with all related rights and obligations. But additional contracting parties could, and in fact should, also be associated to the Fund. The Fede-Fund would generally seek partnerships with the broadest possible range of investors, pension funds, generally institutional investors, loan funds, debt funds, venture capital, private equity, with even explicit clauses to incentivize investor classes that tend to be under-represented (such as business angels or corporates).

The private sector can be involved in three ways: with an equity stake, as debt holder, or as co-investor in European projects. Neither should be a priori excluded.

Allowing for private minority shareholders would certainly help ring-fencing investment processes from political influences, if designed appropriately. Of course, Sovereign members are meant to be the majority shareholders of the Fund. Together with relevant EU institutions, they would irrevocably and unconditionally provide a predetermined contribution to the Fund equity, possibly in accordance to their GDP weight in the Euro area. The equity thereby mobilized could be handled as an endowment by the Fund.

The spending capacity of European states is currently fairly constrained, so leveraging on private funding would be necessary to fund investment at an economically relevant scale. Beyond its equity base, the Fund should therefore be able to raise significant resources on international capital markets through bond issues. As a large multilateral borrower, with substantial sovereign ownership and guarantees, the Fund would be likely to display high credit ratings allowing it to raise funds at advantageous rates.

There are many long-standing, excelling, long-term and/or public investors in the euro area. The Fede-Fund would not compete with them, to the contrary. It would display a specific mix of characteristics: its truly European scope and risk diversification (assets and liabilities); its ability to encompass a diversified ecosystem of investment cultures; its balanced incentives between economic/financial returns and environmental/social standards; and its independence from national politics.

As such, the Fede-Fund would cooperate very closely with the EIB, its subsidiary the EIF, as well as national/regional long-term investors and development banks (CDC, CDP, ICO, KfW, to name a few) in providing investment funding. Fede-Fund could in fact act as a facilitator for the cross-border operation (and cooperation) of such entities that would require potentially non-trivial changes to their statutes and prerogatives if they were to change the scope or scale of their investment activities. The Fede-Fund would proactively encourage cooperation between those institutions. In this role, it would benefit from an association with, or membership in, prominent initiatives, such as the Club of Long-Term Investors or Eurofi (CLTI (2013), Eurofi (2014), EC(2013)).

A Fede-Fund would mark a clear political commitment to European integration. A constructive flagship for new European Commission scheduled to take office after the European elections?

References :

Club of Long-Term Investors (2013). Various pieces.

Eurofi (2014). Documents prepared for the Athens Eurofi Seminar under the Greek EU Presidency on 31/3-1/4/2014.

European Commission (2014). Proposal for an ELTIF.

Giovaninni and Moran (2013). Finance For Growth, Report of the HLEG on SME and Infrastructure Financing.

G20 (2014). A G20 agenda for growth and resilience in 2014, Australian Presidency.

IMF (2014). WEO, April.
Europe  | Money & Finance 
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