A larger use of financial guarantees: the EFSD+ approach
The use of ‘public funding as a guarantee to attract public and private investment to create real jobs’. Launched in 2016, the European Fund for Sustainable Development (EFSD) was based on this modus operandi. It transposed in the field of EU external action the same novel approach introduced in the EU cohesion policy after the 2007-2009 financial crisis.
The Fund is based on the assumption that smart and sustainable investment could only be achieved through private funding. It was designed to create new opportunities for public and private entities through the provision of partial guarantees or risk cushions to financial institutions, typically the development banks which already provide support through loans, guarantees, equity or similar products in states characterised as fragile, LDCs, or highly indebted.
The new EFSD+ became along with the External Action Guarantee the financial arm of the Neighbourhood, Development and International Cooperation Instrument (NDICI) “Global Europe” after the adoption of the Multiannual Financial Framework 2021-2027. It integrates and brings together lessons from formerly separate blending and guarantee instruments like the External Lending Mandate, which provided a guarantee to back European Investment Bank (EIB) lending in pre-accession and neighbourhood countries, and the European Fund of Sustainable Development, which facilitated investment in the European Neighbourhood and in Sub-Saharan Africa. The EFSD+ reflects an evolution with respect to the consolidation of the two instruments and their expansion in scope using.
EFSD+ priorities and portfolio of investment
The EFSD+ operations are financed through the funds made available in the geographic pillar of the NDICI-Global Europe and the Instrument for Pre-accession Assistance III (IPA III) to:
- Foster sustainable and inclusive economic, environmental and social development, with a particular focus on the eradication of poverty;
- Contribute to the reduction of socio-economic inequalities, sustainable and inclusive growth, climate change adaptation and mitigation, environmental protection and management and creation of decent jobs economic opportunities, skills and entrepreneurship, socio-economic sectors, including social enterprises and cooperatives, SMEs, sustainable connectivity, the support to vulnerable groups, the promotion of human rights, gender equality and the empowerment of women and young people;
- Address specific socio-economic root causes of irregular migration and root causes of forced displacement.
One of the main changes in the EFSD+ in relation to the EFSD framework is the expansion of the financial scope of the instrument. Falling under the financial umbrella envelope for the NDICI instrument totalling 79,4 billion euros, the EFSD+ can rely on a broader budget supporting guarantee operations up to 40,7 billion euros. Exclusive investment windows are established for the EIB to cover risks related to lending to sovereign (which for example occurs when a local government asks for a loan for an infrastructure project) and sub-sovereign counterparts (in case of a municipality having no guarantees for a loan). A minimum of 11 billion euros out of the 26,73 billion euros investment window created for the EIB should provide risk cover for these operations. The framework also leaves open the possibility of establishing two additional dedicated investment windows for the EIB related to operations with commercial sub-sovereign counterparts and private sector operations. This represents a reduction in the volume of EIB’s exclusive mandate in relation to the past while extending its geographical scope.
As set by EU law, the EFSD+ has to be implemented through an open and collaborative investment architecture to ensure the optimal use of the sectoral and geographic expertise of eligible counterparts and maximise its development impact. In this regard two open access investment windows dedicated to loans granted in the commercial sub-sovereign field and the private sector are set for other international and development financial institutions with which the European Commission signs a guarantee agreement, covering a total amount of 13,9 billion euros. In order to be covered by a financial guarantee provided under the EFSD+, projects financed by European and international institutions other than EIB should be related to six investment windows:
- Sustainable cities, which covers projects concerning urban development such as waste management, urban transport mobility, energy supply;
- Micro, Small and Medium Enterprises financing for inclusive and green growth and job creation, which allows to support microfinance and capital investment and covers the protection of strategic international value chains;
- Connectivity, which is related to investments in renewables energies, energy storage, transport and digital infrastructure and services;
- Sustainable agriculture, biodiversity, forests and water-natural capital, in which key projects such as the investment in desalinization plants are backed;
- Sustainable finance and impact investment, in which guarantees can be provided for investment aimed at strengthening the credit profile of green bonds than in its turn can have spillover effects in attracting resources for sustainable environment projects.
- Human development, concerning projects in the field of social housing and investment in health.
The advantage of EFSD+ guarantees
The objective of the EFSD+ is to support investments consistent with development policies and priorities defined in the agreements signed with partners. This key principle has allowed the EFSD+ to include also public investment in its portfolio of supported projects. Currency risk is also included in the set of risk coverage of the Fund.
The EFSD+ guarantees are unconditional and irrevocable. Unlike its immediate precursor EFSD, they are unfunded. The EIB and other international partners are funded on first demand as soon as the loss in a payment is reported. The first-loss guarantee mechanism also intends to enable investment in these settings by shifting default risks to the EU.
Most importantly these guarantees are backed by the EU budget. This allows them to be marked with an “AAA” rating. By doing so they offer beneficiaries to be supported by an affordable guarantor, letting them use their financial capital for other initiatives. The more extended global reach of the EFSD+ within the “NDICI – Global Europe” brought the fund to a higher level. Sub-Saharan Africa and the European Neighbourhood have remained regions of emphasis, but the action of the Fund is extended to every fragile and conflict-affected states, Least Developed Countries (LDCs) and heavily indebted poor countries. It's key that all investments covered by EFSD+ guarantees must have a countercyclical effect, increasing the capacity of the economic system to react to internal and external challenges and make progress to achieve the Sustainable Development Goals (SDGs) defined in the 2030 Agenda of United Nation for Sustainable Development ('2030 Agenda'), which commits the European Union to take into account the impact of all policies on sustainable development in other countries and at the global level.