EUROPEAN COMMISSION Brussels, 2.3.2018 COM(2018) 84 final REPORT FROM THE COMMISSION TO THE COUNCIL on the five yearly review of the multiannual financial guidelines for managing the assets of the ECSC in liquidation and, on completion of the liquidation, the Assets of the Research Fund for Coal and Steel Review of the Financial Guidelines for the five-year period 2012 – 2017





Introduction Following the expiry of the ECSC Treaty in 2002, the Member States decided to transfer the assets and liabilities to the European Community (now EU) but keep them apart from the General Budget (Protocol on the financial consequences of the expiry of the ECSC Treaty annexed to the Nice Treaty). The Commission is responsible for the orderly liquidation of the liabilities and to invest the existing assets on the capital markets to generate revenues for the financing of research in the sectors of coal and steel through the Research Fund for Coal and Steel (RFCS). After the end of the liquidation process (to last until 2027), these assets will be known as the “Assets of the Research Fund for Coal and Steel”. On 1 February 2003 the Council adopted three Decisions necessary for the implementation of the Protocol, i.e. a general decision (2003/76/EC) and decisions laying down guidelines for the asset management (2003/77/EC) and for the RFCS research programme (2003/78/EC, replaced by 2008/376/EC) . In accordance with Article 2 of Council Decision 2003/77/EC, the Commission shall reassess the operation and effectiveness of the financial guidelines for the asset management of the ECSC in liquidation (the "Financial Guidelines"), every five years and shall propose amendments if appropriate. The last assessment was reported upon in 2012 and no amendments proposed. A subsequent five-year report is now due. Review of the Financial Guidelines for the five-year period 2012 – 2017 According to Council Decision 2003/77/EC, as amended by Council Decision 2008/750/EC, the Commission shall manage the assets of the ECSC in liquidation in order to "ensure that funds are available as and when needed, while still generating the highest return available, consistent with maintaining a high degree of security and stability over the long-term" (point 3 of the Annex to Council Decision 2003/77/EC). In view of these objectives, the financial guidelines have worked well initially during the 5-year period 2012-2017. However, due to the protracted low-interest rate environment, they now appear to be too restrictive to provide an efficient basis for a prudent asset management approach which delivers satisfactory returns. Against this background, it appears appropriate to enlarge the eligible investment universe in order to allow diversification of the portfolio. Based on historical data, this could increase expected returns over a long-term horizon, even though it cannot be guaranteed that this will improve observed returns in particular over short to medium-term periods. Looking at market conditions, these have been very challenging since 2012 as a low-yield environment has prevailed in the euro bond markets, primarily due to low economic growth and low inflation. The ECB's accommodative monetary policy, and in particular its bond purchase programmes which started in 2015, has further supported this trend. Consequently, yields have now reached historically low and even negative levels. Political uncertainty also impacted financial markets and led to various episodes of turmoil and volatility. Recent examples are the Greek crisis and UK referendum on EU membership. Against this background, the results since the last review in 2012 were positive: amounts were disbursed as and when requested by DG RTD and, furthermore, the return of the portfolio has been satisfactory given the market environment and conservative investment guidelines. More specifically, during the period from 01 July 2012 to 31 December 2016, the portfolio provided a cumulative return of +8.3%. More details can be found in annual ECSC reports as well as in Annex to the Report, where the portfolio's composition as of December 2016 is also presented (see also Annex I to this report). The size of the portfolio decreased slightly during this 5 year period as the total return and new contributions received did not compensate for the cumulative outflows of EUR 216.4 million paid to DG RTD and used to fund research in sectors related to the coal and steel industry. Overall, the total market value of the portfolio as at 31 December 2016 stood at EUR 1.69 billion compared to EUR 1.74 billion as of 30 June 2012, a decrease of about 2.8%. Despite the relatively good performance of the ECSC portfolio compared to relevant benchmarks, the revenues assigned to the funding of research projects for Coal and Steel have been decreasing over recent years. This is due principally to the low-interest rate environment. This has significantly driven down yields and adversely affected the revenues from the portfolio which could be made available for the Research Fund for Coal and Steel. Reasons to change and proposals regarding the Financial Guidelines Background

As of the end of 2016, the performance of the portfolio since the adoption of Council Decision 2003/77/EC has been satisfactory given the conservative investment guidelines. However, over the last years, market conditions have changed substantially. Looking ahead, the financial markets in general and the euro bond markets in particular have become even more challenging, due to strongly negative yields (in particular for securities from issuers with the highest credit quality), high probability of materialization of interest rate risk and markedly reduced liquidity (especially in terms of bonds available for purchase) – entailing increased probabilities of very low or even negative returns going forward. As of now, the two key working assumptions are that (1) the ECSC portfolio has a long-term investment horizon and (2) it is relatively free of material liabilities and hence is not subject to major outflows. On this basis, it is proposed to enlarge the universe of potential investments permitted by the financial guidelines in order to mitigate the impact from low or negative yields as much as possible and enhance the diversification and resilience of the portfolio. Several proposals are set out below. These enlarged investment possibilities must be implemented in ways that are consistent with the capital preservation over a long term horizon and stability objectives of the mandate while enhancing the portfolio's expected returns. The proposals for a modification of the Financial Guidelines would broaden the eligible investment universe of available assets/instruments and possible combinations of risk exposures (e.g. interest and credit risk or even some diversified forms of equity market risk). New investment opportunities would allow the portfolio to be managed more efficiently (in terms of diversification and the risk-return trade-off) and with higher expected returns over the long-term. It should be understood that over the short- to medium-term, these proposals could, depending on market conditions, increase the portfolio's volatility and may also entail negative performances for limited periods faced with unusual or unexpected market conditions. In general, asset management involves an investment risk which cannot be fully eliminated, and returns on the investments may be positive or negative. During periods of very low interest rates and probable rate rises over the coming years, the only way to improve expected returns is to accept higher risk/higher volatility. Due to the intrinsic nature of investments, changing market conditions and interest rate environment, even safe and liquid assets may entail negative returns. Current Financial Guidelines The current Financial Guidelines follow a relatively conservative approach. This is reflected for example in strict absolute limit amounts (e.g. maximum EUR 250 million per EU Member State), high credit ratings (e.g. minimum credit rating of AA, except for EU Member States and EU Institutions) and restrictions on maximum maturity (e.g. maximum 10.5 years remaining at purchase). Current restrictions exclude investment by the ECSC portfolio in a wide range of financial assets. For example: -the rating restrictions exclude almost the entire corporate and financial bond markets. Exposure to the latter could offer diversification and higher returns, which could be helpful to mitigate the impact of negative short-term rates in the current environment; -similar arguments can be made in respect of limits on maturity. These prevent investment in longer-dated bonds which could deliver similar benefits. Modifying these restrictions would allow diversified asset allocations with higher expected returns for the portfolio, while keeping overall portfolio risk at similar levels as currently thanks to negative correlation effects; -a number of asset classes and risk-management techniques are also excluded by the current investment guidelines. Therefore, we recommend changing the current guidelines in order to allow the expansion of the set of investment possibilities through broadening the investment limits including new asset classes that are expected to allow the ECSC portfolio to earn higher risk-adjusted returns over the long-term. Those amendments would be compatible with the requirements laid down in Art 2(1) of Council Decision 2003/76/EC. Proposed changes to the Financial Guidelines A. Adjust the absolute limits, ratings and maturity restrictions It is proposed to adopt a more dynamic approach as regards the technical aspects of implementation that need some flexibility (such as determining risk, maturity and concentration limits). This would allow calibrating them more regularly and closely to evolving market conditions. It would build on the recent guidelines adopted for the guarantee fund of the European Fund for Strategic Investments, one of the other major portfolios managed by the Commission. Risk tolerance could also be defined in broader terms (e.g. by listing the eligible asset categories as such). Limits could be better expressed in terms of market rather than notional value and defined as maximum percentage exposures of the total portfolio market value. This defines exposures more precisely, as due to the low or negative yield environment many securities are priced significantly above par (100%) and the nominals might no longer reflect the true economic value of such exposures. Another reason why a market value, percentage based limit approach has become more relevant is in case the total portfolio market value changes, either due to market valuation or caused by in- or outflows. B. Allow investments in other currencies Currently, the Financial Guidelines are silent on the eligibility of foreign currency investments. In this context it should be noted that euro denominated investments represent only c. 25% of the world bond market.