COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE ECONOMIC AND FINANCIAL COMMITTEE on the European Financial Stabilisation Mechanism
Date: 2010-11-30
Institutions: European Commission
Subjects: economic policy, economic recession, financial aid, financial policy, financial situation

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EUROPEAN COMMISSION 

Brussels, 30.11.2010 
COM(2010) 713 final 

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE 
ECONOMIC AND FINANCIAL COMMITTEE 

on the European Financial Stabilisation Mechanism 

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COMMUNICATION FROM THE COMMISSION TO THE COUNCIL AND THE 
ECONOMIC AND FINANCIAL COMMITTEE 

on the European Financial Stabilisation Mechanism 

INTRODUCTION 

In  May  2010,  the  European  Union  and  euro-area  Member  States  set  up  the  European 
Stabilisation Mechanism that consists of the European Financial Stabilisation Mechanism and 
the  European  Financial  Stability  Facility  to  safeguard  EU  financial  stability  amid  severe 
tensions  in  euro-area  sovereign  debt  markets.  The  European  Financial  Stabilisation 
Mechanism (hereafter referred to as the EFSM) was established by Council Regulation (EU) 
N°407/2010 of 11 May 20101 and constitutes an important pillar of the European framework 
for addressing the current exceptional circumstances.  

According to article 9.(1) of the Regulation, the Commission shall forward to the Economic 
and Financial Committee and to the Council, within six months following the entry into force 
of  the  Regulation  and  where  appropriate  every  six  months  thereafter,  a  report  on  the 
implementation  of  the  Regulation  and  on  the  continuation  of  the  exceptional  circumstances 
that  justified  the  adoption  of  the  Regulation.  To  this  end,  the  Commission  adopts  this 
Communication. 

Article  9.(2)  of  the  Regulation  points  out  that  the  report,  where  appropriate,  shall  be 
accompanied  by  a  proposal  for  amendments  to  the  Regulation  with  a  view  to  adapting  the 
possibility of granting financial assistance without affecting the validity of decisions already 
adopted.  However,  the  Commission  is  of  the  opinion  that  there  is  no  need  to  amend  the 
Regulation at the present juncture and in line with the most recent developments. 

Box 1. Functioning of the EFSM 

The EFSM essentially reproduces for the EU 27 the basic mechanics of the existing Balance 
of Payments Regulation2 for non-euro area Member States. When the mechanism is activated, 
it  allows  the  Commission  to  borrow  in  financial  markets  on  behalf  of  the  Union  under  an 
implicit EU budget guarantee. The Commission then on-lends the proceeds to the beneficiary 
Member State. This particular lending arrangement implies that there is no debt-servicing cost 
for the Union. All interest and loan principal is repaid by the beneficiary Member State via the 
Commission.  The  EU  budget  guarantees  the  repayment  of  the  bonds  through  a  p.m.  line  in 
case of default by the borrower. 

The  EFSM  is  a  part  of  a  wider  safety  net.  Along  side  the  EFSM,  the  European  Financial 

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2 

Council Regulation (EU) No 407/2010 of 11 May 2010 establishing a European financial stabilisation 
mechanism (OJ L 118, 12.5.2010, p.1). 
Council Regulation (EC) No 332/2002 of 18 February 2002 establishing a facility providing a medium-
term financial assistance for Member States' balances of payments (OJ L 53, 23.2.2002, p.1). 

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Stability Facility (EFSF), i.e. funds guaranteed by the euro area Member States, and funding 
from  the  International  Monetary  Fund  are  available  for  euro  area  Member  States.Non-euro 
area Member States are also eligible for assistance under the Balance of Payments Regulation. 
The  EFSM  and  the  EFSF  can  only  be  activated  after  a  request  for  financial  assistance  has 
been  made  by  the  concerned  Member  State  and  a  macroeconomic  adjustment  programme, 
incorporating strict conditionality, has been agreed with the Commission, in liaison with the 
ECB.  

1. IMPLEMENTATION OF THE REGULATION 

Following adoption of Regulation 407/2010, the European Union took the necessary steps to 
enable  a  quick  and  smooth  use  of 
the  EFSM.  These  actions  have  comprised:  
(i) the necessary budgetary adjustments and (ii) an upgrading of the Commission's capacity to 
raise funds on the financial markets. 

Actions taken in relation to the EU budget  

Actions  taken  in  relation  to  the  EU  budget  include:  (i)  the  creation  of  a  budget  line  for  the 
guarantee provided by the EU on Union loans raised for financial assistance under the EFSM; 
and (ii) a revision of the estimate of the available margin under the own resources ceiling. 

Creation of a budget line 

An  appropriate  budget  structure  was  created  for  hosting  the  coverage  provided  by  the  EU 
budget for possible financial assistance operations carried out under the EFSM.3 4 

In  normal  circumstances,  financial  assistance  under  the  EFSM  would  not  entail  any  budget 
expenditure (due to its "back to back" nature). This would only occur in the highly unlikely 
event that a beneficiary Member State defaults on its obligations. The structure includes a new 
budget  line  (01  04  01  03)  for  the  guarantee  provided  by  the  EU  on  Union  loans  raised  for 
financial  assistance  under  the  EFSM.  The  budget  line  carries  a  token  entry  (p.m.).  The 
Commission will ensure that the legal obligations towards the bondholders are fulfilled in a 
timely  manner  and  would  propose,  if  necessary,  to  make  available  on  this  budget  line  the 
appropriations needed.5 

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4 
5 

Amending Budget No 5 for the year 2010 covering the creation of the budget structure for the European 
Financial  Stabilisation  Mechanism  has  been  adopted  by  the  Budgetary  Authority  on  22  September 
2010. The Commission Draft Amending Letter No 2/2011 which also incorporates those changes into 
the 2011 draft budget has been submitted to the Budgetary Authority on 11 October 2010. 
A similar structure already exists for the Balance of payments facility for non euro-area Member States. 
In  case  of  a  default  the  Commission  would  first  raise  the  necessary  amount  to  service  the  debt  by 
drawing  on  its  cash  balances  and,  if  these  are  not  sufficient,  draw  additional  cash  resources  from 
Member States on the basis of Article 12 of Council Regulation No 1150/2000/EC, Euratom of 22 May 
2000 implementing Decision 2007/436/EC, Euratom on the system of Communities own resources. In a 
second step, the Commission would propose to budget the cash advance. 

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A new, corresponding budget line 802 has also been created on the revenue side to account 
for  any  potential  reimbursements  after  an  initial  default  or  for  any  other  revenue  arising  in 
connection with the guarantee provided by the EU. 

Revision of the estimate of the available margin 

Regulation  407/2010  restricts  the  volume  of  outstanding  loans  or  credit  lines  to  the  margin 
available under the own resources (OR) ceiling. Indeed, the own resources decision limits the 
possibilities  for  the  EU  budget  to  call  for  own  resources  payments  from  Member  States 
equivalent  to  1.23%  of  EU  Gross  National  Income  (GNI).  To  be  absolutely  certain  that  the 
Commission will be able to call additional OR from Member States in case of a default on a 
guaranteed payment, the combined total of (i) the Multi-Annual Financial Framework (MFF) 
ceiling  for  payment  appropriations  (or  the  payment  appropriations  authorised  in  the  annual 
budget  if  already  known)  and  (ii)  the  total  amount  of  guaranteed  reimbursements  due 
(principal + interest) must not exceed 1.23% of EU GNI in any given budget year. 

At the time of the adoption of the Regulation, it was estimated that, with careful management 
of  the  repayment  schedules,  a  volume  of  up  to  EUR  60  billion  for  the  EFSM  could  be 
accommodated  below  the  OR  ceiling  in  addition  to  the  volume  of  EUR  35  billion  which 
remains available under the Balance of Payments facility.6 

The available margin under the OR ceiling has recently been re-evaluated based on the most 
recent  macro-economic  data.  There  is  no  reason  to  change  the  basic  assessment  which 
concludes  that,  with  careful  management  of  repayment  schedules,  both  the  EFSM  and  the 
Balance of Payments facility can still be fully accommodated below the OR ceiling. 

Actions taken in relation to the Commission's capacity to raise funds 

Actions  taken  in  relation  to  the  Commission's  capacity  to  raise  funds  have  included  (i)  a 
revision of the Euro Medium Term Note Programme (EMTN) and (ii) a confirmation of the 
Commission's highest possible investment rating. 

EMTN programme revised 

The European Union  and Euratom have  been issuing notes under the EMTN Programme in 
order  to  finance:  (i)  Balance  of  Payments  loans;  (ii)  macro-financial  assistance  to  third 
countries in accordance with Articles 212 and 213 of the Treaty on the Functioning of the EU; 
and (iii) Euratom loans for safety upgrades of nuclear power plants.  

In anticipation of possible increases in the EU's borrowing activity due to the establishment of 
the EFSM, the Programme Offering Circular has been amended accordingly and the amount 
of  the  Programme  has  been  increased  by  EUR  60  billion  to  a  total  of  EUR  80  billion.  If 
needed, the EMTN Programme can be further promptly increased to EUR 110 billion.  

6 

A  further  EUR  15  billion  under  the  BoP  regulation  has  already  been  allocated  as  external  financial 
assistance to Latvia, Hungary and Romania.  

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AAA rating of the EU confirmed 

Following  the  establishment  of  the  EFSM,  the  major  credit  rating  agencies  confirmed  their 
AAA rating on the EU and Euratom issuing notes and, at the same time, applied these ratings 
to the increased EMTN Programme7. 

There  are  many  important  features  that  have  enabled  the  confirmation  of  the  EU's  AAA 
rating. First, the EU is unconditionally committed to honouring its legal obligations towards 
its  lenders.  Second,  the  European  Commission  has  the  right  to  draw  on  Member  States' 
resources  to  ensure  that  sufficient  budget  revenues  are  available  at  all  times  to  cover  all 
obligatory  expenditures,  including  debt  servicing.  And  lastly,  Member  States  are  legally 
obliged to balance the EU’s budget, including debt-servicing. 

The  debt-management  practices  followed  by  the  EU  result  in  a  debt-servicing  profile 
(principal  and  interest  payments)  not  exceeding  the  fiscal  headroom  provided  by  the 
difference between the OR ceiling and annual budgetary payments. The outlook on the EU is 
stable,  reflecting  expectations  that  there  will  be  no  substantive  change  in  the  key  factors 
underpinning the ratings. In the opinion of the major credit rating agencies, solid support from 
Member States and the existing layers of debt-servicing protection are expected to continue to 
underpin –– the EU's very high credit standing. 

2.  ASSESSMENT  OF  CIRCUMSTANCES  JUSTIFYING  CONTINUATION  OF  THE 
EFSM  

The  financial  crisis  has  impacted  heavily  on  the  public  finances  of  Member  States  via 
financial support measures for the financial sector, a discretionary fiscal policy response and 
the operation of the automatic stabilisers. The combined effect has been a sharp widening of 
government budget deficits and a corresponding increase in public debt to GDP ratios. While 
the Member States are now working diligently to consolidate their public finances in line with 
commitments under the Stability and Growth Pact, significant tensions have emerged in euro-
area sovereign bond markets since mid-2009 as reflected in a substantial divergence in yields 
and CDS spreads, particularly for the peripheral Member States. Despite some improvement 
in  the  weeks  following  the  announcement  of  the  EFSM  and  EFSF,  market  conditions  have 
deteriorated again since mid-August, with yield and CDS spreads for the peripheral Member 
States  returning  to  levels  recorded  in  May  2010.  As  issuing  conditions  for  euro-area 
sovereigns remain stressed, it can be concluded that the market circumstances which justified 
the EFSM persist. 

Member States face significant financing needs 

Increased  borrowing  due  to  the  financial  crisis  has  been  reflected  in  higher  government 
financing  needs,  much  of  which  have  been  met  by  short-term  issuance.  Looking  forward, 
therefore,  it  is  clear  that  EU  governments  will  continue  to  face  substantial  financing 
challenges in the coming years.  

7 

See, for example, Standard & Poor's communication of 30 June 2010. 

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On 21 November Ireland requested financial assistance from the European Union and euro-
area  Member  States.  In  the  context  of  a  joint  programme  EU/IMF,  the  financial  assistance 
package to Ireland will be financed from the EFSM and the EFSF, supplemented by bilateral 
loans to be negotiated by EU Member States.  

also 

Chart  1.  Euro  area  governments  refinancing  needs 
(EUR bn, as of September 2010) 

In 2010, most euro area Member States have run high government deficits, which has led to a 
substantial increase in the total issuance of euro-denominated government bonds and a further 
accumulation of government debt. This overall increase in the supply of sovereign bonds has 
aggravated  difficulties  for  some 
smaller  issuers  in  accessing  the 
a 
market.  This 
implies 
continued  rollover  risk  for 
the 
future.  The  amounts  that  will  need 
to  be  raised  from  the  market  in 
2011  are  broadly  the  same  as  in 
2010, and they will remain at least 
that high for several years. Chart 1 
presents  the  amounts  of  euro  area 
government  bonds  outstanding  at 
the end of September and maturing 
over the next 20 years. 

200

300

400

500

600

100

-

In  this  situation,  many  Member 
fiscal 
States 
adopted 
have 
consolidation  measures 
to  be 
implemented  in  coming  years  in 
order  to  prevent  or  slow  down  a 
further  increase  of  the  government 
debt and its servicing cost. However, the refinancing needs of many Member States are likely 
to remain high as consolidation efforts only gradually feed through.  

Source: Bloomberg, EC calculations 

2019

2021

2023

2009

2013

2017

2027

2029

2011

2015

2025

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Issuing conditions have not yet normalised 

Tensions  in  the  euro-area  sovereign  bond  market  have  driven  government  yield  spreads  to 
record levels for some Member States. In May 2010, the yield spreads ranged between 25 and 
965 basis points to  German  Bund, a degree of divergence which is unprecedented since the 
creation  of 
the 
announcement of the EFSM and the 
EFSF, 
declined 
temporarily  but  have  since  widened 
again (see Chart 2). 

Chart  2.  Euro-area  10-year  government  yield  spreads  to 
German Bund 

the  euro.  After 

spreads 

yield 

Greece
Ireland

800

Portugal
Italy

600

400

Netherlands

bonds 

France
Finland

covered 

Spain
Belgium
Austria

In  addition  to  continuing  the  use  of 
monetary  policy  operations  such  as 
the 
purchase 
program 
(CBPP)  and  enhanced 
credit support measures,  tensions  in 
euro-area  sovereign  bond  markets 
prompted  the  ECB  to  launch  the 
Securities  Markets 
Programme 
(SMP)  in  May  20108  in  order  to 
"ensure depth and liquidity in those 
segments  which  were 
market 
an 
dysfunctional", 
"appropriate  monetary 
policy 
transmission mechanism". The ECB has since conducted interventions in the euro area public 
and private debt securities market by purchasing government bonds of specific Member States 
(see  Chart  3).  The  monetary  impact  of  these  bond  purchases  is  sterilised  by  conducting 
liquidity-absorbing operations so as to leave the monetary policy stance unaffected.  

0
Jan 08 May 08 Sep 08 Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10

Source: Bloomberg, EC calculations 

restore 

and 

200

of 

the 

via 

the 

scale 

Chart 3. ECB's Covered Bond Purchase Programme (CBPP) 
vs.  the  Securities  Market  Program  (SMP)  purchases  in  2010 
(in bn EUR) 

By 8 November 2010, the ECB had bought about EUR 64.2 billion of euro area government 
bonds 
SMP. 
(Disaggregation  by  type/country 
of  the  purchases  is  not  made 
public.)  The  ECB  has  been 
reducing 
its 
interventions over time, with no or 
to 
few  purchases  during  July 
to  calm 
September. 
renewed 
bond 
in 
volatility 
markets,  the  ECB  has  recently 
stepped 
its 
temporarily 
government 
purchases, 
bond 
buying bonds worth about EUR 2 
billion in the week ending October 
1st,  and  an  additional  EUR  711 

In  order 

0
Jan-10

up 

May-10

Sep-10

Nov-10

Mar-10

CBPP

Jul-10

SMP

R
U
E

)
n
b
(

60

70

50

10

20

30

40

Source: ECB, EC calculations 

8 

Decision  of  the  European  Central  Bank  of  14  May  establishing  a  securities  markets  programme 
(ECB/2010/5) (2010/281/EU)  

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million in the week ending November 5th. 

Competition for market-based financing likely to remain intense 

The increased refinancing needs of Member State governments in coming years will coincide 
with  similar  refinancing  needs  in  the  banking  sector  and  is  likely  to  ensure  intense 
competition for market-based funding. Significant rollover pressure will be felt through year-
end  2012,  with  around  EUR  1.8  trillion  of  EU  bank  debt  due  to  be  financed  in  the  next  24 
months. This near-term pressure can partly be explained by favourable interest rate conditions 
on  short-term  debt  and  the  significant  roll-over  of  bank  bonds,  including  those  with 
government guarantees.9 (see Charts 4, 5, and 6) An additional factor could be the increase in 
financing needs due to ongoing recapitalisation efforts. 

Chart 4. EU bank bond maturity profiles 
(EUR bn, in 12-month periods from 1 July 2010) 

Chart 5. EU bank debt maturing as % 
of total outstanding (from 1 July 2010) 

700

600

500

400

300

200

100

0

EA

UK

25

20

15

10

5

0

1

2

3
12-month periods

4

5

1

2

3

4

EA

UK

7

8

9

10

5

6

12-month periods

Source: IMF; EC staff calculations 

Source: IMF; EC staff calculations 

Commission calculations show that peak amounts of state-guaranteed bank debt are expected 
to mature in the fourth quarter of 2011 through the second quarter of 2012. Comparing charts 
5  and  6  illustrates  the  close  correlation  between  the  maturity  profiles  of  both  general  and 
guaranteed bank debt and highlights the periods that will be most challenging in the coming 
months and years.  

9 

Heavy  cumulative  issuance  by  banks  in  the  aftermath  of  the  crisis  means  that  approximately  50%  of 
currently outstanding bonds will mature in the next three years. 

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Chart 6. Maturity profile of EU bank debt issuance with government guarantee 

Amounts (EUR bn) 

Number of bonds 

120

100

80

60

40

20

0

120

100

80

60

40

20

0

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

2009

2010

2011

2012

2013

2014

2015

2009

2010

2011

2012

2013

2014

2015

Note: All bonds are considered to expire at the end of the maturity. No intermediate amortisations are considered. 

Source: Bloomberg; Commission staff calculations. 

At  the  same  time,  sovereign  risk  concerns  have  induced  a  "flight  to  quality",  prompting  a 
potential  decline  in  demand  for  bonds  issued  by  economies  with  high-risk  characteristics. 
This could create competition between high-risk sovereigns and AAA-rated, guaranteed bank 
debt  as  long  as  guarantees  remain  in  place.10  Although  guarantee  schemes  that  are  still  in 
place are set to expire on 31 December 201011, the Commission could grant extensions up to 
end-June 2011 (some schemes have already been prolonged) and possibly further if deemed 
necessary. During this time, severe market competition not only in terms of quality, but also 
in respect to quantity, is likely to be sustained. Competition will be particularly challenging in 
the period through year-end 2012 and again in 2014, as debt issuances with 1 to 3-year (the 
bulk) and 5-year maturities come due on both fronts. 

CONCLUSION 

The market situation requires maintaining a safety net 

This Communication describes some of the key challenges for Member State governments in 
financing their budget deficits as a result of the financial crisis and subsequent strains in the 
sovereign  debt  market.  The  European  Financial  Stabilisation  Mechanism  was  created  in 
response to the need for a policy instrument that would help  safeguard financial stability in 
the EU and euro area by alleviating market concerns about the EU's capacity to respond to a 
severe sovereign debt crisis. 

Ambitious  fiscal  reforms,  supported  by  external  financial  assistance  via  a  macro-economic 
adjustment  programme  in  the  case  of  Greece,  have  helped  contain  the  worst  of  the  market 
turmoil.  Nonetheless,  sovereign  risks  remain  elevated,  as  markets  continue  to  focus  on  the 
sustainability of public finances, with some governments having limited access to funding and 
rising costs.  

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Approximately 86% of the nearly EUR 600 billion in government guaranteed bank debt that was issued 
between  October  2008  and  December  2009  was  rated  AAA,  comprising  a  significant  portion  of  the 
totals that will come due through 2012. 
This would mean that when refinancing or in the event of a new issuance, such debt instruments would 
carry the rating of the banks themselves and no longer the rating of the sovereign guarantors.  

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In that context, a shift in investor perception seems to have taken place during recent months, 
with  tensions  in  sovereign  debt  markets  now  expected  to  persist  for  a  longer  period.  This 
revision in investor expectations reflects not only the scale of budgetary adjustment required 
in some Member States, but also the prospect of a relatively gradual economic recovery and a 
durably fragile banking sector. 

National and supranational financial backstops – including the EFSM and EFSF – have been 
established to prevent contagion and provide a critical line of defence. But these measures are 
temporary  and  must  be  combined  with  further  policy  action  in  order  to  rebuild  financial 
system resilience and resume normal market functioning. Current exceptional circumstances 
justify not only the creation of, but also maintaining such mechanisms in place for the time 
being,  as  illustrated  by  the  recent  Irish  request  for  an  EFSM  support.  Withdrawing  these 
backstops  too  early  or  too  abruptly  could  trigger  strong  market  reactions  and  reignite  a 
sovereign debt crisis. 

Against  this  background,  the  Commission  concludes  that  the  exceptional  events  and 
circumstances that justified the adoption of Regulation n°407/2010 establishing a European 
financial  stabilization  mechanism  still  exist  and  that  the  Mechanism  should,  therefore,  be 
maintained. 

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