2014

AN N U A L R E PO RT
EUROPEAN STABILITY MECHANISM

2014

AN N U A L R E PO RT
EUROPEAN STABILITY MECHANISM

2 | EUROPEAN STABILITY MECHANISM

Table of contents
Introduction to the ESM........................................................................................................................................................................................................................... 4
Message from the Managing Director ....................................................................................................................................................................................... 6
Letter of Transmittal to the Board of Governors ............................................................................................................................................................... 9
01. ECONOMIC DEVELOPMENTS ...................................................................................................................................................................................... 11
What have we learned from the euro area crisis? ...................................................................................................................................................... 12
Macroeconomic and financial environment ......................................................................................................................................................................... 20
Programme country experiences ................................................................................................................................................................................................. 26
02. ESM ACTIVITIES ........................................................................................................................................................................................................................... 37
Lending activities......................................................................................................................................................................................................................................... 40
Funding activities......................................................................................................................................................................................................................................... 45
Investment and Treasury ..................................................................................................................................................................................................................... 50
Risk management ...................................................................................................................................................................................................................................... 53
Communications .......................................................................................................................................................................................................................................... 60
03. INSTITUTIONAL FRAMEWORK AND ORGANISATION ......................................................................................................................... 63
Governance ...................................................................................................................................................................................................................................................... 69
Board of Governors .................................................................................................................................................................................................................................. 72
Board of Directors .................................................................................................................................................................................................................................... 74
Board of Auditors ....................................................................................................................................................................................................................................... 76
Organisation .................................................................................................................................................................................................................................................... 78
04. FINANCIAL REPORT................................................................................................................................................................................................................. 85
Financial Statements ............................................................................................................................................................................................................................... 87
05. EXTERNAL AUDITOR’S REPORT ON THE 2014 FINANCIAL STATEMENTS.............................................................116

06. REPORT OF THE BOARD OF AUDITORS ON THE 2014 FINANCIAL STATEMENTS ........................................118
Acronyms and abbreviations ........................................................................................................................................................................................................ 120

ANNUAL REPORT 2014 | 3

Boxes
Current euro area policy toolbox would have made crisis milder..................................................................................................................... 16
Impact of EFSF lending on bond markets .............................................................................................................................................................................. 17
How Greece benefitted from European debt relief........................................................................................................................................................ 29
How macroeconomic imbalances are being corrected ............................................................................................................................................ 33
ESM launches first technical assistance project ............................................................................................................................................................ 34
How the ESM processes its financial transactions ...................................................................................................................................................... 38
How the cost of funding is calculated....................................................................................................................................................................................... 43
ESM enjoys robust credit ratings ................................................................................................................................................................................................. 49
Negative yields present new challenge to safeguarding capital......................................................................................................................... 52
ESM’s financial assistance toolkit ................................................................................................................................................................................................. 64
ESM develops last resort tool for Banking Union........................................................................................................................................................... 66
Regional financial institutions – ESM is the biggest by far ..................................................................................................................................... 67
ESM establishes Administrative Tribunal to decide on staff employment matters ........................................................................... 83
ESM appoints first staff representatives ............................................................................................................................................................................... 84

Spotlight
Throughout the report, we have spotlighted the views of each of the Finance Ministers of the euro area Member
States. These quotes relate to the ESM and its role, not to the text of the pages on which they appear.

4 | EUROPEAN STABILITY MECHANISM

INTRODUCTION TO THE ESM

The European Stability Mechanism (ESM) is a permanent crisis
resolution mechanism established by the euro area countries. The
ESM’s mission is to provide financial assistance to ESM Members
experiencing or threatened by severe financing problems to safeguard
the financial stability of the euro area as a whole and of its Members.
The Luxembourg-based ESM raises funds by issuing debt instruments,
which are purchased by institutional investors. The proceeds enable
the intergovernmental institution, in operation since 8 October 2012,
to provide its Members the following types of financial assistance:
• loans to cover their financing needs;
• loans and direct equity injections to recapitalise financial institutions;
• credit lines to be used as precautionary financial assistance;
• primary and secondary debt market purchases of Member States’
national bonds.
ESM financial assistance is linked to beneficiary Member States
addressing weaknesses in their economies through reforms which
are jointly agreed by that Member, the European Commission, in
liaison with the European Central Bank and, where applicable, the
International Monetary Fund.
More information about the ESM can be found on our website:
www.esm.europa.eu.

Note: The 2014 ESM Annual Report contains the Financial Statements for the
financial year ending 31 December 2014, together with the report of
the external auditors in respect of their audit concerning these Financial
Statements, and a report of the Board of Auditors in respect of these
financial statements.
The description of the policies and activities of the ESM includes certain
information available as of 20 May 2015 but all historic financial data is
limited to the period up to 31 March 2015.

6 | EUROPEAN STABILITY MECHANISM

Klaus Regling
Managing Director
European Stability Mechanism

Message from
the Managing Director
The euro area as a whole put the crisis largely behind
it in 2014. Positive developments were particularly
marked in Cyprus, Ireland, Portugal, Spain and – at
least until autumn 2014 – in Greece, the five euro
area countries that have benefitted from financial
assistance in a European Stability Mechanism (ESM)
or a European Financial Stability Facility (EFSF) programme. Between December 2013 and May 2014,
Spain, Ireland, and Portugal successfully exited their
programmes and regained the investor confidence
that they had lost. Greece was able to tap the bond
market in mid-2014. But problems remain, with concerns particularly focused on Greece. Despite achievements early in the year – an improving economic
performance and policy reforms adopted – by autumn,
Greece had lost cautious recognition from financial
market participants. It must now find a credible way
forward to restore market trust. Overall, however, the
euro area prepared the ground for sustainable growth
in the future.

The ESM and EFSF approach prompted remarkable
improvements in the programme countries: both institutions provide loans at very favourable conditions to
countries that are no longer able to finance themselves
on the markets at reasonable rates. The assistance is,
however, conditioned on strict reform implementation.
To receive the advantageous ESM and EFSF loans, beneficiary countries must make their economies competitive, consolidate budgets, and stabilise financial sectors.
Independent international assessments confirm that
this strategy is working. According to the Organisation
for Economic Co-operation and Development’s Going
for Growth report, Greece, Ireland, Portugal and Spain
were four of the top five most reform-minded countries
in the entire OECD area in 2014. The World Bank’s
Doing Business Survey showed that Greece had made
the biggest leap forward in 2014 among all the countries examined in a ranking that measures the ease
of starting and operating a local business. Provided

ANNUAL REPORT 2014 | 7

the reform momentum is sustained, the former crisis
countries are thus likely to become reform champions
with excellent economic prospects.
The favourable ESM and EFSF lending conditions
are an impressive act of solidarity among euro area
Member States. The combination of loans at very
low interest rates and with unusually long maturities
ensures significant annual budgetary savings for all
the programme countries. Thanks to these ESM and
EFSF programmes, the other euro area Member
States can show solidarity towards the beneficiary
countries without any direct cost to their taxpayers.
The ESM and EFSF help the beneficiary countries to
improve their ability to service their debt. The ESM
shareholders, for example, twice accepted Spain’s
voluntary early repayment of its loan without burdening the country with any significant cost. In a similar
spirit of long-term partnership, the EFSF shareholders
accepted Ireland’s and Portugal’s decisions to reduce
their debt burden by repaying parts of their more
onerous International Monetary Fund (IMF) loans
early. The EFSF shareholders could have asked for
a simultaneous early repayment of the EFSF loan,
which has much more advantageous terms, from
both countries. It refrained from doing so, however, in
order to continue to support them, thus strengthening
their debt sustainability.
Despite uncertainties about Greece, the euro area
has become a stable and much better functioning
currency union. Lithuania underlined its attractiveness
by joining monetary union in 2015 as the 19th country
to adopt the euro. As a result, Lithuania also became
the 19th Member of the ESM. Since the establishment
of the ESM in October 2012, the Baltic state has
become the second new Member to join, following
neighbour Latvia in 2014.
The euro area’s improved fitness stems from determined reform implementation in the programme countries, better economic and fiscal policy coordination at
the European level, a robust monetary policy response
to falling inflation, and a stronger banking system. The
establishment of the Banking Union with a European
supervision of systemic banks under the auspices of
the European Central Bank (ECB) strengthened the
euro area’s foundations.
The crisis both exposed the institutional weaknesses
of the original Economic and Monetary Union and

prompted policy makers to remedy them. In a particularly important step, they established the ESM as the
euro area’s permanent crisis resolution mechanism. It
has a maximum lending capacity of €500 billion, more
than €450 billion of which is still available.
One of the building blocks of Banking Union is the
ESM Direct Bank Recapitalisation Instrument for
euro area financial institutions. Since its adoption in
December 2014, the ESM can recapitalise systemic
and viable banks directly as a last resort measure
based on a unanimous decision among euro area
Member States. Under specific circumstances, the
ESM could use this instrument with up to €60 billion
to safeguard financial stability in the currency union
and to contribute to severing the vicious feedback-loop
between sovereign debt and the banking sector.
The ESM and EFSF can only grant loans to euro area
Member States in a crisis if the two institutions have
raised the money previously on the markets. In 2014,
as in 2013, the two institutions combined were the
fifth largest issuer of euro bills and bonds in the euro
area after Germany, France, Italy, and Spain. Although
the issuing volumes will decrease, the ESM and EFSF
will remain within the ranks of significant euro area
issuers for a long time.
The ESM and EFSF are long-term partners of the
programme countries. With the unusually long maturities of our loans at very low interest rates we will
accompany them for decades to come. In the context
of the Early Warning System, the ESM’s shareholders
have tasked it with monitoring its debtors’ ability to
reimburse ESM loans until they have been fully repaid.
As the largest or one of the largest creditors of the
programme countries our interests are aligned with
theirs. Just like the programme countries we are looking for sustainable economic development that allows
for long-term success so that we can be confident
that the ESM will be repaid in full.
While progress at the national and European level has
reduced the vulnerability and increased the robustness
of the currency union, there is still a need to improve
the euro area’s governance further. To drive this
process forward, the Heads of State and Government
have tasked the Presidents of the Commission, the
European Council, the ECB, and the Eurogroup to put
forward proposals. As the sole institution dedicated
to the euro area alone, the ESM fully supports this
initiative to make the monetary union more resilient.

8 | EUROPEAN STABILITY MECHANISM

ANNUAL REPORT 2014 | 9

Letter of Transmittal
to the Board of Governors
18 June 2015

Dear Chairperson,

I have the honour to present to the Board of Governors the Annual Report in respect of the
financial year 2014, in accordance with Article 23 (2) of the By-Laws of the European Stability
Mechanism (By-Laws).
The Annual Report includes a description of the policies and activities of the European Stability
Mechanism (ESM) during 2014. It also contains the audited Financial Statements as at
31 December 2014, as drawn up by the Board of Directors on 25 March 2015 pursuant to
Article 21 of the By-Laws which are presented in Chapter IV. Furthermore, the report of the
external auditor on the Financial Statements is presented in Chapter V and the report of the
Board of Auditors on the Financial Statements in Chapter VI. The independent external audit was
monitored and reviewed by the Board of Auditors as required by Article 24 (4) of the By-Laws.

Klaus Regling
Managing Director

10 | EUROPEAN STABILITY MECHANISM

ANNUAL REPORT 2014 | 11

01.
ECONOMIC
DEVELOPMENTS

12 | EUROPEAN STABILITY MECHANISM

What have we learned
from the euro area crisis?

Today, the worst of the crisis is over and Europe is
making its way along a slow, yet sustainable, path
to recovery. This is a good time to reflect on what
lessons can be drawn from the crisis, to understand
whether the economic policies deployed are enough to
prevent future crises.
The great European recession revealed economic and
financial vulnerabilities and institutional weaknesses in
the monetary union’s design. National and European
policy makers reacted to the erupting crisis by rapidly
devising solutions. When rescue measures failed to
achieve the desired result, policy makers fine-tuned
and complemented them, eventually reversing market
sentiment and starting the recovery. As we reach the
middle of 2015, the recovery, which still needs to
gain pace, faces downside risks, mostly geopolitical.
In addition, Europe must address the crisis’ remaining
fallout, especially the high unemployment rates a number of countries face.
Still, with the worst behind it, now is a good point
for Europe to take stock of the lessons learned and
consider the next steps to build a yet more robust
monetary union able to withstand future shocks.

KEEPING COMPETITIVENESS ALIGNED
A crucial lesson from the crisis is that countries in
a monetary union cannot sustain large divergences
in competitiveness over an extended period. As the
development of unit labour costs in the five countries
that later entered into an EFSF or an ESM programme
shows, costs rose significantly in comparison to the
rest of the euro area. This resulted in a significant
loss of competitiveness in the programme countries
that translated into large current account deficits
and an increasingly negative international investment
position. This needed to be reversed, either on the
back of macroeconomic reforms linked to financial
assistance programmes or, as in the case of Spain,
through a reform agenda developed independently to
tackle past imbalances.
In economies outside a monetary union, exchange
rate adjustments can resolve these misalignments. In
the euro area, such an adjustment had to be achieved
in part domestically through socially and politically
painful expenditure cutting. Opening and liberalising
product and labour markets to increase and improve
labour productivity has proven to be key. Indeed,

the countries with programmes in place have implemented substantial reforms. In its Going for Growth
survey, the Organisation for Economic Co-operation
and Development (OECD) ranks the reform efforts of
its 34 member states. Among the top five countries,
four underwent an EFSF or ESM programme. The
crisis experience has amply demonstrated that
a comprehensive reform of product and labour markets supports investment and exports, and therefore
facilitates rebalancing and growth.
Pursuing structural reforms is a difficult process,
as governments need to take on vested interests.
The European experience also shows that internal
adjustments through wage and price corrections are
feasible, contrary to what many observers argued
at the time. All countries under EFSF and ESM programmes have dramatically reversed the previous
trend of decreasing competitiveness and are closing
the gap vis-à-vis core countries.

ENSURING PRUDENT FISCAL POLICY
IN GOOD TIMES
Another important lesson concerns fiscal policy. The
crisis underscored the need to pay sufficient ongoing
attention to the sustainability of public finances, even
as economies are growing strongly. When the crisis
worsened, the market had already discounted earlier
consolidation efforts as insufficient, with a resulting and
instantaneous widening in market interest rate spreads
to those of core country debt. Although Greece faced
the most severe fiscal problems, all programme countries reined in public spending, changed tax legislation,
and tightened administrative procedures to increase
revenues. Thus, sound fiscal policies and constant
budgetary development monitoring are fundamental,
especially during the expansionary part of the cycle.
A corollary from the previous two lessons is that
prudent fiscal policy and structural reforms are complementary. In the face of fears of low future growth,
so-called secular stagnation, budgetary sustainability
will result in higher and more stable long-run growth
only if accompanied by structural reforms.

DEEPENING EUROPEAN GOVERNANCE
The crisis revealed that euro area economic governance was not strong enough, particularly for crisis

ANNUAL REPORT 2014 | 13

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Jeroen Dijsselbloem
The Netherlands

As the Chairman of the Board of
Governors I can confidently say that
the ESM has become an effective
crisis resolution mechanism and
I am convinced that the ESM will
play an important role in the
financial stability of the euro area in
the years to come.

“

prevention and financial crisis management. As an
example, it became evident early on in the crisis that
Greek fiscal statistics were not reliable. Member
States reacted by increasing Eurostat’s powers to
scrutinise national statistics. More broadly, they found
it necessary to create stricter debt and deficit rules,
curb the room for political interference, and, in the
absence of joint decision making, introduce balanced
budget rules in the national legal systems. These
procedures, designed to correct macroeconomic
imbalances, also significantly improved economic
policy coordination in the currency union.
All in all, the euro area leaders treated the crisis as
an opportunity to take a quantum leap in European
integration. They strengthened the fiscal rules, initiated surveillance of macroeconomic imbalances, and
established advance coordination of economic policy
through the ’European Semester’. These changes
allow for a comprehensive crisis response without
altering the EU Treaties. With them, Europe embarks
on a new model of economic governance characterised by better policy coordination.

CREATING A LENDER OF LAST
RESORT FOR CRISIS RESOLUTION
Another important lesson from the crisis concerns
the lack of a lender of last resort for governments
within monetary union. When the euro area was set
up, it was taken for granted that Member States

would not lose market access or investor confidence
and, thus, the ability to roll over maturing debt and
finance additional fiscal expenditures at sustainable
rates. The fiscal framework was seen as sufficiently
strong to prevent such situations.
While the ECB played a very active role during the
crisis, and stepped in through several targeted policy
initiatives, it could not take on the role of a lender
of last resort for governments. According to the EU
Treaties, the ECB is not allowed to engage in monetary
financing of state budgets. This is a crucial ingredient
to preserve independent central bank action, maintain
low inflation in the monetary union, and pre-empt
excessive fiscal largesse. Therefore, a new institution
had to play this role. Here as well, the leaders learned
by doing, and improved upon their initial urgent
response by creating, first, the EFSF as a temporary
crisis resolution mechanism and, subsequently, the
ESM as a permanent institution.
At first, the EFSF and ESM lending toolbox mirrored
that of the IMF and the EC. By drawing ongoing lessons
from the evolving crisis, the EFSF and ESM redefined
their lending terms and approach, leading to a new
paradigm of sovereign lending. They dropped the initial
framework, which included a high margin, because
it undermined sustainability and market access. The
political costs turned out to effectively deter the ’moral
hazard’ problem. Financing costs fell to very low levels.
Maturities became very long, stretching from an average of 12.5 years for the Spanish facility to more than

14 | EUROPEAN STABILITY MECHANISM

32 years for the Greek one. (The boxes on the ‘Impact
of EFSF lending on bond markets’ and on ‘How Greece
benefitted from debt relief’ explain these financing
conditions in more detail.) This new approach eased
the programme countries’ fiscal burden and facilitated
their renewed market access at affordable costs.
EFSF lending terms helped programme countries
reduce uncertainty, enabling them to regain access to
capital markets. Today, with over €450 billion available
for support, the ESM continues to help sustain the
confidence of investors and credit agencies, contributing to the stability of the sovereign bond markets.
Looking back, the EFSF and ESM firewall turned
out to be indispensable to overcoming the crisis.
By end-2014, €233 billion had been disbursed to
five countries in under four years. This is three times
as much as the IMF disbursed globally in the same
period. Without the EFSF and the ESM, some euro
area Member States would today likely no longer be
part of the monetary union. Their departure would not
only have posed a huge risk with enormous potential
cost for the country concerned, it would also have
changed the Europe that we know.

FORTIFYING THE FINANCIAL SYSTEM
Already at a fairly early stage of the crisis, European
policy makers recognised the insufficiency of existing
supervision to stem systemic crises and the need to create common supervision standards across Europe and
financial industries. Policy makers created new European
supervisory authorities for banks, insurance companies,
capital market instruments, and rating agencies. The
European Banking Authority drew up a ‘single rule-book’
for European banks, aiming to make the banking system
safer. The European Systemic Risk Board was put in
place to monitor macroprudential risks.
Despite these earlier efforts, lending rates across
countries remained disparate and monetary policy
easing was not effectively transposed into better
lending conditions and credit. Further policy action
was needed, in particular a more comprehensive
approach which ultimately resulted in the multi-layered
Banking Union project.
A European supervisory and resolution structure was
adopted. The Single Supervisory Mechanism (SSM) can
thoroughly supervise banks operating cross-border in
Europe. To assess their strength, the SSM conducted
an initial balance sheet assessment of all the 130 biggest banks it supervises. The banks passed the assessment with limited additional capital requirements.
Moreover, policy makers recognised that banks had
to become better capitalised. The EC estimates
that, between 2008 and 2014, overall bank capital
increased by €560 billion, using primarily private but
also public capital.

At the same time, the impact of the direct and indirect
costs of the bank rescues on European taxpayers
forced a change of paradigm in bank resolution. In one
of the crisis’ most visible lessons, it became clear that
future public sector involvement needed to be capped.
Instead, authorities had to create a system under
which bank creditors would systematically share this
burden. The so-called ‘bail-in’ of the private sector in
these operations increasingly became the approach
used to share losses caused by bank failure. Authorities
have already used bail-ins several times, sparing
public resources in bank recapitalisation or resolution
plans. Bail-ins provide greater market discipline and
force investors to scrutinise their decisions more.
In addition, the Single Resolution Mechanism (SRM)
started its work. Depending on the entry into force of
the intergovernmental Agreement on the transfer and
mutualisation of contributions to the Single Resolution
Fund (SRF), the SRM is expected to be in full force
as of 1 January 2016, when the SRF and the new
bail-in regime become fully applicable. Together, the
SSM and the SRM can address problems emerging
in the banking system efficiently and comprehensively.
They will become the backbone of a more integrated
post-crisis European banking market and contribute to
a better functioning monetary union.

DETERMINING THE NEXT STEPS
A policy response to a crisis is often not the result
of standard decision-making procedures. Policy
makers need to take short-term decisions under
intense pressure. Their challenge was to frame the
immediate crisis response within a wider far-reaching
reform process, which should outlive this crisis and
help prevent the next.
In the end, the policy strategy devised to address the
crisis has proven effective.
It employed structural reforms and growth-enhancing
measures to reduce macroeconomic vulnerabilities.
Additionally, measures to strengthen the resilience of
the banking sector took effect and will create a more
solid and better-integrated European financial system.
Important reforms to reinforce euro area economic
governance were adopted, including strengthening
the fiscal framework and extending surveillance to
macroeconomic imbalances. Last but not least, policy
makers deployed crisis resolution support to ease
economic hardship. Overall, Europe not only successfully addressed the crisis, it also enhanced policy
coordination in ways not considered possible before.
In addition, European policy makers provided significant resources to support investment in long-term
growth. Most recently, the EC launched the ‘Juncker
plan’. Jointly with the European Investment Bank (EIB),
the EC aims to facilitate more than €300 billion in new
investment, and propose policy reforms to overcome

ANNUAL REPORT 2014 | 15

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

“

Johan Van Overtveldt
Belgium

For the economic recovery to
be strong and sustainable,
confidence is the overwhelming
determining factor. For
confidence to gain traction within
the euro zone, a well-performing
ESM is of the highest necessity.

“

investment barriers. Still, a number of challenges
for sustained growth lie ahead. Reducing high debt
levels in the public and private sector and addressing
the effects of an ageing population, likely to constrain
growth, will remain key challenges to be dealt with
in the coming years. Building a resilient European
financial system, able to provide growth financing, will
require further policy action.
The upcoming Four Presidents Report1 will discuss the
next steps to improve growth prospects and enhance
the euro area’s resilience, making proposals to the
Heads of State or Government. The ESM, as the sole
euro area institution, will make a contribution to the
subsequent debate.

1

The Four Presidents’ report on Economic and Monetary Union is
being prepared by the Presidents of the European Council, the European Commission, the European Central Bank and the Eurogroup
for the June 2015 European Council.

Europe has come a long way, and monetary union is
now more robust and resilient to external shocks.
But not all the lessons of the crisis have yet been
fully addressed. A number of challenges for sustained
growth lie ahead: responding to ageing populations,
unwinding high debt levels, and implementing economic reforms to improve low growth prospects. In
the short run, geopolitical factors, frictions in the euro
area and economic changes can lead to economic and
financial volatility. There is thus scope for the euro
area to further strengthen its resilience.
Europe cannot wait for the next crisis to discover,
again, how it should have been better prepared.

16 | EUROPEAN STABILITY MECHANISM

CURRENT EURO AREA
POLICY TOOLBOX
WOULD HAVE MADE
CRISIS MILDER
The recent improvements in euro area governance,
if agreed and implemented before 2007, would not
have prevented the global financial crisis, but they
would have reduced home-made vulnerabilities and
rung the alarm bells much sooner. The following list
of crisis-prompted changes explains how their earlier
adoption would have made the crisis milder and
shorter.

• Financial assistance would have reached beneficiary
Member States faster, had the EFSF and ESM
existed earlier. Investors would then have considered the crisis response more credible, dissuading
some from short-selling and tempering the resulting
turmoil.

• The rising Greek budget deficit, which ultimately
reached 15.6%, would have been detected much
earlier had Eurostat’s powers been strengthened
sooner, entitling it to examine Member States’
public accounts.

• The problems in certain large institutions, particularly in Ireland and Cyprus, could have been tackled
sooner, had Banking Union already been in place.
It would also have improved crisis coordination.
The new bail-in rules of the Bank Recovery and
Resolution Directive would have protected public
accounts better.

• The real estate bubbles in Ireland and Spain might
have been detected earlier, had the new European
Systemic Risk Board already existed. It could have
provided the relevant authorities with recommendations for early corrective action.

• The fiscal rules could have been enforced more
effectively in all Member States, had the Stability
and Growth Pact been reformed earlier. This
would have sent a more decisive signal about their
strictness.

• The large current account imbalances that
emerged in the middle of the last decade would
have been identified earlier, had the new Excessive
Imbalances Procedure already been introduced.

Despite the reforms the euro area will continue to
be affected by external shocks and potential policy
missteps, but the reforms could have shortened and
moderated the crisis that the euro area experienced.

ANNUAL REPORT 2014 | 17

IMPACT OF
EFSF LENDING
ON BOND MARKETS

Since the outbreak of the global financial crisis, fiscal and
monetary authorities have employed a wide range of policies
to overcome it. Central banks embarked on quantitative
easing exercises, while fiscal accommodation helped sustain activity and refloat banks’ balance sheets. In the euro
area, Member States themselves made considerable fiscal
efforts, while the area and the EU as a whole provided significant funds as fiscal assistance via the EFSF, the European
Financial Stabilisation Mechanism, and the ESM.
To make sense of these measures, central banks and fiscal
authorities have analysed their effects, helping policy makers
understand whether the various policies adopted worked or
not. Remarkably, there has been no systematic analysis to
date of the impact of EFSF financing on the affected economies. The structure and condition of EFSF loans underwent
various changes over time, with maturities extended and
margins reduced in an attempt to help relieve the beneficiary
Member State’s debt servicing burden. This analysis focuses
on Ireland and Portugal and excludes Greece, whose original programme did not include the EFSF. The progressive
changes undertaken modified the countries’ debt servicing
profiles, helping improve market access for both Ireland and
Portugal and reducing sustainability concerns.

EVOLVING TERMS AND CONDITIONS OF
EFSF LOANS TO IRELAND AND PORTUGAL
In December 2010, Ireland agreed a financial package
of €85 billion, made up of €17.5 billion in own resources
and €67.5 billion in external resources. The EFSF provided
€17.7 billion. Originally, the EFSF loan to Ireland carried
a margin of 247 basis points over the EFSF’s funding costs
with a maximum average maturity of 7.5 years. Subsequently,
the loan underwent a series of incremental changes. In
July 2011, it was agreed that Ireland would benefit from
a reduction of the loan’s margin to 0 and an extension of
the average maturity to 15 years. Some two years later,
Member States agreed to lengthen the weighted average
maturity further, to up to 22 years from 15. These measures
aimed at supporting Ireland’s efforts to regain full market
access. Portugal in turn entered its EFSF programme in
May 2011. The size of the financial assistance package
was €78 billion, of which the EFSF disbursed €26 billion. At
the programme’s outset, Portugal agreed to pay a margin
of 208 basis points, with a maximum average maturity of
7.5 years. In parallel with the decisions on Ireland, Members
decided to align Portugal’s loan conditions with those already
granted to Ireland. The maturity was extended to 15 years

and the margin reduced to 0 basis points. Finally, Portugal
received an additional seven-year maturity extension, of up to
22 years, in March 2013, also in line with Ireland.

EFFECTING CHANGE: A CASE-STUDY
OF THE IMPACT OF EFSF LOAN TERMS
ON BOND MARKETS
To study, in an informative and simple way, whether the various
changes to the conditions of the EFSF loans to Ireland and
Portugal had a meaningful impact on debt markets, the analysis compares the behaviour of various debt market indicators,
before and after the announcement of the changes in the
terms and conditions of the loans.2 More specifically, it looks
at the effect on secondary markets, focusing on the secondary market for sovereign debt, and assesses the dynamics of
yields and market liquidity as measured by the bid-ask spreads.
Given that maturity extensions work by shifting repayments
into the future, thus opening a window of opportunity for market financing, the effect of the extension should differ across
maturities. This analysis considers the behaviour of 3-, 5- and
10-year maturities to check whether this is the case.
To illustrate the yield curve changes following the contract
amendments, Figure 1 displays the yield curve dynamics
around the set of loan changes. Figure 2 shows the changes
in market liquidity, reflected in the movements of the bid-ask
spreads three months after the announcement. Again, the
information is presented by maturity. Before the July 2011
maturity extension and margin reduction, Ireland was facing
substantial stress, with the yield curve inverted and 3-year
yields averaging 16.47%. The upper-left panel in Figure 1
shows that the change announcement had a strong and
long-lasting positive effect on the yield curve’s evolution. After
just one month, all yields had fallen. After three months,
all yields had declined even further and the yield curve had
flattened. In another sign of the loan amendments’ beneficial
effect, the bid-ask spreads at all maturities narrowed after
the change (Figure 2). As with yields, the largest drops
occurred in the 3- and 5- year maturities. In theory, the relief
should have been felt most at those maturities, given that
the 7.5-year extension’s aim was to provide cash flow relief
beyond that period. The maturities benefiting most were,
indeed, those below the 7-year threshold, indicating that the
measure delivered the expected benefits.
2 There is an important caveat to this approach. One has to control for other shocks that occur simultaneously and could also explain the observed
dynamics. None of the ECB operations took place at the same time as
the changes on the EFSF loans.

18 | EUROPEAN STABILITY MECHANISM

Figure 1. Yield curve dynamics around loan changes
Portuguese yield curve
(21 July 2011 change)

Irish yield curve
(21 July 2011 change)
Yield

Basis points

Yield

Basis points

18%

2,000

18%

2,000

1,600

16%

16%
Pre-announcement

14%
12%

1,600
After 3 months

1,200

14%

500

12%

Pre-announcement

1,200
500

After 1 month

After 1 month

400

10%

8%

0

8%

0

6%

-400

6%

-400

-800

4%

10%

After 3 months

4%
3y

5y

10 y

3y

5y

400

10 y

-800

Change in the corresponding yield after 1 month from the announcement (right axis)

Change in the corresponding yield after 1 month from the announcement (right axis)

Change in the corresponding yield after 3 months from the announcement (right axis)

Change in the corresponding yield after 3 months from the announcement (right axis)

Irish yield curve
(16 March 2013 change)

Portuguese yield curve
(16 March 2013 change)

Yield

Basis points

Yield

6.5%

220.0

6.5%

Basis points
220.0
After 1 month

5.5%

176.0

5.5%

176.0
Pre-announcement

4.5%

132.0

4.5%

132.0

Pre-announcement

After 3 months

3.5%

88.0

3.5%

88.0

44.0

2.5%

44.0

0.0

1.5%

0.0

-44.0

0.5%

After 3 months
2.5%
1.5%

After
1 month

0.5%
3y

5y

10 y

Change in the corresponding yield after 1 month from the announcement (right axis)
Change in the corresponding yield after 3 months from the announcement (right axis)

-44.0
3y

5y

10 y

Change in the corresponding yield after 1 month from the announcement (right axis)
Change in the corresponding yield after 3 months from the announcement (right axis)

Note: Each graph corresponds to the behaviour of the yield curve after specific changes. The July 2011 changes correspond to a maturity extension
and an interest rate reduction. The March 2013 changes correspond to a maturity extension.
Source: Bloomberg

Finally, in March 2013, when the second maturity
extension was approved, Ireland was already enjoying
significantly lower yields. Still, following the announcement, yields on the 3- and 10-year fell further
(lower-left panel in Figure 1). Bid-ask spreads barely
changed, reflecting the successful normalisation of
the Irish bond market.

Similarly, by the time of the first loan modification in
July 2011, Portuguese yields had risen (16.46% on
the 3-year). As the upper-right panel on Figure 1 shows,
following the announcement of the loan changes, the
yield curve shifted down, especially in the shorter
maturity. While the improvement partly reversed in the
subsequent two months, these dynamics confirm that,

ANNUAL REPORT 2014 | 19

Figure 2. Changes in bid-ask spreads following the loan amendments

Portugal

5

15

0

10

-5

5
Basic points

Basic points

Ireland

-10

0

-15

-5

-20

-10

-25

-15

July 2011

March 2013
3y

5y

10y

July 2011

March 2013
3y

5y

10y

Source: Bloomberg

as in the Irish case, the maturity extension provided
a temporary period of reduced sustainability concerns.
Reflecting the limited effect of this first contract
amendment, the bid-ask spreads failed to react positively to the announcement (Figure 2). At the time of
the last maturity extension in March 2013, Portugal
was already facing lower yields, thanks to its good performance under the programme and the ECB’s policy
measures. While immediately after the announcement
only the 3-year yield fell, after three months, the entire
yield curve was well below the pre-announcement
level (Figure 1, lower-right panel). Moreover, bid-ask
spreads narrowed by about one third of their pre-announcement value, further evidence of the secondary
market’s return to normal (Figure 2).
The benefits of the maturity extensions also translated into improved rating agency assessments. The
2013 announcements on EFSF loan maturity changes
exerted the most significant ratings impact. Shortly after

their announcement, Moody’s published a dedicated
rating commentary saying that the extensions were
credit positive for the two countries. Later in 2013,
Moody’s took positive rating actions on both sovereigns,
identifying the maturity extension explicitly as one of the
reasons for the improved liquidity position, which led to
the favourable assessment. S&P also mentioned the
reduction in near-term financing needs and the overall
improvement of the sovereign’s financing profiles when it
took positive rating actions in 2013 and 2014.
The analysis shows that the changes to the EFSF
loans had a material impact on investors’ and rating
agencies’ perception of the countries’ ability to service
their outstanding debt. This finding has important
implications. By providing cheaper and longer-term
financing, the EFSF operations create room for
market financing. Moreover, the substantially lower
medium-term debt-servicing burden that the EFSF
loans deliver reduces the short-term sustainability risk.

20 | EUROPEAN STABILITY MECHANISM

Macroeconomic and
financial environment

In 2014, euro area economic growth sustained its
slow but steady rise, maintaining the course set out
at the end of the previous calendar year. Domestic
activity bolstered the improvement, with household
spending making the most notable contribution. Still,
the improved average gross domestic product (GDP)
masked Member States’ diverging national growth
rates. And, despite the positive growth trend, inflation
decelerated, driven by falling global energy prices
towards the end of the year. The overall fiscal stance
of the euro area became clearly less restrictive with
monetary policy easing further given low inflation.
The major themes in the financial markets throughout
the year were the divergence in monetary policies
across major economies and future expectations
of such divergence. Escalating geopolitical tensions
and concerns about a potential global health scare
in the early part of the year raised doubts about the
robustness of the recovery. An unexpected collapse
in oil prices in the second half of the year improved
the outlook for oil-importing regions such as the
euro area. As a result of the oil price collapse, lower
inflation set the stage for expectations of additional
ECB measures. Towards year-end, Greece burst to
the forefront of euro area concerns, rekindling old
anxieties.

DIVERGING PATTERNS ACROSS
THE GLOBE
World economic output continued to grow in 2014.
Macroeconomic data showed developed economies
diverging, with the United States (US) and the United
Kingdom (UK) improving while Japan lagged. US concerns on the slack in the economy delayed the timing
of the Federal Reserve’s expected first rate hike in this
cycle, while the Bank of Japan, attempting to foster
economic growth, stepped up its very accommodative
monetary policy stance.
In emerging markets, the fall in oil and commodity
prices undermined the economies of net oil-exporting
nations, like some countries in Latin America and the
Middle East as well as Russia. Geopolitical tensions in
some of these countries, like Ukraine and Russia, also
lowered economic performance over the year. China’s
growth continued its moderate path, mostly due to the
rebalancing of its growth model, which requires some
price declines in real estate, credit, and investment
markets. Ongoing structural reforms, coupled with

lower oil prices and a buoyant US recovery, should
support Chinese domestic consumption and growth
perspectives. In contrast, other emerging economies
such as India performed better than expected in 2014.

ANTICIPATING MONETARY EASING:
EURO AREA FINANCIAL MARKETS
Consumer prices extended their 2013 deceleration
throughout 2014. In June, spurred by concerns about
low inflation rates and in particular low credit growth to
households and non-financial corporations, the ECB cut
its key rates and introduced another easing initiative,
Targeted Longer-Term Refinancing Operations (TLTRO),
which it planned to conduct later in the year.
Later in the summer the spectacular drop in oil
prices propelled already declining inflation rates
yet lower. Inflation fell into negative territory in
December (Figure 3). In June, the ECB set a negative
deposit rate, an unprecedented step for a major central bank. Given the deterioration in medium-term inflation expectations, slow growth, and the unsatisfactory
transmission of credit to the real economy, the ECB
launched several other new measures in September
and October. It embarked on its asset-backed securities and covered bonds purchase programme in what
would be the first steps towards a full quantitative
easing programme announced in January 2015.

ANNUAL REPORT 2014 | 21

“

Wolfgang Schäuble
Germany

The European Stability Mechanism,
as our last line of defence against
crises of confidence, is an effective
instrument for safeguarding the
financial stability of the euro area.
It is based on the principle of
solidarity in return for sound public
finances and the implementation
of structural reforms to improve
the competitiveness of programme
countries. This approach has proved
its worth as demonstrated by Ireland,
Portugal and Spain. As we look
towards the future, the ESM will
continue to serve as an integral part
of our efforts to prevent and combat
sovereign debt crises in the euro area.

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

“

Figure 3. Contribution to harmonised index of
consumer prices inflation rate (%)

Figure 4. Selected 10-year yields in the
euro area (%)

1.5

6.0

1.0

12.0
10.5

5.0

9.0

0.5
4.0

7.5

0.0
-0.5

3.0

-1.0

2.0

-1.5

6.0
4.5
3.0

Jan.14

Apr. 14

Jul.14

Oct. 14

Jan.15

Services

Nonenergy Industrial Goods

Food, Alcohol and Tobacco

Energy
Total

Sources: Eurostat and ESM calculations

1.0

1.5

0.0

0.0

Jan. 14

Apr. 14

Jul. 14

Oct. 14

Jan. 15

DE

ES

PT

IE

GR (rhs)

Source: Bloomberg

Given the expectations for, and the implementation of,
the monetary policy easing measures, the yields of all
euro area debt markets ended 2014 lower than they
started it, with the exception of Greece (Figure 4).
These measures also tightened the yield spreads to
the highly rated countries and flattened the yield curve,
with the yields on longer-dated debt instruments declining more than those on the short end. In particular, the

10-year yields in former euro area beneficiary Member
States such as Portugal and Spain declined by around
315 and 240 basis points, respectively, over the year.
As the comparable 10-year German yield declined
around 140 basis points, the Portuguese and Spanish
yield spreads declined by some 175 and 100 basis
points to Germany, respectively.

22 | EUROPEAN STABILITY MECHANISM

SPOTLIGHT

“

The Finance
ew on
Minister’s vi
the ESM

Sven Sester
Estonia

The ESM is an important instrument
for safeguarding financial stability
in the euro area. The ESM has
already proved its necessity by
helping Cyprus and Spain during
their financial difficulties and
has contributed to the enhanced
credibility of the euro area.

“

The expectations for monetary policy easing measures also resulted in a gradual depreciation of the
euro. As of May, the euro started declining against
all major currencies. At year-end 2014, the euro had
depreciated around 30% against the US dollar, and
the nominal effective exchange rate had fallen around
12% since May (Figure 5). The currency drop will
benefit most of the euro area countries, because they
have high trade volumes with countries outside the
euro area. Ireland and Cyprus, which export around
60%–70% of their goods beyond the euro area, will
profit in particular from this trend.
Euro area equity markets held relatively stable in the
first part of the year. Towards the end of the year and
the beginning of 2015, equity prices gained rapidly,
mainly attributed to monetary policy easing expectations, the corresponding improving economic outlook
and capital inflows from foreign investors. From
early 2014 through the first quarter of 2015, the
EuroStoxx gained around 20%, with regional returns
ranging from around -35% in Greece to around +30%
in Ireland. Despite the rise in stock prices, company
earnings have not followed suit, with the price-earnings
roughly doubling since 2011. Banking sector stocks
also climbed in line with the equities trend, buoyed by
enhanced confidence from the successful Asset Quality
Review (AQR). In particular, banking stock prices in

Figure 5. Euro effective exchange rate and
euro/US dollar rate

1.5

115

1.4

110

1.3

105

1.2

100

1.1

95

90

1.0
Jan.14

Apr.14

Jul.14

USD

Oct.14

Jan.15

Effective exchange rate (12 partners, rhs)

Sources: ECB and Bloomberg

France, Germany, and Italy have risen around 20%,
20% and 15%, respectively, since the late October
AQR results. The boost in financial sector confidence
also seemed to support interbank funding in both
secured and unsecured markets.

ANNUAL REPORT 2014 | 23

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Michael Noonan
Ireland

The establishment of the ESM
is an essential part of the
euro area’s crisis resolution
mechanism and in that capacity
it contributes significantly to
economic confidence. The highly
professional approach of the ESM
management and staff has built
an organisation which has the
confidence of its members and
strong credibility in the financial
markets.

“

ACCELERATING EURO AREA GROWTH
Euro area GDP increased by an annual 0.9% rate in
2014, benefitting primarily from higher consumer
spending, and to a lesser extent from government
spending (Figure 6). Towards the end of the year, lower
oil prices and a weaker currency boosted economic
output. Nonetheless, disparities among euro area
Member States remained. A few recorded shrinking

Figure 6. Contribution to annual euro area
GDP growth (% of GDP)

output while others posted growth of varying degrees.
Export performance improved on the back of the euro’s
sharp depreciation. Investment remained subdued
compared to levels prior to the crisis, both for public
and private investment, and lagged behind investment
rates achieved, for example, in the US (Figure 7).

Figure 7. Investment gap between euro area
and US (2008=100)

120
115

2.0

2.0

110

1.5

1.5

105

1.0

1.0

0.5

0.5

0.0

0.0

-0.5

-0.5

100
95

-1.0

-1.0
Q1 14

Q2 14

Q3 14

90
85

Q4 14
80

Private cons.
Investment

Inventories & net acq.
Public cons.

Net Exports
GDP

08

09

10

11

12

13

14

15
EA

Sources: Eurostat and ESM calculations

16
US

Sources: EC, Winter Economic Forecast 2015 and ESM calculations

24 | EUROPEAN STABILITY MECHANISM

In a stronger growth environment, investment is
expected to improve, but it will take some time to
recover from the current weakness in capital formation. Further improvement in investment remains
critical to securing stable long-term euro area growth.
The depreciation of the euro’s effective exchange rate
further boosted euro area export growth, despite
an initial slowdown of economic activity in traditional
export markets that undercut demand. Euro area
unit labour costs rose as productivity trends failed
to offset the area’s upward wage trend. However,
countries with financial assistance programmes
gained competitiveness. Unemployment fell to 11.3%
in December 2014, with youth unemployment encouragingly falling along with it. Consumer confidence
jumped as disposable income rose while economic
sentiment remained positive. In this context, the correction of external imbalances continued in 2014. The
current account balance is expected to rise further
to 2.8% from 2.4%, with Germany, Ireland, and the
Netherlands in particular putting up strong numbers.
At the same time as these economic developments,
the euro area’s fiscal situation continued to improve.
General government debt levels are set to rise
compared to previous years, peaking at around
94% of GDP. These are then expected to decline
gradually over the next several years (Figure 8).

Figure 8. Euro area public debt (% of GDP)

96
94
92
90
88
86
84
82
80

Figure 9. Euro area fiscal and structural
budget balance (% of GDP)

5.0
2.5
0.0
-2.5
-5.0
-7.5
-10.0
10

11

12

13

Fiscal balance

14

15

16

Structural budget balance

Sources: EC, Winter Economic Forecast 2015

Headline fiscal balances continued to gain ground,
driven by increased economic activity benefitting
from a more neutral fiscal stance as measured by
the structural balance figures. The euro area fiscal
balance in particular showed moderate improvement
as the overall deficit is set to narrow to 2.6% in 2014
from 2.9% of GDP in 2013 (Figure 9).
In 2014, countries that benefited from an EFSF or an
ESM financial assistance programme continued on the
path of fiscal consolidation and partially implemented
further structural reforms. Several euro area Member
States, which until recently were under a financial assistance programme, accessed capital markets. Cyprus,
Ireland, Portugal, and Spain were successful and active
in the market when they tapped existing bonds as well
as issued new series. The case of Portugal is worth
noting as it is the most recent to exit successfully an
EFSF financial assistance programme, in May 2014.
The major rating agencies assessed the situation positively for most of the euro area programme countries,
in particular Ireland and Spain, which both received
upgrades from all three major rating agencies after
successfully exiting their programmes. Greece represents an outlier in this respect.

78
10

11

12

13

14

Sources: EC, Winter Economic Forecast 2015

15

16

While indicators are moving in the right direction,
improving economic conditions often lead to diminished pressure to continue with structural reforms.
At the same time the declining level of investment

ANNUAL REPORT 2014 | 25

gives cause for concern; it raises the question as to
whether the recovery can be strengthened to attain
high long-term growth rates. The structural reforms
implemented in programme countries are starting
to bear fruit, and other countries with weak growth
prospects could follow this route. Given ageing populations, structural reforms are crucial for unlocking
investment and growth across the euro area. Against
that background there is a strong call for ambitious
structural reforms in many countries.

CONSIDERING THE RISK FACTORS
AHEAD
Overall the risks to a sustained recovery are rather
balanced. The benefits of low energy prices, the large
effective exchange rate depreciation, and lower yields
through the ECB’s asset purchase programme have

been substantial. Although they have not yet shown
their full impact, these factors could accelerate economic growth beyond current market expectations and
official sector forecasts. Several risk factors, however,
have the potential to throw the positive trends off track,
in particular if these factors were to occur simultaneously. Geopolitical tensions have led to the imposition
of economic sanctions on Russia, curtailing economic
activity in return. Within the euro area, Greek political
and fiscal developments, if not resolved quickly, could
translate into higher uncertainty and therefore lower
confidence in the euro area as a whole. Reform fatigue
may either leave the implementation of previously
agreed measures unfinished or reverse them, with
potentially negative effects on budget targets and
future growth prospects. Lastly, the lack of investment
spending and growth friendly fiscal policies may result
in growth momentum fading, losing a window of opportunity to reinforce the recovery.

26 | EUROPEAN STABILITY MECHANISM

Programme
country
experiences

IRELAND
Ireland re-established sustainable and durable market access in 2014, after successfully concluding
its EFSF financial assistance programme at the end of 2013. During 2012 and 2013, it had engaged
in occasional opportunistic funding and liability management exercises. In 2014, Ireland enjoyed
strong growth and the general government deficit fell within required parameters. Maintaining the
programme’s spending cuts and tax increases, and continuing consolidation efforts, will be necessary
to reduce its high public debt.
The Irish economic recovery gathered pace during
2014. Annualised gross domestic product (GDP) grew
at 4.8% in 2014, the fastest growth rate in Europe, on
the basis of current estimates. Gross national product,
which strips out the effect of the multinational sector (or
foreign-owned subsidiaries of larger companies based
abroad), grew by 5.2% on the year. This is a welcome
development given the heavy reliance on net exports to
produce growth since the beginning of the crisis. The
continued improvement in the labour market has facilitated this turnaround. Unemployment fell to 10.4% at
the end of 2014 from a peak of 15.1% in early 2012.
The housing market has also started to recover, with
double-digit price increases nationally. House prices,
however, remain far below their previous peaks, and
new house completions are below equilibrium.
The fiscal adjustment process continued apace in
2014. The 2014 general government deficit declined
to 4% of GDP, well within the 5.1% limit set under
the Excessive Deficit Procedure. Higher-than-expected
economic growth increased tax revenues, while positive
financial market developments decreased the cost of
Ireland’s debt interest payments. Definitional changes
in Eurostat’s accounting framework provided a further
reduction of the debt-to-GDP ratio as they resulted in
an upward revision of Irish (nominal) GDP by just over
6%. Despite a decrease of approximately 13%, resulting from the liquidation of the Irish Bank Resolution
Corporation, the forecast for public debt remains high
at 110% of GDP. Competitiveness gains continued to
bring benefits, as the 2014 current account surplus
was 6.2% of GDP.

While 2013 was the year of the successful exit from
the financial assistance programme, 2014 confirmed
Ireland’s complete return to market access. Irish sovereign bond yields continued their downward trajectory,
with the 10-year bond yield at 1.25% at the end of
the year. The major ratings agencies upgraded Irish
sovereign bonds in 2014 and awarded them stable
outlooks. These positive market developments have
allowed for the early repayment of a portion of the IMF
loans, facilitated by a waiver by other official creditors,
including the EFSF, of their right to any early repayments. This process could deliver absolute savings of
up to €2.1 billion for the period from 2015 to 2020.
Financial sector developments during 2014 were also
positive. A reduction in costs of funding, coupled with
an inflow of customer deposits, allowed Irish banks to
return to profitability. Stress tests showed that the
two major banks were well capitalised and the capital
shortfall identified in a third bank was too small to
require further government assistance.
The continued monitoring of Ireland’s payment ability under
the Early Warning System showed that Ireland currently
faces no difficulty in meeting its loan service payments.
Despite these positive developments, there have been
growing calls to reverse some of the budgetary spending
cuts and tax increases made under the financial assistance
programme. Some reform fatigue has become apparent,
as the EC also noted. To reduce its very high public debt
levels, Ireland will need to maintain a primary balance in
the coming years. Any weakening of the government’s
revenue-raising capacity would undermine this goal.

ANNUAL REPORT 2014 | 27

Programme
country
experiences

PORTUGAL
During 2014, Portugal kept to the adjustment path, exited its EFSF financial assistance programme
and regained full market access, including making a return to regular bond auctions. GDP expanded
on a yearly basis for the first time since 2010, mostly due to a recovery in domestic demand. Both
the fiscal and external imbalances continued to improve. Further fiscal consolidation and structural
reforms are needed to reduce the still high level of public debt.
After several years of recession, Portugal returned to
growth with a 0.9% GDP expansion in 2014. The composition of growth shifted from that of previous years
with domestic demand expanding by 1.4% and private
consumption by 2.1%. Net trade figures undermined
GDP. Despite an export increase of 3.4%, buoyant
domestic demand drove a rebound of more than 6%
in imports. The current account balance deteriorated
somewhat but still posted a surplus of 0.6% of GDP in
2014, down from a 1.4% surplus in 2013.
The fiscal adjustment continued, as the budget deficit
declined to 4.5% of GDP from 4.9% in 2013, or,
excluding one-off factors, to 3.4% of GDP in 2014
from 5.2% in 2013. As in previous years, this deficit
decline stemmed mostly from an outperformance in
fiscal revenues, driven by improved domestic demand
and a stepped-up fight against fraud and tax evasion.
Government spending exceeded the initial budget target
due both to negative rulings from the constitutional
court, which again cancelled some of the planned
spending cuts, and to an increase in spending in intermediate consumption.
Government debt increased to 130.2% of GDP at the
end of 2014, up from 129.7% in 2013, under the new
Eurostat economy accounting rules. This stock of debt
included a cash buffer of close to €15 billion (6.6% of
GDP) held by the Portuguese Treasury and Government
Debt Agency.
During the year, financial market perceptions continued
to improve, after Portugal was able to exit the economic

adjustment programme without further assistance.
Portugal succeeded in fully establishing market access.
It used syndicated deals and also returned to regular
auctions. Portugal issued at increasingly longer maturities, even issuing a 15-year bond, the longest maturity
issued since 2010.
The financial sector continued to deleverage while
profitability is slowly normalising in a challenging environment. Portuguese banks’ capital position improved,
as shown by the SSM stress tests. This reassured
investors when the Banco Espirito Santo (BES), a major
Portuguese bank, failed in summer. Following its resolution, it was split into a good and a bad bank. The
Portuguese government expects to conclude the sale
of the good bank by June 2015. Notwithstanding some
volatility in July 2014, the resolution of BES did not
lead to any contagion either to other banks or to the
sovereign bond market.
The continued monitoring of Portugal’s payment ability
under the Early Warning System shows that Portugal
currently faces no difficulty in meeting its loan service
payments. Going forward, despite the positive economic
and financial market developments in 2014, and the
end of the adjustment programme, the sustainability
of government debt remains challenging given its high
level and Portugal’s still modest growth prospects.
Most market participants expect a clear commitment to
fiscal discipline. Portugal will need to continue to adhere
to agreed fiscal targets and continue to implement
structural reforms set under the European framework
to reduce its debt level significantly.

28 | EUROPEAN STABILITY MECHANISM

Programme
country
experiences

GREECE
Greece’s economic adjustment programme was designed to restore the sustainability of public finances,
restructure and stabilise the financial system, and support long-term growth through an ambitious structural
reform agenda. By autumn 2014, the economy had stabilised, growing again after six years of recession
and a successful adjustment of the external and fiscal balance. However, Greece then lost the cautious
recognition it was getting from market participants on its achievements. The conclusion of its programme
with the EFSF and the IMF was postponed due to a lack of progress since summer 2014. Greece needs to
provide a clear and credible way forward to restore market trust and return to a sustainable growth path.
The latest successful programme review was completed in April 2014 and the last tranche of the agreed
EFSF disbursement took place in August 2014, after
the completion of agreed milestones. Due to delays in
concluding the final programme review, the Facility has
been extended twice since December 2014 and it is
now set to expire at the end of June 2015.
The economy stabilised in 2014 after six years of recession, with real GDP growing by a seasonally adjusted
0.7%. The economic growth registered in 2014
was mainly driven by a recovery in domestic demand,
supported by considerable gains in the tourism sector.
The external sector continued to contribute positively to
growth, with exports outpacing imports. But the decline
in public consumption persisted in 2014, albeit at a lower
rate than in previous years. On the supply side, wholesale
and retail trade contributed the most to growth.
Preliminary data suggest that in 2014 the government
missed the primary surplus programme target of 1.5%
of GDP. This fiscal underperformance stemmed primarily from tax revenue slippages, given that overall political
uncertainty ahead of the January 2015 parliamentary
elections influenced taxpayer behaviour during the last
months of 2014.
The external adjustment continued in 2014, with
Greece recording a current account surplus (0.9% of
GDP) for a second consecutive year. The improvement
reflects a substantial increase in the services surplus,
which more than offset an increase in the goods deficit. Price competitiveness has improved notably from
2012 onwards due to labour cost adjustment and

the implementation of competition-enhancing reforms,
which facilitated price and wage flexibility. Ambitious
labour market reforms yielded results, with Greece
more than recovering the cumulative loss in labour cost
competitiveness observed between 2000 and 2009.
Greece’s improving economic performance, policy
reforms and the broadly favourable market conditions
gained investors’ recognition during the first half of 2014.
Greece managed to come back to the markets by placing
new 5-year and 3-year bonds at relatively favourable yields.
By mid-October 2014, however, the confidence Greece
was building in financial markets was rapidly undone, due
to weaker programme implementation. Market participants made clear that the perception of regained market
access was premature, triggering a sell-off.
Despite the clear progress achieved in fiscal adjustment
and competitiveness so far, the continuous delays in
programme implementation, accompanied by political
uncertainty, have taken their toll on the Greek economy
and budget. The liquidity and funding conditions for the
economy and the financial sector grew very strained
during the first quarter of 2015 as a result of the
ongoing dialogue between the Greek government and
its official sector creditors. For Greece to regain market confidence and reap the benefits of the substantial
adjustments made to date, the authorities will need to
demonstrate their determination to continue improving
fiscal sustainability, preserve financial sector health,
and boost growth and employment through robust
implementation of structural reforms. These elements
would be crucial for Greece’s long-term outlook and
gradual return to accessing market financing.

ANNUAL REPORT 2014 | 29

HOW GREECE
BENEFITTED FROM
EUROPEAN DEBT RELIEF

Euro area Member States have taken several steps
to ease the lending terms for Greece to support its
ability to service its debt burden, principally through
lower financing costs and longer maturities.
The first European assistance instrument, known as the
Greek Loan Facility (GLF), was amended in June 2011,
when the maturity was extended by five years to a total
of 10 years, the grace period was lengthened to 4.5
from three years, and the margin was lowered by
100 basis points, to 2% in the first three years and
3% thereafter. This change was superseded by the
second amendment in March 2012 where maturities
were extended to 15 years, the grace period raised
to 10 years, and the margin reduced further to
150 basis points over the entire period.
In November 2012, the second Greek financial assistance programme included additional debt alleviation
measures. Worse-than-expected macroeconomic
developments, missed targets and incomplete programme implementation meant additional measures
needed to be taken to reduce financing needs and to
support the sustainability of Greek government debt.
Therefore, the Eurogroup approved a broader set of
measures on the GLF and EFSF loans:
• reduction of the GLF interest rate margin by
100 basis points;
• cancellation of the EFSF guarantee commitment
fee;
• deferral of EFSF interest payments on loans under
the Greek Master Financial Assistance Facility
Agreement by 10 years;3
• return of the Securities Markets Programme (SMP)
profits (when the ECB bought Greek government
bonds with a discount in the secondary market and
made a profit at maturity);

The low financing costs of the European facilities
reduced Greece’s debt servicing burden, thereby
providing authorities with greater fiscal flexibility. The
GLF and EFSF rates remain well below market rates.
Due to the relief measures and market conditions
for EFSF funding, the EFSF lending rate for Greece,
which reflects the market situation, currently stands
at around 1.35%. The EFSF rate compares favourably
with the current IMF lending rate of 3.6%. It also
remains far below the roughly 5% rates that Greece
has had to pay for corresponding maturities over the
past decade and current market rates. Financing at
EFSF and GLF rates therefore entails an important
support component, because they are alternatives to
other, more costly sources of financing.
The measures correspond to substantial economic
debt relief, with effects that transcend the enhanced
fiscal room for manoeuvre provided to Greece.
Considering these maturity extensions and interest
rate deferrals over the entire debt servicing profile
from a net present value (NPV) perspective shows
a reduction in the overall debt burden and reveals
implicit savings. The NPV approach consists of discounting the difference between the future cash flows
of the loans benefitting from lower financing costs
and debt relief measures and the cash flows of the
same loans had they not benefitted from the relief
measures.4 Stretching out principal repayment schedules over such an extended period of time, along with
interest payment deferral, imply that these payments
account for substantially less in NPV terms when
assessed from the Greek side taking into account the
financial market perspective.5

4

For the calculation of the interest Greece would have paid in the
markets, the historical 10-year German bund rate plus a theoretical market spread of Greece at the starting date of each EFSF loan
tranche is used. For the calculation of the interest applicable to the
EFSF loans to Greece, projections of the EFSF cost of funding are
based on the estimate of the funding volumes that the EFSF has to
achieve in the future. The NPV gain is derived from the difference
between these two flows of interest payments. The discount curve
is derived from the German bund plus the theoretical market
spread for Greece as of calculation date.

5

It should be noted that this does not entail any financial loss or
write-down from an EFSF perspective. The EFSF is fully repaid;
Greece has to cover any financing costs related to the agreed
interest rate deferral in line with the amendment of the Master
Financial Assistance Facility Agreement.

• extension of the GLF to 30 years and EFSF weighted
average maturities to 32.5 from 17.5 years.

3

Not applied to Private Sector Involvement (PSI) and bond interest
facilities, which correspond to roughly 25% of the overall EFSF loan
to Greece.

30 | EUROPEAN STABILITY MECHANISM

The economic reduction of the debt burden and
implicit savings from the various relief measures
described above leads to NPV savings equivalent to
49% of Greece’s 2013 GDP. The overall figure comprises an NPV reduction for the EFSF facilities of 34%
of GDP, of which 7% of GDP can be attributed to the
extension of maturities and interest rate deferral, and
27% of GDP can be attributed to the savings from
the financing at EFSF rates compared to market rates
for Greece. To this number, one can add the impact
of the extension of maturities and the lowering of the
margin for the GLF. This adds another 10% of GDP in
NPV reduction. Finally, the return of SMP profits adds
up to 5% of GDP. This overall NPV savings figure as
a percentage of GDP and its breakdown is based on
theoretical assumptions of the interests Greece would

have paid in the markets, compared to estimates of
the future EFSF cost of funding.
From a Greek perspective, the debt relief measures
taken by its European creditors provide a substantive
benefit in fiscal space and overall payment profile. It
cannot be argued that the debt level is unsustainable
by merely looking at the aggregate nominal debt to
GDP ratio. A proper sustainability analysis must consider the structure of Greek debt. Payment obligations
over the years until 2023 are minimal. Thereafter,
the repayment is stretched out over several decades
which, combined with favourable lending rates, results
in an overall high but sustainable debt – provided that
Greece continues its reform agenda.

ANNUAL REPORT 2014 | 31

Programme
country
experiences

SPAIN
The Spanish banking sector remains on a solid path to recovery, following the successful completion
of the ESM financial assistance programme which aimed at repairing the banking system. All
Spanish banks passed the 2014 stress tests showing safe capital ratios. The privatisation of the
banks recapitalised in 2013 is ongoing. In addition, structural reforms are paying off in high output
growth. Reforms and fiscal policies in line with the European framework have strengthened fiscal
sustainability and will continue to do so.
Spanish banks further improved profitability in 2014 due
to lower impairment charges and cost reductions, despite
a slight decrease in operating revenues. Although asset
quality remains a challenge, non-performing loans (NPLs)
continued to decline at most banks. The stock of NPLs
decreased by 12.5% from a January 2014 peak to
December 2014. Over the same period, the NPL ratio
declined only slightly to 12.5% from its peak of 13.6% in
January 2014 due to the continued deleveraging of the
banks’ loan books. The economic recovery is expected to
support further improvements in asset quality in 2015.
Banks’ liquidity remains comfortable and loan-to-deposit
ratios have improved to more sustainable levels. While
the reliance on ECB funding has fallen substantially, it still
remains high for some recapitalised banks.
The economy is recovering, the latest macroeconomic
developments show. Growth accelerated steadily
throughout 2014 with fourth-quarter figures at
a healthy 2.0% year-on-year basis. Overall, in 2014,
domestic demand provided strong support, contributing 2.1% to growth compared to -2.6% in 2013;
however, the contribution of external demand to growth
turned negative to -0.7% compared to 1.5% in 2013.
In 2014, growth in imports outpaced exports (7.6%
vs. 4.2% annual growth), linked to the pick-up in internal demand. The current account balance remained
positive at 0.6% of GDP, compared to 1.5% in 2013,
and is expected to strengthen further in 2015.
The fiscal consolidation process continued and the overall
fiscal deficit of the general government excluding financial
assistance decreased to 5.7% of GDP in 2014 from
6.3% in 2013. This is slightly below the Excessive Deficit
Procedure target and two decimals above the objective

set in the Stability Programme (5.5% of GDP). The 4.2%
deficit target for 2015 still looks ambitious, albeit within
reach. The government included a number of expansionary
measures in the 2015 budget, mainly reducing personnel
and corporate income tax rates. The lower tax rates
may weigh on fiscal performance. However, if domestic
demand continues to increase its contribution to growth,
positive growth momentum may help to compensate for
the negative effect of lower tax rates.
The Spanish sovereign has always kept access to
capital markets. Since late 2012 financing costs have
been declining. In 2014, the risk premium on Spanish
10-year bonds compressed by over 100 basis points
and the yield declined by over 250 basis points, driven
by a better macroeconomic outlook, falling commodity
prices, and ECB interventions, such as deposit rate
cuts, purchase programmes, and the announcement
and execution of refinancing operations. As a result,
yields on Spanish debt hit record lows across the entire
curve, which is likely to lower debt servicing costs in the
medium to long term.
Since the second post-programme mission carried out
in October 2014, economic and financial developments
have continued to improve. The ESM’s Early Warning
System exercise provides a continuously positive assessment of Spain’s ability to honour its ESM loan payments.
Nonetheless, Spain still faces challenges. With debt
approaching 100% of GDP, fiscal performance is critical
given subdued inflation rates and still moderate real
GDP growth. Further structural reform measures to
reduce labour market segmentation and the announced
reform of professional services and associations would
also pave the way for higher near-term growth.

32 | EUROPEAN STABILITY MECHANISM

Programme
country
experiences

CYPRUS
Cyprus started reaping the benefits in 2014 of the sound policies it was implementing under the ESM
financial assistance programme agreed in 2013. During 2014, Cyprus exceeded programme targets
in some key areas, such as on the fiscal side. The situation in the banking sector continued to improve
gradually and capital controls were fully withdrawn in April 2015. The implementation of structural
reforms lagged, however, and full implementation is crucial to improve growth prospects further.
The recession continued in 2014 but proved shallower
than expected with the economy contracting by 2.3%.
Internal adjustment also continued but at a slower
pace than previous programme projections. Inflation
was marginally negative as pressures on disposable
income continued and credit conditions remained tight.
Unemployment declined for the first time since 2008,
mainly due to labour force contraction. Debt-to-GDP
reached 107% and is expected to peak at around
116% in 2015, lower than the previous forecast of
126%. This reduction was primarily driven by Eurostat’s
upward revision of GDP by around 10% due to changes
in definition from the implementation of the ESA 2010
accounting framework.
As to public finances, consolidation measures and
improved tax collection coupled with tight expenditure
controls and a reduced wage bill more than offset the
recession’s impact. This resulted in a primary surplus
of 2.8% in 2014, two years ahead of programme
targets. Fiscal risks remained given the large amount
of government guarantees, which were close to 20%
of GDP. On this front, the ESM is providing technical
assistance to improve the assessment and management of financial risks associated with existing and new
government guarantees.
The reform momentum weakened towards year-end
2014 with privatisation and other key reforms falling
behind schedule after important structural reform
steps were taken early in year. The reform push
needs to be reinvigorated. On 17 April 2015, parliament passed insolvency legislation and repealed the
suspension of the foreclosure law. If this foreclosure

regulation is implemented swiftly, it paves the way for
the completion of the ongoing review.
The financial sector has been adequately capitalised
but the very high level of NPLs weighed on profitability
and outlook. Cypriot banks successfully passed the
Comprehensive Assessment with only one bank, Hellenic
Bank, reporting a small capital shortfall, which it has
since covered through a rights issue to existing shareholders. System-wide NPLs increased but at a much
slower rate, reaching 49.7% at end-November 2014,
and were likely to peak in the first half of 2015. Deposits
have stabilised and the full relaxation of capital controls
in April 2015 had a small positive impact on overall system deposits, even with banks decreasing deposit rates.
Cyprus managed to tap the market for the first time in
three years with a €100 million issuance of a six-year
Eurobond in April 2014 and an oversubscribed issuance
of a five-year Euro Medium Term Note (€750 million) in
June 2014. The authorities continued to work towards
a sustainable return to markets. The ESM is providing
technical assistance focused on optimising the operations of the Public Debt Management Office.
With the passage of insolvency legislation and the
repeal of the suspension of the foreclosure law, Cyprus
moved closer to completing the review and bringing
the programme back on track. Structural reforms,
however, remained behind schedule. If the authorities
succeed in reinvigorating programme implementation
and complete the next reviews, the ESM and IMF can
proceed with the next disbursements over the remaining programme period.

ANNUAL REPORT 2014 | 33

ECONOMIC RECOVERY
IS PICKING UP…
Figure 10. Annual real GDP growth
(%-change)
6

HOW MACROECONOMIC
IMBALANCES
ARE BEING CORRECTED

4
2
0
-2
-4
-6
-8
-10
08

09

10

11

12

13

14

DEFICIT REDUCTION POLICIES
ARE PAYING OFF…

HIGH DEBT TO GDP IS STILL
A CHALLENGE…

Figure 11. Fiscal balance (% of GDP)

Figure 12. Public debt (% of GDP)

5

180

0

160

-5

140

-10

15

16

15

16

120

-15

100

-20
80

-25
60

-30
40

-35

08

08

09

10

11

12

13

14

15

09

10

11

12

13

14

16

INTERNAL DEVALUATIONS ARE
RESTORING COMPETITIVENESS…

EXTERNAL IMBALANCES
IN THE PERIPHERY ARE RECEDING…

Figure 13. Annual change in Nominal Unit
Labour Costs (% change)

Figure 14. Current account balance
(% of GDP)

6

10

4
5
2
0

0
-2

-5

-4
-10
-6
-15

-8
-10

-20

08

09

10

11

12

13

14

15

16

08

ES

09

10

GR

11

12

PT

13

14

IE

15

16

CY

Sources: EC, Winter Economic Forecast 2015

34 | EUROPEAN STABILITY MECHANISM

ESM LAUNCHES
FIRST TECHNICAL
ASSISTANCE PROJECT

The ESM kicked off its first technical assistance project
in 2014, advising the Public Debt Management Office
(PDMO) of Cyprus how to optimise the effectiveness
of its core work and strengthen its risk management.
Generally, technical cooperation activities are an ancillary activity to support a financial assistance mandate.
These advisory services transfer knowledge to the
beneficiary Member State, supporting the relevant
programme country in restoring market access on
a lasting basis and increasing its capacity to repay
its creditors, including the international financial
institutions (IFIs).
Technical assistance can be provided on a case-by-case
basis to a beneficiary ESM Member State, upon its
request and in the areas where the ESM has established in-house skills and first-hand experience, such as
advising Debt Management Offices. The ESM cooperates with other IFIs and European institutions in providing coordinated technical advisory services and also
participates in other IFIs’ technical assistance missions.

At the request of the Cypriot authorities, the ESM is
focusing on two aspects of the PDMO’s activities:
• assisting it in defining its organisational structure,
including on information technology infrastructure,
internal controls and staffing;
• enhancing its market intelligence function, covering
investor relations and the communication of market
information.
The ESM has developed its recommendations for
the Cypriot authorities based on international best
practice. To provide useful and appropriate advice,
the ESM also took into consideration the PDMO’s own
specificities and constraints. The ultimate goal is to
help the PDMO develop the skills of its staff and assist
Cyprus in regaining sustainable market access.

36 | EUROPEAN STABILITY MECHANISM

ANNUAL REPORT 2014 | 37

02.
ESM ACTIVITIES

38 | EUROPEAN STABILITY MECHANISM

4
3

How the ESM processes its financial transactions
Financial transactions at the ESM are conducted by three different teams: Funding, Investment and Lending. These teams can be
regarded as our ‘front offices’ – they are responsible for raising funds by issuing bonds and bills; for investing funds – most importantly,
investing the paid-in capital from ESM Members; and for providing loans to beneficiary Member States. All the transactions carried
out for this purpose need to be validated and processed, which is the area of activity of the ESM’s Middle and Back Office Division.

2

The task of the Middle and Back Office is to correctly record, control, process, pay for and report on every transaction. The Middle
Office embeds risk management and control procedures into transaction processing to guarantee that the ESM adheres to its key
policies, such as on risk, and does not engage in any detrimental activities. In this way, it helps to protect its assets and reputation.
The Back Office ensures that the securities and financial instruments bought or sold are exchanged for the correct amount of money
at the appropriate time and with the right counterparty. The ESM has chosen a Middle and Back Office operating model that mixes
internal and outsourced activities, some of which are mentioned here.
The following steps provide an overview of how the Middle and Back Office handle financial transactions for the ESM’s three front-office
teams, Funding, Investment and Lending.

Post-trade
activities.
The Back Office:
• Ensures the accuracy
and validity of the financial
information on the issue.
• Monitors the settlement
of all funding trades
as well as future cash
flows. It uses a standard
delivery versus payment
(DVP) settlement system,
which ensures that
delivery is made only if
a payment takes place
(The system acts as a link
between a funds transfer
system and a securities
transfer system).
• Reports the list of trades
executed to the European
Investment Bank which
takes care of the financial
accounting.

Trade
matching.
The Back Office:
• Orders an external
bank or clearing house
to check that the ESM
trade details match
those of the institutions
purchasing the
securities.
• Instructs the
‘custodian’ on the
characteristics of the
issue like the amount,
price and maturity,
ultimately ensuring
a proper settlement
process.

Trade
validation.
The Middle Office:
• Verifies the accuracy of
the issuance.
• Checks that the system
can accommodate the
new issue.
• Updates the internal
database with the new
issue.
• Ensures the information on the issue is
accurately recorded in
the internal information
technology system.

SECURITIES
ISSUANCE.
The Funding Team:
The front-office Funding
team issues securities,
specifically bonds or bills,
to raise funds for the ESM
and the EFSF’s financial
assistance programmes
for beneficiary Member
States. Its work is guided
by the ESM funding
plan and Member State
lending needs.

The ‘custodian’
is a specialised
financial institution that
holds securities and assets
for safekeeping in electronic
or physical form. The custodian
acts as a central information
hub, keeping track, for example,
of who currently owns the
issue, since the original issue
purchasers may sell the
securities on.

2
3
4

FUNDING

1

1

ANNUAL REPORT 2014 | 39

Trade
matching.

Trade
validation.

TRADE
EXECUTION.

The Back Office:

The Middle Office:

The Investment
Team:
The ESM’s core
investment activities are
focused on investing the
proceeds of the paid-in
capital and the reserve
fund, thereby contributing
to the ESM’s creditworthiness. To do so, it
initiates a trade by, for
example, selling or buying
a security, like a bond or
a bill. In this process, it
takes into account ESM
risk guidelines, predefined
limits and investment
policy.

• Closely monitors trading
activity.
• Verifies that the trade
details are correctly
recorded in the system in
a timely manner.
• Maintains IT core
financial data to ensure
all trade details are
correct.

1
LOAN
GRANTING.
The Lending Team:
Structures, negotiates,
and implements the
loans that are a pillar
of the ESM’s financial
assistance programmes
to beneficiary Member
States.

2
Trade
validation.
The Middle Office:
• Participates in the
drafting process of
lending documentation
(request for funds,
acceptance and confirmation notices).
• Maintains IT core
financial data to ensure
loan details are correct.
• Verifies that the loan
details are correctly
recorded in the system in
a timely manner.

• Liaises with the
outsourced Back Office
provider and sends
them all ESM investment
securities trade details
for settlement purposes.

Post-trade
activities.
The Back Office:
• Closely monitors the
settlement process.
• Monitors coupon and
redemption income
as well as cash needs or
excess cash.
• Performs cash and
securities reconciliation.

The Middle Office:
• Reports on daily investment trade activities and
positions.
• Reports any breach of
investment guidelines
(limits checks, concentration risk, liquidity risk),
operational risk issues,
audit trails and/or limit
transgression.
• Checks off-market trade
prices.
• Monitors financial
instruments valuation.

3

Trade
matching.
The Back Office:
• Executes disbursements
in compliance with the
lending documentation.

INVESTMENT

‘Reconciling’
an account
means ensuring
and documenting
that an account
balance is
correct.

4

Post-trade
activities.
The Back Office:
• Monitors in- and outflows
to and from beneficiary
Member States.
• Performs cash and
securities reconciliation.

The Middle Office:
• Produces invoices for
all the countries under
a financial assistance
programme.

LENDING

40 | EUROPEAN STABILITY MECHANISM

Lending activities

CYPRUS

year-end 2014, the weighted average maturity stood
at 14.88 years.

In 2014, there were three disbursements under the
Cypriot facility. The ESM signed a Financial Assistance
Facility Agreement with Cyprus on 8 May 2013,
which included a Loan Facility for a total of up to
€10 billion, including an IMF contribution. This
contribution was fixed at €8.97 billion, after the IMF
decided to grant financial assistance to Cyprus of
891 million in special drawing rights (SDR). The loans
to Cyprus will have a maximum maturity of 20 years
and a maximum average maturity of 15 years. At

In 2014, there were three disbursements totalling
€1.1 billion. The first took place on 4 April 2014
for €150 million, followed by a €600 million disbursement on 9 July 2014. The final 2014 disbursement
took place on 15 December 2014 with €350 million
disbursed.
The Cypriot facility has up to €3.27 billion available for
disbursement until the end of the availability period.

Table 1. Funds disbursed to Cyprus in 2013–2014
Tranche

Value date

Maturity

Loan amount (€)

Tranche 1

13/05/2013

13/05/2026

1,000,000,000

13/05/2013

13/05/2027

1,000,000,000

26/06/2013

26/06/2028

1,000,000,000

27/09/2013

27/09/2029

750,000,000

Bank Recap

27/09/2013

27/09/2030

750,000,000

Bank Recap

Tranche 3

19/12/2013

19/12/2019

100,000,000

Tranche 4

04/04/2014

04/04/2030

150,000,000

Tranche 5

09/07/2014

09/07/2031

600,000,000

Tranche 6

15/12/2014

15/12/2025

350,000,000

Tranche 2

Type

Source: ESM

SPAIN
The Financial Assistance Facility Agreement provided
to Spain, which was signed in November 2012, consisted of a Financial Institution Recapitalisation Facility
for €100 billion, with a maximum maturity of 15 years
and a maximum average maturity of 12.5 years. At
year-end 2014, the weighted average maturity stood
at 12.49 years.

During 2012, the first disbursement under the first
tranche was paid out through the delivery of ESM
bonds in an amount of €39.47 billion. The ESM
provided the bonds to the Bank of Spain, which
received them on behalf of the Kingdom of Spain, and
subsequently transferred them to the Fund for Orderly
Bank Restructuring (FROB). The FROB used them to
recapitalise the four financial institutions it had taken
over (Group 1 banks) as well as the Spanish asset
management company Sareb (Tables 2 and 3).

Table 2. Funds requested by Spain for Group 1 Banks
Tranche

Value date

Maturity

Loan amount (€)

Type

Tranche 1

11/12/2012

11/12/2022

6,578,000,000

Bank Recap

11/12/2012

11/12/2023

6,578,000,000

Bank Recap

11/12/2012

11/12/2024

6,578,000,000

Bank Recap

11/12/2012

11/12/2025

6,578,000,000

Bank Recap

11/12/2012

11/12/2026

6,578,000,000

Bank Recap

11/12/2012

11/12/2027

6,578,000,000

Bank Recap

Source: ESM

ANNUAL REPORT 2014 | 41

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Yanis Varoufakis
Greece

The pioneers of Europe’s monetary
union understood well the need
for a common fund that would
stabilise the union in times of crisis
and which would complement the
European Central Bank’s efforts at
maintaining monetary stability.
The European Stability Mechanism
evolved precisely in this vein and
for this purpose.

“

Table 3. Split of the funds requested by Spain for Group 1 banks and Sareb
Institution

Loan amount (€)

BFA-Bankia

17,959,000,000

Catalunya Caixa

9,084,000,000

NCG Banco

5,425,000,000

Banco de Valencia

4,500,000,000

Sareb

2,500,000,000

Source: ESM

The second disbursement of €1.87 billion was made
on 5 February 2013, again through the delivery
of ESM bonds, in a procedure similar to the one
described above. The funds were used to recapitalise

four additional Spanish banks, which could not reach
the required capital levels through other means
(Group 2 banks; Tables 4 and 5).

Table 4. Funds requested by Spain for Group 2 banks
Tranche

Value Date

Maturity

Loan amount (€)

Type

Tranche 2

05/02/2013

11/12/2024

932,500,000

Bank Recap

05/02/2013

11/12/2025

932,500,000

Bank Recap

Source: ESM

Table 5. Split of the funds requested by Spain for Group 2 banks
Institution

Loan amount (€)

Banco Mare Nostrum

730,000,000

Banco Ceiss

604,000,000

Caja 3

407,000,000

Liberbank

124,000,000

Source: ESM

At the end of 2013 the availability period of the
Spanish facility came to an end, which meant that the

undrawn amount of €58.67 billion was automatically
cancelled.

42 | EUROPEAN STABILITY MECHANISM

“

Luis de Guindos Jurado
Spain

It has been a privilege to
participate in the setting up of the
European Stability Mechanism.
Along with the Banking Union,
the ESM was a key element of the
response to the crisis, providing
a backstop for the euro area.
In Spain, the successful
implementation of the ESM
financial sector programme and
the ambitious reform effort have
been essential to address the
problems in some parts of its
banking sector, which in turn was
necessary to get back to growth
and job creation.

PREPAYMENTS

“

Following a partial disposal of FROB’s shares in Bankia
earlier in the year, Spain proposed in June 2014 to
reduce its outstanding ESM loan accordingly, via a voluntary prepayment of €1.3 billion. The ESM Board of
Directors approved Spain’s request on 7 July 2014
with a prepayment value date of 8 July. Spain made
the prepayment in cash, rather than in ESM securities. This was the first time an ESM/EFSF programme
country made an early repayment, sending a positive
market signal about the success of Spain’s ESM programme and the overall attractiveness of the Spanish
economy. Given the amount and the timing of the
operation, this payment ahead of schedule was not
detrimental for the ESM.
Subsequently, on 23 July, Spain made another repayment of €307.54 million. It was related to the unused
bank recapitalisation instruments, which, according
to the terms of the facility, must be returned to the

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

ESM upon expiration of the availability period. These
funds constitute a scheduled repayment. Within the
first tranche to Spain, €2.5 billion was initially expected
to be used by FROB to capitalise Sareb, but the final
amount totalled only €2.19 billion. Consequently, FROB
had €307.54 million of unused funds which were subject
to a scheduled repayment procedure foreseen in the
5 December 2013 acceptance notice. In particular, the
acceptance notice stipulated that any ESM securities
delivered to FROB but not used “on or by 15 July 2014”
should be returned to the ESM, reducing the outstanding amount equal to the nominal principal amount of
such ESM securities. Since the relevant ESM securities
matured in February 2013 and were ‘rolled over’ into
pool funding, the repayment was made in cash.
Following the two repayments, the outstanding
amount of the Spanish facility at year-end 2014 was
€39.72 billion. This outstanding amount was further
reduced in March 2015, following Spain’s second
voluntary prepayment of €1.5 billion.

ANNUAL REPORT 2014 | 43

HOW THE COST OF FUNDING
IS CALCULATED
The EFSF and ESM lending rates aim to fully cover their
funding and operational costs as well as to reflect the
varying risk profiles of each instrument. This approach
has evolved over time. Early on, in 2011, the EFSF used
a back-to-back funding/lending strategy, matching the
funds raised from bill and bond sales to a particular
beneficiary Member State’s disbursement schedule.
Later, to ensure greater funding efficiency and regular
market access, both the EFSF and ESM adopted a different strategy, using a variety of funding instruments
and different maturities. Under this new diversified
funding strategy, the funds raised were no longer attributed to a particular country; instead, they were pooled
and disbursed to programme countries as required.

the type of loans used and the market conditions at the
start of the programme may result in some initial differences in the costs of funding to beneficiary Member
States, over time, as the type of loans becomes more
uniform, the costs of funding tend to converge.

IRELAND AND PORTUGAL
At the beginning of EFSF activity, loans were financed
through fixed-rate bond issuances on a back-to-back basis.

There are still exceptions to this strategy. To recapitalise banks and finance potential resolution costs, for
instance, loans are made via the delivery of EFSF or
ESM notes, termed ‘in kind’ disbursements.

These loans were more expensive, given a higher
interest rate environment at the time, substantially
higher margins charged to borrowers, and the fact
that the EFSF was a new issuer in the market. From
2012 to 2014, the average funding cost of these
fixed-rate bonds was 285 basis points for Irish loans
and 286 basis points for Portuguese loans.

The EFSF and ESM fully transfer their cost of funding to
the beneficiary Member State.6 Additionally, their final
lending rates also include small fees to cover operational costs and a margin to cover credit risk. So, while

From December 2011, after the approval of the
Diversified Funding Strategy, the EFSF progressively
moved to pool-funded loans, which were initially
financed by short-term bills.

EFSF’S COST OF FUNDING
Figure 15. Historical blended lending rates for the EFSF
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0%
Feb 11

May 11

Aug 11

Nov 11

Feb 12 May 12

Aug 12

Nov 12

Feb 13 May 13

Aug 13

Nov 13

IRELAND
Note: The first EFSF loan was signed with Ireland, followed by Portugal and Greece.
Source: ESM

6

This transfer or ‘pass-through mechanism’ is based on a daily
computation of the actual interests accrued on all EFSF and
ESM funding instruments. In the general case of disbursements
sourced from the pool, the accrued interests are allocated to
each disbursement on the basis of the outstanding amounts. In
the exceptional cases of disbursements sourced from back-to-back
funding, like those made in the first EFSF programmes or when
disbursements were made in kind, the daily allocation of interests
only takes into consideration the funding instrument used.

Feb 14 May 14
PORTUGAL

Aug 14

Nov 14
GREECE

44 | EUROPEAN STABILITY MECHANISM

Then, the pool itself gradually moved to longer-dated
debt from bills, which should have created a gradual
upward movement in the cost of funding from 2012 until
the present day. But this upward movement occurred
only in 2012. From the beginning of 2013 it stopped,
mainly because interest rates had decreased and the
spread of EFSF to German bunds had narrowed.

initially disbursed in kind were partly rolled into the
pool, and new pool-funded loans were disbursed. The
Eurogroup decided in late 2012 to defer Greece’s interest payment until December 2022 and cancelled the
initial guarantee commission fees of 10 basis points.
Nevertheless, the rates remain significantly lower
than those of Ireland and Portugal, mostly due to the
funding structure: some loans for bank recapitalisation
to Greece continued to be financed in kind whereas
loans to Ireland and Portugal are only pool funded by
fixed-rate longer-duration funding instruments.

GREECE
For Greece, the dynamics are different, as Figure 15
shows. Initially, Greece was mainly financed by disbursements in kind, indexed on the six-month Euribor
rate (87% of the initial disbursement). Therefore,
the rates started relatively low and gradually moved
upwards until November 2012 as the PSI-related loans

Starting from January 2013, the upward movements
are explained by the rollover of the back-to-back loans
to the pool.

ESM’S COST OF FUNDING
Figure 16. Historical blended lending rates for the ESM
1.20%
1.00%
0.80%
0.60%
0.40%
0.20%
0.00%
Dec 12

Mar 13

Jun 13

Sep 13

Dec 13

Mar 14

Jun 14

Sep 14

Dec 14

SPAIN

CYPRUS

Note: The first ESM programme was signed by Spain, followed by Cyprus.
Source: ESM

SPAIN

CYPRUS

Initially, the ESM absorbed the EFSF bills programme
and only provided financing on a short-term basis.
The ESM thus granted the first loans through
disbursements using short-term paper designed to
boost banks’ capital and cover resolution costs. This
explains why Spain obtained such low rates at the
beginning. From the end of 2013, the ESM started
issuing longer-term paper, which, together with the
rollover to the pool of loans initially disbursed in kind,
explains the increase in the Spanish lending rate.

Until September 2013, the ESM relied principally on
pool-funded loans to finance Cyprus. For the same
period, all Spanish loans were provided instead as in
kind loans of ESM-issued notes. Thus, for the period
until September–December 2013, there was a gap in
funding rates between Cyprus and Spain.
After the disbursement in kind of the bank recapitalisation loan, Cypriot rates responded to the lower
cost by falling 20 basis points. Then, lending rates
started converging and increasing as the ESM issued
longer-term paper, more pool-funded Cypriot loans
were disbursed, and a large amount of Spanish loans
disbursed in kind gradually moved to pool-funded loans.

ANNUAL REPORT 2014 | 45

Funding activities

OVERVIEW OF ESM FUNDING IN 2014

ESM BOND PERFORMANCE

To finance the loans made to beneficiary Member
States, the ESM raises funds on the debt capital
markets by issuing bills and bonds. A portion of the
funds raised are pooled and then disbursed to the
beneficiaries at the same rate. The ESM raises funds
in both long-term markets through bond issuance
and in short-term markets through bill issuance. The
ESM’s objective is clear: to raise the required funds at
the lowest possible rates.

2014 was the first full year that the ESM was active in
the capital markets. During the year, the ESM focused
on completing its outstanding curve. In 2014, all ESM
bonds performed strongly both in terms of yield and
spreads to interest rate swaps.

LONG-TERM FUNDING

Figure 17. Spread performance
of ESM benchmarks

• 7-year bond with a 1.375% coupon issued on
4 March which raised €6 billion;
• 5-year bond with a 0.875% coupon issued on
7 May which raised €3 billion;

20
Mid asset swap spread in basis points

The ESM, which launched funding in the long-term
markets in October 2013 with an inaugural 5-year
bond, had a long-term funding target of €15 billion
in 2014. The ESM successfully achieved this target
through the issuance of bonds in different maturities,
creating new reference points along its yield curve.
The ESM launched three new bonds in 2014:

The compression of swap spreads continued throughout
the year and illustrated investor confidence in the ESM
name. The ESM has now become a well-established
issuer on the debt capital markets.

10
0
-10
-20
-30
-40
-50
Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15

• 2-year bond with a 0% coupon issued on 28 October
which raised €4 billion.

ESM 1.25 10/2018

ESM 1.375 03/2021

ESM 2.125 11/2023

Source: Bloomberg

The ESM raised the remaining €2 billion by re-opening
existing bonds (‘taps’), selling the debt at the current
market price but maintaining the original face value,
maturity and coupon rate. For the first time, it used
the auction system for that purpose, a standard
process for sovereign bonds. The ESM uses the ESM
Bidding System of the Deutsche Bundesbank (EBS) for
all bond and bill auctions.

In absolute terms, ESM bond yields fell across the yield
curve over the year. This absolute yield decline helps
beneficiary Member States going forward, because it
lowers the ESM’s funding costs which translates into
lower interest rates for beneficiary Member States
repaying ESM loans.

Figure 18. Yields of ESM benchmarks

By reopening these bonds and increasing their size,
the ESM provided additional liquidity to these bonds
and enhanced investors’ ability to trade in the secondary market.

2.5
2.0
Yield to maturity (%)

The first tap reopened the 10-year bond initially issued
in November 2013, raising €990.75 million and
bringing this bond’s total size to almost €4 billion. The
second tap reopened the 2-year bond initially issued in
October 2014, raising €987.5 million and bringing its
total size to almost €5 billion.

1.5
1.0
0.5
0.0
-0.5
Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15

ESM 1.25 10/2018

Source: Bloomberg

ESM 1.375 03/2021

ESM 2.125 11/2023

46 | EUROPEAN STABILITY MECHANISM

ESM PLACES FIRST 2-YEAR BOND
On 21 October, the ESM raised €4 billion by placing its first 2-year bond. This bond represented a new point on
the yield curve for the ESM and was the first ESM bond issued with a zero coupon. Although a more unusual
maturity, the 2-year bond took advantage of the market environment. It also allowed the ESM to optimise its
redemption profile, enabling it to be regularly present in the market, and to offer investors the opportunity to
roll over their investments. The issue attracted very strong demand, with high-quality investors such as central
banks and bank treasuries placing orders for more than €5.8 billion. Given the high initial demand, the ESM
reopened the bond on 25 November, bringing the total size to almost €5 billion.

2014 was also the first full year in which both the
ESM and EFSF were active in the market in parallel.
The risk premium for the ESM had initially been lower
than that of the EFSF reflecting, among other things,
the ESM’s strong capital structure as opposed to the
EFSF’s guarantee structure. The rating agencies also
expressed their views on the differing risk profiles of the
two, assigning the ESM a higher rating than the EFSF.
The risk premium between the EFSF and the ESM
diminished, however, over 2014, driven principally by
the ECB’s new monetary policy measures to support
inflation and growth. In early 2015, spreads moved
markedly on expectations of the ECB’s expanded
asset purchase programme. With more liquid bonds
outstanding, the EFSF thus outperformed the ESM;
markets now value both entities similarly. The exception has been the shorter bonds, such as the 2018
bond, as the EFSF and ESM were already priced in line
and touching negative yields in 2015.
The performance and the current levels of yields and
spreads of both the ESM and EFSF show that both issuers are well established and recognised in the markets.

SHORT-TERM FUNDING
The ESM continued its short-term funding programme
in 2014 with its regular 3-month and 6-month bill
auctions. In total, the ESM raised over €38.5 billion
in bills, with each auction raising from €1 billion to
€3 billion.
The demand for bills remained strong in 2014, despite
lower issue sizes in the second half of the year. This
led the bid-to-cover ratio, which rises as debt demand
strengthens, for the 3-month maturity to trend higher
over the year, rising to 4.5 towards year-end from an
early two, making the 2014 average more than three.
Demand for the 6-month tenor also heightened during
the year, with bid-to-cover ratios climbing to four from
1.5 for a 2.5 average in 2014. Total bids averaged
€4.6 billion for the 3-month tenor and €3.7 billion for
the 6-month tenor.

Figure 20. ESM bill auctions: demand
and amounts raised
7

15

5
4
3
2

11

1

9
7

4
v-1

t-1
4

c-1
4
De

No

Oc

4

p14
Se

4

-1
Au
g

4

14

l-1
Ju

nJu

-1
ay
M

Ap

r-1

4

4

14

-1
ar
M

b-

n-

Fe

14

0

5

Ja

ASW difference in basis points

13

6

in billion €

Figure 19. Asset-swap spread difference
between EFSF and ESM bonds

3
Total bids
3-month

1
-1
-3

Source: ESM

-5
Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15

ESM 1.25 07/2018

ESM 1.375 06/2021

ESM 2.125 02/2024

EFSF 1.25 07/2018

EFSF 1.375 06/2021

EFSF 2.125 02/2024

Source: Bloomberg

Total bids
6-month

Issue size
3-month

Issue size
6-month

ANNUAL REPORT 2014 | 47

The Finance
ew on
Minister’s vi
the ESM

After just two years in existence,
the ESM has proved a crucial and
relevant partner towards our
common objective for a more
stable and resilient euro zone,
thanks to the dedication and
expertise of its staff. I am confident
that, as the peak of the crisis
recedes, the ESM will continue
to play a pivotal role as a tool of
solidarity and financial stability in
tackling forthcoming challenges
with the same spirit of service.

“

OVERVIEW OF EFSF FUNDING IN 2014
The ESM is also responsible for raising EFSF funding,
which was used for the disbursements of the Greek and
Portuguese programmes and the rollover of the existing
debt. In 2014, EFSF raised €34.5 billion, covering
a wide range of maturities from a 364-day bond which
raised €4 billion in July, followed two weeks later by
a 30-year bond at the very long end of the yield curve.

EFSF issuances are fully guaranteed through the
over-guarantee structure. Comparing EFSF performance with a synthetic average yield basket of
six highly-rated guarantors demonstrates that the
EFSF has performed well over the last two years. The
spread performance also reveals that the market now
recognises the EFSF as a well-established issuer.

Figure 22. EFSF vs. core guarantors* –
5-year yield levels

EFSF BOND PERFORMANCE

EFSF vs Core Guarantors - 5YR Yield Levels
250

2.50

225
2.00

200
170

1.50
Yield (%)

EFSF bonds also performed strongly in 2014. This
was particularly noticeable at the long end of the yield
curve. For a 30-year bond, for example, yields have
fallen almost 1.5% since the end of 2013. The trend
of falling yields continued into 2015.

150
125

1.00

100
75

0.50

50

Figure 21. Interpolated EFSF curve

25

0.00

0
-25

nJa

Ap

12

3.50

r-1
2
Ju
l-1
2
Oc
t-1
2
Ja
n13
Ap
r-1
3
Ju
l-1
3
Oc
t-1
3
Ja
n14
Ap
r-1
4
Ju
l-1
4
Oc
t-1
4
Ja
n15

-0.50

3.00
Yield to maturity (%)

Yield difference (basis points)

“

SPOTLIGHT

Michel Sapin
France

Diff (EFSF vs Basket)

2.50

5YR AAA Basket

EFSF 5Yr Generic

Note: *Austria, Finland, France, Germany, Luxembourg, and the
Netherlands.

2.00

Source: ESM

1.50
1.00
0.50
0.00
-0.50
3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 8Y 9Y10Y

15Y

EFSF curve 31/12/2013

20Y

25Y

30Y

EFSF curve 31/12/2014
EFSF curve 31/03/2015

Source: Bloomberg

48 | EUROPEAN STABILITY MECHANISM

EFSF PLACES FIRST 30-YEAR BOND
On 22 July 2014, the EFSF placed a 30-year bond, the first such maturity it has issued, for a total of €4 billion.
This bond matches well with the EFSF’s underlying long-term loans. It allowed the issuer to lock in a historically
low yield of 2.392% and, at €4 billion, represented an exceptionally large size for a supranational issuer. It
attracted very strong demand with orders of over €6.1 billion and drew a number of investors to the EFSF
name for the first time. The debt market industry awarded it the ‘Deal of the Year’ in the Euro-supranational
category of the Global Capital Awards©.

Figure 24. ESM investor breakdown

FUNDING OUTLOOK 2015
The ESM announced its 2015 long-term funding
target of €14 billion at end-December 2014. Due to
Spain’s early repayment of €1.5 billion, which the ESM
Board of Directors approved on 9 March 2015, the
long-term funding target was revised downwards by
€1.5 billion to €12.5 billion.

Geographical breakdown

Breakdown by investor type

3%

3%
2%

18%

36%
7%
42%

35

34.5

in billion €

30

15

13.5

15

15

Asia

Central Banks/Govt/Sov. Wealth fund

Euro area

Fund managers

Rest of Europe

Banks

UK & Switzerland

Pension funds/Insurance/Corporates

Other

Others

Note: Total breakdown includes all ESM syndicated bond issues at
time of issue. Placements by auction are not included. As at
10 March 2015.

25
20

17%

47%

Figure 23. EFSF and ESM funding
programmes 2014–2016
40

25%

12.5

10

Source: ESM
7

5

A COMPREHENSIVE COMMUNICATION
STRATEGY

0
EFSF

ESM
2014

2015

2016

Note: Future figures are based on estimates and may vary depending
on market conditions. These figures do not include any cashless
operations. The bill programme will cover shortfalls between
lending requirements and long-term funding.
Source: ESM

In the first quarter of 2015, the ESM raised €3 billion
through the issuance of a 2.5-year bond. The bond
attracted exceptional demand with an order book of
over €9 billion. It was issued with a yield of -0.07% and
therefore became the first Sovereign, Supranational
and Agency issuer to place a euro-denominated syndicated benchmark bond at negative rates.
For the EFSF, the 2015 long-term funding target is
€13.5 billion.

INVESTOR RELATIONS
Since its inaugural bond issue in October 2013, the
ESM has built its investor pool and now counts upon
a well-diversified and consistent base. As the ESM
added points to its yield curve in 2014, it continued to
attract new investors worldwide.

One of the cornerstones of the Investor Relations
strategy has been a clear and transparent communication policy. The quarterly newsletter outlines
the funding programme for the coming quarter. It
provides the dates for the 3-month and 6-month bill
auctions. For the bonds, it is still important to retain
some flexibility to adapt to changing market conditions;
therefore, the newsletter identifies the weeks where
the EFSF or ESM could potentially come to the market
with a transaction. The newsletter also details the
amounts the EFSF and ESM will raise in each quarter.
This enables investors to be fully aware of the amounts
that the EFSF and ESM have to raise per quarter
and indicates clearly when the EFSF and ESM will be
coming to the market to issue a bond.
Subscription to the ESM newsletter can be made via
the Investor Relations section of the ESM website at:
http://www.esm.europa.eu/investors/subscribenewsletter.htm.

ANNUAL REPORT 2014 | 49

ESM ENJOYS
ROBUST CREDIT RATINGS

The ESM is committed to maintaining a high credit
rating to successfully fulfil its mandate. Throughout
2014, it continued to rank among the international
financial institutions with the highest creditworthiness.
Fitch Ratings has assigned it a long-term AAA rating
with a stable outlook and a short-term rating of F1+.
In June 2014, Moody’s Investors Service improved
the ESM outlook on its long-term Aa1 rating to stable
from negative and affirmed its short-term rating of
P-1. Furthermore, in May 2014, DBRS Inc. assigned
the ESM unsolicited long-term and short-term issuer
ratings of AAA and R-1 (high) with a stable trend.
The ESM’s high credit rating derives from the institution’s standalone credit strengths. The following key
elements are emphasised:
• The ESM has a large capital base, which compares
favourably with those of its peers, given total paid-in
capital of €80 billion and total subscribed capital of
€704.8 billion, as of 18 March 2015. Its relatively
low leverage would be preserved even if the ESM
used its maximum lending capacity of €500 billion;
• The ESM has a unique capital call mechanism,
which allows the Managing Director to call capital
to avoid a default on obligations, without requiring

additional approval from the Board of Directors or
the Board of Governors. On a subscribed capital
basis, ESM Members have overall a high average
creditworthiness, in line with AAA-rated institutions;
• The ESM’s risk management guidelines are prudent, in particular as regards the investment of the
paid-in capital portfolios and liquidity management;
• The ESM’s Early Warning System, entailing reviews
of the financial conditions of the beneficiary Member
States well in advance of scheduled repayments,
and the ESM’s preferred creditor status, are robust
credit-enhancing factors.
In addition to credit agencies’ views, the regulatory
treatment of ESM debt is also important for maintaining its diversified investor base. In this regard, the
Basel Committee on Banking Supervision has agreed
that supervisors may allow banks to apply a 0% risk
weight to claims on the ESM. Furthermore, together
with other assets of the highest liquidity, ESM debt is
also included among level 1 assets for the calculation
of the liquidity coverage ratio as classified by the delegated act on the liquidity coverage ratio that defines
the eligible assets and their treatment for EU banks’
liquidity buffers.7

7

Liquidity coverage ratio rules for EU banks are described in EU Regulation 575/2013 (Capital Requirements Regulation).

50 | EUROPEAN STABILITY MECHANISM

Investment and Treasury

INVESTMENT POLICY
The Investment Policy ensures that the investment
of the paid-in capital is implemented in an efficient
and conservative manner. By preserving the paid-in
capital, the policy makes sure that the ESM maximum
lending capacity remains available at all times.
The ESM Guideline on Investment Policy, approved by
the Board of Directors, defines the overall framework
within which the ESM carries out investment and
treasury activities.
Investment and Treasury decisions are overseen
by an Investment Management Committee (IMC)
chaired by the Chief Financial Officer. The Internal Risk
Committee (IRC), chaired by the Chief Risk Officer,
ensures that all investments conform to the ESM Risk
Policy.
The Managing Director is responsible for implementing the investment policy in accordance with the
Guideline on Investment Policy and also for setting up
the appropriate governance framework.

INVESTMENT STRATEGY
In 2014, in a context of modest economic growth
and very low inflation rates, yields in European bond
markets fell to historically low levels, as monetary
policies remained extremely accommodative in major
markets. In Europe, in particular, the aggressive
monetary policy decisions taken by the ECB (cuts
of the deposit facility rate to minus 0.20%, Long
Term Refinancing Operations and additional purchase
programmes) propelled short-term European interest
rates to negative levels.
To reduce the impact of the negative yields on the paid-in
capital, which is divided into a Short Term Tranche (STT)
and a Medium/Long-Term Tranche (MLTT), the size of
the STT was progressively reduced in 2014 in favour
of the MLTT. The STT reached its minimum size of
€5 billion, which is considered large enough in the current market environment to provide the ESM with an
appropriate level of liquidity. The latter is also ensured
by the overall Investment Policy which strongly favours
investment in high-quality liquid assets.

The fall in short-term yields pushed the rest of the
yield curve to a historically low level: the German government 5-year and 10-year bond yields fell, respectively, by 90 and 140 basis points over the year. In
that context, the ESM’s investment strategy for the
MLTT continued to focus on the most appropriate way
to achieve capital preservation over a 3-year horizon.
This led the ESM to prefer investment in highly-rated
assets at positive yields, and to move to longer-dated
debt toward the higher boundary of the target range
(see the box on ‘Negative yields present new challenge
to safeguarding capital’). The portfolio’s curve exposure was designed to take advantage of carry and
roll-down effects, and also to benefit from an expected
flattening of the curve in a low inflation environment.
As the continuous fall in yields led investors to look
for alternative investment opportunities, credit
spreads narrowed across markets. On average, in
the 10-year sector, the credit spread of supranational
and European government agency issuers contracted
by 25 to 30 basis points against Germany, which
supported the performance of ESM paid-in capital
invested in this type of assets (see Figure 25).
Overall, the ESM benefited from this investment strategy which enabled the paid-in capital portfolio to outperform its investment benchmark, a mix of 0/1-year
and 1/3-year indices of highly rated European bonds.

Figure 25. ESM paid-in capital investment
securities breakdown, by asset
class
3%

37%
35%

Sovereign
Government Agency
Supranational
Covered Bonds

25%
Note: Breakdown as of 31 December 2014.
Source: ESM

ANNUAL REPORT 2014 | 51

“

SPOTLIGHT

Pier Carlo Padoan
Italy

The Finance
ew on
Minister’s vi
the ESM

During the crisis, the ESM’s
lending activities together
with its fund-raising capacity
have reassured investors and
contributed to improve conditions
in financial markets. Over the years,
ESM strengthened its organisation
and introduced new instruments
like the direct recapitalisation of
banks. A stronger and evolving
institution is key to further enhance
financial stability in the euro area.

INVESTMENT STRUCTURE

“

The last €16 billion instalment of paid-in capital was
received in April 2014. With this payment, the total
paid-in capital reached its target size of €80 billion.
The investment occurred in a near zero but positive
yield environment for maturities up to two years. The
additional capital was invested, in accordance with
the investment guidelines, across the curve and with
a three-month ramp-up period ending in July.
The paid-in capital (PIC) is invested in high-quality
assets as illustrated by the rating distribution. At the
end of 2014, and depending on the rating agencies’
methodologies, 73.7% to 97.9% of the PIC portfolio
was invested in securities with a rating equal to or
above AA+, with the rest of the assets rated AA/AA(see Figure 26).

Figure 26. Rating distribution of the paid-in
capital securities, by rating agency
100

2.1%
26.1%

80

24.4%

26.3%
3%

60

19.7%

40
20

73.5%

70.7%

Moody’s

Fitch

54.2%

0
S&P
AAA/Aaa/AAA

AA+/Aa1/AA+

AA/Aa2/AA

AA-/Aa3/AA-

Note: Distribution as of 31 December 2014.
Source: ESM

Within this high-quality universe, the exposures of the
ESM’s portfolios are diversified across asset classes.
At the end of 2014, ESM assets were relatively well
balanced with a mix of Sovereign, Supranational, and
Government agency exposure. AAA Covered Bonds
have also contributed to the diversification but remain,
at this stage, a minor exposure for the ESM at 3% of
the total PIC.

52 | EUROPEAN STABILITY MECHANISM

NEGATIVE YIELDS
PRESENT NEW CHALLENGE
TO SAFEGUARDING CAPITAL

Holding assets at negative yields represents a cost,
as the expected return over the remaining life of the
security is negative. For the ESM’s PIC, whose assets
were bought at positive yields, this situation will over
time decrease unrealised gains.
To reduce the impact of negative yields on the PIC’s
expected return – a key objective to ensure capital
preservation – the ESM has initiated a range of
measures:
• In 2014, duration was kept at the higher end of the
duration band to increase the proportion of assets
invested at positive yields.
• Since the last quarter of 2014, additional credit
limits for AAA-covered bond issuers have been
approved.
• Since the start of 2015, assets with deeply negative yields have been actively sold.

In 2015, additional measures could be implemented
to further reduce the impact of negative yields on the
PIC.
Different options such as non-euro investments are
being explored. The aim would be to enable the ESM
to invest in foreign currency assets and hedge back
into euros so that the positions do not generate
foreign exchange risk. Such non-euro hedged foreign
exchange instruments, which are widely used by major
central banks, could contribute to the diversification of
the ESM’s portfolios. It could also contribute to the
ESM’s capital preservation objective by enabling it to
invest, when opportunities arise, at more favourable
conditions than in euros over short-term horizons,
while keeping risk low.
Furthermore, a possible enlargement of the investment universe will be assessed to increase opportunities without affecting the ESM’s overall financial
strength.

ANNUAL REPORT 2014 | 53

Risk management
The ESM has clear risk management objectives
and an established strategy to deliver them through
appropriate governance and core risk management
processes. The organisation’s approach to risk
management derives from the ESM Treaty and the
‘High Level Principles for Risk Management’, both
documents being publicly available.
The ESM’s risk management objectives are stated in
the High Level Principles, and in summary are:
• follow a prudent approach to risk-taking in order to
limit potential losses and ensure continuity in fulfilling
the ESM’s mandate and meeting its commitments;
• maintain minimum capital requirements in order to
ensure the highest creditworthiness and to avoid
unexpected capital calls;
• preserve the ESM’s funding, and hence lending, capacity.
The ESM applies elements of its risk management
framework to all aspects of its mandate, with the
exception of accepting counterparty risk on financial
assistance granted to ESM Members experiencing
severe financial problems, where such assistance is
indispensable to safeguard the financial stability of
the euro area as a whole and of its Member States.
Although the ESM aims to fully cover its financing and
operating costs, the ESM does not aim to generate
profit on financial support granted to beneficiary
Member States and does not provide incentives for
speculative exposures of its investment portfolio.

RISK GOVERNANCE
The Board of Governors delegates authority and
accountability to the Board of Directors for establishing the ESM risk management framework and to the
Managing Director for implementing it. The ESM has
also established two risk committees:
• the Board Risk Committee, a permanent committee of the Board of Directors, advising it on the
overall current and future risk appetite, and assisting it in reviewing and overseeing the development
of the ESM’s risk management framework;
• the Internal Risk Committee, a permanent internal
ESM committee, comprising the Management
Board and Chief Risk Officer, which evaluates,
monitors and approves practices regarding the
implementation of the ESM’s risk management
framework.

Risk management responsibilities within the ESM are
established on the ‘Three Lines of Defence’ concept,
which sets out clearly drawn lines of authority and
appropriate segregation of powers and duties. The
first line of defence consists of business functions
and departments with direct responsibility for the
day-to-day management of risk. The second line of
defence is performed by an independent risk management function, led by the Chief Risk Officer, which oversees the risks assumed by the business and ensures
they are appropriately managed and controlled. The
third line of defence consists of an independent
internal audit function, led by the Internal Auditor,
responsible for providing the Board of Directors with
assurance that risk management controls are operating properly and efficiently. Both the Chief Risk Officer
and Internal Auditor report directly to the Managing
Director to ensure their independence.

RISK APPETITE
ESM Risk Policy documents the appetite for risk
that the ESM Board of Directors is willing to accept
in the execution of the organisation’s mandate. The
ESM management and Risk department cascade this
risk appetite into relevant aspects of governance,
policies, frameworks, and individual limits to ensure
that the organisation’s activities remain within this risk
appetite. In addition, internal statements have been
drafted, defining the tolerance for specific material
risks that the ESM itself can manage and mitigate.

RISK CULTURE
Establishing a strong risk culture is of paramount
importance to the ESM. Risk culture is the combined
set of individual and corporate values, attitudes,
competencies and behaviours that determine the
ESM’s commitment to the management of risk at all
levels. Supported by management, risk culture in the
ESM is founded on a close alignment between the
organisation’s objectives and the risk management
framework. Such a culture embeds an independent
discipline, which in turn ensures rigorous challenge
and objectivity in decision-making.

RISK MANAGEMENT PROCESS
The ESM has implemented a systematic four-step
process to manage the various types of financial and
non-financial risk to which the organisation is exposed.

54 | EUROPEAN STABILITY MECHANISM

Risk identification – the identification of all material
risk exposures, both financial (credit, market and
liquidity risk) and non-financial.
Risk assessment and measurement – the assessment of identified risk exposures to determine their
materiality, based on a combination of quantitative
tools and expert judgement.
Risk monitoring and control – the on-going monitoring and control of material risk exposures, including
limit frameworks, key risk indicators, reporting and
escalation.
Risk management – the process of determining and
executing appropriate actions to actively manage risk
exposures, such as mitigation, transfer, reduction, or
acceptance of the risk.

NATURE OF ESM ACTIVITIES
AND KEY RISKS
The ESM is an intergovernmental, non-commercial
entity, established to support the stability of the euro
area and euro area Member States. To fulfil this

Lending and
stability support
activities

mandate, the ESM needs to maintain the highest
creditworthiness so as both to minimise the cost of
borrowing and thus support lending operations and
to ensure market access. To achieve this aim, risk
management policies and the Investment Policy are
formulated prudently and conservatively.
Nevertheless, as with all financial institutions, the
ESM remains subject to a number of financial and
non-financial risks. These risks are a function of the
ESM’s mandate and operational activities, as well as
its operating model and financial policies. The ESM
therefore implements the appropriate procedures and
processes to identify, assess, measure, monitor, and
manage these risks.

FINANCIAL RISKS
CREDIT RISK
Credit risk – the risk of loss arising from the inability
of a counterparty, issuer, insurer, or other obligor to
fulfil its contractual obligations. The ESM is exposed to
credit risk from two sources: lending and stability support activities; and investment and funding operations.

Credit risk from lending – the risk of loss if Member States which have benefited from
the ESM’s financial stability support fail to fulfil their contractual obligations.
• Lending by the ESM is protected by preferred creditor status, junior only to the IMF,
which is a strong measure mitigating the credit risk from lending.
• As part of its Early Warning System, the ESM assesses the ability of a beneficiary
Member State to repay its obligations. Findings are summarised in a regular report
which is considered by the Internal Risk Committee. This activity is in accordance with
the mechanism for drawing down callable capital if required (see the publicly available
Terms and conditions of capital calls for ESM).
Credit risk from Direct Recapitalisation Instrument – the risk of loss if there is a default
by a financial institution on direct capital assistance in the form of equity and junior debt.

Investment
and funding
operations

Issuer and counterparty risk – the risk of loss as a result of the non-fulfilment of
contractual obligations.
Credit concentration risk – the risk of loss due to investments being too heavily concentrated in a particular issuer, class of issuer, sector, country, or similar category, and therefore
being exposed to the risk that issuer and counterparty risk losses could be highly correlated.
The ESM is primarily exposed to these risks through its need to invest proceeds from its
paid-in capital, the liquidity buffer and the reserve fund.
Credit limits and minimum credit quality thresholds mitigate credit risk exposure.
Compliance with these thresholds is analysed independently by counterparty risk specialists and checked against the ratings assigned to counterparties, issuers and individual
issuances, by the three major rating agencies, namely Fitch, Standard and Poor’s and
Moody’s. In addition, credit risk is also mitigated through the use of collateral, which is
also subject to eligibility requirements and margin calls. The ESM measures and monitors
credit risk exposures and compliance with credit risk rules on a daily basis.

ANNUAL REPORT 2014 | 55

“

Harris Georgiades
Cyprus

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

It is my firm belief that the
establishment of the European
Stability Mechanism has been
decisive in addressing emerging
challenges in the EMU, in the midst
of the unprecedented global
economic crisis.
It is also my belief that the ESM
will remain a key institution,
safeguarding the financial and
economic stability of the EMU from
any future crises.

MARKET RISK

“

Market risk – the risk of loss arising from changes in
the values of financial assets and liabilities (including
off-balance sheet items) due to price fluctuations in
interest rates, foreign exchange and other securities.
Market risk can be structural (in relation to assets and
liabilities) or non-structural (in relation to investments).

Structural

The ESM has both types of market risk: structural for
lending and funding activity, and non-structural for the
investment of the paid-in capital.
The ESM’s main market risk is interest rate risk –
the risk of loss arising from adverse movements in
market yields or the term structure of interest rates.
This type of risk can manifest itself in different ways:

• General interest rate risk – the risk of loss due to an adverse change in the overall level
of interest rates acting on the net level of interest rate exposure between assets and
liabilities.
• Refinancing risk – the risk of loss of income arising from the differences in maturity
profiles of the assets and liabilities (maturity mismatch or ALM risk) due to changes in the
term structure of interest rates, i.e. steepening or flattening of the curve. Refinancing
risk occurs when the maturity of assets is longer than the maturity of the liabilities used
to fund them.

Non-structural

• General interest rate risk – the risk of loss due to an adverse change in the overall level
of interest rates affecting the value of the investments. There will not be a realised profit
or loss unless the investments are subsequently sold at the new interest rate level.
• Basis risk – the risk of loss due to an unexpected divergence in the spread between different sectors of the interest rate market used as the basis for pricing the investments,
or between a derivative product and the exposure it is hedging.

56 | EUROPEAN STABILITY MECHANISM

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Jānis Reirs
Latvia

In a situation when it is necessary
to deal with exceptional financial
stability problems or a situation
where a Member State is
threatened by possible severe
financing problems, the ESM is
an important element to restore
stability in the euro zone. Hence,
it is vital that the ESM continues
to perform as successfully and
productively as it has up to now.

“

Structural interest rate risk is controlled via cash
flow projections performed by the ALM function, supported by a short-term liquidity buffer as described
in the Investment Policy. The ESM is required to
maintain coverage of all outflows up to one year
using the liquidity buffer and part of its capital. Even
though all funding costs arising from refinancing risk
are currently ‘passed through’ to beneficiary Member
States under financial assistance, as defined by the
ESM Pricing Policy, the ESM measures and monitors
this risk continually, since it is generally the case that
long-dated assets will be funded by shorter-dated
liabilities.
Non-structural interest rate risk is controlled by
a series of limits on portfolio duration, monitored
daily. There are also longer-term value-at-risk limits for
each tranche of the paid-in capital as described in the
Guideline on the Investment Policy. These are monitored by means of daily calculations, performed using
a 99% confidence level, which are then converted to
longer-term values and compared with risk appetite.
Value-at-risk does not measure the worst loss that
could be experienced. Hence, in addition, various yield
curve and market sensitivity stress tests are carried out
daily, as well as periodic exercises related to economic
scenarios that are reviewed by the risk committees.

The ESM recognises other market risks:
• Credit spread risk – the risk of loss on an investment in a debt security as a result of a decrease
in the value of the security due to an actual or
market-implied decrease in the creditworthiness of
the issuer. Spread risk can be specific to a particular issuer as well as being driven by changes in
sector, country, and other relevant spreads. This
risk is controlled within the set of value-at-risk limits
described above.
• Foreign exchange risk – the risk of loss arising
from changes in the exchange rates. Since the ESM
currently funds and invests only in the euro, this
risk is not present. To date, the ESM has not used
derivative instruments in any of its activities.
• Equity risk – the risk of loss arising from changes in
the price of equity instruments. These instruments
could arise in the context of the Direct Recapitalisation
Instrument, whereby the ESM would provide capital
directly to certain eligible financial institutions. At
present the ESM has not provided any such capital
directly, hence it holds no equity risk.
Table 6 gives a daily and annualised value-at-risk comparison between the end of 2013 and the end of 2014.

Table 6. Daily and annualised value-at-risk comparison, 2013 and 2014
Portfolio value
in € million

1 day value-at-risk
in € million

Daily % of
portfolio value

Annualised % of
portfolio value

As at 31.12.2014

84,694

110

0.13%

2.06%

As at 31.12.2013

78,307

56

0.07%

1.13%

Source: ESM

ANNUAL REPORT 2014 | 57

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

“ “
Rimantas Šadžius
Lithuania

The European Stability Mechanism
contributes to both financial
stability and solidarity within
the euro zone. I am proud that
Lithuania is a part of it as of 2015.

LIQUIDITY RISK

and instruments used to fulfil ESM’s liquidity needs
(see page 45).

Two main types of liquidity risk are faced by the ESM:
• Funding liquidity risk – the risk of loss arising from
difficulty in securing the necessary funding, or from
a significantly higher cost of funding than normal
levels, due to a deterioration of the ESM’s creditworthiness, or at a time of unfavourable market
conditions (such as periods of high stress).
• Liquidity concentration risk – the risk of loss
arising from concentrations in assets and liabilities
as major sources of liquidity, particularly in times of
market stress.
The ESM addresses these liquidity risks by holding
sufficient capital at all times, invested in appropriately
liquid assets, plus an adequate liquidity buffer to
cover short-term liquidity needs. The liquidity buffer
is managed according to two principles: it must
comply with sound liquidity risk management principles; and it may not become too large compared
with these risks, so as not to generate excessive
cost of carry for beneficiary Member States. At the
end of December 2014, the liquidity buffer stood at
€3.8 billion (2013: €5.0 billion); on average in 2014
it was €9.4 billion (2013: €5.0 billion).
The ESM continually monitors funding conditions, and
stresses its projections of asset and liability cash
flows based on a number of alternate assumptions.
The organisation further minimises liquidity risk
through a diversified funding strategy. The notes to
the ESM Financial Statements provide a table of liquidity gaps by maturity band, and the section covering
funding in this Annual Report describes the strategy

There is a third type of liquidity risk, market liquidity
risk – the risk of loss arising from a position that
cannot easily be unwound or offset at short notice
without significantly influencing its market price due to
inadequate market depth or market disruption. This
risk is present in relation to the investment of the
ESM’s capital, and is controlled by limits such as the
total proportion of a bond issuance that can be held.

NON-FINANCIAL RISKS
The ESM is subject to a number of non-financial risks
due to the nature of its activities and its mandate,
which include operational risk, reputational risk, legal
risk, compliance risk, and political risk. Careful vigilance in regard to all of these risks is a major priority
for the ESM. Each is identified, assessed, and monitored by the relevant ESM department, with periodic
oversight provided by the Internal Risk Committee and
Board Risk Committee.
Operational risk is the potential loss and/or damage
(such as the inability of the ESM to fulfil its mandate)
resulting from inadequate or failed internal processes,
people, and systems or from external events. The
categorisation of the ESM operational risks is based
on guidance from the Basel Committee on Banking
Supervision, namely risks related to:
• execution, delivery and process management;
• counterparts, products and business practices;

58 | EUROPEAN STABILITY MECHANISM

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Pierre Gramegna
Luxembourg

I am proud that Luxembourg
is hosting the ESM, which has
been an important tool for the
stabilisation of the euro zone
since its launch in 2012. I am
convinced that the ESM will
continue to play a decisive role in
the further development of the
Economic and Monetary Union.

“

• internal and external fraud;
• business continuity and system failures;
• employment practices and workplace safety;
• damage to physical assets.
The ESM’s risk appetite contains no tolerance for
material operational risks and a very low tolerance
for other operational risk losses. All departments
ensure proactive mitigation of operational risks and
robust controls in their processes. Should specific
operational risk events occur, these are reported to
an internal operational risk register, with follow-up
conducted to address operational risk issues via the
risk committees and, where necessary, the Board
of Directors. A comprehensive Business Continuity
Management Policy is in place to maintain a robust
business continuity capability.
The above approach to operational risk management
is complemented by: an annual self-assessment of the
top operational risks, based on likelihood and potential
impact; an annual fraud risk assessment, together
with an anti-fraud and control programme; and annual
scenario-based exercises related to business continuity, to ensure the prompt and efficient recovery of the
business from any incident affecting the ESM’s ability
to maintain normal operations.

Reputational risk – the risk of loss and/or damage
arising from a deterioration in the ESM’s reputation,
reducing its access to the market, lowering of credit
rating, loss of political capital, inability to attract suitably qualified staff, and other similar consequences.
This risk is managed by the ESM undertaking its
mandate in accordance with the highest professional
standards and prudent management of all ESM’s
risks, and by having centralised coordination of
external communication, including permanent media
monitoring, regular meetings with journalists covering
the ESM, and membership of a network of European
institutions maintaining an alert on reputational risks.
Legal risk – the risk of loss as a result of inadequate
or inefficient documentation, legal capacity, enforceability of national and international laws; litigation
against the ESM or its assets; and non-compliance
with the Treaty establishing the ESM, associated
By-Laws, or any other applicable laws and contractual
obligations. Legal risk is managed by obtaining review
and advice from internal and external legal counsel
to ensure ESM activities are in compliance with the
law and supported by enforceable, robust contractual
arrangements.
Compliance risk – the risk of loss and/or damage
associated with the non-compliance with internal
policies, procedures and guidelines as well as any
external policies, regulations and directives which

ANNUAL REPORT 2014 | 59

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

“

Edward Scicluna
Malta

The ESM is our flagship financial
institution with an explicit
mandate for economic and
financial stability in times
of need. Such stability is the
cornerstone of all economic and
social progress.

“

might govern the ESM. The Code of Conduct, as part
of the ESM legal framework, defines the fundamental
ethical principles to be assumed by ESM personnel,
such as the requirements regarding the employee’s
integrity and loyalty, guidelines for handling conflicts of
interest, prohibitions on insider trading, restrictions
on financial interest and rules regarding information
secrecy. Following the approval of the Code of Conduct
in March 2014, all staff underwent training and completed certification relating to the Code of Conduct.
Compliance risk is managed by the Compliance Officer,
who on behalf of the Managing Director identifies
and assesses compliance risks, formulates policies

in such areas as anti-money-laundering control and
information barriers, and provides guidance and
training to staff on compliance matters, particularly
in relation to the Code of Conduct. A Compliance
Charter, formulating the mandate of the Compliance
function, is published on the ESM website.
Political risk – the risk of loss and/or damage arising
as a result of a single or multiple political events that
affect the ESM’s ability to perform its mandate, for
example, by reducing access to the market for funding. Political risk is managed principally by the Board
of Governors and closely monitored by the Managing
Director.

60 | EUROPEAN STABILITY MECHANISM

Communications
As a publicly funded international institution with the
mandate to safeguard financial stability in the euro
area, the ESM is committed to ensuring that anyone
interested can understand the organisation and what
it does. The ESM demonstrated this commitment in
2014 by maintaining a consistent presence in the
public domain, communicating frequently with the
general public and its various stakeholders in Europe
and beyond.
Given ongoing public interest, the Managing Director
and ESM senior staff made numerous media appearances in 2014. These helped to explain the ESM’s
activities, economic developments in the euro area
Member States, particularly those with assistance
programmes, market developments, policy decisions
concerning the euro area, and the wider economic
context that influences the euro area. The ESM and its
Managing Director also see it as their task to explain

that while more progress is needed there have been
significant advances in reforming and strengthening
the Economic and Monetary Union both at national
and European level.
The Managing Director participates in the press
conferences held at the conclusion of the monthly
euro area finance ministers’ meetings and visits
individual euro area Member States. The Managing
Director and ESM senior staff took part throughout
2014 in several meetings and conferences worldwide, attended by policy makers or academics. The
speeches, presentations and video recordings of
these conferences are available on the ESM’s website:
www.esm.europa.eu/press/index.htm.
Following an invitation from the European Parliament
in 2014, the Managing Director attended meetings of
the Economic and Monetary Affairs Committee. Since

ANNUAL REPORT 2014 | 61

“

SPOTLIGHT

Hans Jörg Schelling
Austria

The Finance
ew on
Minister’s vi
the ESM

Less than three years after its
establishment, the ESM has
become an indispensable element
of the architecture of the euro
area. Today, the institution has
successfully proven its importance
as a safety net, assisting countries
in exiting financial turmoil and
restoring confidence.

“

the ESM is not an EU institution, this participation is
done on an ad hoc basis to inform and debate with the
European people’s representatives. At its Luxembourg
headquarters, the ESM regularly accommodates visitor groups and journalists for institutional visits and
presentations.
Press releases are the standard means of communication for all important news regarding the ESM.
Communication of important topics, such as the
2014 introduction of the Direct Bank Recapitalisation
Instrument, are sometimes complemented by
a more extensive Frequently Asked Questions (FAQ)
document. The use of social media underpins public
communication.
The ESM Annual Report, presented to the Board of
Governors at the Annual Meeting, is the organisation’s
reference document with an extensive description of

its mandate, its activities and the economic situation
of the euro area with a view to its crisis resolution
and financial stability. In 2015, the ESM plans to
launch a publication programme that will start to treat
in-depth topics related to its mission.
As the crisis subsided in 2014, the ESM organised
occasional conferences to analyse and discuss topics
related to its mandate. The initial conference was
held in Luxembourg in October 2014 with Jacques
de Larosière, the former IMF Managing Director,
speaking on ‘The Future of European Banks’.
The ESM’s shareholders, other stakeholders and the
public can find a comprehensive and regularly updated
set of relevant information, such as legal documents,
financing agreements, institutional information, and
programme and investor-related information on the
ESM website.

ANNUAL REPORT 2014 | 63

03.
INSTITUTIONAL
FRAMEWORK
AND ORGANISATION

64 | EUROPEAN STABILITY MECHANISM

ESM’S FINANCIAL ASSISTANCE TOOLKIT

Loans within
a macroeconomic
adjustment
programme
Objective:

Primary market
purchases

to assist ESM Members in significant need of financing, but which
have lost access to the markets,
either because they cannot find
lenders or because the financing
costs would adversely impact the
sustainability of public finances.

Secondary
market purchases

Conditionality:
Objective:
the ESM may engage in primary
market purchases of bonds or
other debt securities issued by
ESM Members at market prices
to allow them to maintain or
restore their relationship with the
investment community and therefore reduce the risk of a failed
auction. This can complement
the regular loan instrument or
a precautionary programme. The
purchase will be limited to 50% of
the final issued amount.

Conditionality:
no additional conditionality
beyond the underlying
programme.

UNUSED

USED

ESM loans are conditional upon
the implementation of macroeconomic reform programmes
prepared by the EC, in liaison with
the ECB and, where appropriate,
the IMF.

Monitoring:
the same institutions are
entrusted with monitoring
compliance with the agreed
programme conditions for
economic reform. The ESM
Member is obliged to cooperate
with this monitoring and enable
the ESM to perform its financial
due diligence. If the country
deviates significantly from the
programme, disbursements may
be withheld.

UNUSED

USED
IRELAND
PORTUGAL
GREECE
CYPRUS

Objective:
to support the sound functioning
of the government debt markets
when lacking market liquidity
threatens financial stability in
the context of a loan either with
a macroeconomic adjustment
programme or without if the
Member’s economic and financial
situation is fundamentally sound.

Conditionality:
for ESM Members not under
a programme, specific policy
conditions will apply.

UNUSED

USED

ANNUAL REPORT 2014 | 65

Loans for
indirect bank
recapitalisation

Precautionary
credit line

to support sound policies and prevent crisis
situations from emerging. It aims to help ESM
Members whose economic conditions are
sound to maintain continuous access to market financing by strengthening the credibility
of their macroeconomic performance.

both can be drawn via a loan or a primary
market purchase, have an initial availability
period of one year and are renewable:
• Precautionary Conditioned Credit Line
(PCCL): available to a Member State
whose economic and financial situation is
fundamentally sound, as determined by
respecting six eligibility criteria such as
public debt, external position or market
access on reasonable terms.
• Enhanced conditions credit line (ECCL):
access open to euro area Member States
whose economic and financial situation
remains sound but that do not comply
with the eligibility criteria for PCCL. The
ESM Member is obliged to adopt corrective
measures addressing such weaknesses
and avoiding future problems in respect of
access to market financing.
The ESM Member has the flexibility to request
funds at any time during the availability
period.

Monitoring:
when an ECCL is granted or a PCCL drawn,
the ESM Member is subject to enhanced
surveillance by the EC. Surveillance covers the
country’s financial condition and its financial
system.

UNUSED

to preserve the financial stability
of the euro area by addressing
those cases where the financial
sector is primarily at the root
of a crisis, rather than fiscal or
structural policies.

USED

The instrument is relevant for banks (systemically important credit institutions), financial
holding companies, and mixed financial
holding companies as defined in relevant EU
legislation.

Eligibility:

Eligibility:

Two types of credit lines:

Objective:
to help remove a serious risk of contagion
from the financial sector to the sovereign
by allowing the direct recapitalisation of
institutions. The total amount available for this
instrument is limited to €60 billion.

Objective:

Objective:

Direct
recapitalisation
of institutions

the beneficiary Member State
should demonstrate an inability
to:
• Meet capital shortfalls via
private sector solutions.
• Recapitalise the institutions
without adverse effects for its
own financial stability and fiscal
sustainability.
The institutions should be of
systemic relevance or pose
a serious threat to the financial
stability of the euro area or its
Member States. The ESM Member
should demonstrate its ability to
reimburse the loan.

the relevant institutions are considered
eligible if the following situations apply:
• They are or are likely to be in breach of
the relevant capital requirements and are
unable to attract sufficient capital from
private sector sources to resolve their capital
problems.
• Burden-sharing arrangements, such as
bail-in (fully applicable in 2016), in the
Bank Recovery and Resolution Directive,
are insufficient to fully address the capital
shortfall.
• They have a systemic relevance or pose
a serious threat to the financial stability of
the euro area as a whole or the requesting
ESM Member.
• The institution is supervised by the ECB.

will apply to financial supervision,
corporate governance and
domestic law relating to
restructuring or resolution.

• The beneficiary Member State should also
demonstrate that it cannot provide financial
assistance to the institutions without very
adverse effects on its own fiscal sustainability, and that therefore the use of the indirect
recapitalisation instrument is infeasible.

Monitoring:

Conditionality:

the EC enforces compliance
with EU state aid rules and also
monitors other policy conditions
with the ECB and the relevant
supervisory authority.

will apply, addressing the sources of difficulties
in the financial sector and, where appropriate,
the general economic situation of the ESM
Member. Additional institution-specific
conditions will also apply.

Conditionality:

UNUSED

USED
SPAIN

UNUSED

USED

66 | EUROPEAN STABILITY MECHANISM

ESM DEVELOPS
LAST RESORT TOOL
FOR BANKING UNION
The ESM completed in 2014 extensive internal
preparations of more than one year for the introduction of the Direct Recapitalisation Instrument (DRI)
into the ESM’s financial assistance toolkit. DRI is
now one element of a wider package, alongside the
Single Supervisory Mechanism (SSM) and the Single
Resolution Mechanism (SRM), introduced to fortify the
euro area’s Banking Union. The DRI may be used as
a last resort measure after employing other options,
including the bail-in mechanism.

creditors by writing off their claims or converting
them to equity. In addition, a contribution from a resolution financing arrangement, which can only be made
after a minimum of 8% of bail-in has taken place, is
also a pre-condition for the use of the DRI. While the
likelihood of its use has diminished, the DRI remains
a potentially useful instrument, within the given mandate of the ESM as a lender of last resort for euro
area sovereigns and as an investor of last resort to
break the sovereign-bank feedback loop.

The Eurogroup, announcing the DRI in June 2012,
defined its purpose as breaking the link between banks
and sovereigns. Under the DRI, the ESM would provide
financial assistance directly to systemically important
banks in the euro area. The ESM would therefore
take equity risk on its investment. The DRI would not
increase the national debt of the beneficiary Member
State. The use of the instrument is subject to a request
by an ESM Member and requires the respect of strict
conditionality relating to the beneficiary institution as
well as the banking sector and/or the general economic policies of the beneficiary Member State.

The DRI is very different in nature from the other
forms of financial assistance that the ESM provides
by lending to sovereigns. The ESM undertook a major
internal project to be operationally prepared and capable of properly managing the risks if called upon to
provide DRI and meet the dual objectives of supporting
a systemic bank while minimising the risk of loss to the
ESM and taxpayers. The project delivered clear and
workable internal guidelines on how to conduct a DRI
investment covering due diligence, valuation, structuring and transaction monitoring, funding strategy,
systems enhancements, legal and risk frameworks,
and an internal governance process. The relevant DRI
documentation was established and approved by the
ESM Board of Directors.

The operational framework for the DRI also includes
a specific provision in relation to the retroactive application of the instrument, which must be decided on
a case-by-case basis and by mutual agreement.
Since its development, the likelihood of the use
of the DRI has become more remote, due to the
adoption of another key regulation to enhance the
resilience of financial institutions. The Bank Recovery
and Resolution Directive requires bail-in of a banks’

June 2012
Political
announcement
by Euro Area Summit
of DRI

2012

The ECB’s Comprehensive Assessment confirmed the
generally sound level of capital of systemic euro area
banks after the banks prepared for the exercise by
undertaking significant capital raising and other measures. Although unlikely at the present time, DRI may
still be required to counter one-off events or systemic
disruptions, as an instrument of last resort.

Aug. 2013 >>>

2013

Technical discussions between ESM
Members on details of the instrument

April 2014

Discussions between
ESM Members on details
of the instrument and
ESM internal DRI project

Main features
of DRI agreed
and announced
by the Eurogroup

June 2013

2014

2015
National procedures
in some ESM
Member States

ESM Board of Governors
approves the instrument and
the ESM Board of Directors
approves the implementing
documentation

Dec. 2014

ANNUAL REPORT 2014 | 67

REGIONAL FINANCIAL
INSTITUTIONS –
ESM IS THE BIGGEST BY FAR
In a world of increasingly integrated capital markets,
the global financial crisis and subsequent European
financial instability underscored the necessity of
setting up credible financial backstops for crisis
prevention and resolution. Countries that are under
severe financial strain may be shut out of capital
markets and need to seek immediate financing assistance, while others with sound domestic policies and
fundamentals may also suffer from excessive capital
outflows spurred by heightened financial market risk
aversion or spillover from other countries. To tackle
this problem, the Group of Twenty (G20) industrialised
and emerging market economies have promoted
an initiative to strengthen a multi-layered Global
Financial Safety Net (GFSN), with Regional Financing
Arrangements (RFAs) as an important component.
The European experience in dealing with recent crises highlights the importance of mobilising regional
financial resources to complement IMF lending. The
total resources available at existing RFAs, $1.2 trillion
in 2013, almost reached the IMF’s $1.4 trillion that
same year. The EFSF and ESM stand out with their
combined lending capacity totalling €700 billion – the
biggest among RFAs – covering 6.2% of Members’

total gross domestic product and 950% of Members’
aggregate IMF quota shares.
There are eight other major RFAs in the world. Some
of them, such as the Arab Monetary Fund or Fondo
Latinoamericano de Reservas, were created in the
immediate aftermath of past crisis episodes. A few
other RFAs have been created or further institutionalised in recent years.
In Europe, several crisis resolution mechanisms
with different country coverage and lending capacity
precede the creation of the EFSF and ESM. The EU
created a balance of payment assistance facility,
raising its lending capacity to reach a maximum of
€50 billion in 2009. It could provide financial assistance to nine non-euro area countries. An equivalent
mechanism was reproduced for the EU in May 2010
under the name of the European Financial Stabilisation
Mechanism with a lending capacity of €60 billion to
help resolve the euro area crisis. It was activated for
Ireland and Portugal for €48.5 billion.
Asia took a significant step towards stronger
regional coordination in crisis prevention in 2010.

68 | EUROPEAN STABILITY MECHANISM

On 24 March 2010, the existing bilateral swap line
agreements – Chiang Mai Initiative – were merged
into a single contract called Chiang Mai Initiative
Multilateralisation (CMIM). It covers 10 ASEAN countries plus China, Japan, and Korea. CMIM’s total size
has been increased twice in the recent financial crisis,
to $240 billion in 2012 from $78 billion in 2008.
A surveillance unit for the CMIM was also created
in 2011 to monitor and analyse regional economies.
Armenia, Belarus, Kazakhstan, the Kyrgyz Republic,
Russia, and Tajikistan founded an Anti-Crisis Fund of the
Eurasian Economic Community in July 2009. Uniquely
financed by members’ capital contributions, this fund
has a total lending capacity of $8.5 billion; Tajikistan and
Belarus have both benefited from this regional facility.
Finally, the five biggest emerging market economies
signed a treaty establishing the BRICS Contingent
Reserve Arrangement in July 2014. The newest RFA,
whose shareholders are Brazil, Russia, India, China
and South Africa, is endowed with $100 billion in
capital. It is composed of multilateral swap lines akin
to those of the CMIM.

In addition to the creation or further institutionalisation
of RFAs, G20 countries also adopted the Principles
for cooperation between the IMF and RFAs in 2011.
The EFSF and ESM programmes have provided good
examples of how an RFA and the IMF can work
together. Whenever possible, the IMF is an integral
part of European financial assistance programmes.
It has co-financed several programmes, conducted
programme reviews and country surveillance jointly
with European institutions, and has provided technical
assistance. RFAs have comparative advantages in sustaining financial stability at the regional level. They have
in-depth knowledge of region-specific issues and can
mobilise large amounts of financing relatively quickly.
Founded by regional members, RFAs may also
enhance democratic support in regional economies.
Generally, efficient coordination between the IMF and
RFAs generates synergies in terms of resource allocation and surveillance capacity. It also precludes ‘programme shopping’ and the associated moral hazard
by ensuring consistent sets of economic conditions
linked to financial assistance.

Figure 27 a. Lending capacity relative to
regions’ GDP (%)

Figure 27 b. Lending capacity relative to
regions’ IMF quota (%)

7

1,000 950.57
6.20

6
800
5
600

4

428.76

3

400
243.20

2
1.33
1

1.23
0.63

0.39

0.05

0.35

0.48

81.48 78.63

59.39

0.15

16.41

11.51

F
AM

F

AR
FL

AC

NA
FA

SM

Bo
PF
EU

EF

IM

BR
IC
S

/E
M
ES

CM

FS

F
AM

F

AR
FL

AC

PF

FA
NA

SM

Bo
EU

EF

IM

F

BR
IC
S

CM

FS
/E
M

F

0

0

ES

179.57

200

Notes: GDP data as of the fourth quarter of 2013 from the World Bank’s World Development Indicators.
GDP data are missing for Myanmar, Palestine, Somalia and Syria.
CMIM = Chiang Mai Initiative Multilateralisation; BRICS = BRICS Contingent Reserve Arrangement; EFSM = European Financial Stabilisation
Mechanism; EU BoPF = EU Balance of Payments Facility; NAFA = North American Framework Agreement; ACF = Anti-Crisis Fund;
FLAR = Fondo Latinoamericano de Reservas; AMF = Arab Monetary Fund.
Sources: RFA official documents; IMF; World Bank; ESM calculations

ANNUAL REPORT 2014 | 69

Governance

The ESM shareholders are the 19 euro area Member
States. Their subscription to ESM authorised capital
is based on the ECB’s capital contribution key in force
at the time of the signature of the ESM Treaty on
2 February 2012. At equal weighting, this key reflects
the ESM Members’ respective shares of the EU total
population and gross domestic product.
The accession of new Member States is factored into the
capital key, slightly reducing the founding ESM Members’
contribution keys. Nominal capital subscription and paid-in
capital amounts remain unchanged.
In line with Article 42 of the ESM Treaty, ESM Members
with a gross domestic product (GDP) per capita of less
than 75% of the EU average in the year immediately
preceding their ESM accession benefit from a temporary
correction mechanism. Both recent ESM joiners Latvia
and Lithuania benefit from this temporary correction,
which applies for 12 years after the date of euro adoption.
During this period, the initial capital subscription of the
ESM Member benefiting from the correction will be lower,
thus leading temporarily to a lower paid-in capital contribution. Once the temporary correction comes to an end, the
ESM Member must deposit the remaining amount.

Board of Governors’ 2013 approval, Latvia officially
became the 18th ESM Member on 13 March 2014 –
making it the first new Member State to join the ESM
since its October 2012 inauguration. Latvia qualifies for
a temporary correction, and its capital contribution key
was therefore set at 0.2757%, resulting in a capital
subscription of €1.93 billion, including €221.2 million in
paid-in capital. Latvia will make the payments of paid-in
capital in five annual instalments of €44.24 million each.
Latvia paid the first instalment on 19 March 2014 and
the second on 18 March 2015. Once the temporary
correction comes to an end in 2026, Latvia must deposit
the remaining €102.9 million.

LITHUANIA ACCEDES TO ESM TREATY
Lithuania joined the euro area on 1 January 2015,
following formal approval by the Council of the European
Union in 2014. In October 2014, the Board of Governors
approved Lithuania’s application for ESM membership
and Lithuania officially became the 19th ESM Member on
3 February 2015.

Latvia joined the euro area on 1 January 2014, following
the Council of the European Union’s approval in 2013.
According to the ESM Treaty, all euro area Member
States become ESM Members. As such, following the

Based on the temporary correction mechanism,
Lithuania’s capital contribution key was set at 0.4063%
resulting in a capital subscription of €2.86 billion,
including €327.2 million in paid-in capital. Lithuania
will pay the paid-in capital in five annual instalments of
€65.44 million each. Lithuania paid the first instalment on
11 February 2015, and the remaining four instalments
will be paid annually through 2019. Once the temporary
correction comes to an end in 2027, Lithuania must
deposit the remaining €159.4 million.

Table 7. Shares and capital, by ESM Member

As of 18 March 2015.

LATVIA ACCEDES TO ESM TREATY

ESM Members

ESM key (%)

Number of shares

Subscribed capital (€ 000)

Belgium

3.4534

243,397

24,339,700

2,781,680

Germany

26.9616

1,900,248

190,024,800

21,717,120

Estonia

0.1847

13,020

1,302,000

148,800

Ireland

1.5814

111,454

11,145,400

1,273,760

Greece

2.7975

197,169

19,716,900

2,253,360

Spain

11.8227

833,259

83,325,900

9,522,960

France

20.2471

1,427,013

142,701,300

16,308,720

Italy

17.7917

1,253,959

125,395,900

14,330,960

Cyprus

0.1949

13,734

1,373,400

156,960

Latvia

0.2746

19,353

1,935,300

88,480

Lithuania

0.4063

28,634

2,863,400

65,440

Luxembourg

0.2487

17,528

1,752,800

200,320

Malta

0.0726

5,117

511,700

58,480

Netherlands

5.6781

400,190

40,019,000

4,573,600

Austria

2.7644

194,838

19,483,800

2,226,720

Portugal

2.4921

175,644

17,564,400

2,007,360

Slovenia

0.4247

29,932

2,993,200

342,080

Slovakia

0.8184

57,680

5,768,000

659,200

Finland

1.7852

125,818

12,581,800

1,437,920

100

7,047,987

704,798,700

80,153,945.920

Total

Paid-in capital (€ 000)

Source: ESM

ESM SHAREHOLDERS

70 | EUROPEAN STABILITY MECHANISM

ESM GOVERNANCE STRUCTURE

BOARD
OF GOVERNORS
The Board of Governors is the ESM’s
highest decision-making body. It comprises
government representatives of each ESM
Member with responsibility for finance.
Representatives of the EC and the ECB
may participate in its meetings as
observers. The Board of Governors
is chaired by the President of the
Eurogroup, Jeroen Dijsselbloem.

BOARD
OF DIRECTORS
The Board of Directors consists of senior
civil service officials from each ESM
Member who are highly competent in economic and financial matters. The EC and
the ECB may participate in its meetings as
observers. The Board of Directors ensures
that the ESM is run in accordance with
the ESM Treaty and the By-Laws. It
takes decisions as provided for in the
ESM Treaty or as delegated by the
Board of Governors.

BOARD
OF AUDITORS
The Board of Auditors is an independent oversight body composed
of five members. They are appointed
by the Board of Governors upon
proposal of the Chairperson of the
Board of Governors, the supreme
audit institutions of the ESM
Members on a rotating basis,
and the European Court of
Auditors.

COMPENSATION
COMMITTEE
The Compensation Committee advises
the Board of Directors and the
Managing Director on matters of staff
compensation and periodically revises
the framework and principles of staff
compensation, the total annual salary
mass and the evolution of the
salary band boundaries.

Banking
Committee
Finance Committee
Approves and takes action on matters
related to ESM structural risks as
defined in the ESM Risk Policy, mainly
re-financing, liquidity and interest rate
risks related to its operations.

chaired by:

MANAGING DIRECTOR

Performs technical reviews and
provides final internal approval prior
to the submission of proposals linked
to the direct recapitalisation instrument
(DRI) to the Board of Governors, Board
of Directors or any other external
counterparties.
The Banking Committee only convenes
in the context of a DRI operation
and therefore did not formally
meet during 2014.

MANAGING DIRECTOR

Investment
Management
Committee
Considers matters regarding the
implementation of the ESM Guideline
on Investment Policy for the ESM
Investment Portfolios and the Liquidity
Buffer.

DEPUTY MANAGING DIRECTOR
AND CHIEF FINANCIAL OFFICER

ANNUAL REPORT 2014 | 71

MANAGING
DIRECTOR
The Managing Director, Klaus Regling, is
responsible for conducting the current
business of the ESM under the direction
of the Board of Directors. The Managing
Director chairs the meetings of the
Board of Directors and participates
in those of the Board of Governors.
He is the ESM’s chief of staff and
legal representative.

MANAGEMENT
BOARD

RISK COMMITTEE
The Risk Committee advises the Board
of Directors on the ESM’s overall
current and future risk appetite. It
also assists the Board of Directors
in reviewing and overseeing the
implementation of the ESM risk
management framework by the
Managing Director.

Internal Risk
Committee

The Management Board assists the
Managing Director in conducting
the current business of the ESM,
preparing the decisions of the
Board of Governors and the
Board of Directors and seeing
to their implementation.

INTERNAL
COMMITTEES

Corporate Projects
Committee

Considers any matters regarding the
evaluation, monitoring and approving of
practices linked to the implementation of
the ESM Risk Management Framework
and risk management within ESM
operations.

Prioritises, approves, and oversees
the execution of all ESM corporate
projects.

CHIEF RISK OFFICER

SECRETARY GENERAL

Incident
Management
Team
Oversees the development and
implementation of an effective business
continuity capability within the ESM and
coordinates the ESM response in the
event of incidents that may affect
normal ESM operations.

SECRETARY GENERAL

72 | EUROPEAN STABILITY MECHANISM

Board of Governors
Annual Meeting 19 June 2014

KEY DECISIONS
The Board of Governors meets at least once a year
and whenever the affairs of the ESM so require.
In 2014, the Board of Governors held five meetings
and took the following key decisions:
• Approved three updates to the Memorandum
of Understanding with Cyprus (1 April 2014,
7 July 2014 and 8 December 2014).
• Approved the ESM 2013 Annual Report
(19 June 2014).
• Approved the accession of Lithuania to the ESM
(13 October 2014).
• Established the instrument for the Direct
Recapitalisation of Institutions (8 December 2014).
• Appointed PricewaterhouseCoopers (PwC) as
independent external auditor for a three-year term
(8 December 2014).

ANNUAL MEETING OF THE
BOARD OF GOVERNORS
On 19 June 2014, the Board of Governors held
its second annual meeting at the ESM premises
in Luxembourg during which it approved the ESM
2013 Annual Report as drawn up by the ESM
Managing Director. In addition, the Chairperson of the
Board of Auditors and the external auditor addressed
the Governors with regard to the 2013 Financial
Statements.
The Managing Director presented the Governors
with an overview of key ESM developments and institutional affairs of the past financial year. The annual
meeting also allowed the ESM management and staff
to have a direct exchange with the ESM Governors.
The Governors welcomed the considerable progress
the ESM had made in maturing as an institution
and acknowledged that the ESM as a permanent
institution had proven to be an important pillar in the
architecture of the euro area.

SHAREHOLDER ENGAGEMENT
The ESM places great emphasis on shareholder relations and engagement. Since its inception, the ESM has participated in the various political forums where its shareholders are represented to discuss matters of relevance to
its mandate, such as the Eurogroup, the Eurogroup Working Group, and the Task Force for Coordinated Action. In
2014, the ESM launched various initiatives to reinforce accountability and enhance shareholder relations. At its debut
Shareholders Day, the ESM welcomed representatives from the finance ministries of ESM Members to help deepen
their technical understanding of the ESM’s operations. The ESM also implemented an extended reporting tool for
shareholders via a secure online interface. The development of an online shareholder relations tool, covering Board
activity, institutional archives and reporting, was initiated in the second half of 2014.

ANNUAL REPORT 2014 | 73

THE NETHERLANDS

CYPRUS

Jeroen Dijsselbloem,

Harris Georgiades,

Chairman of the Board of Governors,

Minister of Finance, appointed on 3 April 2013

Minister of Finance,
appointed on 27 September 2012

LATVIA

BELGIUM

Johan Van Overtveldt,
Minister of Finance,
appointed on 15 December 2014,
- replacing Koen Geens,
originally appointed on 27 March 2013

Jānis Reirs,
Minister of Finance, appointed on
5 November 2014,
- replacing Andris Vilks, originally appointed on
13 March 2014
LITHUANIA

Rimantas Šadžius,
GERMANY

Minister of Finance, appointed on 3 February 2015

Wolfgang Schäuble,
Federal Minister of Finance,
appointed on 27 September 2012

LUXEMBOURG

Pierre Gramegna,
Minister of Finance, appointed on 4 December 2013

ESTONIA

Sven Sester,

MALTA

Minister of Finance, appointed on 9 April 2015,

Edward Scicluna,
Minister for Finance, appointed on 13 March 2013

- replacing Maris Lauri,
originally appointed on 3 November 2014,
- who replaced Jürgen Ligi,
originally appointed on 27 September 2012

AUSTRIA

Hans Jörg Schelling,
Minister of Finance, appointed on
1 September 2014

IRELAND

Michael Noonan,
Minister of Finance, appointed on
27 September 2012

- replacing Michael Spindelegger, originally appointed
on 16 December 2013
PORTUGAL

GREECE

Maria Luís Albuquerque,

Yanis Varoufakis,

Minister of State and Finance, appointed on
2 July 2013

Minister of Finance, appointed on 27 January 2015,
- replacing Gikas Hardouvelis,
originally appointed on 10 June 2014,
- who replaced Giannis Stournaras,
originally appointed on 27 September 2012

SLOVENIA

SPAIN

Luis de Guindos Jurado,

- replacing Uroš Cufer, originally appointed on
21 March 2013

Minister of Economy and Competitiveness,
appointed 27 September 2012

SLOVAKIA

Dušan Mramor,
Minister of Finance,
appointed on 18 September 2014,

Peter Kažimír,
Michel Sapin,

Deputy Prime Minister and Minister of Finance,
appointed on 27 September 2012

Minister of Finance and Public Accounts,
appointed on 2 April 2014,

FINLAND

FRANCE

Antti Rinne,
- replacing Pierre Moscovici,
originally appointed on 27 September 2012
ITALY

Pier Carlo Padoan,
Minister of Economy and Finance,
appointed on 22 February 2014,
- replacing Fabrizio Saccomanni,
originally appointed on 28 April 2013

Minister of Finance, appointed on 6 June 2014,
- replacing Jutta Urpilainen, originally appointed on
27 September 2012

74 | EUROPEAN STABILITY MECHANISM

Board of Directors
FINLAND
Tuomas
Saarenheimo

BELGIUM
Jozef Kortleven
GERMANY
Thomas
Steffen

SLOVAKIA
Vazil Hudák

ESTONIA
Märten Ross
IRELAND
Nicholas O’Brien

SLOVENIA
Irena Sodin

PORTUGAL
Isabel Castelo
Branco

GREECE
George Chouliarakis

BOARD
OF DIRECTORS

AUSTRIA
Harald Waiglein

SPAIN
Rosa María
Sánchez-Yebra Alonso

FRANCE
Bruno
Bézard

THE NETHERLANDS
Hans Vijlbrief

ITALY
Vincenzo La Via

MALTA
Alfred Camilleri
LUXEMBOURG
Isabelle Goubin
LITHUANIA
Miglė Tuskienė

CYPRUS
George Panteli
LATVIA
Līga Kļaviņa

KEY DECISIONS
The Board of Directors’ meetings are chaired by the Managing Director. In 2014, the Board of Directors held
11 meetings and took the following key decisions:
• Replaced members of the Risk Committee (27 February and 30 September 2014).
• Adopted the ESM Code of Conduct (12 March 2014).
• Approved the Early Warning System Procedure (24 March 2014).
• Appointed the members of the ESM Administrative Tribunal (24 March 2014).
• Approved the disbursement of three tranches of financial assistance to Cyprus (2 April, 7 July and
8 December 2014).
• Appointed new members and chairperson of the Compensation Committee (24 April and 30 September 2014).
• Approved the voluntary partial prepayment of Spain’s ESM loan (7 July 2014).
• Approved the administrative budget for the financial year 2014 (27 November 2014).
• Approved the renewal of the ESM diversified funding strategy (27 November 2014).
• Approved implementing documentation in relation to the instrument for direct recapitalisation of institutions
(8 December 2014).

ANNUAL REPORT 2014 | 75

BELGIUM

Jozef Kortleven,

Counselor General,
Ministry of Finance,
appointed on
28 September 2012
GERMANY

Thomas Steffen,

State Secretary,
Federal Ministry of
Finance, appointed on
24 September 2012
• Member of the
Compensation
Committee from
9 October 2012,
reappointed until
9 October 2017
ESTONIA

Märten Ross,

Deputy Secretary General
for Financial Policy and
External Relations, Ministry
of Finance, appointed on
21 October 2013
IRELAND

Nicholas O’Brien,

Assistant Secretary,
International and EU
Division, Department of
Finance, appointed on
1 July 2014
• Member of the
Compensation
Committee from
30 September 2014
until 9 October 2016,
replacing James O’Brien,
originally appointed on
9 October 2012
• Member of the
Compensation
Committee from
21 March 2013 until
1 July 2014
GREECE

George Chouliarakis,

Chairman, Council of
Economic Advisors,
appointed on
4 February 2015,
replacing Anastasios
Anastasatos,
originally appointed on
13 November 2014,
who replaced
Christodoulos Stefanadis,
originally appointed on
24 June 2014,
who replaced
Paniagiotis Tsakloglou,
originally appointed on
27 September 2012

SPAIN

Rosa María
Sánchez-Yebra Alonso,

Secretary General for the
Treasury and Financial
Policy, appointed on
25 September 2014
• Member of the
Compensation
Committee from
9 October 2014 until
9 October 2017,
replacing Iñigo Fernandez
de Mesa Vargas,
originally appointed on
8 October 2012
• Member of the
Compensation
Committee from
9 October 2012 until
25 September 2014
FRANCE

Bruno Bézard,

Director General of
the Treasury, Ministry
of Finance and Public
Accounts, appointed on
2 July 2014,
replacing Ramon
Fernandez, originally
appointed on
5 October 2012
ITALY

Vincenzo La Via,

Director General of
the Treasury, Ministry
of Economy and
Finance, appointed on
4 October 2012
• Chairman of the Board
Risk Committee from
9 October 2012 until
8 October 2015
CYPRUS

George Panteli,

Senior Economic
Officer, Ministry of
Finance, appointed on
29 April 2013
LATVIA

Līga Kļaviņa,

Deputy State
Secretary, Ministry of
Finance, appointed on
30 January 2015,
replacing Baiba Bāne,
originally appointed on
22 July 2014
who replaced Sanita Bajāre,
originally appointed on
13 March 2014

LITHUANIA

PORTUGAL

Financial Counsellor,
Ministry of Finance,
appointed on
4 March 2015

Secretary of State of the
Treasury, appointed on
14 January 2014

Miglė Tuskienė,

LUXEMBOURG

Isabelle Goubin,

Director of the
Treasury, Ministry of
Finance, appointed on
19 March 2014
• Member of the
Compensation
Committee from
24 April 2014 to
8 October 2015,
replacing Georges
Heinrich, originally
appointed
9 October 2012,
• Chairman of the
Compensation
Committee from
9 October 2012 until
19 March 2014
MALTA

Alfred Camilleri,

Permanent Secretary,
Ministry of Finance,
appointed on
28 September 2012
• Member of the
Compensation
Committee from
9 October 2012 until
9 October 2016
• Chairman of the
Compensation
Committee from
24 April 2014 until
9 October 2016
THE NETHERLANDS

Hans Vijlbrief,

Treasurer-general
of the Ministry of
Finance, appointed on
5 October 2012
• Member of the Board
Risk Committee from
9 October 2012 until
9 October 2014,
reappointed until
9 October 2017
AUSTRIA

Harald Waiglein,

Director General for
Economic Policy and
Financial Markets of
the Federal Ministry of
Finance, appointed on
8 October 2012
• Member of the Board
Risk Committee from
9 October 2012 until
8 October 2016

Isabel Castelo Branco,

• Member of the Board
Risk Committee from
27 February 2014 until
8 October 2016,
replacing João Sousa,
originally appointed on
27 September 2012
• Member of the Board
Risk Committee from
9 October 2012 until
14 January 2014
SLOVENIA

Irena Sodin,

State Secretary, Ministry
of Finance, appointed on
24 October 2014,
replacing Mitja Mavko,
originally appointed on
17 April 2013
SLOVAKIA

Vazil Hudák,

State Secretary, Ministry
of Finance, appointed on
28 September 2012
• Member of the Board
Risk Committee from
9 October 2012 until
9 October 2014,
reappointed until
9 October 2017
FINLAND

Tuomas Saarenheimo,

Permanent
Under-Secretary, Ministry
of Finance, appointed on
12 September 2013

76 | EUROPEAN STABILITY MECHANISM

Board of Auditors
The members of the Board of Auditors were initially
appointed on 8 October 2012 for a non-renewable
term of three years, with the exception of Katarína
Kaszasová and Ulrich Graf, whose names were drawn
by lot to be appointed for a non-renewable term of
four years in order to ensure Board continuity. New
members to the Board of Auditors will be appointed
for a non-renewable term of three years.
NAME

TERMS OF OFFICE

Ulrich
Graf

Chairperson as of 8 October 2014
Vice Chairperson from
21 March 2014 until
7 October 2014
Member as of 8 October 2012

Igors
Ludboržs

Vice Chairperson as of
8 October 2014
Member as of 19 December 2013

Katarína
Kaszasová

Chairperson from 21 March 2014
until 8 October 2014
Vice Chairperson as of
8 October 2012 until
20 March 2014
Member as of 8 October 2012

Marc
Gengler

Member as of 8 October 2012

Jules Muis

Member as of 8 October 2012

The Board of Auditors inspects the ESM accounts and
verifies that the operational accounts and the balance
sheet are in order. Furthermore, it audits the regularity, compliance, performance, and risk management
of the ESM in accordance with international auditing
standards and monitors the ESM internal and external
audit processes and their results.
In 2014, the Board of Auditors held nine meetings
and met once with the ESM Board of Directors. The
Chairperson of the Board of Auditors met with the
Chairperson of the Board of Governors and attended
the annual meeting of the Board of Governors. During
its meetings, ESM management and senior staff
updated the Board of Auditors regularly on ESM activities, the ESM governing bodies and other relevant
issues and developments.
The Board of Auditors was also provided with presentations and written opinions by the ESM management as
well as external experts on specific topics requested by
them. The Board of Auditors met regularly with the internal audit function and monitored and reviewed the work
and independence of the external auditors. Between
July and November 2014, the Board of Auditors acted
as observer to the ESM external audit procurement
process for the financial years 2014–2016.
In fulfilling its role, the Board of Auditors also
reviewed the ESM Financial Statements as of
31 December 2014 and the working papers of the
external auditor. The Board of Auditors carried out
an independent audit of the ESM Risk Management
in January 2014 and of the ESM Lending Operations
in November 2014. In February 2015, it conducted
a follow-up review of the ESM Risk Management.
The Board of Auditors prepares an annual report
in respect of the ESM financial statements which is
contained in the ESM Annual Report in addition to the
external auditor’s opinion. The Board of Auditors draws
up an annual report for the Board of Governors which
summarises its audit work and recommendations for
the respective year. This report is made accessible to
the national parliaments and the supreme audit institutions of the ESM Members, as well as to the European
Court of Auditors and the European Parliament.

ANNUAL REPORT 2014 | 77

“

SPOTLIGHT

Maria Luís Albuquerque
Portugal

The Finance
ew on
Minister’s vi
the ESM

The ESM has been an important
achievement in deepening the
EMU and reinforcing the stability
of the euro area. It represents
what most unites Member States,
a sense of common goals and
objectives to ensure the euro area
and the EU as a whole remain
united, strong and fit to provide
its citizens with growth and jobs.

“

INTERNAL CONTROL
The ESM recognises the importance of effective internal controls, which provide the foundation for the safe
and sound operation of the organisation. In October
2013, as part of the maturing of the institution, the
Board Risk Committee supported the implementation
of the principles of the Basel Committee’s Framework
for Internal Control Systems in Banking Organisations.
Since then the ESM has made significant progress
in further developing its internal controls with the
objective of completing a comprehensive and effective
internal control system by the end of 2015. The
ESM internal control framework translates the Basel
Committee’s principles into relevant entity level,
process level, and Information Technology controls
consistent with the nature, complexity, and risks
inherent in the ESM activities. The internal control
framework complements the three lines of defence
concept, which the Board of Directors established
with the ESM Risk Policy.

In 2014, the ESM continued to strengthen its internal
control environment by:
• allocating additional staff to the second and third
lines of defence;
• developing key institutional policies, including
the Code of Conduct applicable to all members
of staff, Directors and alternate Directors; the
Whistleblowing Procedure; and the Information
Security and Data Protection Policies;
• devoting a project to the systematic review and
formalisation of internal controls across all areas of
the organisation;
• adding controls and automation in the booking of
accounting entries and the preparation of the financial statements;
• implementing a central project management office
and the set-up of a Corporate Projects Committee;
• developing a comprehensive business continuity
plan and a dedicated disaster recovery site.

78 | EUROPEAN STABILITY MECHANISM

Organisation

ESM ORGANISATIONAL STRUCTURE
MANAGING
DIRECTOR
Klaus Regling*

Head of
Communications
Wolfgang
Proissl
Chief
Risk Officer
Peter Harlow

Internal
Auditor
Leticia Lucas

GENERAL
COUNSEL
Ralf Jansen*

Deputy
General
Counsel
David
Eatough

SECRETARY
GENERAL

CFO/
DEPUTY MD

Kalin Anev
Janse*

Christophe
Frankel*

ECONOMICS
& POLICY
STRATEGY
Rolf Strauch*

Head of HR
Sofie
de Beule-Roloff

Head of IT
& Operations
David Wallace

Head of
Investment &
Treasury
Sebastien
Levy

Head of
Funding
Siegfried Ruhl

Head of
Economic &
Market
Analysis
Agnès
Belaisch

Head
of Finance
& Control
Thomas Pies

Head
of Corporate
Governance &
Internal Policies
Florian
Zinoecker

Head
of ALM
and Lending
Olivier Robin

Head
of Middle
& Back Office
Françoise
Blondeel

Head
of Strategy
& Inst.
Relations
Nicola
Giammarioli

* Member of the Management Board
Note: As of 31 December 2014.

Head of
Banking
Andres Sutt

ANNUAL REPORT 2014 | 79

MANAGEMENT BOARD AND HEADS OF DIVISION

80 | EUROPEAN STABILITY MECHANISM

“

Dušan Mramor
Slovenia

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

The European Stability
Mechanism was born in 2012,
as the child of the most severe
crisis to hit Europe since the
Second World War. It has
established itself as a credible
backstop for euro zone member
countries in financial difficulties.
Without the ESM, many countries
would have been forced to leave
the euro zone.

“

RESPONSIBILITIES OF DEPARTMENTS
FINANCE
The Finance department is responsible for raising the
funds to enable the ESM to fulfil its mission and to structure, negotiate and implement the Financial Assistance
Facilities. It monitors and manages the structural risks,
such as those related to interest rates or liquidity, and
performs the institution’s cash management function.
The department ensures that all ESM financial transactions are adequately booked, settled, controlled, and
reported. It also plays a front-end role in monitoring
risks, including counterparty, settlement, and operational. In addition, the department manages the paid-in
capital and implements the ESM Investment Policy.

BANKING
The Banking department monitors and analyses
the euro area banking system and SSM-supervised
banks and participates in financial sector-related
programme work in countries benefitting from ESM
financial assistance. The department also participates
in technical assistance work on banking-related topics.
It was responsible for the design and internal implementation of the direct recapitalisation instrument. In
January 2015, the Banking department was merged
with the Economics and Policy Strategy department,
where it continues to handle the same responsibilities.

ECONOMICS AND POLICY STRATEGY
The Economics and Policy Strategy department develops, assesses, and reviews the ESM’s policy strategy,
financial architecture, and financial assistance instruments. It analyses the general macroeconomic environment and the functioning of the financial markets,
specifically in relation to sovereign debt. In addition, it
develops the Early Warning System reports on macroeconomic and credit risks in programme countries,
develops and maintains credit risk assessment for the
ESM investment strategy, and coordinates the ESM’s
activity with EU and international institutions.

LEGAL
The Legal department provides expert legal support
and legal documentation to the ESM and manages
the legal risks arising from the organisation’s unique
mandate. It works closely with all other departments
to preserve the ESM’s interests, provide an effective
contribution to ESM strategy with respect to the
integrity of the business, mitigate legal risks that may
result from ESM business activities, and provide legal
advice regarding ESM activities and operations. The
department also manages corporate legal structures
and corporate matters, provides transaction support,
and is involved in the review of new products.

ANNUAL REPORT 2014 | 81

“

SPOTLIGHT

The Finance
ew on
Minister’s vi
the ESM

Peter Kažimír
Slovakia

The European Stability
Mechanism is undeniably one
of the key institutional anchors
designed to safeguard the
stability of the euro zone. Impact
and aftermath of the crisis on our
economies and public finances
would undoubtedly be much
worse without having the ESM
in place.

SECRETARY GENERAL

“

The Secretary General’s department provides key
corporate services to the ESM and to external
stakeholders, and maintains relations with other
international financial institutions and organisations.
The department is organised into four areas.
Corporate Governance and Internal Policies manages
shareholder relations with ESM Members, provides
the secretariat for the meetings of the ESM Board of
Directors, Board of Governors, and Board of Auditors,
and develops ESM internal policies, the internal control framework, and the business continuity planning.
It also provides procurement functions and acts as
the ESM central project management office. IT and
Operations provides all Information Technology, infrastructure and facilities management services required
for ESM operations. Finance and Control develops and
maintains the ESM accounting policies, monitors and
reports on the ESM financial position, and maintains
effective internal controls over the preparation,
integrity, and fair presentation of the ESM Financial
Statements. Human Resources ensures that the ESM
attracts and retains excellent staff and fosters an
inspiring work environment.

INTERNAL AUDIT
Internal Audit is an independent and objective
assurance function that assists the ESM by bringing
a systematic and disciplined approach to evaluating

and improving the ESM’s risk management, internal
control, and governance processes. All activities, operations, and processes of the ESM may be subjected to
internal auditing. Internal Audit reports directly to the
Managing Director and has its objectives set in the
ESM Internal Audit Charter.

COMMUNICATIONS
The Communications department is tasked with
explaining to the public, media, and all stakeholders
the ESM’s mandate and actions. To accomplish its
task, the department shapes its messages and provides information through all available communication
channels: website, social media, publications, visitor
groups, interviews, speeches, press conferences, and
other public appearances by the Managing Director
and the other members of the Management Board.
In coordination with the other euro area institutions
and the ESM Members, the department seeks to help
shape a common political and economic narrative for
the entire currency union.

RISK AND COMPLIANCE
The Risk function acts as the ESM’s central independent risk oversight function, developing and maintaining
a regular inventory of risks, identifying, assessing,
and proposing mitigating alternatives. It also reports
risks in a consistent manner to ESM management and

82 | EUROPEAN STABILITY MECHANISM

“

SPOTLIGHT

Antti Rinne
Finland

The Finance
ew on
Minister’s vi
the ESM

The ESM has quickly grown
into a mature institution with
its excellent management and
highly skilled staff. Its sound
investment and risk management
policies further contribute to the
stability of the euro area, making
the ESM a valuable component of
the monetary union.

“

the Board of Directors, setting the limit framework
and escalating any limit breaches, and fostering
a risk culture throughout the whole organisation. The
Compliance function seeks to assist the Managing
Director and staff in carrying out the ESM’s mission
in a manner that stands up to the closest public scrutiny, by implementing a compliance framework which
upholds sound and responsible business practices.

HUMAN RESOURCES

diversity and inclusion awareness. Given the complexity of the notion of diversity, the ESM organised efforts
to promote it in stages. As a first step, the ESM has,
in particular, examined opportunities to:
• improve gender balance and empower women;
• encourage the recruitment of women;
• support dual career couples;
• promote working practices accommodating different needs;
• reduce potential obstacles in managing a diverse
workforce.

The ESM aims to attract and retain top talent in
a competitive European and global employment landscape. In 2014, the ESM recruited 41 staff members
and reached a total of 136 staff, secondees, trainees,
and interims at year-end from over 30 nationalities
and a variety of professional backgrounds. The ESM
staff is set to grow to 147 by the end of April 2015.
One factor that is becoming increasingly critical in
recruiting and retaining staff is diversity awareness.

Still, there is room for more progress in different
areas of diversity. In particular, the institution can take
further measures to create an inclusive environment
that promotes greater gender diversity. In support of
the diversity initiatives, ESM has initiated partnerships
with other EU institutions, the Ministry of Finance in
Luxembourg, and local organisations.

At the ESM we view diversity as multi-faceted, including
aspects such as: gender, nationality, religion, race and
ethnicity, disability, and sexual orientation. Diversity
and inclusion are a key part of the ESM’s core values
and are thus closely tied to our organisational goals
and everyday activities.

The ESM has also organised an internal working group
on diversity to advance diversity initiatives and create
a platform to exchange information on diversity issues
relevant to staff. It is composed of the Secretary
General, the Head of Human Resources, the Head of
Middle and Back Office, the Head of Economics and
Market Analysis, the Senior Internal Auditor and the
chairperson of the staff representation committee.

In 2014, the ESM took a number of steps to support

ANNUAL REPORT 2014 | 83

ESM ESTABLISHES
ADMINISTRATIVE TRIBUNAL
TO DECIDE ON STAFF
EMPLOYMENT MATTERS
The Board of Directors established the Administrative
Tribunal of the ESM (ESMAT) and adopted its Statute
on 29 October 2013, ensuring that ESM staff members can effectively enjoy their human right of access
to justice regarding their employment conditions. The
independent body hears and passes judgement on
staff employment matters within its competence as
defined by the Statute.
The ESM needed to establish its own Administrative
Tribunal to guarantee staff members’ access to justice, because the ESM is a separate legal entity under
public international law and its employees cannot
currently apply to the Court of Justice of the European
Union. The design of the ESMAT complies with the
principle of good administration and cost effectiveness, as ESMAT-related costs will be proportionate to
the number of cases it handles.
The ESMAT is composed of five members, including
a President and a Vice-President. The members
are appointed for a renewable term of office of
five years, although at the inception of the ESMAT,

two of the five members were appointed for an initial
term of four years.
On 24 March 2014, the Board of Directors took note
of the appointment as members of the ESMAT, of:
Julian Currall, for a five-year term; Celia Goldman, for
a five-year term; Virginia Melgar, for a four-year term;
Haris Tagaras, for a four-year term; and Gerhard
Ullrich, for a five-year term. The ESMAT inaugural
meeting took place on 10 March 2014. During the
meeting, Ms Melgar was elected President and Mr
Tagaras, Vice-President.
On 4 December 2014, the ESMAT established,
pursuant to Article 5(1) of the Statute, its Rules of
Procedure. The ESM also entered into a Memorandum
of Understanding with the European Free Trade
Association (EFTA) Court in December 2014. Under the
agreement, the EFTA Court renders registry services
to the ESMAT. On 2 February 2015, a hypothetical
test case was filed to test that the procedures were
functioning appropriately.

84 | EUROPEAN STABILITY MECHANISM

ESM APPOINTS FIRST STAFF
REPRESENTATIVES

The ESM appointed its first Staff Representatives in
September 2014. Out of eight candidates, three staff
members were elected for a two-year term by secret ballot open to all members of staff. Voter turnout was 81%.
The ESM Staff Rules mandate the Staff Representatives
to represent the general interests of staff within
the ESM. For this purpose they meet regularly
with the Managing Director and Secretary General
and collaborate on a working level with the Human
Resources division. They also consult with staff on
a collective and individual basis, communicate relevant
developments and management initiatives to staff,

and promote staff’s awareness and engagement on
matters of common interest. Since their election, the
Staff Representatives have developed relationships
with representative bodies from peer institutions to
discuss best practice and inform their work, and are
participating members of the pan-institutional College
of the Presidents of Staff Committees.
As the ESM continues to mature, the goal of the Staff
Representatives is to help meet the ESM’s institutional
objectives in ways that maintain high staff engagement and support the ESM’s unique culture, ultimately
strengthening the ESM’s ability to fulfil its mandate.

ANNUAL REPORT 2014 | 85

04.
FINANCIAL REPORT

2014 RESULTS
The ESM is the permanent crisis resolution mechanism for the euro area. Its purpose is to provide
stability support through a number of financial assistance instruments to ESM Member States which are
experiencing, or are threatened by, severe financial
problems. The ESM is thus not profit driven and does
not provide incentives for speculative exposures of its
investment portfolios. The ESM does not aim to reach
any budgeted target for its financial result.
The operating income of the ESM is mainly driven
by the interest margin on its lending activity and the
return of investment on the paid-in capital. The ESM
Pricing Policy defines the distinct elements of the total
cost of a loan.

Balance Sheet
At year-end, the total balance sheet of the ESM was
€752.6 billion, a decrease of €7.8 billion over the previous year, mainly due to the expiry of the Transitional
Investment Portfolio (TIP) at the end of 2014.
Loans and advances to euro area Member States
decreased by €0.5 billion, following the early repayments from Spain (€-1.6 billion) and new disbursements to Cyprus (€1.1 billion). At year-end, loans
amounted to €45.4 billion.
To provide financial assistance to ESM Member
States, the ESM relies on its funding activity. In
2014, the total liability in respect of debts evidenced
by certificates decreased by 18% to €49.2 billion.
The decrease is mainly linked to the expiration of
the TIP. The TIP addressed the transitional aspects

related to the emergence of the ESM as a new issuer
in the financial markets together with the continued
rollover activity of the EFSF. Part of the proceeds
of short-term ESM-issued funding instruments was
invested in short-term EFSF-issued instruments.
As of 31 December 2013, the TIP had a value of
€9.1 billion.
On 30 April 2014, the 17 euro area Member States
which established the ESM completed their scheduled
payments of paid-in capital, with the transfer of the
fifth and final tranche of €15.7 billion. The ESM
has thus achieved its target level of paid-in capital
of €80 billion. In addition, Latvia became the ESM’s
18th member on 13 March 2014 and made a first
instalment for the payment of paid-in shares in the
amount of €44.2 million. At year end, the paid-in
capital was invested in ESM assets in the form of cash
and equivalents, deposits with central banks and debt
securities including fixed-income securities.
Unrealised gains or losses resulting from the valuation
of the securities portfolio are recognised in the fair
value reserve within the equity position of the ESM.
As of 31 December 2014, the fair value reserve
was €512.9 million compared to €-115.7 million
at the end of 2013. Due to the ESM’s conservative
investment strategy the fair value variation remains
very limited and the risk of a loss at maturity or at the
time of sale of an investment is generally low.

Profit and Loss account
For the financial year 2014, which was the second
full year of operation, the ESM recorded a positive net
result of €443.9 million. Compared to 2013, income
rose by €190 million.

86 | EUROPEAN STABILITY MECHANISM

The ESM recorded interest income of €710.1 million
for 2014. In parallel the interest charges in relation
to the funding activities amounted to €348.7 million.
In addition to interest income on loans, the investments made from the paid-in capital contributed
significantly to ESM results. In 2014, the ESM recognised interest income of €197.9 million on the paid-in
capital investments, compared with €81.6 million in
2013. In addition, the realised income from sales
of debt securities in the paid-in capital portfolio was
€102.9 million, up from €26.1 million in 2013.
The operating costs, which include general administrative expenses and depreciation of fixed assets,
increased by €10.3 million, mainly due to an increased
number of staff. As the ESM provides administrative
services to the EFSF, €21.3 million of the operating

costs were charged to the EFSF which are recognised
as other operating income. The ESM continues to
focus on budgetary discipline and effective cost
control.

OUTLOOK FOR 2015
The ESM expects its net realised result to remain relatively stable. The ESM will continue to invest the paid-in
capital in line with the established investment policy.
Nevertheless, a sustained low interest rate environment might pose challenges in managing the portfolio.
To support its financial assistance programmes in
2015, the ESM has a funding target of €12.5 billion.
This reflects the early repayment from Spain in the
first quarter of 2015.

ANNUAL REPORT 2014 | 87

Financial Statements

CONTENTS
Balance sheet ................................................................................................................................................................................................................................................ 88
Off-balance sheet ........................................................................................................................................................................................................................................ 89
Profit and loss account ......................................................................................................................................................................................................................... 90
Statement of changes in equity ..................................................................................................................................................................................................... 91
Statement of cash flows....................................................................................................................................................................................................................... 92
Notes to the financial statements ............................................................................................................................................................................................... 93

88 | EUROPEAN STABILITY MECHANISM

BALANCE SHEET
As at 31 December 2014
(in €‘000)
Notes

31.12.2014

31.12.2013

Cash in hand, balances with central banks and
post office banks

5

4,388,003

4,968,640

Loans and advances to credit institutions

6
18,656,514

22,976,514

18,656,514

22,976,514

45,421,460

45,933,000

(a) issued by public bodies

55,518,169

46,762,403

(b) issued by other borrowers

6,132,255

3,599,372

61,650,424

50,361,775

86

128

ASSETS

(a) other loans and advances

Loans and advances to euro area Member States

7

Debt securities including fixed-income securities

8

Intangible assets
Tangible assets

9

3,447

2,944

Subscribed capital unpaid

2.13/15

621,714,100

620,000,000

Subscribed capital called but not paid

2.13/15

176,960

15,712,416

11

595,061

460,654

752,606,055

760,416,071

49,163,608

60,026,441

49,163,608

60,026,441

Prepayments and accrued income

10

Total assets
LIABILITIES
Debts evidenced by certificates

12

(a) debt securities in issue

Other liabilities

13

23,591

22,831

Accruals and deferred income

14

273,367

229,112

49,460,566

60,278,384

Total liabilities
SHAREHOLDERS’ EQUITY
Subscribed capital

2.13/15

701,935,300

700,000,000

Fair value reserve

8

512,863

(115,716)

2.6.1/16

253,403

-

-

(498)

Reserve fund
Profit/loss brought forward
Profit for the financial year

443,923

253,901

Total shareholders’ equity

703,145,489

700,137,687

Total equity and liabilities

752,606,055

760,416,071

ANNUAL REPORT 2014 | 89

OFF-BALANCE SHEET
As at 31 December 2014
(in €‘000)
Notes

31.12.2014

31.12.2013

3,268,000

4,386,000

3,268,000

4,386,000

OFF-BALANCE SHEET
Commitments
(a) undisbursed loans to euro area Member States

23

90 | EUROPEAN STABILITY MECHANISM

PROFIT AND LOSS ACCOUNT
For the financial year ending 31 December 2014
(in €‘000)
Notes

2014

2013

Interest receivable and similar income
(a) on cash and cash equivalents
(b) on loans and advances to credit institutions
(c) on loans and advances to euro area
Member States

17

(d) on debt securities including fixed-income
securities

1

-

23,002

13,245

499,608

268,979

187,474

70,600

710,085

352,824

Interest payable and similar charges
(a) on debts issued

Commissions receivable
Commissions payable
Other operating income

(348,662)

(110,680)

(348,662)

(110,680)

-

105

(10)

(109)

21,250

17,010

102,931

26,093

(19,148)

(13,965)

- wages and salaries

(13,501)

(10,292)

- social security

(5,647)

(3,673)

18

Net profit on financial operations
General administrative expenses
(a) staff costs

19

of which relating to pension
(b) other administrative expenses

Value adjustments in respect of intangible and
tangible assets
Profit for the financial year

20

(4,969)

(3,196)

(21,761)

(16,876)

(40,909)

(30,841)

(762)

(501)

443,923

253,901

ANNUAL REPORT 2014 | 91

STATEMENT OF CHANGES IN EQUITY
For the financial year ending 31 December 2014
(in €‘000)

Subscribed
capital

Fair value
reserve

Reserve
fund

Profit/loss
brought
forward

Profit/loss for
the financial
year

Total

700,000,000

19,548

-

-

(498)

700,019,050

Allocation of the
result of 2012

-

-

-

(498)

498

-

Profit for the financial
year

-

-

-

-

253,901

253,901

Fair value reserve

-

(135,264)

-

-

-

(135,264)

700,000,000

(115,716)

-

(498)

253,901

700,137,687

Subscribed
capital

Fair value
reserve

Reserve
fund

Profit/loss
brought
forward

Profit for the
financial year

Total

700,000,000

(115,716)

-

(498)

253,901

700,137,687

Subscription of
capital

1,935,300

-

-

-

-

1,935,300

Allocation of the
result of 2013

-

-

-

253,901

(253,901)

-

Allocation of profit
brought forward to
the reserve fund

-

-

253,403

(253,403)

-

-

Profit for the financial
year

-

-

-

-

443,923

443,923

Fair value reserve

-

628,579

-

-

-

628,579

701,935,300

512,863

253,403

-

443,923

703,145,489

At
1 January 2013

At
31 December 2013

At
1 January 2014

At
31 December 2014

92 | EUROPEAN STABILITY MECHANISM

STATEMENT OF CASH FLOWS
For the financial year ending 31 December 2014
(in €’000)
2014

2013

443,923

253,901

762

501

(1,223)

(422)

Cash flows from operating activities:
Profit for the financial year

Adjustments for:
Value adjustments in respect of tangible and intangible assets

Changes in:
Tangible and intangible assets
Accrued interest and interest received

(1,217,211)

(702,405)

Prepayments

(54,115)

(18,596)

Accruals and deferred income and interest paid

301,433

79,744

760

3,964

1,136,919

378,080

Other liabilities
Interest received
Up-front service fee received

5,500

32,325

Interest paid

(262,678)

(70,985)

Net cash provided by operating activities

354,070

(43,893)

(10,660,070)

(41,701,005)

4,320,000

(6,475,000)

Cash flows from investing activities
Change in debt securities including fixed-income securities
Change in loans and advances to credit institutions
Loans disbursed during the year

511,540

(6,465,000)

(5,828,530)

(54,641,005)

Payment of capital

15,756,656

31,424,832

Changes in debt securities in issue

(10,862,833)

20,552,891

4,893,823

51,977,723

Net decrease in cash and cash equivalents

(580,637)

(2,707,175)

Cash and cash equivalents at the beginning of the financial year

4,968,640

7,675,815

Cash and cash equivalents at the end of the financial year

4,388,003

4,968,640

Net cash used in investing activities
Cash flows from financing activities

Net cash provided by financing activities

The accompanying Notes form an integral part of these financial statements.

ANNUAL REPORT 2014 | 93

Notes to the financial statements

1.

GENERAL INFORMATION

The European Stability Mechanism (“ESM”) was inaugurated on 8 October 2012 and established as an international financial institution with its registered office at 6a, Circuit de la Foire Internationale, L-1347 Luxembourg,
Grand Duchy of Luxembourg.
The finance ministers of the then 17 euro area countries signed the Treaty establishing the European Stability
Mechanism (ESM Treaty) on 11 July 2011. A modified version, incorporating amendments aimed at improving
the ESM’s effectiveness, was signed in Brussels on 2 February 2012. The ESM Treaty entered into force on
27 September 2012 and the ESM was inaugurated on 8 October 2012 following ratification by the then 17 euro
area Member States.
Latvia joined the euro area on 1 January 2014. The Latvian parliament ratified the ESM Treaty on 30 January 2014,
and Latvia officially became the ESM’s 18th Member on 13 March 2014. The ESM’s Treaty was amended.
The present financial statements cover the period from 1 January 2014 to 31 December 2014, while comparative figures cover the period from 1 January 2013 to 31 December 2013.
On a proposal from the Managing Director, the Board of Directors adopted the financial statements on 25 March 2015
and authorised their submission to the Board of Governors for approval at their 18 June 2015 meeting.

1.1. General overview of the financial assistance programmes
The ESM is authorised to make use of the following lending instruments for the benefit of its Members, subject
to appropriate conditionality:
• grant financial assistance in the form of loans to an ESM Member (ESM Shareholder) in the framework of
a macroeconomic adjustment programme;
• purchase of bonds or other debt securities in the primary debt market and arrange operations on the secondary debt market in relation to the bonds of an ESM Member;
• grant precautionary financial assistance to ESM Members in the form of credit lines;
• provide financial assistance for the recapitalisation of financial institutions through loans to the of ESM Members’
governments.
The ESM can also directly recapitalise systemic and viable euro area credit institutions under specific circumstances and as a last resort measure, following the 8 December 2014 ratification of a new instrument, the
Direct Recapitalisation of Institutions.

1.2. Overview of the pricing structure of the financial assistance programmes
The total cost of financial assistance to a beneficiary Member State is an aggregate of several distinct elements
that are established in the ESM Pricing Policy:
• Base rate – the cost of funding incurred by the ESM, derived by a daily computation of the actual interest
accrued on all bonds, bills and other funding instruments issued by the ESM.
• Commitment fee – the negative cost of carry and issuance costs, charged for the period from raising funds by
the ESM until disbursement to the beneficiary Member State or for the period from the refinancing of the relevant

94 | EUROPEAN STABILITY MECHANISM

funding instrument until its maturity. The commitment fee will be applied ex-post on the basis of the negative carry
actually incurred.
• Service fee – the source of general revenues and resources to cover the ESM’s operational costs. The service
fee has two components:
- up-front service fee (50 bps) generally deducted from the drawn amount,
- annual service fee (0.5 bp) paid on the interest payment date.
• Margin – paid on the interest payment date. The margin charged differs across financial support instruments.
- For loans granted, the margin is 10 bps;
- For primary market support facility, the margin is 10 bps;
- For secondary market support facility, the margin is 5 bps;
- For precautionary financial assistance granted, the margin is 35 bps;
- For financial assistance provided to an ESM Member for the recapitalisation of its financial institutions, the
margin is 30 bps.
In addition, the ESM Pricing Policy includes specific elements tied to financial assistance for the Direct
Recapitalisation of Institutions.
Penalty interest may be applied to overdue amounts, which corresponds to a charge of 200 bps over the higher
of either the Euribor rate applicable to the relevant period selected by the ESM or the interest rate which would
have been payable.

1.3. The ESM’s financial assistance to Spain
The Eurogroup, which comprises the finance ministers of the euro area countries, reached political agreement on
20 July 2012 that financial assistance should be granted to Spain for the recapitalisation of its banking sector,
following an official request from the Spanish government. The assistance was designed to cover the estimated
capital requirements along with an additional safety margin, amounting to €100 billion. The loans were provided
to Spain’s bank recapitalisation fund, Fondo de Restructuración Ordenado Bancaria (FROB), and then channelled
to the relevant financial institutions. The assistance was initially committed under a European Financial Stability
Facility (“EFSF”) programme. On 28 November 2012, the ESM Board of Governors decided the ESM would
assume this commitment, in line with Article 40(1) and (2) of the ESM Treaty.
This was the ESM’s first financial assistance programme. It was also the first use of the instrument for recapitalising
banks through loans granted to a government. There were no contributions from other lenders.
On 3 December 2012, the Spanish government formally requested the disbursement of €39.5 billion of funds. On
5 December 2012, the ESM launched and priced notes, which were transferred to FROB on 11 December 2012.
FROB used these notes for the recapitalisation of €37.0 billion in the following banks: BFABankia, Catalunya-Caixa,
NCG Banco and Banco de Valencia. FROB also provided €2.5 billion to Sareb, the asset management company,
for assets arising from bank restructuring.
On 28 January 2013, the Spanish government formally requested a second disbursement of €1.8 billion for the
recapitalisation of Banco Mare Nostrum, Banco Ceiss, Caja 3 and Liberbank. The funds were transferred to FROB
in the form of ESM notes on 5 February 2013.
The ESM financial assistance programme expired on 31 December 2013. In total, the ESM disbursed €41.3
billion to Spain to recapitalise the banking sector. The remaining undisbursed amount of the facility was cancelled.
On 7 July 2014 the ESM Board of Directors approved Spain’s voluntary request to make an early repayment
of €1.3 billion of its loan. This was the first time a euro area country that benefited from a financial assistance
programme requested to make a repayment ahead of schedule. The repayment took place on 8 July 2014 and

ANNUAL REPORT 2014 | 95

was accompanied by a scheduled repayment of unused funds of €0.3 billion on 23 July 2014. Both repayments
were made in cash.

1.4. The ESM’s financial assistance to Cyprus
The Cypriot Government requested stability support on 25 June 2012. In response, the Eurogroup agreed the
key elements of a macroeconomic adjustment programme on 25 March 2013.
The agreement on the macroeconomic adjustment programme led euro area members to decide on a financial
assistance package of up to €10 billion. On 24 April 2013, the ESM Board of Governors decided to grant
stability support to Cyprus. On 8 May 2013 the ESM Board of Directors approved the Financial Assistance
Facility Agreement (FFA). The ESM provides up to €8.968 billion, and the International Monetary Fund (IMF)
contributed around €1 billion.
According to the terms of the FFA, the first tranche of financial assistance was provided to Cyprus in two
separate disbursements: the first €2.0 billion were disbursed on 13 May 2013, and the second of €1.0 billion
on 26 June 2013. The second tranche of assistance, €1.5 billion of ESM floating rate notes, was disbursed on
27 September 2013. The Cypriot government used the notes for the recapitalisation of the cooperative banking
sector. The third tranche of assistance, of €0.1 billion, was disbursed on 19 December 2013. During 2014,
€1.1 billion in disbursements was made.
The financial assistance facility is designed to cover Cyprus’s financing needs after including proceeds from burden-sharing measures that the Cypriot government has adopted. These needs include budgetary financing, the
redemption of medium and long-term debt, and the recapitalisation of financial institutions. They exclude the
country’s two largest banks, Bank of Cyprus and Cyprus Popular Bank, which the Cypriot government subjected to
restructuring and resolution measures.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies applied in the preparation of these financial statements are set out below.

2.1. Basis of presentation
The accompanying financial statements are prepared and presented in accordance with the Directive 86/635/EEC
of the Council of the European Communities of 8 December 1986 on the annual accounts and consolidated
accounts of banks and other financial institutions, as amended by Directive 2001/65/EC of 27 September 2001,
by Directive 2003/51/EC of 18 June 2003 and by Directive 2006/46/EC of 14 June 2006 (the ‘Directives’).
Their specific application by the ESM is described in the subsequent notes. Directive 2006/46/EC has been
amended by Directive 2013/34/EU. The ESM applies the same transitional period as that applicable to the
Member States for transposition by 2016.
The ESM prepares an Activity Report (‘description of policies and activities’) that is presented separately from the
financial statements.
The preparation of financial statements in conformity with the Directives requires the use of certain critical
accounting estimates. It also requires Management8 to exercise its judgement in applying the ESM’s accounting
policies. Areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates
are significant to the financial statements are disclosed in Note 2.3.

2.2. Basis of measurement
The accompanying financial statements are prepared on a historical cost basis, except for the loans and advances
to euro area Member States and the debts evidenced by certificates which are measured at amortised cost, and

8

As per Article 7 (5) of the ESM Treaty the Managing Director shall conduct, under the direction of the Board of Directors, the current business
of the ESM; as per Article 21 (1) of the ESM By-Laws the Board of Directors shall keep the accounts of the ESM and draw up its annual
accounts.

96 | EUROPEAN STABILITY MECHANISM

the paid-in capital and reserve fund investments which are measured at fair value with gains and losses recognised
in the fair value reserve.

2.3. Use of estimates
In preparing the financial statements, Management is required to make estimates and assumptions that affect
reported income, expenses, assets, liabilities and the disclosure of contingent assets and liabilities. The use of
available information and application of judgement are inherent in the formation of estimates. Actual results in the
future could differ from such estimates and the resulting differences may be material to the financial statements. Any
revision to accounting estimates is recognised prospectively in current and future periods.
The ESM is entitled to charge 50 bps of up-front service and 0.5 bps annual service fees to cover the ESM’s
operational cost, as Note 1.2 describes. The ESM recognises the up-front service fees over a seven year period,
to reflect the expected occurrences of the expenses that it aims to cover.
ESM reviews its loans and advances to euro area Member States at each reporting date to assess whether
a value adjustment should be recorded. The ESM is a permanent crisis resolution mechanism that aims at
supporting beneficiary Member States’ return to public financial stability. In particular, judgement by management
and the ESM governing bodies is required in the estimation of the level of value adjustment, by determining the
amount and timing of future cash flows. No value adjustment was required as at 31 December 2014 and 2013,
and thus none has been recognised.

2.4. Foreign currency translation
The ESM uses the euro (€) as the unit of measure for the capital accounts of Member States and for presenting
its financial statements.
Foreign currency transactions are recorded at the rates of exchange prevailing on the date of the transaction.
Exchange differences, if any, arising out of transactions settled during the year are recognised in the profit-and-loss
account as net profit or loss on financial operations.
Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the
closing exchange rates on that date.
Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the
exchange rates at the dates of the initial transactions. Non-monetary items measured at fair value in a foreign
currency are translated using the exchange rates at the date when the fair value was determined.
The exchange differences, if any, are recognised in the profit-and-loss account and related assets and liabilities
are revalued on the balance sheet.

2.5. Cash in hand, balances with central banks and post office banks
Cash in hand, balances with central banks and post office banks include cash in hand, demand deposits and other
short-term highly liquid investments with original maturities of three months or less. Bank overdrafts, if any, are
shown within borrowings in current liabilities on the balance sheet.

2.6. Debt securities including fixed-income securities
The ESM has established the following portfolio categories to clarify the management of its financial assets:

2.6.1. Paid-in capital and reserve fund investments
The ESM’s capital provisions are laid down in Chapter 3 of the ESM Treaty. The initial aggregate nominal value of
paid-in shares is €80 billion. The net income generated by the ESM operations and the proceeds of the financial
sanctions received from the ESM Members under the multilateral surveillance procedure, the excessive deficit

ANNUAL REPORT 2014 | 97

procedure and the macro-economic imbalances procedure established under the Treaty on the Functioning of the
European Union (TFEU) are put aside in a reserve fund, in accordance with Chapter 5 of the ESM Treaty.
The proceeds of the paid-in capital and reserve fund are invested in accordance with the Investment Policy
approved by the Board of Directors. The main objective of such investments is to ensure that the maximum
lending volume is always readily available, and to absorb potential losses.
The paid-in capital and reserve fund investments are segregated into separate portfolios (investment tranches).
The characteristics and relative size of each tranche are described below:
Short-term tranche
The tranche with the highest requirements for the liquidity of investments is the short-term tranche. The main
objective of the short-term tranche is to allow the ESM to face any temporary disbursement to cover any shortfall,
due to a non-payment by a beneficiary country. This tranche is invested in liquid investment instruments with
a capital preservation objective at a one-year horizon, with a high level of confidence.
Medium/Long-term tranche
The medium/long-term tranche is designed to ensure the ESM’s financial strength. This tranche is managed
to enhance the return of the investment portfolios and is subject to the constraints specified in the investment
objectives, as well as the asset eligibility criteria. This tranche is also mainly invested in liquid investment
instruments, and could also be monetised.
The paid-in capital and reserve fund investments are initially recognised at fair value including any transaction
costs, and measured subsequently at fair value with gains and losses recognised in the fair value reserve, except
for impairment losses and foreign exchange gains and losses, until the financial asset is derecognised. Unrealised
gains or losses are accumulated in the fair value reserve until such investment is sold, collected or otherwise
disposed of, or until such investment is determined to be impaired.
If such financial asset is determined to be impaired, the cumulative gain or loss previously recognised in the fair
value reserve is recognised in the profit and loss account. Interest, however, is recognised on a straight-line basis.

2.6.2. Liquidity buffer investments
The ESM’s borrowing strategy must meet several objectives and principles to comply with the purpose established
in Article 3 of the ESM Treaty. The market environment where the ESM operates is volatile. The general borrowing
strategy must therefore allow for a rapid reaction to unexpected market developments, including the build-up
of liquidity buffers during periods of systemic risk. This is to ensure market access, even in difficult market
environments with a high degree of uncertainty.
The liquidity buffer proceeds are invested in accordance with the investment guidelines for the short-term tranche
of the paid-in capital and reserve funds’ investments described in Note 2.6.1.

2.6.3. Fee investments
In 2014 the ESM invested the service fees and the margin collected from ESM operations into deposits and short
term highly rated debt securities. The fee investment portfolio is invested following the same investment guidelines
as for the short-term tranche of the paid-in capital and reserve funds’ investments described in Note 2.6.1.

2.6.4. Transitional Investment Portfolio
The transitional investment portfolio, which comprised short-term notes issued by the EFSF, was temporary
and expired in November 2014. The portfolio aimed at providing intermediate short-term financing to the EFSF,
because the EFSF bill programme was substituted by the ESM bill programme. This portfolio allowed the EFSF to
roll short-term funding from the former EFSF bill programme into long-term funding.
The securities in this portfolio were initially recognised at fair value, including any transaction costs, and were
subsequently measured at fair value. Gains and losses were recognised in the fair value reserve, except for
impairment losses and foreign exchange gains and losses, until the financial asset was derecognised. Unrealised
gains or losses were accumulated in the fair value reserve until these investments were derecognised.

98 | EUROPEAN STABILITY MECHANISM

2.6.5. Determination of fair value
For financial instruments traded in active markets, the determination of fair values for financial assets and
financial liabilities is based on quoted market prices or dealer price quotations.
A financial instrument is considered to be trading in an active market if quoted prices are readily and regularly
available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices
represent actual and regularly occurring market transactions on an arm’s length basis.
Where the fair values of financial instruments recorded on the balance sheet cannot be derived from active markets, they are determined using valuation techniques that include the use of mathematical models. The chosen
valuation techniques incorporate factors that market participants would take into account in pricing a transaction
and are based whenever possible on observable market data. If such data is not available, a degree of judgement
is required in establishing fair values.

2.7. Loans and advances to credit institutions and to euro area Member States
Loans and advances are non-derivative financial assets with fixed or determinable payments that are not traded in
an active market. Loans and advances are initially recognised at their net disbursement amounts, and subsequently
measured at amortised cost.
Transaction costs and premiums/discounts are amortised in the profit-and-loss account through interest receivable
and similar income. Interest income on loans and advances to credit institutions and to euro area Member States
are also included in interest receivable and similar income in the profit-and-loss account.
Specific value adjustments present the risks of non-recovery for all or part of their amounts. Value adjustments
are accounted for in the profit-and-loss account as value adjustments in respect of loans and advances and are
deducted from the appropriate asset items on the balance sheet.

2.8. Intangible assets
Intangible assets are recorded on the balance sheet at their acquisition cost, less accumulated amortisation.
Amortisation is calculated on a straight-line basis over the estimated life of each item purchased. Intangible assets
comprise computer software that are amortised within three years.

2.9. Tangible assets
Tangible assets are recorded on the balance sheet at their acquisition cost, less accumulated depreciation.
Depreciation is calculated on a straight-line basis over the estimated life of each item purchased, as set out below:
• permanent equipment, fixtures and fittings: nine years or until the end of building rent period;
• furniture and office equipment: five years;
• IT equipment: three years.
If works performed on leased properties are capitalised (as fixture and fittings) then the estimated life of those
assets should not exceed the duration of the lease agreement.

2.10. Prepayments and accrued income
Prepayments and accrued income are related to invoices received and paid in advance as the underlying expense
is not exclusively related to the reporting period together with any income relating to the financial year in question,
which will only be received in the course of a subsequent financial year.

ANNUAL REPORT 2014 | 99

2.11. Debts evidenced by certificates
Debts evidenced by certificates are presented at their amortised cost. Transaction costs and premiums/discounts
are amortised in the profit-and-loss account through interest payable and similar charges. Interest expenses on
debt instruments are also included in interest payable and similar charges in the profit-and-loss account.

2.12. Provisions
Provisions are intended to cover liabilities the nature of which is clearly defined and which at the date of the
balance sheet are either likely to be incurred, or certain to be incurred but uncertain as to the amount or as to
the date on which they will arise.
Where there are similar obligations, the likelihood that an outflow will be required in settlement is determined by
considering the class of obligations as a whole.

2.13. Subscribed capital
As at 31 December 2014 the ESM’s shareholders were the 18 euro area Member States. In accordance with
Article 8 of the ESM Treaty, the initial authorised capital is €701.9 billion, which is divided into 7,019,353
shares, with a nominal value of €100,000 each. The initial authorised capital was subscribed by the shareholders
according to the initial contribution key provided in Article 11 and calculated in Annex I of the ESM Treaty. The
authorised capital was divided into paid-in shares and callable shares, where the initial total aggregate nominal
value of paid-in shares was €80.2 billion.
In accordance with Article 4 of Directive 86/635/EEC as amended, the initial authorised capital stock of €701.9
billion is recognised in equity as subscribed capital. The callable shares are presented as subscribed capital
unpaid on the asset side of the balance sheet. Called capital not yet paid by the shareholders is recognised on the
asset side of the balance sheet as subscribed capital called but not paid.

2.14. Accruals and deferred income
Accruals and deferred income are related to income received before the balance sheet date but not exclusively
related to the reporting period, together with any charges which, though relating to the financial year in question,
will only be paid in a subsequent financial year.

2.15. Interest receivable and payable
Interest income and expenses for all interest-bearing financial instruments are recognised within interest receivable and interest payable in the profit-and-loss account on an accrual basis.
Once a financial asset or a group of similar financial assets has been written down as a result of an impairment
loss, interest income is recognised using the rate of interest used to discount the future cash flows for the
purpose of measuring the impairment loss.
On the balance sheet, accrued interest is included in ‘Prepayments and accrued income’ under assets and in
‘Accruals and deferred income’ under liabilities.

2.16. Employee benefits
(a)

Pension obligation

For a transition period from 1 January 2013 to 30 April 2013, the ESM was affiliated with the Luxembourg
national social security system on a voluntary basis. As a complementary insurance, a defined contribution plan
was operated and funded through payments from the ESM (employer) as well as from the employees to insurance
companies. The contributions were recognised as employee benefit expenses when they were due.

100 | EUROPEAN STABILITY MECHANISM

Since 1 May 2013, the ESM discontinued the previous arrangement and set up a pension plan with defined
contribution characteristics funded through payments to an external insurance company. This insurance scheme
also covers the risk of death and disability.
The pension plan is funded by contributions from the ESM (employer) as well as from the employees. The plan is
accounted for as a defined contribution plan and corresponding payments are recognised as employee benefit
expenses as they fall due.
(b)

Termination benefits

Upon termination of employment in certain conditions, a re-settlement allowance is payable to members of staff.
Such termination benefits cannot be reliably estimated. As further described in Note 19, no provision is recognised as at 31 December 2014.

2.17. Taxation
Within the scope of its official activities, the ESM, its assets, income, property and its operations and transactions
shall be exempt from all direct taxes under Article 36 of the ESM Treaty. ESM Members have agreed to remit or
refund all indirect taxation, subject to certain exceptions under the same provision of the ESM Treaty.

3.

RISK MANAGEMENT

This section presents information about the ESM’s exposure to and its management and control of risks, in
particular the primary risks associated with its use of financial instruments. These are:
• credit risk,
• market risk,
• liquidity and funding risk, and
• operational risk.
Given the nature of the ESM’s mandate, where credit risk from lending arises as a result of activities performed in
support of beneficiary Member States under a Financial Assistance Facility Agreement, the credit risk in the ESM’s
lending exposure has to be accepted.

3.1. Risk management organisation
The ESM follows a prudent approach to risk-taking in order to limit potential losses and to ensure continuity in
fulfilling its mandate and meeting its commitments.
According to the ESM’s High Level Principles for Risk Management the targeted risk appetite should preserve the
ESM’s funding capacity, ensure the highest creditworthiness and avoid unexpected capital calls. The risk appetite is
described in the Risk Policy and is set in the form of a global risk budget quantifying the maximum tolerable potential
loss over a defined time horizon with an agreed probability. It covers all financial and non-financial risks of the ESM,
and both on- and (if applicable) off-balance sheet items. The risk profile is defined by a set of limits applicable to
curtail all types of risks within risk appetite. The ESM does not aim to generate profit on financial support granted
to beneficiary Member States and does not provide incentives for speculative exposures in its investment portfolio.
Departments and business functions assume direct responsibility for the day-to-day management of risk. All staff
are responsible for ensuring that risks relating to their operations are identified, followed up and reported to the
Risk Department. The Risk Department exercises central oversight of risk and ensures a comprehensive and
consistent implementation of the risk management framework by all business functions.

ANNUAL REPORT 2014 | 101

The Managing Director bears full accountability for the implementation and functioning of the risk management
framework, adequate reporting to the Board of Directors and for further developing the Risk Policy.
The Chief Risk Officer is the head of the Risk Department and is a direct report of the Managing Director. The Chief
Risk Officer is responsible and accountable for informing the Managing Director on all risks which the institution
may face to ensure enforcement and oversight. The Managing Director, as Chairman of the Board of Directors,
reports risk-related information to the Board of Directors, principally through the Board Risk Committee.
To support the implementation of the ESM’s risk policies, an Internal Risk Committee (IRC) has been created. The IRC
translates the risk appetite into the internal limit structure, which is described in the Risk Policy approved by the Board
of Directors. The IRC assists the Board of Directors in ensuring the adequacy of the ESM’s internal limit structure and
limit setting, providing recommendations on changes of the internal limit structure, on the identification of relevant
risks, and on the suitability of methods to monitor and manage them. The IRC conducts on a periodical basis a risk
self-assessment and reports the result to the Managing Director.

3.2. Credit risk
Credit risk is defined as the potential for loss arising from the inability of a counterparty, issuer, insurer or other obligor
to fulfil its contractual obligations for full value when due. Counterparty risk is considered a particular form of credit
risk which derives from the lending and support operations to beneficiary Member States, investment of paid-in capital,
placement of possible excess liquidity, and hedging operations. Issuer risk is also a particular form of credit risk that
derives from investment in securities of the paid-in capital and excess liquidity.
The inherent risk of non-payment of any beneficiary Member State in relation to loans to euro area Member
States is not managed or mitigated by the ESM’s risk function. We therefore refer to Note 4 below which further
describes the treatment of loans to euro area Member States.

3.2.1. Maximum exposure to credit risk without taking into account of any collateral and
other credit enhancements
The following table shows the maximum exposure to credit risk for the components of the balance sheet without
taking into account of any collateral and other credit enhancements. For on-balance-sheet positions, these exposures are based on net carrying amounts as reported on the balance sheet.
In €‘000

Maximum exposure
31.12.2014

Maximum exposure
31.12.2013

Cash in hand, balances with central banks and post office banks

4,388,003

4,968,640

Loans and advances to credit institutions

18,656,514

22,976,514

Debt securities including fixed-income securities

61,650,424

50,361,775

On balance sheet credit risk exposure

84,694,941

78,306,929

-

-

84,694,941

78,306,929

Off balance sheet items
Maximum credit risk exposure

This table does not include the loans and advances to euro area Member States, as the inherent risk of non-payment
of the beneficiary Member States is not managed by the Risk function of the ESM, as described in Note 3.2.

3.2.2. Risk profile of counterparties and issuers
The following tables show the breakdown of the financial assets per credit rating. In respect of debt securities
including fixed-income securities, the credit ratings of individual issuances (or in the case of short-term securities
their long-term rating equivalents) are presented. In case the ratings of issuances are not available the issuers
rating is presented. For other financial assets the credit ratings of the counterparties are presented.

102 | EUROPEAN STABILITY MECHANISM

These tables do not include the breakdown of the loans and advances to euro area Member States, as the
inherent risk of non-payment of the beneficiary Member States is not managed by the risk function of the ESM,
as described in Note 3.2.
In €’000
Cash in hand, balances with central banks and post office banks

Credit rating*
not rated**
AA+

Loans and advances to credit institutions

not rated**
AA+

Debt securities including fixed-income securities

Clean carrying value
as at 31.12.2014
4,386,627
1,376
18,655,000
1,514

not rated**

2,639,676

AAA

30,442,526

AA+

12,337,497

AA

14,940,124

AA-

1,290,601

Total

84,694,941

* Based on the worst rating provided by the major rating agencies (Moody’s, Standard & Poor’s or Fitch) presented based on the rating scale as
used by Fitch.
** “Not rated” means balances placed with Eurosystem central banks and with the Bank for International Settlements, which do not have ratings.

In €’000
Cash in hand, balances with central banks and post office banks

Credit rating*
not rated**
AA+

Loans and advances to credit institutions

Debt securities including fixed-income securities

not rated**

Clean carrying value
as at 31.12.2013
4,966,086
2,554
22,975,000

AA+

1,514

AAA

23,051,756

AA+

20,231,283

AA

7,026,189

AA-

52,547

Total

78,306,929

* Based on the worst rating provided by the major rating agencies (Moody’s, Standard & Poor’s or Fitch) presented based on the rating scale as
used by Fitch.
** “Not rated” means balances placed with Eurosystem central banks, which do not have ratings.

3.2.3. Credit risk on debt securities including fixed-income securities
The ESM invests in assets that fulfil the high credit risk standards as required by the Investment Policy Guideline.
To mitigate the credit risk on its investments, the ESM has also established a detailed structure of credit limits.
The measurement of credit exposures and the monitoring of limit compliance is performed daily.

3.3. Market risk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of
changes in market prices. Market risks could arise from open positions in interest rate and currency products,
all of which are exposed to general and specific market movements and changes in the level of volatility of market
rates such as interest rates and foreign exchange rates.

ANNUAL REPORT 2014 | 103

3.3.1. Interest rate risk
Interest rate risk is defined as the potential for loss arising from adverse movements in interest rates. The main
sources of interest rate risk include asset or liability re-pricing, triggered by covenants or market movements,
yield curve shifts, and changes in the funding or lending spread. This risk applies to the paid-in capital investments
and may in the future be minimised using interest rate derivatives.
Structural interest rate risk is defined as the risk of a mismatch between the interest rate re-pricing of assets
and liabilities on the balance sheet. The current pricing policy for the ESM passes through the cost of funding to
beneficiary Member States.

3.3.2. Currency risk
All debt securities issued, and loans and receivables granted to the programme countries, as well as the paid-in
capital investments, are denominated in euros. The ESM does not therefore face any currency risk.

3.4. Liquidity risk
The ESM will honour its obligations under its issued debt securities from proceeds that stem from its support
programmes, supported by its capital. The ESM monitors its liquidity position on a daily basis in respect of its
funding liquidity risk, market liquidity risk and liquidity concentration risk.
Funding liquidity risk is defined as the inability to raise money in a timely manner. Should such a situation arise, the
ESM could be unable to settle obligations in a timely fashion and be held in breach of obligations. Funding liquidity
risk is managed by maintaining multiple credit lines and investing capital in high-credit-quality liquid assets that can
be used to raise cash to meet obligations as they fall due.
Market liquidity risk is defined as the potential for loss arising from a position that cannot easily be unwound
or offset at short notice without significantly and negatively influencing the market price because of inadequate
market depth or market disruption. Market liquidity risk is minimised by investing capital in high credit quality liquid
assets, ensuring the ESM does not hold a significant proportion of a security issuance and adopting adequate
measurements that allow the timely detection of liquidity deteriorations.
Liquidity concentration risk is defined as the potential loss arising from concentrations in assets and liabilities as
major sources of liquidity. A concentration in assets can disrupt an institution’s ability to generate cash in times of
illiquidity or reduced market liquidity for certain asset classes. A liability concentration (or funding concentration)
exists when the funding structure of the institution makes the ESM vulnerable to a single event or a single factor,
such as a significant and sudden withdrawal of funds or inadequate access to new funding. Liquidity concentration
risk is minimised by securing credit lines and adopting a diversified funding strategy.

104 | EUROPEAN STABILITY MECHANISM

The following tables analyse the ESM’s financial assets and liabilities and the shareholders’ equity by maturity on
the basis of the period remaining between the balance sheet date and the contractual maturity date.

Less than 3
months

From 3
months to 1
year

From 1 to 5
years

More than 5
years

Total

Cash in hand, balances with
central banks and post office
banks

4,388,003

-

-

-

4,388,003

Loans and advances to credit
institutions

9,656,514

9,000,000

-

-

18,656,514

Loans and advances to euro
area Member States

-

-

-

45,421,460

45,421,460

Debt securities including
fixed-income securities

4,315,634

9,031,116

45,066,574

3,237,100

61,650,424

Prepayments and accrued
income

245,963

349,098

-

-

595,061

18,606,114

18,380,214

45,066,574

48,658,560

130,711,462

49,163,608

As at 31 December 2014
in €‘000
ASSETS

Total financial assets
LIABILITIES
Debt securities in issue

8,428,974

15,832,358

14,946,159

9,956,117

Other liabilities

23,591

-

-

-

23,591

Accruals and deferred income

77,752

59,603

132,869

3,143

273,367

8,530,317

15,891,961

15,079,028

9,959,260

49,460,566

Shareholders’ equity*

-

-

-

81,254,429

81,254,429

Total shareholders’ equity**

-

-

-

81,254,429

81,254,429

10,075,797

2,488,253

29,987,546

(42,555,129)

(3,533)

Less than 3
months

From 3
months to 1
year

From 1 to 5
years

More than 5
years

Total

Cash in hand, balances with
central banks and post office
banks

4,968,640

-

-

-

4,968,640

Loans and advances to credit
institutions

11,226,514

11,750,000

-

-

22,976,514

Loans and advances to euro
area Member States

-

-

-

45,933,000

45,933,000

Debt securities including
fixed-income securities

8,805,165

13,028,663

26,974,414

1,553,533

50,361,775

Prepayments and accrued
income

178,530

282,124

-

-

460,654

25,178,849

25,060,787

26,974,414

47,486,533

124,700,583

60,026,441

Total financial liabilities

Net of financial position
As at 31 December 2013
in €‘000
ASSETS

Total financial assets
LIABILITIES
Debt securities in issue

11,778,544

22,943,538

22,344,768

2,959,591

Other liabilities

21,898

933

-

-

22,831

Accruals and deferred income

10,046

54,677

131,271

33,118

229,112

11,810,488

22,999,148

22,476,039

2,992,709

60,278,384

Shareholders’ equity*

-

-

-

64,425,271

64,425,271

Total shareholders’ equity**

-

-

-

64,425,271

64,425,271

13,368,361

2,061,639

4,498,375

(19,931,447)

(3,072)

Total financial liabilities

Net of financial position

* Excluding subscribed capital unpaid and subscribed capital called but not paid.
** The shareholder’s equity has no defined maturity.

ANNUAL REPORT 2014 | 105

3.5. Operational risk
Operational risk is defined as the potential loss and/or the inability of the ESM to fulfil its mandate resulting
from inadequate or failed internal processes, people and systems or from external events. Operational risks are
categorised in line with the guidance by the Basel Committee on Banking Supervision, as follows:
• execution, delivery and process management;
• counterparts, products and business practices;
• fraud;
• business continuity and system failures;
• employment practices and workplace safety;
• damage to physical assets.
Management has no tolerance for material operational risks, including those originated through third party/
vendor engagements, which may result in the inability of the ESM to effectively fulfil its mandate, or in significant
loss and/or reputational damage. No actual operational risk losses were identified in 2014.
All departments are responsible for proactive mitigation of operational risks and for the robustness of the controls
in their processes. If specific operational risk events occur, these are reported to an internal operational risk
register. Formal escalation procedures have been established involving the Internal Risk Committee and the Board
Risk Committee to ensure the active involvement of senior management and, where necessary, the Board of
Directors in addressing operational risk issues. All departments, with support from the Operational Risk function,
perform a root-cause analysis of operational risk events and implement improvements in the underlying processes
and controls to reduce the probability of re-occurrence. This approach is complemented by an annual self-assessment of the top operational risks of the ESM (based on likelihood and potential impact), which are reviewed and
monitored by the Internal Risk Committee.

4.

CREDIT RISK IN RELATION TO LOANS TO EURO AREA MEMBER STATES

The ESM, as per its mandate, grants financial assistance to euro area Member States experiencing severe financial problems, if indispensable to safeguard the financial stability of the euro area as a whole and of its members.
The assistance, therefore, aims at providing financial support according to rules that differ from those of financial
markets, given that the overall aim is to support the beneficiary Member State’s return to public financial stability.
The determination of debt sustainability and the close monitoring and conditionality attached to all financial assistance
to beneficiary Member States, as negotiated with the European Commission in liaison with the European Central Bank
(ECB) and whenever possible the IMF, addresses and mitigates credit risk. It is the mutual understanding of the ESM
Members that ESM loans enjoy preferred creditor status that is similar to the IMF, while accepting preferred creditor
status of the IMF over the ESM. This does not, however, apply to financial assistance in the form of ESM loans following
a European financial assistance programme that existed when the ESM Treaty was signed (as at 31 December 2014
this applies to the financial assistance granted to Spain). The ESM has implemented an early warning procedure as
requested by the ESM Treaty to monitor the ability of the beneficiary Member State to repay its obligations.
The ESM provided financial assistance to Spain for the recapitalisation of its financial sector which must be repaid by
2027. It is currently providing financial assistance to Cyprus, which is implementing a macroeconomic adjustment
programme. Note 7 provides a breakdown of all disbursed amounts, as well as the movements during the period.
From an investor’s point of view, the ESM’s capital structure and the possibility of capital calls address the risk
arising from beneficiary Member States’ non-payment and potential losses from other risks. Under Article 9
of the ESM Treaty there are two different instances when a capital call can be made to cover losses or avert
non-payment, as described in Note 15.
A capital call to replenish paid-in capital can be made to cover any losses in paid-in capital due to a non-payment by
a beneficiary Member and if losses occurring due to other factors would lead to the reduction in the countervalue
of the paid-in capital below the threshold of 15% of the maximum lending volume of the ESM.

106 | EUROPEAN STABILITY MECHANISM

Furthermore, an emergency capital call would be made if needed to avoid default of an ESM payment obligation
to its creditors.
These mechanisms provide the strongest possible assurance that ESM debt securities will always be serviced
and repaid.

5.

CASH IN HAND, BALANCES WITH CENTRAL BANKS AND POST OFFICE
BANKS (IN €‘000)

The composition of cash in hand, balances with central banks and post office banks is as follows:
31.12.2014

31.12.2013

4,386,627

4,966,086

1,376

2,554

4,388,003

4,968,640

Current account balances with central banks
Current account balances with other banks
Total cash in hand, balances with central banks and post office banks

6.

LOANS AND ADVANCES TO CREDIT INSTITUTIONS (IN €‘000)

The following table shows the breakdown of the other loans and advances to credit institutions:
31.12.2014

31.12.2013

18,655,000

22,975,000

1,514

1,514

18,656,514

22,976,514

Money market deposits
Other deposits
Total loans and advances to credit institutions

At the balance sheet date, the money market deposits contain exclusively money market deposits with central
banks of the Eurozone.
Other deposits consist entirely of the lease guarantee deposit in relation to the ESM rental agreement.

7.

LOANS TO EURO AREA MEMBER STATES (IN €‘000)

The following table shows the geographical breakdown of loans per financial assistance programme and by
borrowing country:
Nr. of loans

Nominal amount

Clean carrying value as at
31 December 2014

- to Spain

6

39,721,460

39,721,460

- to Cyprus

7

5,700,000

5,700,000

13

45,421,460

45,421,460

Nr. of loans

Nominal amount

Clean carrying value as at
31 December 2013

- to Spain

6

41,333,000

41,333,000

- to Cyprus

4

4,600,000

4,600,000

10

45,933,000

45,933,000

Loans to euro area Member States

Total

Loans to euro area Member States

Total

ANNUAL REPORT 2014 | 107

The following table shows the movements of the loans to euro area Member States during 2013 and 2014:
Balance as at 1 January 2013

39,461,824

New disbursements

6,465,000

- to Spain

1,865,000

- to Cyprus

4,600,000

Premiums/discounts amortization

6,176

Balance as at 31 December 2013

45,933,000

Balance as at 1 January 2014

45,933,000

New disbursements

1,100,000

- to Cyprus

1,100,000

Early repayments

(1,611,540)

- from Spain

(1,611,540)

Balance as at 31 December 2014

8.

45,421,460

DEBT SECURITIES INCLUDING FIXED-INCOME SECURITIES

The following table shows the details of the debt securities valuation and their classification as at
31 December 2014:

In €‘000

Clean amortised cost

Unrealised
gains

Clean fair
(carrying)
value

Nominal
amount

Paid-in capital portfolio

61,058,497

512,858

61,571,355

59,415,262

79,064

5

79,069

78,170

Fee investments
Transitional investment portfolio
Total

-

-

-

-

61,137,561

512,863

61,650,424

59,493,432

The following table shows the details of the debt securities valuation and their classification as at 31 December 2013:

In €‘000

Clean amortised cost

Unrealised
losses

Clean fair
(carrying)
value

Nominal
amount

Paid-in capital portfolio

41,412,128

(110,983)

41,301,145

40,298,126

Transitional investment portfolio

9,065,363

(4,733)

9,060,630

9,066,900

50,477,491

(115,716)

50,361,775

49,365,026

Total

As at 31 December 2014, the clean amortised cost of the debt securities is €61,137.6 million
(31 December 2013: €50,477.5 million), against a clean fair value of €61,650.4 million (31 December
2013: €50,361.8 million). The difference represents the unrealised result and is recognised directly in the
equity within the fair value reserve.
In respect of the paid-in capital portfolio within debt securities including fixed-income securities, the ESM has an
established investment policy setting strict investment guidelines that focus on issuers with the highest credit
standing in euro and includes a limit structure to mitigate the maximum exposure per counterparty. The transitional investment portfolio was temporary and expired in November 2014. Regarding the fee investments, see
Note 2.6.3.
As at 31 December 2014, the debt securities including fixed income securities of the paid-in capital investments
include securities that are not listed on regulated markets with a total clean fair value of €10,973.6 million
(31 December 2013: of €13,346.1 million). Their fair values are determined using valuation techniques, as
disclosed in Note 2.6.5. All other securities are listed on regulated markets and the fair values of these assets
are determined based on quoted market prices.

108 | EUROPEAN STABILITY MECHANISM

Debt securities including fixed-income securities include debt securities issued by public bodies and debt securities
issued by other issuers. Public bodies cover central banks, central governments, regional governments, local
governments, supranational institutions and governmental agencies. As at 31 December 2014, debt securities
issued by public bodies amounted to €55,518.2 million (31 December 2013: €46,762.4 million), while debt
securities issued by other borrowers amounted to €6,132.2 million (31 December 2013: €3,599.4 million).
The figures relating to the split between public bodies and other borrowers for debt securities including fixed-income securities have been reclassified for 31 December 2013 to ensure comparability with the figures for the
year ended 31 December 2014.

9.

INTANGIBLE ASSETS (IN €‘000)

The following table shows the movements of the intangible assets during 2014:
Software

Total intangible assets

Balance as at 1 January 2014

186

186

Additions and disposals (net)

21

21

207

207

(58)

(58)

Historical cost

Balance as at 31 December 2014
Accumulated amortisation
Balance as at 1 January 2014

(63)

(63)

(121)

(121)

Balance as at 31 December 2014

86

86

Balance as at 31 December 2013

128

128

Fixtures and
fittings

Furniture and office
equipment

Total tangible assets

Balance as at 1 January 2014

2,217

1,215

3,432

Additions and disposals (net)

947

255

1,202

3,164

1,470

4,634

(248)

(240)

(488)

Amortisation
Balance as at 31 December 2014
Net book value

10.

TANGIBLE ASSETS (IN €‘000)

The following table shows the movements of the tangible assets during 2014:

Historical cost

Balance as at 31 December 2014
Accumulated depreciation
Balance as at 1 January 2014
Depreciation

(329)

(370)

(699)

Balance as at 31 December 2014

(577)

(610)

(1,187)

Balance as at 31 December 2014

2,587

860

3,447

Balance as at 31 December 2013

1,969

975

2,944

Net book value

ANNUAL REPORT 2014 | 109

11.

PREPAYMENTS AND ACCRUED INCOME (IN €‘000)

The following table shows the breakdown of the prepayments and accrued income:
31.12.2014

31.12.2013

- Debt securities including fixed-income securities

456,526

404,035

- Loans and advances to euro area Member States

59,708

31,732

Interest receivable on:

6,024

6,199

Amounts charged to the EFSF for administrative services (Note 18/21)

- Loans and advances to credit institutions

38,260

17,010

Commitment fee receivable

34,252

1,184

Prepayments
Total prepayments and accrued income

12.

291

494

595,061

460,654

DEBTS EVIDENCED BY CERTIFICATES (IN €‘000)

The following table discloses the details of debt securities in issue outstanding as at 31 December 2014,
together with the coupon rates and due dates.
Financial assistance
programme

ISIN code

Nominal
amount

Issue date

Maturity date

Coupon

Cyprus

EU000A1U98Y4

1,500,000

27/09/2013

27/03/2015

6M Euribor 21 bps

Spain

EU000A1U98W8

12,000,000

11/12/2012

11/12/2015

6M Euribor 6 bps

Spain

EU000A1U98X6

1,865,000

05/02/2013

05/08/2015

6M Euribor 15 bps

Long-term Funding

EU000A1U98Z1

7,000,000

15/10/2013

15/10/2018

1.25%

Long-term Funding

EU000A1U9803

3,000,000

20/11/2013

20/11/2023

2.125%

Long-term Funding

EU000A1U9811

6,000,000

04/03/2014

04/03/2021

1.375%

Long-term Funding

EU000A1U9829

3,000,000

14/05/2014

15/10/2019

0.875%

Long-term Funding

EU000A1U9803**

990,750

27/06/2014

20/11/2023

2.125%

Short-term Funding

EU000A1U98G1

1,490,000

24/07/2014

22/01/2015

N/A*

Short-term Funding

EU000A1U98J5

1,489,700

21/08/2014

19/02/2015

N/A*

Short-term Funding

EU000A1U98L1

983,750

18/09/2014

19/03/2015

N/A*

Short-term Funding

EU000A1U98M9

998,150

09/10/2014

08/01/2015

N/A*

Short-term Funding

EU000A1U98N7

972,000

23/10/2014

23/04/2015

N/A*

Short-term Funding

EU000A1U9837

4,000,000

28/10/2014

28/10/2016

N/A*

Short-term Funding

EU000A1U98P2

972,250

06/11/2014

05/02/2015

N/A*

Short-term Funding

EU000A1U98Q0

995,000

20/11/2014

21/05/2015

N/A*

Short-term Funding

EU000A1U9837**

987,500

27/11/2014

28/10/2016

N/A*

Short-term Funding

EU000A1U98R8

994,800

04/12/2014

05/03/2015

N/A*

Total
* Zero-coupon bond.
** Tap issue.

49,238,900

110 | EUROPEAN STABILITY MECHANISM

The following table discloses the details of debt securities in issue outstanding as at 31 December 2013,
together with the coupon rates and due dates.
Financial assistance
programme

ISIN code

Nominal
amount

Issue date

Maturity date

Coupon

Cyprus

EU000A1U98Y4

1,500,000

27/09/2013

27/03/2015

6M Euribor 21 bps

Spain

EU000A1U98X6

1,865,000

05/02/2013

05/08/2015

6M Euribor 15 bps

Spain

EU000A1U98U2

6,500,000

11/12/2012

11/06/2014

6M Euribor 12 bps

Spain

EU000A1U98V0

12,000,000

11/12/2012

11/12/2014

6M Euribor 12 bps

Spain

EU000A1U98W8

12,000,000

11/12/2012

11/12/2015

6M Euribor 6 bps

Long-term Funding

EU000A1U9803

3,000,000

20/11/2013

20/11/2023

2.125%

Long-term Funding

EU000A1U98Z1

7,000,000

15/10/2013

15/10/2018

1.25%

Short-term Funding

EU000A1U9720

1,996,650

05/12/2013

06/03/2014

N/A*

Short-term Funding

EU000A1U9712

1,983,600

21/11/2013

22/05/2014

N/A*

Short-term Funding

EU000A1U9704

1,972,300

07/11/2013

06/02/2014

N/A*

Short-term Funding

EU000A1U97Z3

2,461,000

24/10/2013

24/04/2014

N/A*

Short-term Funding

EU000A1U97Y6

1,989,700

03/10/2013

09/01/2014

N/A*

Short-term Funding

EU000A1U97X8

2,442,100

19/09/2013

20/03/2014

N/A*

Short-term Funding

EU000A1U97V2

1,441,800

22/08/2013

20/02/2014

N/A*

Short-term Funding

EU000A1U97T6

1,937,000

25/07/2013

23/01/2014

N/A*

Total

60,089,150

* Zero-coupon bond.

The following table shows the movements of the debt securities in issue during 2013 and 2014:
Balance as at 1 January 2013

39,461,824

Issuance during the period

63,400,091

Maturities during the year

(42,847,200)

Premiums/discounts amortization

11,726

Balance as at 31 December 2013

60,026,441

Balance as at 1 January 2014

60,026,441

Issuance during the period

53,443,958

Maturities during the year

(64,334,450)

Premiums/discounts amortization

27,659

Balance as at 31 December 2014

49,163,608

All debt securities in issue as at 31 December 2013 and 31 December 2014 are issued under English law as
the governing law.

ANNUAL REPORT 2014 | 111

13.

OTHER LIABILITIES

As at 31 December 2014, the other liabilities are entirely composed of supplier’s invoices which are not yet settled
amounting to €23.6 million (31 December 2013: €22.8 million), from which €14.8 million (31 December 2013:
€14.8 million) is against the EFSF.

14.

ACCRUALS AND DEFERRED INCOME (IN €‘000)

The following table shows the breakdown of the accruals and deferred income:

Interest payable on debts evidenced by certificates

31.12.2014

31.12.2013

103,774

31,928

Deferred income on up-front service fee

169,593

197,184

Total accruals and deferred income

273,367

229,112

As explained in Note 2.3., the amortisation of the up-front service fee is recognised in the profit-and-loss account
on a linear basis under interest receivable and similar income on loans to euro area Member States.

15.

SUBSCRIBED CAPITAL

In €’000
At 1 January 2013

Subscribed
capital

Subscribed,
uncalled capital

Subscribed, called
capital

700,000,000

(620,000,000)

80,000,000

Subscription to the authorised capital

-

-

-

Authorised capital calls

-

-

-

700,000,000

(620,000,000)

80,000,000

Subscribed capital

Subscribed,
uncalled capital

Subscribed, called
capital

700,000,000

(620,000,000)

80,000,000

1,935,300

(1,935,300)

-

-

221,200

221,200

701,935,300

(621,714,100)

80,221,200

At 31 December 2013

In €’000
At 1 January 2014
Subscription to the authorised capital
Authorised capital calls
At 31 December 2014

On 31 December 2014, the ESM’s shareholders were the 18 euro area Member States. The contribution key for
subscribing to the ESM authorised capital is based on the key for subscription, by the national central banks of the
ESM Members, of the ECB’s capital.
Latvia joined the ESM on 13 March 2014 and subscribed to an authorised capital of 19,353 shares with a par
value of €100,000 each, representing €1,935.3 million of subscribed capital of which €221.2 million was called.
As at 31 December 2014 Latvia had made a first instalment for the payment of paid-in shares in the amount of
€44.2 million.
On 31 December 2014, the authorised capital is €701.9 billion (31 December 2013: €700.0 billion), divided
into 7,019,353 shares (31 December 2013: 7,000,000 shares), with a par value of €100,000 each, and is
split according to the contribution key. Out of the total authorised capital, €621.7 billion (31 December 2013:
€620.0 billion) is callable. On 31 December 2014, the called subscribed capital amounted to €80.2 billion
(31 December 2013: €80.0 billion), of which €80.0 billion (31 December 2013: €64.3 billion) is paid.
In the subsequent financial period, on 3 February 2015, Lithuania joined the ESM and became its 19th Member.
Lithuania’s capital subscription will be €2.86 billion, including €327.2 million in paid-in capital. The payment of
paid-in capital will be made in five annual instalments of €65.4 million each.

112 | EUROPEAN STABILITY MECHANISM

ESM Key (%)

Number of
shares

Subscribed
capital
(in €’000)

Subscribed capital
called and paid
(in €’000)

27.0716

1,900,248

190,024,800

21,717,120

French Republic

20.3297

1,427,013

142,701,300

16,308,720

Italian Republic

17.8643

1,253,959

125,395,900

14,330,960

Kingdom of Spain

11.8709

833,259

83,325,900

9,522,960

Kingdom of the Netherlands

5.7012

400,190

40,019,000

4,573,600

Kingdom of Belgium

3.4675

243,397

24,339,700

2,781,680

Hellenic Republic

2.8089

197,169

19,716,900

2,253,360

Republic of Austria

2.7757

194,838

19,483,800

2,226,720

Portuguese Republic

2.5023

175,644

17,564,400

2,007,360

Republic of Finland

1.7924

125,818

12,581,800

1,437,920

Ireland

1.5878

111,454

11,145,400

1,273,760

Slovak Republic

0.8217

57,680

5,768,000

659,200

Republic of Slovenia

0.4264

29,932

2,993,200

342,080

Republic of Latvia

0.2757

19,353

1,935,300

44,240

Grand Duchy of Luxembourg

0.2497

17,528

1,752,800

200,320

Republic of Cyprus

0.1957

13,734

1,373,400

156,960

Republic of Estonia

0.1855

13,020

1,302,000

148,800

Malta

0.0729

5,117

511,700

58,480

Total

100.00

7,019,353

701,935,300

80,044,240

ESM Members
as at 31 December 2014
Federal Republic of Germany

As at 31 December 2014 the subscribed capital called but not paid amounts to €177.0 million
(31 December 2013: €15,712.4 million).
On 30 April 2014, the 17 euro area Member States which established the ESM completed their scheduled
payments of paid-in capital. The fifth and final tranche transferred to the ESM amounted to €15.7 billion. The
ESM has thus achieved its target level of paid-in capital of €80 billion. The remaining €177.0 million is Latvia’s
yet unpaid amount.
There are three different instances when a capital call can be made, in accordance with Article 9 of the ESM
Treaty.
i. A general capital call under Article 9(1) of the ESM Treaty concerns payment of the initial capital and an
increase of paid-in capital that could be necessary, for example, to raise the lending capacity. To initiate such
a call, the Managing Director of the ESM, would make a proposal to the Board of Governors outlining the
objective of such a call, the amounts and contributions for each shareholder and a proposed payment schedule.
The Board of Governors, by mutual agreement, may call in authorised capital at any time.
ii. A capital call under Article 9(2) of the ESM Treaty to replenish paid-in capital could happen for two reasons:
- to cover a shortfall due to a non-payment by a beneficiary country and,
- if losses occurring due to other factors lead to the reduction in the countervalue of the paid-in capital below
the threshold of 15% of the maximum lending volume of the ESM.
The Managing Director would make a proposal to the Board of Directors, which would specify the losses
incurred and the underlying reasons. A simple majority of the Board of Directors is required to agree to call in
capital under these circumstances.
iii. An emergency capital call, under Article 9(3) of the ESM Treaty, would be used for the acceleration of the
paid-in capital during the ramp-up period to comply with the requested capital ratio and to avoid default of an
ESM payment obligation to its creditors.

ANNUAL REPORT 2014 | 113

The Managing Director has the responsibility to make such a capital call to ESM shareholders if there were
a risk of default. As stated in the ESM Treaty, the ESM shareholders have irrevocably and unconditionally
undertaken to pay on demand such a capital within seven days of receipt of the demand.
If an ESM member fails to meet the required payment under a capital call made pursuant to Article 9(2) or (3),
a revised increased capital call would be made to all ESM Members by increasing the contribution rate of the
remaining ESM Members on a pro-rata basis, according to Article 25 (2) of the ESM Treaty. When the ESM Member
which failed to contribute settles its debt to the ESM, the excess capital is returned to the other ESM Members.

16.

RESERVE FUND

As foreseen by Article 24 of the ESM Treaty the Board of Governors shall establish a reserve fund and, where
appropriate, other funds. Without prejudice to the distribution of dividends pursuant to Article 23 of the ESM
Treaty, the net income generated by the ESM operations and the proceeds of possible financial sanctions received
from the ESM Members under the multilateral surveillance procedure, the excessive deficit procedure and the
macro-economic imbalances procedure established under the Treaty on the Functioning of the European Union
(TFEU) are put aside in a reserve fund, in accordance with Chapter 5 of the ESM Treaty. The primary purpose of
the reserve fund is the absorption of potential losses.
On 19 June 2014, the Board of Governors decided at their annual general meeting to establish the reserve
fund and to appropriate the accumulated net result of the previous financial periods amounting to €253.4
million to the reserve fund. This amount also represents the outstanding balance of the reserve fund as at
31 December 2014.

17.

INTEREST RECEIVABLE AND SIMILAR INCOME ON LOANS AND ADVANCES
TO EURO AREA MEMBER STATES (IN €‘000)

Interest receivable and similar income on loans and advances to euro area Member States are detailed as follows:
2014

2013

Interest on loans (*)

432,265

236,859

Amortisation up-front service fee

33,091

30,936

Commitment fee

34,252

1,184

499,608

268,979

Total interest and similar income

(*) The interest on loans comprises base rate interest representing the cost of funding of the ESM, the margin and the annual service fee as they
are all defined in the ESM Pricing Policy.

18.

OTHER OPERATING INCOME

The EFSF has asked the ESM to provide administrative and other support services to assist it in performing
its activities. To formalise this cooperation, the ESM and EFSF entered into a service level agreement from
1 January 2013.
Under the agreement’s terms, the ESM is entitled to charge the EFSF service fees to achieve a fair cost-sharing
arrangement. For the services during the financial year 2014, the ESM charged the EFSF €21.3 million (2013:
€17.0 million). The amount had yet to be paid at balance sheet date (refer to Note 11).

19.

STAFF COSTS

Staff costs are detailed as follows (in €‘000):

Salaries and allowances
Social security costs
Pension costs
Total staff costs

2014

2013

13,501

10,292

678

477

4,969

3,196

19,148

13,965

114 | EUROPEAN STABILITY MECHANISM

The ESM employed 122 persons as at 31 December 2014 (102 as at 31 December 2013).
In addition to its own employees, the ESM has expenses for employees seconded from other International
Financial Institutions, as well as interim and temporary staff hired from external agencies. The related cost
amounts to €1.1 million for the 2014 financial year (2013: €1.0 million) and are accounted for as other
administrative expenditures (refer to Note 20).
Upon termination of employment, a re-settlement allowance may be paid and the payment of this benefit is subject
to several criteria, as described in Note 2.16. Taking into account the complex structure of termination benefits
and the fact that the ESM has no historical data to estimate the occurrence of such events, no provision is
recognised as at 31 December 2014 and 31 December 2013.

20.

OTHER ADMINISTRATIVE EXPENDITURES (IN €‘000)

Other administrative expenditures consist of fees paid for professional services and miscellaneous operating
expenses and are detailed as follows:
2014

2013

Outsourced services (mainly IT, HR and accounting services)

6,161

4,008

Treasury related services

3,808

1,752

Advisory services

3,315

5,033

Rental and related services

2,831

1,104

Interim and secondment fees (Note 19)

1,088

1,239

Legal services

851

908

Rating agencies fees

359

814

Other services
Total other administrative expenditures

21.

3,348

2,018

21,761

16,876

RELATED-PARTY TRANSACTIONS

Key management
The ESM has identified members of the Board of Governors, Board of Directors and the Management Board as
key management personnel.
The members of the Board of Governors and the Board of Directors were not entitled to remuneration during
the period.

Transactions with shareholders
The ESM granted loans to Spain and Cyprus, which are also shareholders of the ESM, as disclosed in more detail
in Note 7. In the course of its investment activity, the ESM purchases debt securities issued by its shareholders.
Such securities are reported as debt securities including fixed-income securities on the balance sheet.

Transactions with the European Financial Stability Facility (EFSF)
The EFSF is a public limited liability company (Société Anonyme) incorporated under Luxembourg law on
7 June 2010 following decisions taken by the euro area Member States on 9 May 2010 within the framework of
the Ecofin Council. The EFSF’s mandate is to safeguard financial stability in Europe by providing financial assistance
to euro area Member States within the framework of a macro-economic adjustment programme.
The EFSF was created as a temporary rescue mechanism. In accordance with its Articles of Association, the EFSF
will be dissolved and liquidated when all financial assistance provided to euro area Member States and all funding
instruments issued by the EFSF have been repaid in full. Since 1 July 2013, the EFSF may no longer engage in
new financing programmes or enter into new loan facility agreements.

ANNUAL REPORT 2014 | 115

External expenses incurred by the EFSF in relation to establishing and running the ESM were recharged by the
EFSF to the ESM, together with other non-expense related items. The total amount of items recharged to the
ESM, and recognised as expense in 2012, in an amount of €14.8 million had not yet been paid at balance sheet
date (refer to Note 13).
The EFSF has asked the ESM to provide certain administrative services and other support services to facilitate
the performance of its activities. To formalise this cooperation, the two organisations entered into a service level
agreement. The ESM charged the EFSF €21.3 million for the financial year 2014, and €17.0 million for the
financial year 2013, which had not yet been paid at balance sheet date (refer to Note 11) under the terms of
the Agreement. The ESM recognised these amounts as other operating income in the profit and loss account.
On a temporary basis, the ESM invested in short term notes issued by the EFSF, as disclosed in Note 2.6.4. and in
Note 8. The transitional investment portfolio was of temporary nature and expired in November 2014. During 2014
the highest outstanding amount of the transitional investment portfolio was €16.9 billion.

22.

AUDIT FEE (IN €‘000)

The total fees accrued are presented as follows:
2014

2013

Audit fees

240

261

Total Audit fees

240

261

23.

OFF-BALANCE SHEET ITEMS

As at 31 December 2014, the off-balance sheet items represent the undisbursed part of €3.3 billion
(31 December 2013: €4.4 billion) for the financial assistance programme to Cyprus of up to €9 billion.
Any further disbursement is subject to conditionality in line with the Memorandum of Understanding attached to
the Financial Assistance Facility Agreement.
On 31 December 2013, the €100 billion financial assistance programme to Spain expired and as a result, any
remaining undisbursed funds were automatically cancelled.

24.

EVENTS AFTER THE REPORTING PERIOD

Except for those included in the notes to the financial statements, there have been no material post balance
sheet events which could require disclosure or adjustment to the 31 December 2014 financial statements.

116 | EUROPEAN STABILITY MECHANISM

05.
EXTERNAL AUDITOR’S REPORT ON
THE 2014 FINANCIAL STATEMENTS

ANNUAL REPORT 2014 | 117

To the Board of Governors
of the European Stability Mechanism
Luxembourg, 27 March 2015

We have audited the accompanying financial statements of European Stability Mechanism, which comprise the balance sheet as at 31 December 2014,
the profit and loss account, the statement of changes
in equity and the statement of cash flows for the year
then ended and a summary of significant accounting
policies and other explanatory information.

BOARD OF DIRECTORS’ RESPONSIBILITY FOR THE FINANCIAL STATEMENTS
The Board of Directors is responsible for the
preparation and fair presentation of these financial
statements in accordance with the general principles
of the Directive 86/635/EEC of the Council of the
European Communities of 8 December 1986 on the
annual accounts and consolidated accounts of banks
and other financial institutions, as amended by Directive
2001/65/EC of 27 September 2001, by Directive
2003/51/EC of 18 June 2003 and by Directive
2006/46/EC of 14 June 2006 (“the Directives”),
and for such internal control as the Board of Directors
determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error.

RESPONSIBILITY OF THE
“RÉVISEUR D’ENTREPRISES AGRÉÉ”
Our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit in accordance with International
Standards on Auditing as adopted for Luxembourg
by the “Commission de Surveillance du Secteur
Financier”. Those standards require that we comply
with ethical requirements and plan and perform the
audit to obtain reasonable assurance about whether
the financial statements are free from material
misstatement.

An audit involves performing procedures to obtain
audit evidence about the amounts and disclosures
in the financial statements. The procedures selected
depend on the judgment of the “Réviseur d’entreprises agréé”, including the assessment of the risks
of material misstatement of the financial statements,
whether due to fraud or error. In making those risk
assessments, the “Réviseur d’entreprises agréé”
considers internal control relevant to the entity’s
preparation and fair presentation of the financial
statements in order to design audit procedures that
are appropriate in the circumstances, but not for
the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also
includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Board of Directors, as
well as evaluating the overall presentation of the
financial statements.
We believe that the audit evidence we have obtained
is sufficient and appropriate to provide a basis for our
audit opinion.

OPINION
In our opinion, the financial statements give a true and
fair view of the financial position of European Stability
Mechanism as of 31 December 2014, and of the
results of its operations and its cash flows for the year
then ended in accordance with the general principles
of the Directives.
PricewaterhouseCoopers,
Société coopérative
Represented by
Pierre Krier

118 | EUROPEAN STABILITY MECHANISM

06.
REPORT OF THE BOARD OF AUDITORS
ON THE 2014 FINANCIAL STATEMENTS

ANNUAL REPORT 2014 | 119

Luxembourg, 31 March 2015

The Board of Auditors of the European Stability
Mechanism (ESM) was set up pursuant to Article 30
of the Treaty establishing the ESM and Article 24 of
the ESM By-Laws. The Board of Auditors is independent from the Board of Directors and its members are
appointed directly by the Board of Governors.
The Board of Auditors carries out independent audits
of regularity, compliance, performance and risk management of the ESM, inspects the ESM accounts, and
monitors and reviews the ESM’s internal and external
audit processes and results. Information on the audit
work of the Board of Auditors, its audit findings,
conclusions and recommendations for the year ended
December 2014 are included in the annual report,
which has been prepared in accordance with Article
24(6) of the ESM By-Laws and submitted to the Board
of Governors.
This Board of Auditors´ report on the financial statements is addressed to the Board of Governors in
accordance with Article 23(2)(d) of the ESM By-Laws.

It is delivered in respect of the financial statements
of the ESM for the year ended 31 December 2014.
In 2014 the ESM has made further progress in
design and implementation of internal, operational
and managerial controls. The institution is still in the
process of introducing a comprehensive integrated
controls framework that should finally enable ESM
Management to confirm the adequacy and effectiveness of the internal controls as a whole. The Board
of Auditor notes that, to the best of its judgment, no
other material matters have come to its attention that
would prevent it from recommending that the Board
of Governors approve the ESM financial statements
for the year ended 31 December 2014.

On behalf of the Board of Auditors
Ulrich Graf
Chairperson

120 | EUROPEAN STABILITY MECHANISM

Acronyms and abbreviations
ALM
AQR
Bps
BRRD
CDS
CRD
CRR
DMO
DRI
EBA
EBS
EC
ECB
ECCL
EFSF
EMU
ESM
ESMAT
ESRB
EU
EWS
FFA
FROB
GDP
GLF
HICP

Asset and Liability Management
Asset Quality Review
Basis points
Bank Recovery and Resolution Directive
Credit Default Swap
Capital Requirements Directive
Capital Requirements Regulation
Debt Management Office
Direct Recapitalisation Instrument
European Banking Authority
(Deutsche Bundesbank’s) ESM Bidding
System
European Commission
European Central Bank
Enhanced Conditions Credit Line
European Financial Stability Facility
Economic and Monetary Union
European Stability Mechanism
Administrative Tribunal of the European
Stability Mechanism
European Systemic Risk Board
European Union
Early Warning System
Financial Assistance Facility Agreement
(Spanish fund for orderly bank
restructuring)
Gross Domestic Product
Greek Loan Facility
Harmonised Index of Consumer Prices

IMF
IRC
LTRO
MoU
NPL
NPV
OECD
OMT
PCCL
PIC
PSI
RFA
Sareb
SGP
SMEs
SMP
SSA
SSM
SRB
SRF
SRM
TIP
TLTRO
VaR
WAM

International Monetary Fund
Internal Risk Committee
Long-Term Refinancing Operation
Memorandum of Understanding
Non-Performing Loan
Net Present Value
Organisation for Economic Co-operation
and Development
Outright Monetary Transactions
Precautionary Conditioned Credit Line
Paid-in Capital
Private Sector Involvement
Regional Financing Arrangement
(the Spanish asset management company/bad bank)
Stability and Growth Pact
Small and Medium-sized Enterprises
Securities Markets Programme
Sovereign, Supranational and Agency
(bond issuers)
Single Supervisory Mechanism
Single Resolution Board
Single Resolution Fund
Single Resolution Mechanism
Transitional Investment Portfolio
Targeted Longer-Term Refinancing
Operations
Value at Risk
Weighted-Average Maturity

Photographs: Kapture, Babylonia and Shutterstock. Portrait photos are courtesy of the euro area finance ministries.

6a Circuit de la Foire Internationale
L-1347 Luxembourg
Tel: (+352) 260 962 0
info@esm.europa.eu
www.esm.europa.eu
DW-AA-14-001-EN-C | ISBN 978-92-95085-05-3 | ISSN 2314-9493 | doi:10.2852/15451