The European Union's Economic and Financial Affairs Council on 10 October discussed three options to restructure the EU's development finance institutions, with the intention of streamlining resources to target sub-Saharan African markets and mitigate climate change. The plan aims to strengthen the EU's position as the world's largest donor of official development aid. However, progress is likely to be slow because of disagreements between EU member states, and between the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB), primarily over the extent of non-EU involvement.

The EU recognizes that its development finance institutions (DFIs) are too fragmented and should be restructured to compete with China's Belt and Road Initiative, and the United States Development Finance Corporation, especially in sub-Saharan Africa. The discussions stem from an EU 'Wise Persons Group' (WPG) report published on 8 October and discussed as a non-legislative item at the EU Economic and Financial Affairs Council meeting held prior to the EU summit on 17-18 October. The WPG concluded that the EU's development finance architecture is fragmented and should be restructured to contribute more coherently to meeting the EU's political aims in sub-Saharan Africa, which include competing with China and the US, reducing poverty, and mitigating climate change. The WPG stated that the separation of the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD) is a significant barrier to achieving these goals. Instead, it is suggested that the EU should create a new, well-capitalized European Climate and Sustainable Development Bank (ECSDB) for lending to the region using a range of financial instruments and crowds in the private sector in collaboration with EU member states' own DFIs, such as the French Development Agency (Agence français de développement: AFD) and the German state-owned KfW. The ECSDB would focus on issuing grants and concessional lending, while providing technical assistance to borrowers. The three proposed options are:

1. Transforming the EBRD into the new ECSDB by transferring the extra-EU activities of the EIB to the EBRD;
2. Creating a new mixed ownership bank with the EIB, EBRD, EU member states, and the European Commission as shareholders, with the EIB ceasing extra-EU activities;
3. Tasking the EIB with establishing a subsidiary for its extra-EU activities with European agencies and member states acquiring major shareholdings.

The EBRD already wants to expand into sub-Saharan African markets and supports option one, but France and Germany oppose this on the basis that it cedes too much control of development finance to non-EU states such as the US and potentially also the United Kingdom. The EBRD's board agreed in May 2019 to advance plans for expanding its operations away from the Commonwealth of Independent States and into sub-Saharan African markets for the first time. However, its shareholding structure is generating disagreement. The UK emphasized during the discussions that the EBRD's international presence was stronger because of its non-EU shareholders. The EBRD's largest shareholder is the US (10%), followed by France, Germany, Italy, Japan, and the UK (all at 8.6%). The combined votes of EU members fall short of enforcing strategic decisions (requiring a 66% minimum share), a position that will further weaken once the UK leaves the EU. Conversely, France and Germany would prefer to remove or minimize the EBRD's non-EU shareholders, rather than expand its mandate, or otherwise create a new EIB subsidiary (under option three). This also has driven the alternative proposal to create a new mixed-ownership bank that is fully EU-owned, but this plan is opposed by the EBRD's non-EU shareholders and by the EIB.

Further EU studies into the three options are therefore likely, indicating that any institutional changes to the EU's development financing arrangements are unlikely before 2021, which would also require the consent of all member states and the European Parliament. All three proposals require significant, additional capital outlays under the EU's budget and political approval from all 28 member states and the European Parliament. The divergence of opinion between member states, EU agencies, and non-EU states strongly indicates that a consensus arrangement is unlikely to be agreed in the one-year outlook. In addition, the US and UK probably will insist that any further studies consider how the proposed ECSDB would interact with existing multilateral financial institutions operating in sub-Saharan Africa, such as the World Bank, International Monetary Fund, and African Development Bank.

Indicators of changing risk environment

• The EBRD selects a French candidate as its next chairperson in May 2020, replacing the UK's representative, indicating greater support for increasing EU control of development finance and favoring the development of options two and three.
• France and Germany reject the EBRD's proposal in May 2020 to expand its operations into sub-Saharan African markets - as both board representatives already did in October 2018 - indicating strong opposition to pursuing option one.
• The EBRD votes to broaden its mandate away from supporting CIS countries in transitioning to democratic systems of government towards poverty reduction, indicating growing support for option one.
• The EU member states agree to increase the budgetary capacity of the EIB under the next Multi-annual Budgetary Framework (2021-27), implying that option three is more financially feasible, thereby increasing EU support for it.
• The European Commission opts to open EU budget guarantees to the EBRD and other member states' DFIs, indicating growing support within the EU for option one.
• Other EU member states join Spain in calling for the EBRD's operations to also target Latin America, likely complicating its expansion plans given it currently does not have a footprint there, while expansion into Latin America is likely to face strong US opposition, thereby further delaying any restructuring.
• Economic indicators point to a significant downturn in the eurozone's performance in 2020-21, implying greater pressure on EU budgetary capacity from lower fiscal receipts and higher social security outlays, reducing member states' support for all of the options, especially option one, which would require the greatest capital investment and incur the highest running costs.

Posted 24 October 2019 by Chris Suckling, Associate Director, Risk Quantification, S&P Global Market Intelligence