European financial architecture for development

The Wise Persons Group’s Verdict: Opportunities and challenges to restructuring the European Financial architecture

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Migration and climate change enjoy the highest priority on the EU’s external policy agenda. Together, they also rekindled the Union’s interest in its southern neighbor. Increasingly, European policy-makers link their own destiny and prosperity to Africa’s development. Yet, Africa’s development necessitates substantial financial, political, and security related efforts. In June 2018, a high-level meeting of France and Germany in the town of Meseberg observed that the EU’s architecture for external investment features various organisations with overlapping mandates, notably the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD). It thus called for the creation of a Wise Persons Group to review this architecture and present options for reform, which presented its conclusions in a report published on 8 October 2019. Yet while all involved agree on the diagnosis that a reform is needed, they have different views as to the most effective treatment.

In the World Investment Report, UNCTAD estimated that an additional USD 2.5 trillion per year are needed in low and lower middle income economies in order to achieve the Sustainable Development Goals (SDGs) by 2030. There is a strong recognition that public finance alone will not be able to close this gap. Any solution to this problem thus depends on the mobilization of additional private capital. Through blending mechanisms and guarantees, which mitigate projects’ financial and political risks, public and private investors shall be incentivized to become more active in regions and sectors they traditionally avoided. 

Simultaneously, emerging donors, most notably China, have begun to challenge the European model of development cooperation. The need for private capital and the rise of emerging donors and their respective impact on development cooperation shape European development policy. 

Tellingly, the current negotiations on the next EU budget, the so-called Multiannual Financial Framework (2021-2027), are dominated by the desire to create a more visible and coherent European external financial architecture that is both attractive to private investors and increases the EU’s visibility abroad. EU institutions and the Member States agree that, in order to incentivize private capital to venture into high-risk environments, existing blending mechanisms and EU guarantees need to be scaled up. 

In contrast to this substantive aspect of the debate, stakeholders have different visions, when it comes to the needed institutional reorganization of the existing system. While most stakeholders agree that the EU’s visibility in the realm of development finance needs to be improved, opinions differ widely as to how and by whom these improvements are to be transposed. This diversity of opinions is largely due to the multitude of well-established institutions, each of which seeks to defend – and if possible expand – their own prerogatives and business model. 

A key player is the EIB. Based on its self-perception as an investment bank, it has a streamlined and very efficient administrative structure, yet has neither developed strong country expertise nor ensured a stronger presence ‘on the ground’. The EIB is a financial giant and to this day remains the largest multilateral lender in the world investing between 25% and 30% of its portfolio into climate change mitigation. Only slightly above 10% of the bank’s total portfolio are disbursed outside Europe, which due to large overall size of the bank still makes for a significant investment footprint. 

Despite what the name suggests, the London-based EBRD is not a European institution for all intents and purposes but is capitalized by European and non-European shareholders, including the U.S. and Russia. The bank embraces multilateralism and insists on the importance of regional offices, of which it currently maintains 53 in 38 economies, yet none in sub-Saharan Africa. Until 2020 the bank envisions to achieve 40% of its investments to be channeled into green finance.   

In addition to the EIB and EBRD, there are 19 European development finance institutions (DFIs) and national development banks, which bring in national expertise and networks. European DFIs engage in EU development policy individually, as well as through the association of European Development Finance Institutes (EDFI). While EDFI includes smaller as well as larger DFIs, among them sizeable institutes from the Netherlands and the United Kingdom, the French AFD and the German KfW stand out from the crowd by their virtue as Europe’s largest national development banks. Those banks bring in considerable expertise as well as networks at home and in the regions where they operate. Due to their size and formalized agreements (Mutual Reliance Initiative), which ease cooperation between them, the AFD and KfW are able to co-finance large scale infrastructure projects like the world’s largest solar power plant Ouarzazate in Morocco.

 

 

EIB

AFD

KfW

EBRD

Triple A

Total financing

€64.19 bn

€11.4 bn

€75.5 bn

€9.5 bn

Outside EU

€8.1 bn

€11.4 bn

€10.6 bn

€3.1 bn

In Africa

€3.3 bn 

€5.3 bn

€5.21 bn

€1.4 bn

Staff

2900

2650

6376

2050

Regional offices

50 (27 outside the EU)

85

63

53

Fig. 1: Comparison between the largest bilateral and multilateral European lenders.

Given this complicated picture and the diverging positions among development finance stakeholders, the Council of the European Union – on proposition of France and Germany – mandated a Wise Persons Group (WPG) to assess options for a more efficient and sustainable European financial architecture for development. The group published its final report this Tuesday, in which it presents three scenarios for a future European Climate and Sustainable Development Bank. 

  • In a first scenario, the experts view the EBRD as the European development bank, bereaving the EIB of its external lending activities. 
  • Another scenario values the efficiency of the EIB and suggests the creation of an EIB development subsidiary, with EIB itself becoming a minority shareholder next to the European Commission, the member states and national DFIs. 
  • In their third and last scenario, the group of experts recommends the creation of a mixed-ownership entity. The European Commission and the EIB are listed as the majority shareholders of this new institution, while national development finance institutes, international finance institutes, and partner countries would become minority shareholders. This scenario sees itself as a compromise, aimed at fostering coordination whilst making use of the expertise of the largest number of stakeholders. Instead of endorsing any specific scenario, the report calls for further feasibility studies on all options.

Fig. 2. The three scenarios assessed by the WPG.

The ongoing debate as well as the WPG report has largely focused on institutional considerations and the direct interests of the concerned institutions and the member states, unfortunately too often overshadowing the more substantive concerns about the development relevance and impact of the European development finance system as a whole. Although one may have expected a clearer proposal by the WPG, their call for a more thorough cost-benefit assessment constitutes an opportunity to consider other factors than the institutional dimension.

Instead of emphasizing increased EU visibility as the ultimate goal and benchmark against which the various scenarios are to be tested, a serious reform of the system in place should concentrate on the very essence of sustainable development in partner countries. Next to questions of economic efficiency and debt sustainability – a point the WPG report only touched upon briefly – such an assessment needs to include ecological and social concerns in partner countries. Acknowledging partner countries’ needs is more than merely an act of altruism, but would well-reflect on the EU’s ambition to be a global leader in promoting sustainable development. If the European model of development finance successfully caters  to partner economies’ needs and produces results, it would more likely be perceived as a viable alternative to China’s Belt and Road initiative. For this purpose a coordinated, evidence-based EU development policy is needed. In particular, social and ecological features could become a strong selling point of European development policy, and could ingrain – in line with the recent van der Leyen proposal – climate as the competitive edge of the Union.

Authors: Lennart Kaplan and Benedikt Erforth.

Image courtesy of Jose Luis Cernadas Iglesias via Flickr.

 

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