There is no European Financial Safety Net, and therefore no Global Financial Safety Net

Introduction

Financial regulators frequently refer to the Global Financial Safety Net, or GFSN, as the bulwark against a repeat of the Global Financial Crisis and the Eurozone crisis 2007-13. The GSFN consists of multiple regional and national rescue funds, backstopping countries and banking systems in various ways.

The Eurozone component is the European Stability Mechanism (ESM).¹ It has bailed out Cyprus and Greece, and proposes in future to backstop the Eurozone’s banking system backstop – the Single Resolution Fund.²

Does the ESM exist, though? If it doesn’t, the GFSN is a fiction too.

What is the problem?

The ESM and its predecessor the European Financial Stability Facility (EFSF) are co-operatives, assisting members when they need it but dependent upon the other members to furnish them with the resources required to render that assistance. ‘Resources’ includes standing surety for funds borrowed from international investors. This requires a caucus of members to maintain high credit ratings, or else the concept of a safety net collapses.

What has happened to the EFSF?

The EFSF is now closed to new programmes. It has a single debt programme of €241 billion:³

• Thirteen of the twenty Eurozone member states act as guarantors for the EFSF’s debts;

• Ireland, Portugal, Cyprus and Greece are recipients of EU financial assistance programmes and cannot therefore act as guarantors;^{4 5}

• Latvia, Lithuania and Croatia were not yet Eurozone members at the EFSF’s inception;

• The amount of a member state’s guarantee is calculated in line with the Capital Key of that member state’s central bank in the European Central Bank, re-based to 100%;⁶

• The Capital Key is then raised to 165%, and applied to €241 billion to determine the guarantee amount;⁷

• The guarantees are several but not joint, so no member state can be called upon for the whole €241 billion, but each is liable up to the maximum amount of its guarantee, irrespective of whether other member states meet calls on their guarantees;⁸

• In other words, if there is a call and a member state cannot meet it, the calls on the other member states are raised, but not so that the calls will cause their guarantee amounts to be exceeded.

Interplay between credit ratings of the EFSF and of the EFSF guarantors

The EFSF’s credit rating was recently lowered to AA-.⁹ This was because France was downgraded from AA to AA-,¹⁰ reducing to below 100% the proportion of the EFSF’s bonds covered by guarantees from member states with ratings of AA or better.

Here is a summary of the guarantees of member states behind the EFSF’s €241 billion debt programme:^{11 12}

	Of all guarantors	Of guarantors rated AA or better	Of guarantors rated AA- or better
Guarantee amount	€397.7 bn	€175.7 bn	€264.7 bn
Outstanding bonds as at 31/12/23	€190.4 bn	€190.4 bn	€190.4 bn
Guarantee coverage	208.8%	92.3%	139.0%

ESM’s guarantee fund

The ESM has a different legal mechanism for calling for more funds: part-paid shares. All Eurozone member states are ESM shareholders, and they have subscribed to €708.5 billion of capital and paid in €80.6 billion of it. The guarantee fund is the difference – €627.9 billion of subscribed-but-not-called capital. Member states have an unconditional, irrevocable and several obligation to pay that in upon the ESM’s call.

ESM lending ceiling and loans outstanding now

The ESM has a lending ceiling of €500 billion.

It currently has €82.6 billion of loans to Greece, Spain and Cyprus, funded broadly with €91.8 billion of bonds issued.¹³ The paid-in capital of €80.6 billion and €9.2 billion of the bonds are held as €89.8 billion of cash balances and securities.

The guidelines around the ESM’s capacity to make new loans are:

1. The paid-in capital should remain invested in cash balances and securities, as having this large liquidity buffer contributes to the ESM’s credit rating;
2. New loans should be funded by the issuance of new bonds;
3. The ESM already has €82.6 billion of loans, so the ‘firepower’ remaining in its bazooka is, at least on paper, €417.4 billion;
4. For its bonds-in-issue to enjoy a given credit rating, though, their amount must be exceeded by the amount of callable capital committed by member states who enjoy that credit rating or better.

ESM lending capacity is dependent upon where it wants its own credit rating to be

The ESM had €91.8 billion of bonds-in-issue at the end of 2023, covered by the €204.7 billion of callable capital from the AAA-rated member states (Germany, Netherlands, and Luxembourg). The ESM could issue bonds for, and make new loans, of €112.9 billion with the assurance of its AAA rating remaining intact.

To go further than €112.9 billion it would have to begin relying on Austria and Finland – both with ratings of AA+. These member states only add €28.3 billion of callable capital, which raises the capacity for new bonds and loans to €141.2 billion, at the price of the ESM being downgraded to AA+ itself.

Extending the process to the two AA-rated member states – Belgium and Ireland – adds a further €31.3 billion of callable capital, increasing the capacity for new bonds and loans to €172.5 billion, at the price of the ESM being downgraded to AA.

A meaningful increase in capacity occurs only when France is counted upon

A meaningful increase in capacity only occurs when the callable capital of France is included, the price for which would be that the ESM’s rating would fall to AA-, as the EFSF’s has, assuming that France had not been further downgraded in the meanwhile. That would add a further €129.0 billion of capacity, bringing it to €301.5 billion.

Here is a table summarizing those calculations.¹⁴ Notably €9.2 billion of the €91.8 billion of bonds-in-issue is currently held in cash and securities. This amount could be diverted into new lending without any change of policy. The ESM also has the option of exploring with rating agencies whether it could reduce the proportion of its paid-in capital held as cash and securities without damaging its credit rating. If it could, then that would release a further amount for new lending. The table caters for a global amount of €50.0 billion to be diverted from cash and securities into new lending:

	Callable/AAA states	Callable/ AAA & AA+ states	Callable/AAA to AA states	Callable/AAA to AA- states
Callable capital amount	€204.7 bn	€233.0 bn	€264.3 bn	€393.3 bn
ESM bonds-in-issue	€91.8 bn	€91.8 bn	€91.8 bn	€91.8 bn
Capacity	€112.9 bn	€141.2 bn	€172.5 bn	€301.5 bn
Incremental capacity per credit rating level	—	€28.3 bn	€31.3 bn	€129.0 bn
Total new and existing lending capacity15	€195.5 bn	€223.8 bn	€255.1 bn	€384.1 bn
Diversion of €50.0 bn of cash and securities	€50.0 bn	€50.0 bn	€50.0 bn	€50.0 bn
Revised new ESM loan capacity16	€162.9 bn	€191.2 bn	€222.5 bn	€351.5 bn
Undershoot versus €500.0 bn ceiling	€337.1 bn	€308.8 bn	€274.5 bn	€148.5 bn

Summary and conclusions

The ESM’s capacity, according to its current rules and policies, is too low when measured against the size of a bailout programme if any large member state faced difficulties: Italy (BBB-rated) has a national debt of €2,895 billion, Spain (A-rated) has €1,573 billion and France €3,100 billion.

Even a diversion of €50 billion of cash and securities does not make a meaningful difference.

Getting anywhere near the capacity-on-paper of €500 billion and retaining a credible credit rating both depend on France – on its neither being downgraded further nor requiring a bailout itself.

With these contingencies in mind, it is not too much to say that the strength-on-paper of the ESM is only impressive if it remains on paper and is not tested for real. That means it is not a viable European Financial Safety Net. If that is the case, no Global Financial Safety Net can be said to exist either.