To bond or not to bond? Competing visions on common financing to combat COVID-19 – what now?



In a surprising joint statement on May 19, 2020, Germany’s Chancellor and France’s president unveiled plans for “A French-German Initiative for the European Recovery from the Coronavirus Crisis”1 (the Initiative). This included a proposal for an EU bond to raise €500 billion. Before an analysis of what the bond would entail and whether this would be the now almost mythical corona bond (as analyzed in the first Client Alert in this series2), let us turn our attention to the French-German Initiative in its entirety. We will also examine some of the responses since then, notably the “non-paper”3 from Austria, Denmark, the Netherlands and Sweden (the ADNS Non-Paper). The European Union (EU) Commission will set out further details on the Recovery Fund on Wednesday, May 27, 2020, which will be covered in the third part of this Client Alert series.

The goal of the Initiative is clear: a stronger Europe once the crisis is over. “We, France and Germany, are fully committed to live up to our responsibility for the EU and we will help pave the way out of the crisis.” The introductory paragraph undoubtedly hints at the predominantly social measures outlined in the following pages, in a departure from the economic focus of the EU documents released as of late. The next paragraph represents new bold thinking in stating: “To this end, more than ever, we need to benefit from the strength of acting together as Europeans and to join our forces in ways we have not used before.” 

The Initiative includes four measures:

  • A €500 billion recovery fund would 
  • The EU’s regular budget
  • The multiannual financial framework (MFF) of €1 trillion (possibly amended upwards) for the next seven years 
  • €2 trillion in state aid that has already been committed.4

In contrast, the ADNS Non-Paper states that to support an efficient and sustainable recovery, the MFF should reprioritize areas less likely to contribute to the recovery and be financially sound and sustainable, and that national contributions should be limited. The ADNS Non-Paper proposes a time-bound Emergency Recovery Fund, with a sunset clause of 2 years5, that would operate on a loans for loans approach. In contrast to the Initiative, the proposed Emergency Recovery Fund in the ADNS Non-Paper does not state the overall level of financing to be raised, but instead suggests that the Commission needs to scope its funding needs. The ADNS Non-Paper does not clarify how to finance the time-bound Emergency Recovery Fund and does not discuss common bonds. The wording “not leading to any mutualization of debt” is put prominently in bold, and given the opposition from the Netherlands on that topic, any such common issuance is unlikely to be followed if the ADNS Non-Paper proposal goes forward. That leaves important questions unanswered. 

In contrast and rather surprisingly given the previous opposition to common debt, the Initiative does follow the statements raised by the Commission that its proposed Recovery Fund ought to be financed by bonds issued by the European Commission. Repayment is to flow from the EU budget, i.e., where economically more capable countries contribute more than those less established. Given the opposition to debt mutualization expressed by certain Member States (including Germany), the Initiative considers that each EU Member State would be liable for repayments in line to the contribution made to the MFF. The Initiative, certainly when compared to the ADNS Non-Paper, seems to be have a more workable way forward, and which may be more palatable to certain other EU Member States, such as Italy, Spain and France, which have expressed support for common debt instruments (including SBBS – rebranded as Corona Bonds as discussed below). 

Aims and proposals in the French-German Initiative

1. Developing strategic health sovereignty with an EU “Health Strategy”

In terms of the health strategy, the proposal is to build on a new European approach for a “strategically positioned European healthcare industry” which will reduce EU dependency and upgrade the existing system. This means increasing research and development European capacities and coordination on the international level; establishing common strategic stocks of medicines and medical products; coordinating European procurement policies regarding vaccines and treatments; setting up an EU “Health Task Force”, and establishing common European standards for health data interoperability. 

If we want to focus on the small details, it is worth mentioning that the quotation marks used in the original document are in the French-style. That, combined with the fact that this is a French-German initiative and not the other way round, seems to suggest which country and leader was the driving force behind this project.

2. Setting up an ambitious “Recovery Fund” at the EU level for solidarity and growth

While a more contentious and presumably French idea in light of Germany’s widely publicized stance on the topic, this part of the document does not feature French-style quotation marks. What this section states is that France and Germany propose to allow the European Commission to finance the needed recovery support by “borrowing on markets on behalf of the EU under the provision of a legal basis in full respect of the EU Treaty, budgetary framework and rights of national parliaments”. The Recovery Fund would amount to €500 billion and be aimed at the most affected sectors and regions on the basis of EU budget programs and in line with European priorities. The fund will enhance the convergence of European economies and thus their competitiveness and aims to increase investment in the digital and green sectors. The prevailing idea is for the fund to be a complementary provision, and thus linked to a repayment plan beyond the current MFF on the EU budget. It should also be based on “a clear commitment of Member States to follow sound economic policies and an ambitious reform agenda”. A further point includes improving the framework for fair taxation and establishing a common Corporate Tax Base. The Initiative clearly states that its authors aim for a swift agreement to be reached on the issue, which given the initial reactions, seems unlikely.

3. Speeding up the green and digital transitions6

The Initiative clearly reaffirms the European Green Deal, in line with President von der Leyen’s Priorities for the European Commission. It puts forward various proposals focused on setting EU emission reduction targets, potentially introducing minimum carbon pricing, fitting each sector with a green recovery roadmap, and accelerating digitalization. 

4. Enhancing the EU economic and industrial resilience and sovereignty and giving a new impulse to the Single Market 

This section focuses on:

  • Supporting the diversification of supply chains and adjusting the EU Commission’s industrial strategy to support the economic recovery; 
  • Modernizing the European competition policy by accelerating the adaptation of state aid amongst others; 
  • Ensuring a swift return to a “fully functioning internal market” with a potential to deepen it to the point of an integrated market in the areas of energy, capital markets and digital
  • Ensuring the full functioning of the Schengen area; 
  • Speeding up the discussion on the EU framework for minimum wages adapted to national situations, to reinforce what the Initiative refers to as “social convergence”. 

So what does this all mean for markets?

As expected, section two of the Initiative, the Recovery Fund, merits the most discussion. When news broke of the unexpected shift in gear, there were some notable reactions. Austria was quick to comment that it, alongside the Netherlands, Denmark and Sweden, remained firm in their position against the possible fund. Unsurprisingly, Italy, Spain and Portugal voiced their agreement for the need for a Recovery Fund. The European Commission has also indicated that it welcomes the proposal in light of the challenges faced by the EU and acknowledges the need to find a solution especially in relation to the European budget. Commission President von der Leyen, however, is also clear on the fact that the views of all Member States and the European Parliament will be taken into account. While the French and German leaders plan to explain and clarify all points of the proposal and unite the EU behind it, they may have a difficult task ahead of them.

Is the proposed Recovery Fund the same as Corona Bonds? Yes and no. There is not yet enough detailed information on how exactly the Fund will operate or be financed. This is expected to be released on May 27, 2020. However, what we know so far is that its goal would be to target the most affected regions. What needs to be remembered is that Sovereign Bond Backed Securities (SBBS) did not have in their heart the idea of pooling Eurozone debt in the sense of economically aiding some countries at the expense of others. The underlying social idea is perhaps still there, however the economic argument varies vastly. 

If Corona Bonds, or even joint French-German “mini-SBBS” were to follow the same original proposed path as SBBS - i.e. with debt issued by Eurozone countries and tranched in several tranches with the most senior aimed at financial institutions with the whole process involving no mutualization - then the Fund will be different not least because of its structure. It would however be similar in terms of its aim. If Corona Bonds are truly mutualized debt issued to member states of the EU, not to investors as SBBS would have been/would be7, and if the Fund were to be financed by debt issued by the EU and backed by all 27 members and then distributed to countries in need, then the two sound strikingly similar. However, the prevailing thought in the press seems to be that said funds would be distributed as grants rather than loans and the Initiative speaks of a “binding repayment plan”. Either way this marks a rather important shift in opinion across Europe, especially if the plan involves the former. 

So what next?

Things are definitely changing very rapidly and it seems the most turbulent months are yet to come, not only financially but also politically, both on the national and European level. The EU’s budget, the MFF, still remains to be settled in full. Will the French-German Initiative go forward, the alternative plan from Austria, Denmark, the Netherlands and Sweden (referred to by the press as the Frugal Four) in the ADNS Non-Paper, or more likely, some combination of the two and elements from the EU Commission’s own plan announced on May 27, 2020? Regardless of how the Recovery Fund’s operating model is agreed, the discussion on these items will continue to determine the EU’s future direction where some form of common debt (with or without mutualization) is likely to be here to stay. 

In the interim however, while debate between those backing the French-German Initiative and those behind the ADNS Non-Paper is helpful and welcome, it is for the EU Commission to take charge with direction to get a final form of announced measures from the conceptual stage through to deployment and impact. 

Please get in touch with any of our Eurozone Hub lawyers if you require further information on the developments discussed above and how to navigate and seize opportunities. 

  1. Read the statement here.
  2. Read “Sovereign bond backed securities or Corona bonds - can you spot the differences?” here.
  3. Read non-paper here.
  4. Read “An overview of the EU’s “Spring 2020” fiscal support and regulatory relief measures here.
  5. Which raises the question as to whether this is even sufficient.
  6. There were unfortunately no quotation marks in this part of the document.
  7. Depending on whether the proposed sovereign bond-back securities regulation will eventually be enacted

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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