52003DC0604

REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL - Comprehensive report on the functioning of the Guarantee fund

TABLE OF CONTENTS

EXECUTIVE SUMMARY

1. INTRODUCTION

2. THE GUARANTEE FUND MACHANISM AND ITS MAIN CHANGES DURING THE PERIOD 1998-2002

2.1 The objectives

2.2 Key features

2.2.1 Main characteristics of guarantees given to the EIB

2.2.2 Borrowing/lending operations covered by the Fund

2.2.3 Provisioning the Guarantee Fund

3. DEVELOPMENT AND PERFORMANCE OF THE GUARANTEE FUND OVER THE PERIOD 1998-2002

3.1 Protection given by the Fund against unforeseen demands on budget appropriations in the event of default

3.2 Budgetary discipline

4. IMPACT OF ENLARGMENT ON THE GUARANTEE FUND

5. THE PARAMETERS OF THE GUARANTEE FUND

5.1 The target amount and the Fund's capacity for guaranteed lending

5.2 Terms and conditions of the Community Guarantees to the EIB

6. TECHNICAL IMPROVEMENTS

ANNEXES

Annex 1: Breakdown of outstanding amounts per country according to risk coverage. (situation at 31 December 2002).

Annex 2: Outstanding amounts on EIB guaranteed loans signed with amortisations over the 2003-2006 period.

Annex 3: The Guarantee Fund over the 2002-2006 period based on current parameters.

Annex 4: Outstanding amounts on EIB guaranteed loans signed in favour of the 10 new Member States.

Annex 5: Theoretical assumptions based on the current provisioning and guarantee rates parameters.

Annex 6: Use of the Reserve in the framework of the 2000-2006 Financial Perspectives.

Annex 7: Breakdown of outstanding amounts per country (Bulgaria, Romania and Turkey) according to risk coverage (situation at 31 December 2002).

Annex 8: Historical data on differences between EIB forecasts and loans signed.

Annex 9: Financial flows from and to the Guarantee Fund.

EXECUTIVE SUMMARY

Regulation N° 1149/1999 dated 25 May 1999 stipulates that a comprehensive report on the functioning of the Guarantee Fund (the "Fund") has to be prepared at the latest before 31 December 2006 or at the time of the conclusion of the first accession agreement with new Member States. The present report accordingly covers the period 1998-2002.

The Fund has continued to fulfil its main objectives during the period 1998-2002 in providing a liquidity cushion for the Community budget against defaults on guaranteed loans and as a mechanism to fix a financial framework for Community guarantees covering Commission and EIB external lending. The volume of defaults has been low.

The Fund covers guaranteed loans and loan guarantees to third countries. The approaching accession of 10 countries to the EU in 2004 will affect the Fund as several of these countries have benefited from EIB loans guaranteed by the EU Budget. Guaranteed loans to these countries will no longer be covered by the target amount of the Fund as soon as they join the European Union. The guarantees themselves will remain in place but the outstanding risk will be borne by the EU budget directly. The same situation will arise in the case of further accessions. The Commission is proposing an amendment to the Regulation to establish rules for addressing all such situations.

On the basis of current forecasts for guaranteed loan operations and the proposed revision to the general lending mandate for the EIB set out in the Commission's mid-term review [1], no immediate requirement to change the parameters of the Fund has been identified.

[1] Mid-term review of EIB external lending Mandate pursuant to Council Decision 2000/24/EC of 22 December 1999, as amended.

The Commission, however, envisages the introduction of some technical improvements to the Fund's provisioning procedures in order to further facilitate the functioning of the Fund. These improvements will not require any change to the Regulation.

1. Introduction

Council Regulation (EC, Euratom) No 2728/94 of 31 October 1994 ("the Regulation") established a Guarantee Fund ("the Fund") for external actions so that the Community's creditors could be reimbursed in the event of any default by the beneficiaries of loans granted or guaranteed by the Community.

A first review of the functioning of the Fund took place in 1998 in accordance with Article 9 of the Regulation that stipulated that "the Commission is to submit, before 31 December 1998, a comprehensive report on the functioning of the Fund".

Regulation N° 1149/1999 dated 25 May 1999 [2] modified Art.9 which now stipulates that another report has to be prepared at the latest before 31 December 2006 and at the time of the conclusion of the first accession agreement with new Member States. In view of the signing of an accession agreement by 10 States on 16 April 2003 the present report analyses:

[2] Article 1 4. of the regulation 1149/1999: "The Commission shall submit to the European Parliament and the Council comprehensive reports on the functioning of the Fund, both at the time of the conclusion of the first accession agreement with the applicant States, and before 31 December 2006. The Commission shall, if necessary, submit to the Council appropriate proposals for modification of the parameters of the Fund."

- The functioning of the Fund

The Commission presents a brief analysis, in the light of the experience gained over the period 1998-2002, of the results achieved by the Fund as compared with the objectives set. This covers the description and analysis of the key characteristics of the Fund such as liabilities, defaults covered by the Fund, and its financing.

- The impact of enlargement

The impact on the Fund of the accession of 10 new Member States on 1 May 2004 is analysed. The report examines the coverage of risk on the outstanding debt guaranteed by the EC for these countries and the nature of the liabilities to be assumed by the EU budget upon accession. The Commission is presenting separately a proposal for the amendment of the Regulation establishing the Fund to take account of this new situation and the impact on the Fund of future accessions.

- The assessment of the parameters of the Fund [3]

[3] Regulation N° 1149/1999 Article 1 4.

This assessment is made in the light of the experience gained so far with the functioning of the Fund and the forecast volume of additional lending to be covered by EU guarantee up to end-2006.

- Technical improvements in the functioning of the Fund

The report outlines technical changes envisaged to improve the functioning of the Fund without modifying any of its parameters.

The annexes to this report set out financial data relating to the Fund's results over the period 1998-2002 and present simulations on the development of the Fund over the period 2002-2006.

2. The Guarantee Fund Mechanism and its main changes during the period 1998-2002

2.1 The objectives

Set up at a time when the guarantees on loans granted to non-member countries were growing rapidly, the Fund and the related Reserve for Guarantees were intended:

- to provide the Community with an instrument to protect the Community budget against the impact of Community guarantees being called in. One principal function of the Fund is therefore to provide a liquidity cushion in order to avoid calling on the Community budget every time a default or late payment on a guaranteed loan arises;

- to create an instrument of budgetary discipline by laying down a financial framework for the development of the Community policy on guarantees for Commission and EIB loans to non-member countries.

2.2 Key features

The Guarantee Fund mechanism covers lending in third countries through three very different mechanisms: guarantees of European Investment Bank (EIB) external lending, Euratom external lending and EU macro-financial assistance (MFA) loans to third countries.

2.2.1 Main characteristics of guarantees given to the EIB

Loan guarantees are issued with respect to loans granted in third countries by the EIB. When the recipient of a guaranteed loan fails to make a payment on the due date, the EIB asks the Community to pay the amounts owed by the defaulting debtor in accordance with the respective guarantee contract. The amounts must be paid to the EIB within three months of receiving the EIB's request. The EIB always seeks a second public or private guarantor in addition to the Community guarantee and is obliged to activate such third party guarantees before a call under the EU guarantee is paid (for more details on the type of guarantees see point 4. below).

Since the entry into force of the Regulation, the Fund provides the liquidity for the payments to the EIB under defaulted loans.

An implementation agreement was concluded between the Community and the EIB on 20 and 22 January 1999 to determine payment and repayment procedures in connection with Community guarantees to the EIB.

2.2.2 Borrowing/lending operations covered by the Fund

In this type of operation covered by the Fund, the Community borrows on the financial market and on-lends the proceeds (at the same rate and for the same term) to non-member countries (macro-financial assistance MFA) or to companies (Euratom).

The loan repayments are scheduled to match the repayments of the borrowings due from the Community. If the recipient of the loan is late in making a repayment, the Commission must draw on its resources to repay the borrowing on the due date. The funds needed to pay the budget guarantee in the event of late payment by the recipient of a loan granted by the Community are raised as follows:

a) the amount required may be taken provisionally from cash resources in accordance with Article 12 of Council Regulation (EC, Euratom) No 1150/2000 of 22 May 2000, implementing Decision 94/728/EC, Euratom, on the system of the Community's own resources. This method is used so that the Community can immediately repay the borrowing on the date scheduled even in the event of late payment by the recipient of the loan;

b) if the delay extends to three months after the due date, the Commission draws on the Fund to cover the default;

c) in the unlikely event that there are insufficient resources in the Guarantee Fund, the Council Regulation No 1150/2000 envisages a transfer procedure to provide the budget with the appropriations needed to cover the default. Under this procedure any margin available in the guarantee reserve (see below) would be drawn on first.

2.2.3 Provisioning the Guarantee Fund

The overall annual amount of lending and guaranteeing is constrained by the Reserve for loans and loan guarantees in third countries (the "Reserve") for provisioning the Guarantee Fund, although the ceilings for EIB external lending are set by the Council and cover a number of years without annual ceilings. If, subsequent to the relevant Council Decisions granting the guarantees to the EIB, the resources of the Fund became inadequate, it would be a matter for the budgetary authority to honour any EIB calls on the Community guarantee. The Inter-institutional Agreement of 29 October 1993 on budgetary discipline and improvement of the budgetary procedure and the Inter-institutional Agreement of 6 May 1999 provided for the entry of a reserve for loan guarantees and guaranteed loans to non-member countries as a provision in the general budget of the European Communities. The annual amount of the guarantee Reserve is defined in the Financial Perspectives for 2000-2006, i.e. EUR 200 million at 1999 prices [4].

[4] The conditions for the entry, use and financing of the guarantee reserve are laid down in the following decisions:

This Reserve amount and the rules of the Fund limit the lending/guarantee capacity to about EUR 3 billion per year (depending on the guarantee rate). In principle, whenever a new loan or loan guarantee is decided, a certain fraction of the capital amount of that loan or guarantee has to be provisioned out of the Reserve. The provisioning rate together with the amount of the Reserve therefore determines the overall amount of possible lending or guaranteeing. If, for example, all loans and guarantees had to be fully provisioned and the provisioning rate was 10 per cent, a reserve amount of EUR 100 would constrain the lending and guarantee capacity to EUR 1000 per year. In practice the situation is complicated by the different treatment of loans and guarantees.

The base for the provisioning differs according to the guarantee rate applicable. All Euratom and MFA loans are guaranteed at a rate of 100%, i.e. the provisioning rate is applied to the total amount of the loan. The loan guarantees granted to the EIB vary, depending on the loan portfolio concerned. For each loan portfolio, the EIB receives a guarantee expressed as a percentage of the total portfolio. Within each portfolio individual EIB loans are, de facto, guaranteed at 100% until the global ceiling is reached [5]. In order to determine the amount to be provisioned in the Fund, in a first step, the total loan amounts are multiplied by the respective guarantee percentages. The result of this calculation is then multiplied by the provisioning rate.

[5] Given the particular risk involved, a 100% guarantee was granted to the EIB in the case of the mandate Baltic Sea Russia Special Action. While older global loan guarantees for the EIB had guarantee rates of 75 % and 70 %, under the current 2000-2007 general mandate only 65% of the EIB lending envelope for third countries is guaranteed by the Community.

Historically the amounts paid into the Fund were obtained by applying the rate of provisioning (14%) to the calculation base set out above. Pursuant to Articles 2 and 4 of the Regulation establishing the Fund, the Fund was endowed by payments from the general budget equivalent to 14% of the capital value of the operations until it reached the target amount. As this had been reached at 31 December 1997, the Commission, in accordance with the Regulation, submitted proposals to review the rate of provisioning. These proposals appear in the comprehensive report on the functioning of the Fund which the Commission drew up in accordance with Article 3 of the Regulation (COM(1998) 168 final of 18 March 1998). Based on these proposals, the Regulation was amended by Council Regulation (EC, Euratom) No 1149/1999 of 25 May 1999 under which the provisioning rate for the Fund and the target amount was fixed at 9% from 1 January 2000.

The target amount of the Fund relates the outstanding amount of the loans and loan guarantees covered by the Fund to the size of the Fund's assets. At the end of each year the Fund's assets are compared with its target amount, obtained by multiplying the total of guaranteed loans and loan guarantees by the target rate. Excess amounts are reimbursed to the Community budget [6].

[6] Should the amount of the Reserve be insufficient, Article 5 of the Regulation N° 2728/1994 will be applied.

In practical terms, the provisioning of the Fund follows different rules according to the type of operation covered. In the case of EIB loans, the provisioning of the Fund currently takes place at the beginning of each year, based on the forecast provided by the EIB of total loans to be signed in the respective year. These preliminary EIB forecasts have regularly exceeded the final amount of loans signed in the corresponding year. The difference between forecast and realisation is balanced at the end of each year when the Fund is aligned to its target amount (see paragraph above).

In the case of MFA loans, the provisioning takes place at the moment of the decision of the Council to grant macro-financial assistance, i.e. on an individual basis. This procedure is also applied even if the loan is paid out in several tranches over a period of more than one year. Euratom loans, on the other hand, are under current rules fully provisioned at the time of the signature of the loans.

3. Development and Performance of the Guarantee Fund over the period 1998-2002

3.1 Protection given by the Fund against unforeseen demands on budget appropriations in the event of default

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Since its beginning in 1994, the Fund has prevented any disruption of budget implementation that would have occurred as a result of the defaults on payments to the Community. Chart 1 shows how the Fund has succeeded in absorbing the impact of calls on the guarantee.

Had it not been for the Fund, the Community would repeatedly have had to use budgetary resources to provide the necessary guarantees and this would have required redeployment of appropriations in the course of budget implementation. Since 1998, 11 calls for a total of EUR 58,8 million have been handled through the Fund mechanism, all concerning guarantees issued to the EIB for loans in the former Yugoslavia [7]. (see Table 3 below).

[7] It should be noted that in December 2002, a call on the Fund was made by the EIB for a guaranteed loan in Argentina. The connected payment however was made in February 2003.

Table 2 provides details of the financial movements on the Fund.

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Several factors have contributed to the Fund's continued growth during the period under review:

- Substantial payments from the Reserve: between 1998 and 2002, aggregate payments into the Fund from the reserve totalled EUR 1.136,4 million, as compared with EUR 5.877 million in new loans guaranteed, with a provisioning rate of 14% for the 1998-2000 period and 9% for 2000-2002 (see Table 2). The income generated by the investment of Fund resources also made a significant contribution to the growth of the Fund. During the exercise 2002, interest earned by the Fund represented 38 % of the Reserve for loans and loan guarantees in third countries, or 47% of the amount effectively drawn from this Reserve in 2002.

- Defaults covered by the Fund since 1998: as is shown by Table 3 below, the level of disbursements from the Fund (aggregate disbursements, net of reimbursements) has since its conception never exceeded 5% of liabilities for guarantees. The highest percentage during the reporting period 1998-2002 was the result of defaults on EIB loans in Republics of the former Yugoslavia. These loans are amortised and arrears have been repaid to the Fund respectively in 2000 and essentially in 2001.

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- The stability of guarantee disbursements from the Fund: disbursements from the Fund amounted to EUR 410 million during the period 1994-1997. During the period 1998-2002 they declined substantially and never exceeded EUR 17 million. In 2002, there was no call on the Fund. The ratio between the liabilities and the disbursements has steadily declined. There were also significant financial flows in the opposite direction: during the 1998-2002 period EUR 432 million were recovered by the Fund by way of late reimbursements (see Table 3)

- The total volume of liabilities covered by the Fund has substantially increased since 1998: guaranteed liabilities rose from EUR 9.481 million in 1998 to EUR 15.358 million at the end of 2002. Over the same period the Fund itself grew EUR 365 million from EUR 1.280 million to EUR 1.646 million. The Fund exceeded its target amount (initially 10% then 9% of liabilities on loans) at the end of each year of the whole 1998-2002 period, giving rise to transfers of the excess amounts to the budget (for more detail see Annex 3 and Annex 8). Yet there has been no decrease in lending activities since 1998; indeed, the volume of new guaranteed operations, all three instruments together, has increased by EUR 5.877 million (disbursements for these operations are spread over several years). Over the same period, however, the amounts reimbursed on earlier guarantees have amounted to EUR 4.574 million.

The theoretical maximum annual risk borne by the Community budget from guaranteed loans and loan guarantees can be calculated as the estimated amount of principal and interest due each financial year, assuming that all payments due would be in default. The resulting figure (annual liquidity risk) represents the maximum stress for the Community budget. In this estimation [8] all operations - disbursed, adopted and proposed - are included. This annual liquidity risk is estimated to amount to EUR 1.915 million in 2003 rising to EUR 3.098 million by 2006.

[8] Only an estimation is possible as changes in interest and exchange rates as well early reimbursements (assumed to be zero in this context) cannot be forecast with certainty.

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The Fund's assets (1.646 million) cover 88 % of the annual liquidity risk in 2003. Based on available forecasts on guaranteed lending activities, it is estimated that in the coming years, this annual risk coverage ratio is expected to decline, and to reach approximately 46 % in 2006.

An important explanation for this trend is the increasing repayments of principal due on EIB loans issued under the 2000-2007 lending mandate, which have a particularly important effect in 2006.

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The trend in liquidity coverage does not imply a growing risk of default and the forecast ratios are considered to be sufficient for covering such risks. It should be recalled that actual loan defaults on EIB lending, representing about 90% of the risks covered by the Fund, have remained so far at a very low level of less than 1% of the EIB guaranteed loans.

3.2 Budgetary discipline

As explained above, the parameters of the Fund place an upper limit for the maximum amounts available for guaranteed loans or loan guarantees. On the occasion of the decision on the Regulation of 1999 amending the Regulation establishing the Fund, the Council expressed the hope that the main parameters of the Fund mechanism could be kept at their present level until 2006 in order to maintain budgetary discipline.

The aim to maintain budgetary discipline has, however, to be judged against the political objectives of the Community that relate to granting loans in third countries. The Commission is presenting separately its mid-term review of the 2000-2007 EIB external lending mandate, with proposals for restructuring the mandate and to introduce a new envelope for EIB lending to Russia and the Western NIS. These Commission proposals can be contained within the ceilings currently available in the Fund. The margin available in the Fund for further increases of guaranteed operations beyond those now proposed for the remaining period of the financial perspectives amounts to EUR 80 million until 2006 which corresponds to EUR 891 million in additional guaranteed lending operations (see Tab 7 for details). This amount effectively sets a budgetary ceiling on additional needs for MFA and Euratom lending in this period beyond those foreseen at present, on the basis of the existing parameters of the Fund. This situation is examined further in section 5.

4. Impact of enlargement on the Guarantee Fund

The Fund covers the risk of loans and loan guarantees to third countries [9]. The approaching accession of 10 countries to the EU in 2004 will therefore affect the Fund as several of these countries have benefited from EIB loans guaranteed by the EU Budget. It should be noted that there are no MFA or Euratom loans outstanding in these countries.

[9] Annex to the Council Regulation (EC, EURATOM) No 2728/94 of 31 October 1994

The guaranteed loans to these countries will no longer be covered by the target amount of the Fund as soon as they join the European Union and thus cease to be "third countries". It should be stressed that this does not mean a withdrawal of the guarantee from these loans, rather that a call on such a guarantee would impact on the EU budget directly. This implies that any call on the guarantee for these loans would have to be provisioned via a dedicated budget line and would impact directly on the contribution of Member States to the budget.

A proposal for an amendment to the Council regulation on the Fund is being presented by the Commission to fix the rules for an orderly transfer of these liabilities from the Fund to the budget. These rules will apply to similar situations arising under future accessions. According to forecasts for 1 May 2004, the outstanding amount affected will be about EUR 3.808 million.

If it is assumed that all 10 new Member States will accede to the EU as of 1 May 2004, then the withdrawal of the outstanding amount of guaranteed loans to these ten states from the Fund would imply that the Fund would be reduced by, and the EU budget receive an estimated amount of about EUR 343 million [10]. Since the credit risk reflected in such loans would have to be directly assumed by the EU budget and frequent significant calls directly on the budget would create uncertainties for budget execution, it is appropriate to analyse the nature of this credit risk in some detail.

[10] Calculated at the current target rate of 9%. The application of historical rates is not considered as the rebalancing mechanism of the fund has effectively reduced the provisions for these loans to 9%.

The credit risk relating to these loans concerns two types of risk: political risk and commercial risk. The Community guarantee always covers the ultimate political risk. However in some cases, the Community guarantee also covers the commercial risk of a loan.

The distinction between commercial and political credit risk for the Community budget concerning the EIB loans under guarantee can be evaluated by analysing the three possible configurations of risk coverage that exist:

1) loans under the Risk Sharing scheme : under the Risk Sharing scheme [11], the EIB assumes the commercial risk, and the Community budget only the political risk;

[11] For a more detailed discussion of the risk sharing see: Commission Report to the European Parliament and the Council Mid-term review of EIB external lending Mandate pursuant to Council Decision 2000/24/EC of 22 December 1999, as amended.

2) loans without risk sharing but with a third-party guarantee of a public authority : due to the sovereign nature of the guarantee, the residual risk for the Community budget is limited to the political risk; and

3) loans without risk sharing but with a third-party guarantee of a private entity (financial institution, enterprise, etc.) : in these cases, the Community budget is also exposed to the commercial risk as it cannot be assumed that the private guarantor will always honour its guarantee.

The table below indicates the risk coverage of the guaranteed loans to the ten new Member States as of the accession date [12].

[12] These figures are estimates as certain details such as interest and exchange rate developments, early reimbursements etc. cannot be known with certainty. The situation as of 31 December 2002 and a table providing information on the reimbursement pattern of these loans can be found in the annex.

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The entry of the new Member States to the European Union implies that only the commercial risk of those loans not covered by the Risk Sharing scheme with the EIB need now to be considered as a risk for the budget. The residual commercial risk for the EU budget, and therefore Member States, could materialise if both the commercial project and the private guarantor would not be able to service the debt according to the loan contract. At present, 68 out of the 264 projects realised in the new Member States fall in this category. This maximum risk exposure will, due to amortisation of the loans, decrease over time. Annex 2 shows the development of the maximum risk exposure of the commercial risk that would fall from EUR853,7 million at the end of 2002 to EUR 733,2 million at the time of the accession.

At the end of the financial perspectives in 2006, the commercial risk on the amount outstanding for the 10 new Member States will have fallen to about EUR 480 million. In 2021 the last loan to the 10 new Member States will have been repaid (see also Annex 4).

While it is not possible to quantify the probability of a default of the individual loans concerned, it should be noted that during the reporting period there has not been a single case where the Guarantee Fund has been called to assume the commercial risk of a loan. In other words, the debtors or their private guarantors have in the past been always able to service the respective loans.

This analysis of the risk coverage of guaranteed EIB loans to the 10 new Member States suggests therefore that it seems feasible to withdraw these loans from the Fund as of the date of accession. The additional contingent liability on the EU budget appears to be acceptably low.

As enlargement takes place on 1 May 2004, this would give rise to a special transfer from the Fund to the EU budget. The amount of the transfer would be calculated on the basis of the outstanding amount of guaranteed loans to the new Member States. The amounts of the loans would then be multiplied by the target rate of 9%. The amount calculated that way is then to be transferred from the Fund to the EU budget.

It should be noted that a decision to transfer the credit risk of the 10 new Member States covered by the Fund directly to the EU budget would create a precedent for future enlargements. Therefore the risk situation concerning the three applicant states, Turkey, Bulgaria and Romania, should also be mentioned. The amount of the overall risk for these 3 countries on 31 December 2002 was EUR 2.457 million. There were no loans with a commercial risk (see annex 7).

5. THE PARAMETERS OF THE GUARANTEE FUND

The capacity of the Guarantee Fund to absorb the planned/estimated guaranteed operations by the Commission (macro-financial assistance and Euratom) and the EIB is an important indicator for the evaluation of the appropriateness of the Fund's parameters. Table 7 below shows the Fund's capacity on the basis of EU guaranteed lending (MFA, Euratom) forecasts as of May 2003 and the Commission's proposals set out in the review of the EIB external lending mandate 2000-2007. The forecast covers only the period remaining within the existing Financial Perspectives, i.e. 2003-2006 represent a ceiling on EIB lending. While the amount for the EIB represents a ceiling, the figures for Euratom and MFA are only indicative. Decisions on macro-financial assistance are made on an ad hoc basis, while the trend in future Euratom lending will depend both on the available loan volume set by the Council and the speed at which acceptable projects to enhance safety are put forward.

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Table 7 clearly shows that the Fund's absorption capacity is sufficient to accommodate the planned and forecast lending operations. It should however be noted that the remaining margin of manoeuvre is rather limited. For the whole period 2004-2006 the cumulated margin for additional guaranteed loans is estimated to be EUR 459 million in the case of macro-financial assistance and Euratom (at a 100% guarantee rate).

5.1 The target amount and the Fund's capacity for guaranteed lending

While therefore there is no immediate need to consider changes in the Fund's parameters, the Commission is keeping the question under review so as to be able to respond as necessary to unforeseen future developments in lending and guarantee requirements.

In 1998, the Commission proposed (COM(1998)168 final - 98/0117(CNS)) a revision of the existing parameters of the Fund by lowering the target amount from 10% to 8% and the provisioning rate from 14% to 6%. Experience of the functioning of the Guarantee Fund at that time indicated that a ratio of 8% between the Fund's resources and guaranteed liabilities, would have been adequate. In addition, the provisioning of the Guarantee Fund at a 6% rate was deemed sufficient to attain the target amount. Therefore, the Commission proposed that the Council should decide to modify both the target amount and the provisioning rate. The Council fixed both rates at 9%, i.e. at levels above those suggested by the Commission. However, in parallel, the Budgetary Authority decided to lower, more than proportionally, the amount of the reserve for Guarantees from EUR356 million to EUR200 million for 1999. This adjustment led to a further tightening (by 13% in terms of MFA and Euratom operations) of the limit in the external lending and guarantee capacity of the Community.

Experience since 1998 suggests that a provisioning rate of 9% may be higher than necessary to meet the Fund's liquidity requirements, taking into account interest earned on the Fund's invested assets. If additional annual guarantee capacity were to be needed therefore, this could be relatively easily achieved by adjusting the provisioning rate. This measure would increase the available margin for new loans without any additional financial resources needed. A simulation of a decrease of the provisioning rate can for information purposes be found in the annex. A decrease in the provisioning rate of 1% would, for example, allow the provisioning of EUR312 million in additional macro-financial assistance or in Euratom lending initiatives over the period 2004-2006.

A modification of the target rate, on the other hand, would necessitate a fuller review of the underlying loans and guarantees. There are however good grounds for considering that the target rate is unduly high. First, calls on the Fund have been very low and would have to increase substantially before affecting the liquidity provided by the Fund. Second, the effective target rate is considerably higher than 9% since, under the Regulation, the target volume includes 100% of total outstanding of EIB lending rather than the total outstanding contingent liabilities falling on the EU budget (which are limited under most current Mandates to 65% of the total volume).

5.2 Terms and conditions of the Community Guarantees to the EIB

Given the historically low default rate and the additional security of third party guarantees, coverage of 65 % of the EIB loan portfolio exposure also appears to be extremely prudent. The risks in the EIB's guaranteed loan book will be affected, however, to some extent by the shift away from enlargement countries towards other countries with a higher credit risk.

In addition, as shown in table 5, (the "worst-case" scenario), the annual risk coverage ratio will deteriorate over the period 2003-2006.

Against that background it does not appear opportune to propose any change in the rate of coverage at this stage. But this will need to be re-examined in depth as the current mandates come to an end and the arrangement under the new Financial Perspective are considered.

6. TECHNICAL IMPROVEMENTS

As can be seen from Annex 8, the provisioning of the EIB guaranteed loans that is based on the EIB forecast for each year, has always exceeded the realisation of loan signatures as recorded at the end of such year. This leads to an unnecessary strain on the margins and the risk of apparent excess demand for Fund resources at the beginning of each year.

In order to avoid this problem, the Commission services are considering the possibility of changing the timing of provisioning of EIB loans. Under this scenario, at the beginning of each year the EIB would present a preliminary forecast for the whole year and a more precise forecast for the first 6 or 7 months. On the basis of the latter, a first provisioning of the Guarantee Fund would take place at the beginning of each year, in line with the present procedure.

Towards the middle of each year, the EIB would provide the latest available figures on the realised signatures for the year and an updated forecast for the remainder of that year. On the basis of this information, a second provisioning would take place for the second half of the year. At this time, the competent Commission services would also collect updated forecasts for MFA and Euratom loan decisions/signatures for the remainder of the year (on the basis of realised loan decisions/signatures and an improved forecast).

The likelihood of a conflict concerning the utilisation of the Reserve should at this stage be much lower than at the present, as the over-estimations current in the actual system would be less likely. Forecasts for a shorter period of time have a higher probability of being correct. If this analysis is confirmed by further discussion with the EIB, the Commission intends to implement this technical change from 2004.

ANNEXES

Annex 1: Breakdown of outstanding amounts per country according to risk coverage (situation at 31 December 2002).

Annex 2: Outstanding amounts on EIB guaranteed loans signed with amortisations over the 2003-2006 period.

Annex 3: The Fund over the 2002-2006 period based on current parameters.

Annex 4: Outstanding amounts on EIB guaranteed loans signed in favor of the 10 new Member states.

Annex 5: Theoretical assumptions based on the provisioning and guarantee rates parameters.

Annex 6: Use of the Reserve in the framework of the 2000-2006 Financial Perspectives.

Annex 7: Breakdown of outstanding amounts per country (Bulgaria, Romania and Turkey) according to risk coverage (situation at 31 December 2002).

Annex 8: Historical data on differences between EIB forecasts and loans signed

Annex 9: Financial flows from and to the Fund.

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