52003DC0587

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL - SHAPING SUPPORT FOR PRIVATE SECTOR DEVELOPMENT IN THE MEDITERRANEAN {SEC(2003) 1110}

1. Introduction

The Laeken European Council of 14-15 December 2001 invited the Council and the Commission to examine the setting up of a Euro-Mediterranean Development Bank. Following this request the Commission on 27.2.2002 adopted a report to the Council on "A new Euro-Mediterranean Bank [1] ". The report, having considered different options, favoured the establishment of an EIB majority-owned subsidiary which would incorporate the Bank's activities in the Mediterranean.

[1] Ref. SEC (2002) 218.

There was a consensus among the Commission, Member States and the EIB that the lack of private sector development and investment in the Mediterranean was a core impediment to achieving higher growth rates and to the region's long term economic development, and that private sector projects should have the priority of EU investment support to the region.

In March 2002 the Ecofin and European Council in Barcelona decided to enhance the EIB's existing activities in the region through the creation of a Facility within the Bank. They nevertheless concluded that a decision on the incorporation of this facility into an EIB subsidiary should be considered again after one year. In its 14 March 2002 conclusions the ECOFIN states that "On the basis of the evaluation of the Facility performance, and taking into account the outcome of consultations with our Barcelona Process Partners, a decision on the incorporation of an EIB majority owned subsidiary dedicated to our Mediterranean Partner Countries will be considered and taken one year after the launching of the Facility".

The new Facility is a important instrument in the broader context of the Barcelona Euro-Mediterranean Partnership framework launched in November 1995. The economic and financial pillar of the Barcelona framework aims at creating an area of shared prosperity through the progressive establishment of a free trade-area between the EU and its Partners and among the Mediterranean Partners themselves, accompanied by substantial EU financial support for economic transition in the Partners and for the social and economic consequences of this reform process. More recently, in March 2003, the Commission proposed in its "Wider Europe" Communication to the Council [2] a new framework for relations with the European Union's Eastern and Southern neighbours, offering them a stake in the Single Market in return for concrete progress demonstrating shared values and effective implementation of political, economic and institutional reforms. FEMIP, or subject to the Council's review a possible Euro-Mediterranean Bank, was identified as one of the instruments expected to contribute to the development of a prosperous neighbourhood area.

[2] COM (2003) 104 final of 11.3.2003

The Facility started its operations on 1 September 2002 and was officially launched at a meeting held in Barcelona on 18 October 2002. The meeting provided the opportunity to establish the Policy Dialogue and Co-ordination Committee (PDCC), a consultative board which will also be a discussion forum on the private sector investment environment and which meets twice a year. Member States, the Commission, but also Mediterranean Partners and International Financial Institutions are represented in the PDCC. The second meeting of the PDCC was held on 3 April 2003 in Istanbul.

The review requested by the Council in March 2002 is now expected to take place in the Autumn of 2003, i.e. one year after the launching of FEMIP. To facilitate this review, the Commission launched an Extended Impact Assessment (EIA) on the FEMIP. Impact assessments are used by the Commission as a tool to improve the policy development process and are to be carried out for all major initiatives [3]. The EIA report from Commission services has now been completed in September 2003. Having examined the current status quo for FEMIP, it assesses the two core options - developing FEMIP or establishing a subsidiary- and their potential impact on a number of criteria. The purpose of an EIA is not to draw policy conclusions, but to provide facts and analysis on the design of options and their impact, so as to clarify the implications of policy choices to be made.

[3] Communication of the Commission on Impact Assessment. 5.6.2002 COM(2002) 276.

Commission services consulted the main stakeholders in this process, in particular Mediterranean Partners. Overall, while a number of the latter's representatives enquired on the features of each option and the nature of the choice to be made, those which expressed a view recognised that the creation of a subsidiary would allow for more ownership and would be seen as a strong and visible political commitment. Some in particular inquired on the costs of the products to be offered by a subsidiary and how they would compare with current terms available under FEMIP.

Taking the findings of this forward-looking Extended Impact Assessment into account, and based on the limited experience with FEMIP since its start, the present Communication aims at providing elements that will allow the Council to take the decision it announced in March 2002. Against the background of the need to stimulate private sector development in the Mediterranean region, it examines the relative merits of the various options, looks at their costs and gives recommendations on the possible ways ahead.

2. The private sector development priority

Over the last decade, economic growth in the Mediterranean Partners has been insufficient to absorb a growing workforce. The lack of private sector [4] development is seen as a key explanation for this situation, which deteriorated further over the last two years. Enhancing the role of the private sector in the region should therefore be a key objective for the medium and the long term. SMEs in particular need to be provided with the appropriate financial products to support their investment needs.

[4] Private sector enterprises are in this Communication understood as enterprises controlled by private shareholders.

Countries in the region have been slow to shift the emphasis from the State to the market with the State still heavily involved in the real and financial sectors in many countries, in particular, Syria, Algeria and Egypt, discouraging investment. Privatisation has generally proceeded slowly, although this is only one aspect of private sector development. Existing enterprises, especially SMEs, are not well prepared to face growing international competition and will need to undertake important investments to increase their level of productivity. New entrepreneurs find it difficult to enter markets and the reform process is delayed or stalled. In the Mediterranean region much needs to be done to modernise company law, investment codes and customs and tax regulations. Weak legal frameworks (contract enforcement and property rights) contribute to uncertainty and lower investment. The level of foreign direct investment (FDI) to the Mediterranean has been low by international standards and has not kept pace with the global expansion in international capital flows. A comparison between current investment needs and the characteristics of the supply of financial capital in Mediterranean Partners points to a mismatch between supply and financing needs, long term investment finance being difficult to mobilise.

The primary responsibility for the current private sector environment and its future developments lies with Mediterranean Partners. They need to foster private sector development by establishing business friendly environments and streamlining the often bloated public sector. A functioning financial services sector is also a fundamental condition for stimulating private sector investment. However the difficulties of local private sector firms make it even more important to have an instrument -from the supply side of finance- able of meeting the challenges of a difficult environment. SME access to finance, especially to long term instruments has remained very limited and should also be addressed. Just waiting for a change on the demand side may not lead to any rapid results.

Private sector development is a key element of the EU's Euro-Mediterranean policy, as enshrined in the Barcelona Declaration and the bilateral Association Agreements. Under the agreements' economic framework, trade liberalisation measures will stimulate private sector investment and thereby enhance the competitiveness and growth prospects of Mediterranean economies. The EU and its Mediterranean Partners need a dynamic instrument and corresponding relationship, able to support private sector operations through the provision of hands-on private banking advice and finance and, in the longer run, to develop domestic long-term credit markets. The often unfavourable private sector environment in the region makes the case for a tailor-made private sector development instrument even more compelling.

For these reasons, the Commission considers FEMIP's private sector mandate to be a crucial feature. Support to private sector development was already considered the key priority in its February 2002 Report to the Council. The EIB and Member States concurred with the Commission and the March 2002 Ecofin Council [5] recognised the need to stimulate private sector development in Mediterranean Partners, in order to facilitate a higher level of economic growth consistent with the growth of the labour force in the region. The establishment of FEMIP was a very important first step, notably because for the first time a shift of Euro-Mediterranean financial cooperation towards private sector finance was decided.

[5] Conclusions of the 14 March 2002 Ecofin Council meeting.

3. Options for the development of the Euro-Mediterranean financial cooperation

The forthcoming Council review now needs to conclude which is the most suitable instrument -FEMIP or a subsidiary- to accompany and accelerate the shift of operations in the Mediterranean to private sector development.

To this end, two core options are being analysed. The first option, developing FEMIP, therefore starts from the hypothesis that the existing operations of FEMIP are continued and further developed. The second option is that of incorporating all or part of the FEMIP portfolio into an EIB majority-owned subsidiary.

The two options considered

The first option is defined as a further development of the newly established Facility, with a private sector development mandate. This would entail possible adjustments in the Bank's financial policies, and more specifically as regards its operations in the Mediterranean. Under this option, FEMIP would remain a department within the Bank, operated by EIB staff as presently, potentially increasing their number. FEMIP would thus continue its operations and develop its products as far as possible under the general umbrella of the EIB, notably its statute and financial policies. The Facility would continue to operate mainly under Council lending mandates, for the time being with the Community Budget guarantee, and with the contribution of the EC budget mainly for technical assistance support to its operations, risk capital operations and interest rates subsidies for environmental projects. Operations would remain centrally managed from Luxembourg, with a few regional or country offices.

The second option is defined as the establishment of a majority-owned EIB subsidiary. Under this option, part or the totality of the Bank's portfolio of assets in the Mediterranean would be incorporated in the subsidiary. The new subsidiary would have its own staff, statute, and financial policies and be entrusted, like FEMIP, with a private sector development mandate. Staff would be substantially increased in order to enable the resource-intensive development of its private sector operations. The new subsidiary would offer a broad range of financial products. It would have a profile close to that of multilateral development banks, in particular a financial standing and a capital base aimed at securing a best creditor status and a Triple A rating. Operations would be centrally managed from its headquarters, with an important role devoted to local country offices. The assumption is that, while the Bank would retain a majority shareholding position in the subsidiary, its capital would be opened to Member States, the European Community and also to Mediterranean Partners. Its governance would reflect this opened shareholding structure.

In analysing these two core options, assumptions had to be made regarding their various features. These assumptions do not necessarily mean that the option eventually decided by the Council should have those features, for instance because there are overlaps between both options and because certain features may evolve over time or depend on political, institutional or budgetary considerations.

3.1 First option: retaining and developing FEMIP

The establishment of FEMIP

The EIB has a long experience in the Mediterranean and has established a portfolio of operations -worth around EUR 10 billion projects approved- and a business network which makes it presently one of the main players among International Financial Institutions active in the region. The establishment of FEMIP as an EIB instrument decided in 2002 enabled the Bank to maintain the continuity of its operations in the Mediterranean, and Mediterranean Partners to benefit from the EIB operational capacity and favourable lending conditions. The Bank lends to Mediterranean Partners' beneficiaries under Council mandates. The current mandate foresees a lending envelope with the Community Budget guarantee of up to EUR 6.4 billion over the period 2000-2007 and is presently the subject of a Mid-Term Review. Under the general external lending mandate the Bank also lends to Turkey under a Special Action Programme (up to EUR 450 million) and Terra (up to EUR 600 million) specific envelopes. In addition to this general mandate a special EUR 1 billion envelope was established in the EIB in 2000 after the Nice European Council, without the Community Guarantee, to finance major trans-regional transport, energy and environmental projects in the region.

The bulk of these operations have traditionally been public sector operations. On a number of projects which are not covered by a sovereign guarantee the Bank applies the risk sharing mechanism whereby it covers the commercial risk from a commercial guarantor, while the political risk is covered the Community budget. Risk sharing at this stage currently represents 15% (some 4% without Turkey) of Bank lending operations in the region achieved on a mandate and assimilated basis, to be compared with a Council objective of 30% for operations under the total external mandate in each region. Projects financed with "global loans" through financial intermediaries also contribute to private sector development to the extent that SMEs are the main final beneficiaries, even though most intermediary financial institutions are public-owned banks. Altogether, the Bank's combined activities in favour of private sector development, including corporate loans and global loans on own resources, and risk capital on EC budget resources, represent over the last three years around 30% of the Bank's activities in the Mediterranean.

In order to develop FEMIP, the Bank established the FEMIP department as a cost centre and increased its staff. By Mid-2003 there were 25 persons working exclusively on FEMIP (and roughly another additional 25 full time staff involved inside the Bank by providing support assistance). The Bank expects to recruit between 12 and 18 additional staff and to reach a total staff of around 40 persons working only on FEMIP by end 2003. Staffing needs are currently being reassessed.

The Bank's October 2002 Business Plan for the Facility foresees:

- a sizeable increase in lending over 2003-2006, up to a level of around EUR 2 billion per year by the end of period, compared with some EUR 1.4 billion commitments in 2001;

- a gradual shift of operations towards the private sector. Following the first Business Plan would imply that by 2005-2006 private sector operations would still represent a minority share of the Bank's annual lending. The Bank has acknowledged the private sector priority and established a private sector operations division within the FEMIP department.

The development of operations since the establishment of FEMIP tends to indicate that the Business Plan's conservative estimates can be exceeded: FEMIP has performed well over its first year of operations. Since the establishment of the Facility in October 2002, and by August 2003, 63 % of operations in volume have been committed in favour of private sector support. This pattern however remains to be confirmed over a longer period as this share of private sector operations is contingent upon a small number of large operations. Past and recent experience tend to confirm that it is a challenging task for the EIB, as well as for other IFIs, to focus their activities in the Mediterranean on private sector development.

The Community strongly supports EIB activities in the region, notably through sizeable contributions from the EC budget:

i./ provisioning of the EC budget guarantee fund : each EUR 1 billion of Bank-FEMIP guaranteed loans requires EUR 58.5 million of provisions from the reserve for guarantees;

ii./ interest rates subsidies for environment projects, paid from the MEDA budget, for which amounts vary considerably every year (possibly around EUR 30 million on a long term average);

iii./ risk capital funds from the EC budget (mainly financed from MEDA). The Commission has pledged EUR 150 million risk capital support over the period of the business plan (2003-2006); under its current statute [6] the Bank cannot normally commit equity funds from its own resources; current arrangements through the provision of risk capital funds from the Community budget, managed by the Bank, allow to compensate for this statutory limitation;

[6] Article 20 of the EIB statute forbids the Bank of engaging into equity operations.

iv./ technical assistance; one of the main changes in the context of the establishment of FEMIP is that significant MEDA grant resources have been made available to finance technical assistance. In June 2002, the Commission pledged a package of EUR 105 million technical assistance to support FEMIP projects over the period 2003-2006. This package implies a considerable increase of funds devoted to technical assistance (from EUR 3 million before FEMIP) to EUR 25 million annually under FEMIP.

This support has been made available to the Bank under the assumption that a majority of EIB commitments in the region would go to the private sector at the end of this period. Community support is however costly and, in order to ensure long term sustainability of the instrument, it will require recurring commitments from the Community budget (see also costing elements below).

Further developing FEMIP

In order to increase FEMIP's impact on private sector development and keep the share of private sector financing above 50 percent, it is assumed that a number of adaptations/innovations can be brought into the current instrument:

- an increased recourse to local financial institutions to channel loans to local firms, notably SMEs, can play a catalytic role to support the local financial sector's supply of finance geared towards local entrepreneurs' needs, notably micro-credit and risk capital ;

- exploring the possibility for the EIB to borrow on local capital markets and lend to local borrowers in local currencies. This would avoid exchange rate risks for private sector borrowers who focus on local rather than export markets;

- new financial products, notably SME guarantees with the support of the European Investment Fund's experience and know-how; to the extent that the EIB's statute can be amended, in particular Article 20 (2) which excludes equity participation, the EIB could also increase its risk capital activities by providing own resource equity;

- enhancing the Bank's risk profile by accepting single borrower guarantees and reviewing current guarantor rating requirements, pursuant to Article 18(3); to the extent that Article 18(3) can be amended, significantly reviewing the Bank's financial policies by enhancing the Bank's risk profile; concurrently, the Bank could modulate its private sector loan pricing and provisioning policy in function of the enhanced risk profile;

- increasing the Bank's leverage on other sources of finance by limiting its relative share of each project financed and developing syndicated loans.

Overall, FEMIP's activities on own resources benefit from the EIB leverage to raise a high amount of funds on the market at favourable borrowing conditions, owing to the Bank's best creditor status. They further benefit from the Bank's low operating costs which, with the support of the Community guarantee, enable FEMIP to offer attractive lending conditions. However, the EIB current statute and corporate culture make it challenging for FEMIP to shift its operations and to have a catalytic role on private sector development in the Mediterranean. Provided a number of enhancements can be brought to the Facility, notably to introduce a less risk-averse behaviour, FEMIP could over time enhance its contribution to private sector development in the region.

3.2 Second option: incorporating part or the totality of FEMIP into an EIB majority-owned subsidiary

The second possible option in order to enhance the Euro-Mediterranean financial cooperation and shift the emphasis of its support to private sector development is the establishment of a majority-owned EIB subsidiary, incorporating part or the totality of FEMIP's operations. A number of arguments have been examined, notably in the context of the Extended Impact Assessment, on the rationale for this incorporation into a subsidiary.

Risk profile : the current conservative risk profile of the Bank which, according to its statute, cannot commit equity resources and needs to secure adequate guarantees for its lending operations, makes it difficult for FEMIP to shift its operations to private sector development; this however may to some extent change if amendments to the Statutes recently approved by the EIB Board are approved by the IGC and ratified.

Intensity of resources: private sector development is a resource-intensive process, notably in terms of staff, as shown by the experience of other IFIs entrusted with a private sector mandate (the IFC and the EBRD); a dedicated instrument may more easily depart from current EIB staffing standards, although there is no absolute impediment to increasing staff resources within FEMIP.

Corporate culture: in spite of a high proportion of private sector lending in its intra-EU operations, the Bank is still highly specialised in public infrastructure finance and has over time developed a corporate culture which reflects this specialisation; a subsidiary would facilitate the shift to a more merchant banking culture.

Partnership : the current instrument reflects the decision-making process and governance on EIB operations within the EU, which means that EIB Mediterranean lending projects are approved by the Bank's board as any other project, without Mediterranean Partners having any say; the Bank has however established a consultative board, the PDCC, which discusses the Facility's main orientations and its business plan. A new subsidiary would be opened to Mediterranean Partners which would be offered a stake in the new institution. This would increase the ownership/partnership of the instrument.

Interaction with local economic reforms. A subsidiary with increased staff dedicated to private sector banking, providing a hands-on due diligence of private sector projects, would be superior in interacting with local economic reforms. Mediterranean Partners' representatives in the subsidiary's board -provided the latter subscribe a share of the capital- could also play an important role in this respect. This dynamic interaction could facilitate the establishment of a more business-friendly legal and economic environment in the region. Furthermore, it would provide an incentive for the Partners to make more optimal use of the other instruments of the Euro-Mediterranean Partnership.

Long term political commitment and visibility. The incorporation of FEMIP as a new institution would no doubt represent a strong political commitment and give a long term perspective and sustainability to the Euro-Mediterranean financial cooperation geared towards investment finance. Rather than depending on annual budgetary commitments, the EU's interest would be entrenched in the form of its participation in the capital of the subsidiary. It would also give a high degree of visibility to this political commitment.

The Commission has examined two possible sub-options as regards the possible establishment of an EIB-majority owned subsidiary.

Sub-option 1: full incorporation of FEMIP into a majority-owned subsidiary.

Under this first variant of the subsidiary option, the totality of FEMIP's existing portfolio, i.e. about EUR 10 billion (approved operations) would be incorporated into the new subsidiary. This would have a number of advantages:

- the subsidiary would immediately benefit from a revenue stream on existing operations which would contribute to its financial sustainability;

- existing teams and staff could, to a large extent, constitute the core of the new institution's personnel and bring in their experience of Mediterranean operations;

- the blend of public and private sector operations in the same institution may be complementary as there are a number of borderline projects such as privatisation operations, or public-private partnerships such as BOT -build-operate-transfer- infrastructure projects which could benefit from this dual public-private banking approach.

The new institution would need to be secured with a capital base reflecting its risk profile and financial standing with a best creditor status. If the Community Budget guarantee is extended to the new subsidiary's operations, at least for political risks, its gearing ratio could be set at an intermediate level between the current EIB gearing ratio of operations-to-capital of 2.5 : 1 and the usual gearing ratio of development banks, i.e. 1 : 1.

The contributions to the capitalisation of a new subsidiary would depend on the composition of its ownership. While the EIB would bring in its portfolio and subscribe the totality or a large share of its majority stake with the incorporated assets, other shareholders - Member States and the European Community - would need to subscribe their paid-in share through cash payments. The amounts concerned (see below costing elements) are contingent on the relative share of minority participations and the proportion of paid-in capital. If Mediterranean Partners are offered a stake in the new institution and thus subscribe a share of the capital, they will have to contribute to its capitalisation as well.

Sub-option 2: incorporating only FEMIP's private sector projects into a private-sector-only EIB majority-owned subsidiary.

Under this variant of the option to establish an EIB subsidiary, only the private sector operations of the Bank would be incorporated into the new institution. The remainder of FEMIP activities in the Mediterranean -mainly public infrastructure projects- would remain within the EIB itself. This option is thus a dual one combining a continuation of EIB public sector activities in the Mediterranean Partners with a subsidiary mandate restricted to the private sector inside the EIB group. A number of arguments can be considered in favour of this option.

Capitalisation needs would be limited, even assuming a 1 : 1 gearing ratio, since the size of the portfolio of operations to incorporate would be much lower - maybe EUR 1 to 2 billion pending assumptions on the delineation of private sector operations to incorporate. There would be no need to secure a new capital base for the bulk of the Bank's existing projects - mainly public infrastructure projects- and for the future share of operations related to public sector lending. The contributions to the capital of the Community and Member States would hence be lower than in the case of a full incorporation of FEMIP.

The EIB-FEMIP's high efficiency as regards public lending would be retained. EIB-FEMIP public lending - i.e. the bulk of its current operations, mainly in the field of infrastructure - has performed well over the past and current external lending mandates and is considered particularly efficient given the EIB's recognised expertise in this area and its high cost-effectiveness. This efficiency, combined with the EC budget guarantee, translates into low lending rates and allows for the EIB to be an important player in the field of infrastructure finance in the Mediterranean. Under a dual FEMIP-public sector and subsidiary-private sector option this important asset would not be jeopardised.

Flexible risk profile and pricing policies. The new subsidiary's risk profile would be adjusted to private sector development needs. The new subsidiary would adopt a pricing policy in line with its costs and risk profile. Lending rates oriented towards market interest rates would reduce the scope for price distortions and potential crowding out effects on other lending institutions.

Compatibility with existing Community guarantee arrangements. The EC budget guarantee on the bulk of the Bank's external lending contributes to the Bank's low lending rates, since the EIB is not carrying the eventual risk of default on its own accounts. A mid-term review of EIB external lending mandates for the period 2000-2007 is expected to take place in the Council at the same time as the current FEMIP review. The Commission is expected to propose for this mid-term review to endorse a continuation until January 2007 of Community guaranteed external lending mandates. Under a dual FEMIP-public sector and subsidiary-private sector option there would be no immediate need to discontinue or modify the guarantee regime for public sector operations and to modify public sector lending rates. Private sector lending of a new subsidiary would de jure fall outside the scope of the existing EC budget guarantee which only applies to existing Council mandates which the EIB is entrusted with.

Overall, the incorporation of FEMIP into a majority-owned subsidiary, tailor-made to meet private sector development needs, is expected to have a higher degree of flexibility in addressing those needs, including through the adoption of a less risk adverse profile, better suited to private sector finance. It would hence be expected to have a higher impact on private sector development in the region. The new institution would have a high degree of political visibility. A higher level of ownership with the participation of Mediterranean Partners in the institution's capital and governance would also facilitate interaction with local economic reforms to promote a more business friendly environment. Capitalisation costs related to minority shares subscriptions by the EC and Member States could to a greater or lesser degree be compensated by savings from the EC budget. The incorporation of FEMIP into a subsidiary could either cover its full portfolio, thereby providing a significant revenue stream for the new subsidiary, or only be partial, limited to private sector operations, thereby initially requiring a more limited capital base and lower capital subscriptions.

4. Costing elements

Both core options -developing FEMIP and a subsidiary- have a number of budgetary implications. FEMIP operations will remain "notionally" covered by a share of the EIB's capital, 5% of which is paid-in (Member States budget contributions). Moreover, FEMIP is rather costly for the EC budget (provisioning costs, EC budget support). Member States may want to consider additional contributions to further develop FEMIP, notably related to the establishment of a donors' Trust Fund now being considered by the Bank.

FEMIP's incorporation into a subsidiary would have budgetary implications; - direct capitalisation costs for the minority shareholders, in particular the EC, Member States and possibly Mediterranean Partners which would be higher than equivalent "notional" capitalisation costs of the EIB; - possible savings of provisioning costs from the EC budget if the Community budget guarantee is fully or partially lifted ; - possible savings from the EC budget on risk capital funding; to the extent that a subsidiary would not be constrained by current limitations of the EIB statute; the subsidiary would be able to commit risk capital from its own resources instead of from EC budget funds.

The conclusion of this comparison [7] is that, while all options have a cost: - retaining FEMIP with its main existing features will require sustained, and possibly higher, Community Budget support in order to guarantee its operations, and to finance its risk capital operations, technical assistance and interest subsidies for environmental projects; - assuming that the EC and Member States take a significant stake in a new subsidiary, FEMIP's full incorporation into a subsidiary could be more costly from a consolidated EU perspective than retaining the Facility, in spite of a number of possible savings related to de-programming risk capital support from MEDA or to the reduction or cancellation of provisioning EIB own resources loans. Seen from a more restricted EC budget perspective the impact of an incorporation of FEMIP into a subsidiary could vary over the long term, pending assumptions; - FEMIP's partial incorporation into a subsidiary may not be substantially more costly over the long term from a consolidated EU perspective than retaining and developing FEMIP - under a number of assumptions it may even be cheaper-. Seen from a restricted EC budget perspective it would potentially be cheaper owing to the above mentioned savings made on the EC budget support.

[7] See Extended Impact Assessment, notably section III.4.3.

Additional EC budget expenditure related to a subsidiary's capitalisation would have to remain compatible with the current Financial Perspective's tight budgetary margins. On an illustrative basis, in case of a full incorporation of FEMIP already in 2004 and assuming a EUR 25 billion long term portfolio of operations: - with a 2:1 operations-to-capital gearing ratio, an EC 10% participation in the new institution, and a 10% paid-in capital released over 10 years, the Community Budget would have to contribute with annual payments of EUR 12.5 million in 2004, 2005 and 2006; - with a 1:1 gearing ratio, an EC 10% participation in the new institution, and a 20% paid-in capital released over 10 years, the Community Budget would have to contribute with annual payments of EUR 50 million in 2004, 2005 and 2006.

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Such amounts may already be fully or to a large extent secured from savings realised from MEDA (deprogrammed risk capital support as of 2004; some 122 million over 2004-2006) and appear compatible with the Financial Perspective. The range of possibilities as outlined in the table below is however broader, pending assumptions to be made on the main parameters (gearing ratio between 1 and 2.5, EC participation between 5% and 25%, paid-in between 10% and 25%). Assuming a release of capital contributions over 10 years, this could imply annual budget payments between EUR 5 and 156 million in 2004, 2005 and 2006.

A partial incorporation of FEMIP (for instance under the "private-sector-only" alternative mentioned above) would be less costly and would be compatible with the Financial Perspective. On an illustrative basis, assuming a EUR 7.5 billion portfolio of operations, a 1:1 gearing ratio, an EC 10% participation in the new institution, and a 10% to 20% paid-in capital released over 10 years, the Community Budget would have to contribute with annual payments of EUR 7.5 to 15 million in 2004, 2005 and 2006. The full range of possibilities, with a 1:1 gearing ratio and under the same other assumptions as above implies possible annual contributions between EUR 4 and 47 million already in 2004, 2005 and 2006.

Any choice of extension or reconsideration of the EC budget guarantee as regards the subsidiary's lending operations would also need to be made consistent with the Mid-Term Review of the Bank's external lending mandates due to be examined by the Council at the same time as the FEMIP review.

5. Conclusion

A generally weak private sector and an unfavourable business environment in the Mediterranean impede growth in the region. Unless this situation is reversed Mediterranean Partners will not be able to offer sufficient growth and an acceptable future to their growing population and workforce. Upon this diagnostic a dynamic redirection of the Euro-Mediterranean financial cooperation was decided in March 2002 in Barcelona to address private sector financing needs, and led to the creation of FEMIP.

The establishment of an instrument to catalyse private sector investment and reforms in the region is however representing a challenge for the EIB. The successful development of the Facility will to a large extent rely on the EIB's overall institutional environment which plays a decisive role in shaping its main characteristics. FEMIP, as operations from the Bank more generally, benefits from a high degree of efficiency in terms of leverage and cost-effectiveness provided by this belonging to the EIB. The establishment of a more flexible instrument with different statute, increased dedicated staff and a new corporate culture and governance, by incorporating FEMIP into a majority-owned subsidiary designed to meet private sector financing needs, would increase the instrument's effectiveness, i.e. its capacity to meet its private sector mandate objectives, at a limited cost.

The Commission therefore concludes that, although both the development of FEMIP and the setting up of an EIB majority-owned subsidiary for operations in the Mediterranean could provide a significant contribution to private sector development in the Mediterranean, a subsidiary entrusted with the means corresponding to a strong private sector mandate would have a higher impact. A subsidiary is expected to have a higher degree of flexibility in addressing private sector needs, including through the adoption of a less risk adverse profile, better suited to private sector finance, with the full range of state-of-the-art fianncial products geared to private sector finance. Capitalisation costs related to minority shares subscriptions by the EC and Member States could to a greater or lesser degree be compensated by savings from the EC budget.

FEMIP's incorporation into a subsidiary would also increase the ownership and visibility of the instrument, ensure the long term sustainability of the Euro-Mediterranean financial co-operation and adequate governance arrangements would provide a stronger interaction with the Mediterranean Partners in ensuring the necessary reforms on their side. In the Commission's view, it should therefore be retained as the preferable option. However, if the Council considers that the subsidiary option cannot be pursued at this time, the Commission would recommend that FEMIP should as a first stage be retained and further developed, and it should be agreed to incorporate it as a second stage into an EIB majority-owned subsidiary.

Subject to the Council's own conclusions, the Commission is ready to make the necessary legislative proposal allowing for the setting up of an EIB majority-owned subsidiary, incorporating part or the totality of FEMIP's outstanding operations and entrusted with a private sector mandate, with a Community participation as a shareholder. In any event, such a Commission proposal will remain consistent with the existing Financial Perspective.

ANNEX : Executive Summary of the Extended Impact Assessment.

ANNEX

Commission services Extended Impact assessment.

Executive summary [8]

[8] The full text of the Commission services working paper Extended Impact Assessment on "Shaping support to private sector development in the Mediterranean" is being made publicly available together with the present Communication.

i. Over the last decade economic growth in the Mediterranean Partner countries ("the Mediterranean") has been insufficient to absorb a growing workforce. The lack of private sector development is seen as a key factor explaining this situation, which deteriorated further over the last two years. Enhancing the role of the private sector in the region should therefore be a key objective for the medium and the long term. This requires in the first place a more business friendly environment. In this context, a comparison between current investment needs and the characteristics of the supply of financial capital in the Mediterranean also points to a mismatch between supply and financing needs, long term investment finance being difficult to mobilise. SMEs in particular need to be provided with the appropriate financial products to support their investment needs.

ii. In order to address these needs, in March 2002 the Ecofin and European Council in Barcelona decided to enhance the existing activities of the European Investment Bank (EIB) in the Mediterranean through the creation of a Facility within the Bank. Private sector development was considered a key priority. The Bank has proceeded rapidly with the setting up of the Facility for Euro-Mediterranean Investment and Partnership (FEMIP). FEMIP started its operations on 1 September 2002 and was officially launched at a meeting held in Barcelona on 18 October 2002.

iii. The Ecofin and European Council nevertheless considered that the question of whether to incorporate this facility into an EIB majority-owned subsidiary should be considered one year after the launching of the Facility. The review requested by the Ecofin and the European Council one year after its creation is subsequently scheduled to take place in Autumn 2003.

iv. In order to prepare the ground for the line to take in this review, the Commission decided to conduct an Extended Impact Assessment [9].

[9] Commission Work Programme 2003, Ref. COM(2002) 0590, Annex 2.

Impact Assessments

Impact Assessments are used by the Commission as a tool to improve the policy development process and are to be carried out for all major initiatives [10]. Impact Assessments examine the main choices in view of a policy decision to be made and outline their potential impacts, from an ex-ante perspective. They identify the likely positive and negative impacts of proposed policy actions, enabling informed policy judgements to be made and to identify trade-offs in achieving competing objectives.

[10] Communication of the Commission on Impact Assessment. 5.6.2002 COM(2002) 276.

Preliminary draft assessments may be prepared in the early stage of the process. Extended impact assessments - as in the present case - are meant to be prepared before the key decision intervenes.

v. Options. Two schematic policy options have been considered for this impact assessment. For the sake of comparison in the present assessment, certain assumptions have been made in order to define each of these options. This schematic approach should not be seen as prejudging their ultimate design. Another possible option where the current Facility would stay in place without being further enhanced is considered as the baseline case forming the starting point for these two options.

vi. The first option is defined as a further development of the newly established Facility (Developing FEMIP, referred to as the "FEMIP" option in this report), with a private sector development mandate. This would entail possible adjustments in the Bank's financial policies, and more specifically as regards its operations in the Mediterranean. Under this option, FEMIP would remain a department within the Bank, operated by EIB staff as presently, potentially increasing their number. FEMIP would thus continue its operations and develop its products as far as possible under the general umbrella of the EIB, notably its statute and financial policies. The Facility would continue to operate mainly under Council lending mandates, for the time being with the Community Budget guarantee, and with the contribution of the EC budget mainly for technical assistance support to its operations, risk capital operations and interest rates subsidies for environmental projects. Operations would remain centrally managed from Luxembourg, with a few regional or country offices.

vii. The second option is defined as the establishment of a majority-owned EIB subsidiary ("subsidiary"). Under this option, part or the totality of the Bank's portfolio of assets in the Mediterranean would be incorporated in the subsidiary. The new subsidiary would have its own staff, statute, and financial policies and be entrusted, like FEMIP, with a private sector development mandate. Staff would be substantially increased in order to enable the resource-intensive development of its private sector operations. The new subsidiary would offer a broad range of financial products. It would have a profile close to that of multilateral development banks, in particular a financial standing and a capital base aimed at securing a best creditor status and a Triple A rating. Operations would be centrally managed from its headquarters, with an important role devoted to local country offices. The assumption is that, while the Bank would retain a majority shareholding position in the subsidiary, its capital would be opened to Member States, the European Community and also possibly to Mediterranean Partners. Its governance would reflect this opened shareholding structure.

viii. In order to conduct an assessment of the two options a number of impact criteria were defined. These include the effectiveness of options in achieving policy objectives and their efficiency taking into consideration resource mobilisation. The impact on private sector development has been a core benchmark in assessing the options. Furthermore, consistent with the conclusions of the Gothenburg European Council of 15-16 June 2001, impact criteria have been examined in the present report covering a broad sustainable development perspective, including the economic, financial, employment and environment dimensions.

ix. Consultation of stakeholders. Commission services have maintained close contacts with the EIB services in the course of the present assessment. Mediterranean Partners were consulted as the main stakeholders in this process. While a number of Mediterranean Partners' representatives enquired on the features of each option and the nature of the choice to be made, those which expressed a view recognised that the creation of a subsidiary would allow for more ownership and would be seen as a strong and visible political commitment. Some in particular inquired on the costs of the products to be offered by a subsidiary and how they would compare with the current terms available under FEMIP. Enterprise confederations which were also consulted emphasised SME [11] financing needs and called for a reinforcement and a diversification of the supply of finance. Commission services also had a number of informal contacts with the European Investment Fund (EIF), the World Bank, the International Finance Corporation (IFC), the African Development Bank and the European Bank for Reconstruction and Development (EBRD).

[11] Small and Medium Sized Enterprises (SMEs). EC usual definition: enterprises of less than 500 employees

x. Effectiveness. As regards effectiveness - mainly in meeting the core objective of supporting private sector development - the estimated impact of the two options is not invariant to the underlying assumptions. Nevertheless, it is clear that each option has a distinct impact on meeting private sector investment needs of the region and contributing to growth. A number of other objectives have also been assessed, namely the capacity of supporting local financial sector development, addressing local SME needs and financing key transnational infrastructure projects as well as public-private partnerships.

xi. As a baseline case, FEMIP has, owing to the strong commitment of its dedicated staff, quickly become operational. It benefits from the EIB corporate environment, its logistic, infrastructure and experience. Under the FEMIP option, private sector operations can be increased from their current modest level, using local financial institutions to channel loans to local firms, notably SMEs. However, developing the private sector orientation under this option is a real, although not impossible, challenge given the need to adapt a number of the EIB's statutory provisions and standing practices for this purpose across the Bank, in the absence of any similar private sector mandate for the remainder of EIB operations.

xii. The subsidiary option could be more effective than the FEMIP option in meeting the private sector development mandate by adopting a less risk-averse profile than the EIB, developing a pro-active institutional capacity through a high level of staff resources dedicated to private sector banking, ensuring more proximity to local operators, pursuing market-oriented pricing policies to cover both enhanced risk taking and higher operating costs, as well as offering the full range of state-of-the-art financial products geared to private sector finance for which the local supply is presently limited.

xiii. Efficiency. Under the baseline status quo, the current FEMIP instrument is, as it stands, very efficient in terms of costs and leverage as regards the Bank's own resource operations. It benefits from the EIB's low cost borrowing conditions and of synergies with the Bank's other activities and departments. It provides low cost loans to Partner Countries and has a high leverage on other sources of finance raised on the market to carry out its operations. In terms of proportionality of means mobilised to implement lending operations the FEMIP option can be considered as providing a higher leverage as regards its own resource operations than a subsidiary. This comparison is hampered by the fact that under the current statutes, the FEMIP option would rely on external funding for its risk capital operations.

xiv. Under the subsidiary option, operations would need to be secured with capital reflecting the risk profile, and may -subject to the risk profile retained- require a lower capital-to-operations gearing ratio, which may have to be reduced from the current 2.5:1 EIB overall ratio. The percentage of paid-in capital, to secure the subsidiary with an adequate working capital, would need to be higher than the current EIB 5% paid-in capital. The counterpart would be the capacity to develop a broader offer of financial products and to conduct risk capital operations independently from external funding.

xv. Assuming that the Community and Member States take a direct participation, they will have to contribute to its capital. The extent of this support would be subject to the eventual features of the subsidiary and be compensated to a greater or lesser degree by savings from the EC budget since MEDA [12] risk capital support and the provisioning of loans in the Guarantee Fund for external lending would no longer be needed, at least in part.

[12] The MEDA programme established under Council Regulation (EC)1488/96 is the principal financial instrument of the European Union for the implementation of the Euro-Mediterranean Partnership. The programme offers technical and financial support measures to accompany the reform of economic and social structures in the Mediterranean partners.

xvi. For Mediterranean Partners, the enhanced features of the subsidiary option compared to FEMIP would imply correspondingly higher interest rates and a possible capital contribution if they were offered a stake in the institution. These potential cost implications are the counterpart of increased ownership of the instrument and additional benefits in terms of private sector development.

xvii. Subsidiarity will continue to be better ensured by retaining a Community instrument - FEMIP or a subsidiary- than through a multiplication of national financing schemes. A Community direct stake in a subsidiary can already be financed under the current Financial Perspective and would moreover contribute to enhancing cooperation with other Community instruments such as MEDA and securing consistency with the policy objectives of the Community in the Mediterranean. Any choice of extension or reconsideration of the EC budget guarantee as regards the subsidiary's lending operations would also need to be made consistent with the current Mid-Term Review of the Bank's external lending mandates.

xviii. Sustainable development. Assuming that a subsidiary would broadly adopt the EIB's existing environmental policies and continue its operations in this area, the options have been found to be neutral in terms of environmental impact. While it has not been possible to identify a quantified impact of the existing EIB operations on employment in the Mediterranean, a subsidiary is estimated to be potentially more effective over the long term in contributing to employment creation, mainly because of its higher effectiveness in stimulating private sector development. Adapting and developing FEMIP would however have a positive impact as well.

xix. Partnership with Mediterranean Partners eligible to FEMIP operations is currently ensured through their presence in FEMIP's consultative board, the Policy Dialogue and Coordination Committee (PDCC). This board only has a consultative role and FEMIP's governance, being subject EIB rules, does not ensure any co-decision with Mediterranean Partners. The subsidiary option would enhance ownership if the beneficiaries of its operations were offered a stake in the new institution. They would thus participate in its governance as full partners.