Scope affirms the European Union’s and Euratom’s AAA rating with Stable Outlook
Scope Ratings GmbH (Scope) has today affirmed the European Union’s and Euratom’s AAA long-term issuer and senior unsecured foreign-currency ratings, along with a short-term issuer rating of S-1+ in foreign currency. All Outlooks are Stable.
Summary and Outlook
The AAA rating of the European Union (EU) reflects the supranational’s ‘excellent’ shareholder support and ‘excellent’ intrinsic strength.
The rating benefits from the largest European economies being the EU’s highly rated key member states, with a weighted average rating of AA-, the supranational’s track record and solid legal basis for receiving timely financial support, and the extraordinary support mechanisms ensuring de facto joint and several support from the EU’s member states. In addition, the EU’s legally enshrined debt service priority combined with its meaningful budgetary flexibility to delay significant amounts of its annual expenditure provides further investor assurance.
The EU’s institutional profile is characterised by its record of excellent governance and irreplaceable mandate for its member states. Not only is it at the heart of Europe’s Covid-19 response, via the SURE and NGEU programmes, but it is also leading the continent’s transition towards a carbon-neutral and climate-resilient economy with its forthcoming EUR 250bn green bond programme.
The EU’s financial profile benefits from a very strong liquidity profile driven by high, prudently managed liquid assets, excellent market access given its global benchmark issuer status, and a diversified funding base. The EU’s high asset quality reflects its direct lending mostly to EU sovereigns, the benefits conferred by its preferred creditor status and the resulting track record of zero non-performing loans.
Challenges, which are marginal at the AAA level, relate to the almost tenfold increase in outstanding liabilities anticipated over the coming years, which will result in higher debt repayments going forward, and the steady increase in outstanding guarantees, mostly to the European Investment Bank (AAA/Stable).
The Stable Outlook reflects Scope’s assessment of the EU’s financial buffers to withstand shocks. The rating could be downgraded if, individually or collectively: i) highly rated key member states are downgraded, ii) the EU’s institutional setup weakened; and/or iii) the EU’s liquidity buffers declined.
The first driver of the EU’s AAA rating is its very high shareholder support.
The EU’s borrowings are backed by the EU budget, which is mostly financed by GNI-based transfers from EU member states, as well as custom duties and VAT. The largest European economies – Germany (AAA/Stable), France (AA/Stable), Italy (BBB+/Stable), Spain (A-/Stable), Poland (A+/Stable), the Netherlands (AAA/Stable), Sweden (AAA/Stable) and Belgium (AA-/Stable) – account for around 75%-80% of the EU’s economy, population and GNI-based national budgetary transfers and thus constitute the EU’s key member states, with a weighted-average rating of AA-. This considers that the United Kingdom does not provide budgetary contributions for liabilities and obligations taken after 2021, due to its exit from the EU on 30 January 2020.
Scope highlights that the EU's shareholder support also includes extraordinary mechanisms that enhance its debt service ability. Debt is usually repaid using the proceeds of repayments from borrowing countries that received back-to-back financing of loans. While this layer of protection will continue to apply to loans provided under the SURE instrument and the NGEU recovery fund, it will not apply to NGEU grants.
However, in case a borrowing country fails to repay its loan to the EU on time, or, in the case of bonds raised to provide direct grants to member states via NGEU, ‘the European Parliament, the [European] Council and the [European] Commission shall ensure that the financial means are made available to allow the [European] Union to fulfil its legal obligations in respect of third parties1. Scope acknowledges this legal debt service priority to third parties, taking into account the budgetary flexibility of the European Commission to delay significant amounts of the EU’s annual expenditure of about EUR 60bn-40bn from the European Structural and Investment Funds.
Moreover, in case the EU's available cash resources were to be insufficient to service debt, the European Commission is legally entitled to draw funds from all member states. In such an adverse event, which Scope deems unlikely, the additional funds ‘shall be divided among the Member States, as far as possible, in proportion to the estimated budget revenue from each of them2. In addition, member states are legally obliged to ‘execute the Commission's payment orders following the Commission's instructions and within not more than three working days of receipt3. In Scope’s opinion, this is an exceptionally strong and timely guarantee mechanism, with a de facto joint and several support framework that is unique among supranationals. These considerations provide the EU with a very strong institutional setup that underpins the excellent shareholder support assessment from Scope.
The second driver of the EU’s AAA rating is its very strong institutional profile.
This reflects the EU’s excellent governance and irreplaceable mandate for its EU members, being at the forefront of the EU’s policy design and implementation, including via financial assistance programmes to countries in financial distress, programmes to close Europe’s investment gap, facilitate the recovery from the Covid-19 crisis, and foster Europe’s transition to carbon neutrality.
In response to the Covid-19 crisis, the EU’s financial activities and outstanding liabilities will increase almost tenfold over the coming years to around EUR 950bn, or about 7% of the EU-27 GDP, on account of SURE and NGEU. The SURE instrument demonstrates the solidarity among EU member states. It is the world’s largest social bond programme to date, having raised EUR 89.6bn. Funds have been disbursed to 19 member states since October 2020 to help finance sudden increases in public expenditure for the preservation of employment related to the Covid-19 shock.
In addition, at least 37% of the Recovery and Resilience Facility – which accounts for 90% of NGEU – is set for green investments. As a result, at least 30%, or EUR 250bn, of NGEU bond issuance will be directly linked to the objectives of a green and sustainable economic recovery. This will transform the EU into the largest green bond issuer worldwide and underline its commitment to achieving its climate targets. The first issuance based on the EU’s Green Bond Framework, which is aligned with the green bond principles of the International Capital Market Association (ICMA), is set for October 2021. Both instruments highlight the exceptional importance of the EU to its member states and underpin Scope’s assessment of the EU’s very strong institutional profile.
The third driver underpinning the EU’s AAA rating is its very strong financial profile.
The EU’s conservative liquidity management and budgetary practices result in high and stable liquid assets. Over the past five years, the cash balance has never dropped below EUR 10bn; over the past 10 years, the lowest recorded was in June 2010 at EUR 6.2bn. As of end-2020, cash stood at EUR 16.7bn. In addition to the cash balance, Scope’s calculation of the EU’s liquid assets also includes the budgetary margin. This refers to the difference between the maximum resources the EU can draw on from its member states without the need for any subsequent decision by national authorities, the so-called ‘own resources ceiling’, and the annual payment appropriations for EU expenditure. The own resources ceiling is legally binding, and it has never been reached. Thus, Scope has conservatively adjusted this margin for the pro-rata budgetary contributions of member states rated AA- or above, currently at around 65%.
Critically, member states decided to increase the own resources ceiling from 1.20% of the EU's estimated GNI to 1.40%, to account for Brexit as well as potential sudden drops of the economy such as the one in 2020 prompted by the Covid-19 pandemic. In addition, member states agreed to set aside a further 0.6pp until 2058 to cover repayment of all liabilities from NGEU borrowings. The total ceiling is thus 2.00% of the EU’s GNI, or about EUR 282bn for 2021.
The margin between the potential maximum member state contribution of the EU’s highly rated shareholders and the actual payments for the 2021-27 period – adjusted for ‘other revenues’ that increase the budgetary margin as well as the share of member states rated AA- or above – is around EUR 100bn, on average, over the 2021-27 period. Together with the estimated average cash balance of EUR 23.6bn*, this results in liquid assets of around EUR 123bn for 2021-27.
Conversely, for 2021, Scope estimates the EU’s liabilities maturing within 12 months at around EUR 140bn for 2021. This includes bond repayments (EUR 2.7bn) and disbursements of EUR 137bn, driven by SURE (EUR 50bn) and NGEU (EUR 80bn). Looking ahead, Scope estimates that the EU’s disbursements will increase substantially to around EUR 150bn each year during the 2021-25 period, on account of NGEU. On this basis, Scope estimates the liquid assets ratio to hover at around 70%-80% during 2021-25. Critically, once these large disbursements are made, the liquidity ratio will again increase gradually to above 150% by 2027, assuming no additional significant disbursements are made for other financial assistance programmes. A ratio of 100% (50%) implies that all outstanding liabilities and all committed disbursements due within a year can be financed with available liquid assets for more than 12 (six) months without the need to access capital markets.
Looking further ahead, from 2028 onwards, the EU will have to gradually repay its outstanding liabilities. Scope estimates that annual bond repayments due within one year will likely amount to less than EUR 45bn. This assumes, conservatively, that the EU repays each year the maximum amounts of EUR 10bn under SURE and EUR 29.25bn under NGEU. Actual figures are likely to be lower, however. Still, even this amount can be fully covered by the EU’s liquid assets, due to the high cash balances but particularly because the own resources ceiling will remain elevated at 2.00% of the EU’s GNI until all bond repayments for the NGEU programme are made.
The EU’s financial profile also benefits from its excellent capital markets access. Scope notes that the EU’s debt securities benefit from preferential regulatory treatment as they are i) designated as Level 1 HQLA assets for liquidity coverage requirements; ii) assigned a 0% regulatory risk weight under the Basel framework; iii) eligible for preferential treatment under Solvency II; and iv) eligible for the European Central Bank’s asset purchase programmes, in addition to enjoying appeal among ESG investors. SURE bonds are classified as social bonds under an ICMA-compliant Social Bond Framework and about EUR 250bn of the NGEU bonds will be under the ICMA-compliant Green Bond Framework. The EU’s recent bond issuances for SURE and NGEU have benefited from extraordinary investor demand, being multiple times oversubscribed and resulting in highly favourable funding costs (with negative rates up to 10 years) across the yield curve. In fact, the EU’s issuances have recorded the largest ever order books for a supranational issuer in the euro market, underpinning investor confidence.
The EU’s financial profile is further supported by its high asset quality and excellent asset performance, reflecting its preferred creditor status and regionally diversified portfolio. The EU’s main risk exposure relates to financial assistance provided via SURE, NGEU and the European Financial Stabilisation Mechanism. Via these programmes, the sovereign exposures to Italy (BBB+/Stable), Portugal (BBB+/Stable), Ireland (AA-/Stable), Spain (A-/Stable), Poland (A+/Stable), Belgium (AA-/Stable) and Greece (BB+/Stable) account for around 85% of the EU’s total direct loan exposure. Based on Scope’s sovereign ratings, this corresponds to a weighted-average borrower quality of around A-. Looking ahead, Scope expects the EU’s asset quality to remain broadly unchanged as loan disbursements accelerate under the NGEU programme.
Despite these credit strengths, the EU also faces the following credit challenges:
First, the EU’s total borrowings are expected to increase almost twentyfold due to the SURE and NGEU programmes, to just under EUR 1trn by 2026 from around EUR 52bn as of December 2019. While this will solidify the EU’s position as the world’s largest supranational issuer, strengthen its ambition to create an EU safe asset, and provide member states with a targeted, timely and temporary counter-cyclical fiscal stimulus to facilitate the economic recovery from the Covid-19 shock, it also implies that future EU budgets will need to address significantly higher annual debt repayments.
Second, the EU’s ultimate credit risk also includes guarantees provided to i) the European Investment Bank (EIB); ii) the European Fund for Sustainable Development, with guarantees totalling EUR 1.5bn; and, going forward, iii) the InvestEU programme, with guarantees of EUR 26.2bn. Guarantees to the EIB relate to its activities i) outside of the EU, with a guarantee ceiling of EUR 35.4bn as of 2020, which covers, in particular, the meaningful exposure to Turkey (B/Negative); and ii) classified under the European Fund for Strategic Investments (EFSI), with a guarantee ceiling of EUR 26bn on the EIB’s related investments, which are, on average, riskier than the traditional risk profile of the EIB’s portfolio.
Scope highlights that the overall size of guarantees has increased substantially since 2015 to around EUR 62bn at end-2020 on account of the EFSI and will continue to rise over the coming years to around EUR 90bn, driven by the InvestEU programme. Still, Scope notes that the risk borne by the EU budget is significantly curtailed by the assets of the related guarantee funds, which are combined in the Common Provision Fund as of 2021. As of end-2020, the Guarantee Fund for External Actions had assets of EUR 2.8bn, the EFSI Guarantee Fund had EUR 8.0bn, the EFSD guarantee fund had EUR 804m, and InvestEU will be provisioned for EUR 10.5bn and the External Action Guarantee for EUR 10bn. These assets result in a high provisioning rate for the comparatively new programmes, which would absorb any losses before resources would need to be drawn from the EU budget. In addition, Scope notes positively i) the track record of very low annual default payments, which to date have never exceeded EUR 110m in a given year; and ii) the EU’s conservative financial management, including ample liquidity buffers and upfront provisioning of the guarantee funds.
Finally, the withdrawal of the United Kingdom from the EU has resulted in a higher dependence on any one shareholder’s ability to provide EU budgetary contributions. In addition, while the annual rebates for the GNI-based contributions of highly rated EU member states are fixed for the years to come, they result, all else equal, in higher net budgetary contributions by member states with lower creditworthiness. These considerations may become relevant again for the next Multiannual Financial Framework negotiations from 2027 onwards, when most of the repayments for SURE and NGEU start becoming due.
Factoring of environment, social and governance (ESG)
Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. ESG factors are explicitly captured in Scope’s assessment of the institutional profile, which Scope assesses as ‘very strong’ for the EU.
Scope’s supranational scorecard
Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative AAA rating for the EU. Additional considerations allow Scope to incorporate idiosyncratic characteristics that cannot be assessed in a consistent and comprehensive manner across all supranationals, but which may still affect the creditworthiness of the issuer.
For the EU, no additional considerations have been identified.
A rating committee has discussed and confirmed these results.
For further details, please see Appendix II of the rating report.
* This estimate is based on the average cash balance for the 2018-20 period.
The main points discussed were: i) institutional profile; ii) financial profile, including asset quality, liquidity and funding; iii) shareholder support; iv) additional considerations; and viii) consideration of peers.
Rating driver references
1. Treaty on the Functioning of the European Union. Article 323
2. Article 14 (4) of the Council Regulation (EU, Euratom) No. 609/2014
3. Article 15 (1) of the Council Regulation (EU, Euratom) No. 609/2014
The methodology used for these Credit Ratings and/or Outlooks, (Supranational Rating Methodology, 7 September 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation YES
With Access to Internal Documents YES
With Access to Management NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Credit Rating prepared by Alvise Lennkh, Executive Director
Person responsible for approval of the Credit Ratings: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 1 February 2019. The Credit Ratings/Outlooks were last updated on 30 October 2020.
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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