Implementing the EU budget through financial instruments — lessons to be learnt from the 2007-2013 programme period

Executive summary

I

The European Union is currently facing serious challenges such as the economic and financial recovery and the management of the refugee crisis. Therefore, the EU’s decision-makers are seeking ways to maximise the effect­iveness and efficiency of the available EU budget, which accounts for less than 1 % of the EU’s gross domestic product (GDP).

II

Financial instruments are a delivery tool to provide financial support from the EU budget. Financial support provided to final recipients through financial instruments may take the form of loans, guarantees and equity investments.

III

If properly implemented, financial instruments provide two specific benefits compared to grants:

• the possibility of leveraging the public funds (i.e. mobilising additional private and public funds to complement the initial public funding); and
• the revolving nature of their capital endowment (i.e. the use of the same funds in several cycles).

The fact that loans have to be paid back and guarantees have to be released or, in the case of equity investments, returned should in principle also have an impact on the behaviour of final recipients, leading to the better use of public funds and reducing the likelihood that the final recipients will become dependent on public support.

IV

During the 2007-2013 programme period financial instruments set up under the European Regional Development Fund (ERDF) and the European Social Fund (ESF) were used by 25 out of 28 EU Member States: in total, 972 ERDF and 53 ESF financial instruments were set up across the EU. By the end of 2014, around 16 billion euro had been paid as contributions from the ERDF and ESF operational programmes (OPs) to these instruments. This represents a significant increase compared to around 1.3 billion in the 2000-2006 programme period and 0.6 billion euro in the 1994-1999 programme period allocated to such instruments. During the same period, 2007-2013, the overall contribution from the EU budget to the 21 financial instruments managed directly or indirectly by the Commission was about 5.5 billion euro. These centrally managed financial instruments operate across all EU Member States.

V

Through this audit, we examined whether financial instruments were an efficient mechanism to implement the EU budget during the 2007-2013 programme period. Our audit was carried out between October 2014 and March 2016 and focused on the areas of regional, social, transport and energy policy. Our analysis covers all 1 025 ERDF and ESF financial instruments set up during the 2007-2013 programme period under shared management, as well as six centrally managed financial instruments in these areas. The data presented in this report are based on the latest available information provided by the Commission in September 2015 reflecting the situation at the end of 2014.

VI

Our audit identified a number of significant issues that limited the efficiency of financial instruments as a mechan­ism to implement the EU budget during the 2007-2013 programme period.

• A significant number of ERDF and ESF financial instruments were oversized and, by the end of 2014, continued to face significant problems in disbursing their capital endowments (on average, around 57 % of all capital endowment paid from the OPs to the financial instruments had been used). A contributing factor to the excessive initial capital endowments was the Member States’ intention to avoid de-commitments throughout the 2007-2013 programme period.
• Overall, financial instruments in both shared and central management were not successful in attracting private capital.
• So far, only a limited number of ERDF and ESF financial instruments have been successful in providing revolving financial support.
• For ERDF and ESF financial instruments, high levels of management costs and fees compared to the actual financial support to final recipients which also appear to be significantly higher than those of centrally managed instruments or private-sector investment funds.

VII

At the same time, we also note that improvements were made in the legal framework for the 2014-2020 programme period as regards financial instruments based on the expertise gained during the 2007-2013 programme period, but certain issues remain.

VIII

In our report, we recommend that

• The Commission’s ex ante assessment for centrally managed instruments should systematically include an ­analysis of the ‘lessons learnt’ to date.
• The Commission, in addition to the ‘lessons learnt’, should also assess the effect of major socioeconomic changes on the rationale of the instrument and the corresponding contribution required from the EU budget in the context of their respective mid-term reviews for all centrally managed financial instruments.
• The Commission and the Member States should aim at optimising the size of specific ERDF and ESF funds to take, wherever possible, advantage of the significant economies in the cost of operating funds. Additional guidance should be provided to Member States on how to set up such financial instruments within Member States or at Union level (which are managed directly or indirectly by the Commission).
• The Commission should provide in the financial regulation (and subsequently in sectorial regulations) a defin­ition for the leverage of financial instruments applicable across all areas of the EU budget, which clearly distinguishes between the leverage of private and national public contributions under the OP and/or of additional private or public capital contributions, and takes into account the type of instrument involved.
• For ERDF and ESF financial instruments under the 2007-2013 programme period, the Commission should ensure at closure that Member States provide complete and reliable data on private contributions on capital endowments, both through the OPs and in addition to them.
• For ERDF and ESF financial instruments, the Commission should provide additional guidance to Member States on how best to apply the provisions on preferential treatment to attract more private capital without allocating excessive risks to public contributors to the financial instruments’ endowments.
• For centrally managed financial instruments, the general risk-sharing principles which may have an impact on the EU budget should be defined in the legislation governing the instrument concerned.
• For all financial instruments funded from the EU budget during the 2014-2020 programme period, the Commission should ensure that only structures which are in line with its own recommendations and actions with regard to tax arrangements are implemented by Member States, the Commission itself and the EIB group.
• The Commission should take appropriate measures to ensure that Member States maintain the revolving nature of the funds during the required 8-year period after the end of the eligibility period for the 2014-2020 programme period.
• The Commission should provide guidance in respect of the provisions allowing financial instruments to continue to be used into the following programme period, in particular for cases where fund managers are selected on the basis of public procurement.
• The Commission should ensure that Member States report comprehensive information on management costs and fees incurred and paid by March 2017 in view of the upcoming closure of the 2007-2013 programme period.
• The Commission should clarify that the ceilings for management costs and fees need to be applied to the actual capital endowment used by the financial instrument, i.e. the contribution from the OP that has been used to provide financial support to final recipients.
• As regards the performance-based remuneration of fund managers in the 2014-2020 programme period the Commission should make a legislative proposal aiming at a revision of the existing provisions in the common provisions regulation (CPR) to strengthen the incentive effect of these arrangements.
• Member States’ managing authorities should make extensive use of the existing performance-based elements of the remuneration for fund managers when negotiating funding agreements.
• The Commission should carry out a comparative analysis of the implementation costs of grants and repayable financial support, mainly through financial instruments, for the 2014-2020 programme period with a view to establishing their actual levels. Such information would be particularly relevant for preparing legislative proposals for the post-2020 period and determining an adequate level of technical assistance.

Introduction

What are financial instruments?

01

The European Union is currently facing serious challenges such as the economic and financial recovery and the management of the refugee crisis. Therefore, the EU’s decision-makers are seeking ways to maximise the effectiveness and efficiency of the available EU budget, which accounts for less than 1 % of the EU’s gross domestic product (GDP).

Financial instruments⁷ are a delivery tool to provide financial support from the EU budget through loans, guarantees and equity (or quasi-equity) investments for the implementation of projects (see Table 1)⁸.

Annex I provides an illustration of how the different types of financial instruments operate.

Table 1

Main types of financial instruments supported by the EU budget

Loan	Guarantee
‘Agreement which obliges the lender to make available to the borrower an agreed sum of money for an agreed period of time and under which the borrower is obliged to repay that amount within the agreed time’. Under a financial instrument, a loan can help where banks are unwilling to lend on terms acceptable to the borrower. They can offer lower interest rates, longer repayment periods or have lower collateral requirements.	‘Written commitment to assume responsibility for all or part of a third party’s debt or obligation or for the successful performance by that third party of its obligations if an event occurs which triggers such guarantee, such as a loan default*’. Guarantees normally cover financial operations such as loans.
Equity	Quasi-equity
‘Provision of capital to a firm, invested directly or indirectly in return for total or partial ownership of that firm and where the equity investor may assume some management control of the firm and may share the firm’s profits’. The financial return depends on the growth and profitability of the business. It is earned through dividends and on the sale of the shares to another investor (‘exit’), or through an initial public offering (IPO).	‘A type of financing that ranks between equity and debt, having a higher risk than senior debt and a lower risk than common equity. Quasi equity investments can be structured as debt, typically unsecured and subordinated and in some cases convertible into equity, or as preferred equity’. The risk return profile typically falls between debt and equity in company’s capital structure.
* European Commission (2015). Guidance for Member States on Financial Instruments – Glossary.
Source: European Commission and EIB, FI Compass — Financial instrument products: Loans, guarantees, equity and quasi-equity, p. 3.

02

Compared to grants (which are the traditional way of providing funding from the EU budget), financial instruments, if properly implemented, can provide two specific benefits:

• the possibility of leveraging the public funds (i.e. mobilising additional private and public funds to complement the initial public funding); and
• the revolving nature of their capital endowment (i.e. the use of the same funds in several cycles) allows each euro of funding through financial instruments in principle to be used more than once.

03

The fact that loans have to be paid back and guarantees have to be released or, in the case of equity investments, returned should in principle also have an impact on the behaviour of final recipients, leading to the better use of public funds and reducing the likelihood that the final recipients will become dependent on public support.

04

A common definition for financial instruments was first provided in the revision of the financial regulation in 2012; this definition has since been applied in the sectorial regulations for the 2014-2020 programme period (see Annex II).

Use of financial instruments in implementing the EU budget since 2007

Use of financial instruments funded from the EU budget

05

The EU budget can be implemented through shared management (i.e. in cooper­ation with Member States such as in cohesion policy), through direct management (i.e. by its departments or through executive agencies) or through indirect management (i.e. by entrusting budget implementation tasks to third countries or to different entities)⁹. The latter two are collectively referred to as centralised management.

06

Financial instruments are used in different parts of the EU budget:

• Shared management financial instruments in the area of cohesion are set up mainly under the European Regional Development Fund (ERDF), and to a lesser extent under the European Social Fund (ESF). Since the 2014-2020 programme period, financial instruments can also be used for the Cohesion Fund (CF). Each instrument has to be implemented within the framework of an operational programme (OP), which is decided by the managing authorities responsible for that programme, together with its size and design¹⁰. Financial instruments are also used under the European Agricultural Fund for Rural Development (EAFRD) and the European Fisheries Fund (EFF).
• Centrally managed financial instruments are financed from various budgetary areas such as research, enterprise and industry, education and culture, etc. For these instruments the Commission, together with its partners, is directly involved in their design and in developing their investment strategy and endowment. The decision to set up these instruments is taken by the budgetary authorities (i.e. the European Parliament and the Council) on the basis of a Commission proposal.

Rules for selecting the fund manager of financial instruments

07

In shared management, financial instruments can be set up as standalone funds or as sub-funds of a holding fund, later referred to as specific funds (see Figure 1). A holding fund, sometimes also referred to as a ‘fund of funds’, is a fund set up with the objective of managing different types of instruments. It also allows making contributions from one or more OPs to one or several financial instruments.

08

Financial instruments are generally managed by private- or public-sector banks or other financial intermediaries rather than public administrations. For ERDF and ESF instruments, the selection of a fund manager has to comply with EU and national public procurement rules if the management of the fund is tendered out. In situations where public procurement rules do not apply (i.e. in case the fund management contract is not a public service contract), the managing authority can designate the fund manager subject to complying with the relevant State aid rules (see paragraphs 10 to 12).

09

The EIB group (which comprises the European Investment Fund (EIF) and the European Investment Bank (EIB)) benefits from a special status since they can be appointed as fund managers without a public procurement proced­ure¹¹. They also manage most of the centrally managed instruments for which the fund manager is designated in the legislative proposal.

Financial instruments and the EU State aid rules

10

EU funds under shared management are considered part of the national or regional budgets and as such are potentially subject to State aid control. When implementing the financial instrument, managing authorities must therefore ensure compliance with State aid rules¹². The relevant State aid rules are contained in the new general block exemption regulation (GBER)¹³ and the Commission’s new guidelines for risk finance¹⁴, which both came into effect in July 2014.

11

For each ERDF and ESF financial instrument, the managing authority has to provide evidence that it is either¹⁵:

• conforming with normal market practice (which in practice means that the management of the fund has been selected following an open, transparent and non-discriminatory process); or
• covered by the de minimis regulation¹⁶; or
• an exempted aid, because it falls under the GBER or falls under a notified aid scheme in accordance with the Commission’s guidelines for risk finance.

12

Centrally managed financial instruments (which do not use national or regional resources, and thus are not part of Member State budgets) fall outside of the scope of the EU’s State aid rules, because the main condition of Article 107 TFEU ‘[…] granted by a Member State or through state resources’ is not fulfilled.

Background information on the number of financial instruments and their capital endowment since 2007

2007-2013 programme period

13

During the 2007-2013 programme period financial instruments were used by 25 out of 28 EU Member States. Only Croatia, Ireland and Luxembourg did not use this funding mechanism¹⁷. Annex III and IV give an overview of the ERDF and ESF instruments per Member State.

14

As shown in Table 2, by the end of 2014 around 15.2 billion euro had been paid as ERDF OP contributions and 0.8 billion euro through ESF OP contributions. This represents a significant increase compared to around 1.3 billion in the 2000-2006 programme period and 0.6 billion euro in the 1994-1999 programme period¹⁸.

15

During the 2007-2013 programme period, the EU contribution paid to financial instruments corresponded to 5 % of the total EU funding for the ERDF and 1 % of the total EU funding for the ESF for the entire period. The EU budget accounted for 69 % and 56 % of the total contribution to the capital endowments of the ERDF and ESF 2007-2013 financial instruments, respectively (see Table 2). In terms of financial support for the final recipient, the EU contribution accounted for 63 % (ERDF) and 65 % (ESF).

Table 2

Implementation of ERDF and ESF financial instruments (2007-2013) as of 31 December 2014

	Amounts committed in funding agreements to financial instruments (amounts in million euro)			Amounts paid from OPs to financial instruments (amounts in million euro)			Amounts paid from financial instruments to final recipients (amounts in million euro)
	OP1	EU	EU/OP %	OP	EU	EU/OP %	OP	EU	EU/OP %
ERDF	17 061	10 946	n.a.	15 189	10 452	69 %	8 871	5 594	63 %
ESF		472		829	462	56 %	318	207	65 %
Total	17 061	11 418	67 %	16 018	10 914	68 %	9 189	5 801	63 %
Source: ECA, based on the most recent Commission data as of September 20152.
1 For the OP amounts committed no separation between ERDF and ESF financial instruments is presented in the Commission’s implementation report.
2 EGESIF_15-0027-00, ‘Summary of data on the progress made in financing and implementing financial engineering instruments reported by the managing authorities in accordance with Article 67(2)(j) of Council Regulation (EC) No 1083/2006 — Programme period 2007-2013 — ­Situation as at 31 December 2014’, pp. 21 and 54.

16

According to the latest data reported by the Commission, 972 ERDF financial instruments and 53 ESF instruments had been set up across the EU. Out of these, 903 are specific ERDF funds and 49 are specific ESF funds (see Table 3). 31 of the ERDF instruments are managed by the EIB group (see paragraph 9).

17

In addition, there were 14 instruments funded through the EAFRD and 6 instruments funded by the EFF. For the 2007-2013 programme period, these two funds did not require Member States to report on financial instruments, so there are no official data in this respect¹⁹. However, based on data compiled by the Court, at the end of 2013 the capital endowment of funds co-financed by the EAFRD can be estimated at around 700 million euro, and around 72 million euro for the EFF (in both cases including the national contributions to the programmes).

Table 3

ERDF and ESF financial instruments per type of specific fund (2007-2013) as of 31 December 2014

	ERDF		ESF
	Number of funds	Endowment (in million euro)	Number of funds	Endowment (in million euro)
Specific funds, out of which:
— loan instruments	371	5 637	31	417
— guarantee instruments	171	2 215	7	196
— equity instruments	162	2 006	1	70
— mixed instruments (combination of loans, guarantees, equity or other instruments)	110	2 496	5	59
— other instruments	6	65	0	0
— type not reported	83	770	5	74
Total	903	13 189	49	816
Source: ECA, based on the most recent Commission data as of September 2015.

18

For the centrally managed instruments, the EU’s overall contribution allocated to 2007-2013 instruments in all budgetary areas was about 5.5 billion euro²⁰, spread over 21 financial instruments²¹. These instruments operate across all EU Member States.

2014-2020 programme period

19

Within the EU budget, the European Structural and Investment Funds (ESIFs) are the main source of funding for capital investment and infrastructure, with a total budget of around 450 billion euro for the 2014-2020 programme period.

20

Since 2011 the European Parliament and European Council has encouraged an increased use of financial instruments²². This political commitment is also reflected in the common provisions regulation (CPR) which provides for an extended use of financial instruments to deliver all five ESIFs (i.e. also the Cohesion Fund) and all thematic objectives for the programmes²³.

21

At the end of 2015 the Commission estimated that, for the 2014-2020 programme period as a whole, approximately 21 billion euro will be allocated to financial instruments from the five ESIFs²⁴. Since the average EU contribution to the total endowments of such instruments for the 2007-2013 programme period was around 68 % by the end of 2014²⁵, we estimate that the 21 billion euro amount coming from the EU budget will probably correspond to approximately 31 billion euro in total allocations (not taking account of additional national and private financing that may be provided to the funds outside the ESIF programmes).

22

In comparison, the European Fund for Strategic Investments (EFSI) aims to mobil­ise at least 315 billion euro in private and public long-term investment across the EU over the period from 2015 to 2017 and the funding of projects in subsequent years.

Audit scope and approach

23

Through this audit, the Court examined whether financial instruments were an efficient mechanism to implement the EU budget during the 2007-2013 programme period. In that context our report addresses the following main audit questions:

• were financial instruments appropriately sized in view of market needs?
• did financial instruments succeed in attracting private capital?
• were financial instruments providing revolving financial support?
• did financial instruments prove to be a cost-efficient method to implement the EU budget?

For each of these questions, we examined which lessons could be learnt from the main shortcomings identified. We also assessed to what extent they had been addressed in the regulations applicable to the 2014-2020 programme period.

24

Our audit covers the period from 2009 to 2015. We focused on the areas of regional, social, transport and energy policy. In particular, our review covers all ERDF and ESF financial instruments, as well as six centrally managed financial instruments in the areas of social, transport and energy policy. Several issues identified in this report may, however, also affect other areas of the EU budget where such instruments are used.

25

The audit work consisted of the following elements:

• a review of various Commission, EIB, EIF and third-party analyses and publications.
• the analysis of the most recent annual monitoring report published by the Commission in September 2015, covering all 1 025 ERDF and ESF financial instruments. This analysis, based on data reported by the Commission in November 2015, was also made for six²⁶ of the 21 instruments under central management (accounting for an EU contribution of 789 million euro, or 14 % of the total amount of all 21 instruments)²⁷.
• an examination of 10 case studies of financial instruments implemented in the area of the EU budget covered by this report²⁸, including a field visit to one Member State (Slovakia).
• a follow-up review of 45 financial instruments audited in compliance audits carried out by the Court since 2009 (whose results were previously reported in our annual reports) and 54 financial instruments examined by our perform­ance audits since 2012.
• a survey of 85 managing authorities and fund managers involved in the implementation of financial instruments. Out of the 85 entities surveyed, 82 relate to ERDF and ESF instruments under shared management and three to centralised management. There were 66 replies for shared management instruments and two for centrally managed ones.
• interviews with more than 40 officials from the Commission, the EIB and the EIF and more than 10 experts from organisations with expertise in the field²⁹.

26

The Court has already carried out numerous examinations of the use of financial instruments, and has reported since 2011 on the findings in several annual reports³⁰ and special reports³¹. Moreover, the Commission itself, but also the EIB, the EIF, the European Parliament, national audit bodies and private-sector fund managers, have identified a number of issues in recent years which collectively limited the effectiveness of financial instruments during the 2007-2013 programme period. This report builds also on these assessments.

Observations

Were financial instruments appropriately sized in view of market needs?

27

Financial instruments are not projects themselves but a delivery tool for funding from the EU budget. In cohesion policy, the decision of a managing authority to deliver OP support through a financial instrument is not so much a decision of whether to invest OP resources or not (this is already predefined in the OP) but rather how to invest: through a one-off grant or support through a financial instrument providing a repayable financial support.

28

We have therefore examined to what extent the 1 025 ERDF and ESF instruments used their capital endowment to provide different forms of financial support to final recipients and analysed several factors contributing to the instruments’ low disbursement rates to final recipients during the 2007-2013 programme period: the level of the initial capital endowments of the instruments, whether market needs were properly addressed by the managing authorities and specific difficulties faced by regional financial instruments. We also analysed how similar aspects were dealt with in the case of centrally managed instruments.

Excessive capital endowment led to low disbursement rates, avoidance of de-commitment and potential reimbursement at closure

29

The financial instruments disbursement rates have already been examined in several of the Court’s annual and special reports³². In this report we analyse the latest available information reported by the Member States to the Commission as at 31 December 2014, published in September 2015. Our analysis of these most recent data shows that a significant number of them continue to face difficulties in using their capital endowments as planned.

30

Table 4 shows the disbursement rates for each of the 25 Member States which implemented financial instruments during the 2007-2013 programme period³³. The percentages presented are averages for all ERDF and ESF instruments in the Member State concerned. A significant number of financial instruments were established only in 2012 or afterwards.

Table 4

Implementation of ERDF and ESF financial instruments per Member State — as of 31 December 2014

Member State	OP contributions committed (in million euro)	Out of which EU contribution	%	OP contributions paid to financial instruments (in million euro)		OP contributions paid to final recipients (in million euro)
				Amount	% of commitment	Amount	% of payment	% of commitment
Estonia	200	125	63 %	200	100 %	191	95 %	95 %
Poland	1 196	1 008	84 %	1 190	100 %	1 104	93 %	92 %
Slovenia	124	105	85 %	124	100 %	112	90 %	90 %
Hungary	916	778	85 %	897	98 %	751	84 %	82 %
Germany	1 629	1 025	63 %	1 554	95 %	1 265	81 %	78 %
Malta	12	10	83 %	12	100 %	10	81 %	81 %
Portugal	854	531	62 %	477	56 %	386	81 %	45 %
Czech Republic	278	171	62 %	278	100 %	223	80 %	80 %
Denmark	74	35	47 %	51	68 %	40	80 %	55 %
Romania	150	129	86 %	150	100 %	118	78 %	78 %
Sweden	161	74	46 %	157	97 %	121	77 %	75 %
Lithuania	507	409	81 %	444	87 %	331	75 %	65 %
France	460	240	52 %	419	91 %	310	74 %	67 %
Belgium	396	159	40 %	396	100 %	288	73 %	73 %
Finland	75	35	47 %	75	100 %	51	68 %	68 %
Latvia	216	160	74 %	216	100 %	145	67 %	67 %
United Kingdom	1 632	710	44 %	1 483	91 %	983	66 %	60 %
Cyprus	20	17	85 %	20	100 %	13	63 %	63 %
Bulgaria	388	330	85 %	388	100 %	228	59 %	59 %
Austria	27	10	37 %	27	100 %	13	49 %	49 %
Netherlands	75	20	27 %	67	90 %	32	47 %	42 %
Greece	1 789	1 477	83 %	1 589	89 %	695	44 %	39 %
Italy	4 538	2 809	62 %	4 460	98 %	1 427	32 %	31 %
Spain	1 233	954	77 %	1 234	100 %	330	27 %	27 %
Slovakia	112	95	85 %	112	100 %	23	21 %	21 %
Total	17 061	11 418	67 %	16 018	94 %	9 188	57 %	54 %
Note: Croatia, Ireland and Luxembourg are not listed, as they had no ERDF and ESF financial instruments during the 2007-2013 programme period.
Source: ECA; based on 2015 Commission data.

31

By the end of 2014, with only 1 year before the end of the initial eligibility period (31 December 2015), only 57 % of ERDF and ESF instruments’ endowments had been disbursed to final recipients. Disbursements were low in particular for financial instruments in Slovakia (21 %), Spain (27 %) and Italy (32 %). Moreover, a further three Member States (Greece, Netherlands, Austria) had disbursed less than half of their initial endowments.

32

Overall, 177 of the 972 ERDF financial instruments (18 %) and 16 of the 53 ESF financial instruments (30 %) had disbursed less than a third of their endowment by the end of 2014. For these 177 instruments, their total unused endowment amounted to 4.2 billion euro as at 31 December 2014. For these instruments, we consider it to be unlikely that the available funding will be used once, even though the Commission has extended the eligibility period until March 2017 (see paragraph 43). The final disbursement rate of the financial instruments can, however, only be assessed at the end of their life cycle, especially as regards those set up towards the end of the programme period.

Low disbursement rates due to excessive initial endowment of financial instruments

33

During our interviews, it was often argued that the financial and economic crisis had had a major effect, and had negatively affected disbursement rates to final recipients. However, given the size of the problem, we consider that this is neither the only nor the main factor behind low disbursement rates. In fact, low disbursement rates are primarily due to an excessive endowment of the financial instruments in the first place.

34

Our analysis of the data published by the Commission in 2015 showed that there is a positive correlation between ERDF and ESF absorption rates at Member State level and financial instruments’ disbursement rates to final recipients (see Figure 2a and Figure 2b). This analysis illustrates that those Member States which already face difficulties in absorbing the ERDF and ESF budget often have even more significant problems in disbursing the capital endowment allocated to financial instruments.

Increase in capital endowments of financial instruments in 21 out of 25 Member States

35

In 21 out of 25 Member States, we also found that the initial endowment had been increased since 2011. Overall, around 7.1 billion euro of additional funding from the 2007-2013 ERDF and ESF OPs had been allocated to financial instruments since then.

36

Most of these increases in the instruments’ capital endowment were made in Italy (2.5 billion euro), Spain (0.9 billion euro), Greece (0.9 billion euro), the United Kingdom (0.7 billion euro) and Hungary (0.5 billion euro). These five Member States alone account for 77 % of the total increase of capital endowment during the entire period. Four of these five Member States (Italy, Spain, the United Kingdom and Hungary) had a below-average ERDF absorption rate at the end of 2014 (see Figure 2a).

Provisions in the legal base for the 2007-2013 programme period created incentives for Member States to use financial instruments to circumvent the risk of de-commitment of EU funds

37

The legal base for the 2007-2013 programme period made it possible for Member States to absorb the EU contribution to the ERDF and ESF OPs upfront through the use of financial instruments. These upfront contributions could be used by Member States as a mechanism to avoid the risk of de-commitment (‘n + 2’ rule)³⁴ (see Box 1).

38

This arrangement has created an incentive for Member States to ‘park’ at least part of the EU’s contribution to the OPs in the accounts of the banks and financial intermediaries managing the funds, without it being actually used for its intended purposes (see Box 2).

39

On the other hand, we found one case where the endowment of financial instruments had been reduced to take into account market conditions and projected disbursement rates, which is considered good practice. (see Box 3).

40

Excessive endowments of financial instruments have a negative impact on management costs and fees, where these are determined on the basis of the capital paid into the fund rather than the fund manager’s performance. Oversizing the endowment provides a means of generating income for the fund managers without them actually providing the services expected (see paragraphs 116 to 125).

Particularly low disbursement rates for financial instruments managed by the EIB group

41

Our analysis also showed that the average disbursement rate for the 31 ERDF and ESF instruments manged by the EIB and the EIF was particularly low: 43 % as compared to 60 % for the instruments managed by other fund managers.

Extension of eligibility period for financial instruments in shared management until March 2017 through Commission guidance only

42

The EU contribution corresponding to the unused endowments (i.e. funds not paid or guaranteed to final recipients by the end of the eligibility period) must be returned to the EU budget at closure. Given the low average disbursement rates, the Court already stated in its 2014 annual report that financial instruments could not all be expected to have used the available funds in full by the end of 2015³⁵.

43

In April 2015, the Commission published revised guidelines on closure which extended the eligibility period for financial instrument-related expenditure from 31 December 2015 until 31 March 2017³⁶. The general eligibility period is however established by Article 56(1) of the general regulation. In its 2014 annual report, the Court considered that a legal provision can only be modified by legislation of equal or superior legal value so that the hierarchy of norms is duly respected³⁷. Thus it was concluded that a Commission guideline could not alter rules adopted by the legislative procedure of the European Parliament and the Council.

44

Based on our analysis, and making a linear projection of the disbursement in previous years, we estimate that more than 5.0 billion euro of funds allocated to ERDF and ESF instruments would remain unused by the end of 2015 without any extension of the eligibility period. Some 3.9 billion euro of these are contributions from the EU budget to the OPs. Actual figures of the amounts used between January 2015 and March 2017 will be available only by the end of 2017, at the earliest.

Addressed in the 2014-2020 programme period?

45

Because the contributions from the OPs are now made through staggered payments, financial instruments should be more appropriately sized, resulting in improved disbursement rates (see Box 4).

Market needs were not always properly assessed by managing authorities before funds were allocated to ERDF and ESF financial instruments

46

We also examined whether market needs had been properly assessed before the setting up of financial instruments and the allocation of funds to them. The market needs or ex ante assessments should make it possible to understand the needs of the market and what type of support (loans, guarantees or equity investment) is most appropriate to address the identified market gaps. They should also determine the funding needs, and ultimately assess whether the intended policy objective can be achieved best by a financial instrument. This has also been highlighted in our previous special reports and in other studies as a precondition for the success of such instruments³⁸.

Assessment of market needs was not mandatory for financial instruments during the 2007-2013 programme period

47

During the 2007-2013 programme period, the only explicit regulatory reference to market needs assessments (also referred to as a ‘gap assessment’) relates to holding funds³⁹.

48

For all other specific funds, until 2009, it was possible to infer an indirect obligation to carry out such an assessment from the need to provide a business plan for each instrument⁴⁰. However, the September 2009 amendments to the legal basis introduced lighter requirements concerning these business plans⁴¹. Since then, while it is still mandatory to submit a business plan, almost all specific requirements have been removed (such as the targeted enterprises or urban projects, the criteria, the terms and conditions for financing them and the justification for, and intended use of, the contribution from the OP). We consider that the added value of a business plan in the absence of such information is limited.

49

The obligation to perform a market needs assessment also did not exist for the centrally managed financial instruments set up in the 2007-2013 programme period. For the six centrally managed instruments covered in this report, we observed different practices. Even though a legal requirement did not exist, we generally saw that some degree of market needs assessment, such as impact assessments, market analysis studies, public consultation, etc., was performed for all of them.

In nearly half of the cases examined, market needs had been assessed too high

50

In previous special reports, we have already identified significant shortcomings in the robustness of market needs assessments⁴². In particular, assessments of market needs should be based on underlying assumptions which are rational and realistic. Otherwise, the instruments may not address actual market needs, resulting in overcapitalisation of the instrument and/or little or no real impact on the ground.

51

Assessing market needs serves a number of purposes, including the identification of a market failure and determination of the market size. In this regard our overall analysis shows that the assessment of market needs was not sufficiently robust during the 2007-2013 programme period. While the majority of respondents to our survey (82 %) indicated that they had carried out a market needs assessment, this did not prevent oversizing: nearly half of the financial instruments (19 out of 41) managed by those of our respondents which had carried out a market needs assessment still exhibited disbursement rates of less than 50 % of the instruments’ total endowment by the end of 2014. Only five instruments (12 %) used their initial endowment in full (see Figure 3).

52

In a previous special report we have already pointed out that, during the 2007-2013 programme period, the methodology applied to carry out market needs assessments and the plausibility of the underlying assumptions were not subject to any checks by a body which is independent from the managing authority. This weakness may have contributed to overoptimistic assessments being made by a large number of managing authorities⁴³.

Addressed in the 2014-2020 programme period?

53

During the 2014-2020 programme period, a detailed ex ante assessment is mandatory for shared management instruments to establish evidence of market failures (or suboptimal investment situations) and to estimate the level and scope of public investment needs. This assessment must also set out the types of financial instrument most suited to the situation. Moreover, the ex ante assessment must be submitted to the OP’s monitoring committee for information, and its summary findings and conclusions must be published within 3 months of being finalised (see Annex V). However, there is still no requirement to carry out an independent check of the ex ante assessment and the plausibility of its underlying assumptions before deciding on the instrument’s initial capital endowment.

54

Since the entry into force of the new financial regulation on 1 January 2013, carrying out an ex ante evaluation is also mandatory for all new centrally managed instruments (see Annex V). Nevertheless, the ex ante assessment includes neither an analysis of the lessons learnt, nor the possibility of review in case of major socio­economic changes, as is the case for shared management. A mid-term review (which could address such aspects) is undertaken for most, but not all, centrally managed financial instruments.

Regional focus contributed to Member States setting up a large number of small-sized financial instruments in the 2007-2013 programme period

ERDF and ESF financial instruments significantly smaller than centrally managed funds or private investment funds

55

ERDF and ESF OPs are implemented under shared management by national or regional authorities, meaning that financial instruments set up to deliver national or regional programmes are to follow the programmes’ demarcations in terms of geography and eligibility. In order to be eligible, projects must be located in a region eligible for the OP from which the financial instrument has received its endowment⁴⁴.

56

Within the EU, 952 ERDF and ESF specific funds were set-up during the 2007-2013 programme period (see Table 3). This implies that for most regions several funds were put in place. Our analysis shows that ERDF and, in particular, ESF financial instruments are relatively small. The average EU contribution to an ERDF instrument is 80 million euro for holding funds and 10 million euro for specific funds. The average EU contribution to an ESF instrument is 10 million euro for holding funds and 9 million euro for specific funds. In contrast, by the end of 2014, according to data reported by the Commission, the contribution from the EU budget to the centrally managed funds, which theoretically cover all Member States, was up to 1.2 billion euro. Private equity funds are operating on average with 150-500 million euro.

57

However, implementing funds with a higher capital endowment can result in significant economies of scale and efficiency gains. This is because the overhead costs and the associated risks can be spread over a sufficiently large number of final recipients. In other words, the individual ERDF and ESF specific funds often do not have the size which in the fund industry is considered appropriate to operate them efficiently.

Addressed in the 2014-2020 programme period?

58

During the 2014-2020 programme period Member States enjoy greater flexibility in setting up financial instruments. For instance, OPs may combine one or more complementary investment priorities from the ERDF, the CF and the ESF under a single thematic objective⁴⁵.

59

Moreover, the legal prerequisites for establishing instruments with significantly larger capital endowments were introduced⁴⁶. In particular, the possibility of setting up shared management instruments at EU level has been introduced for the 2014-2020 programme period⁴⁷ (see Box 5).

60

There are also considerable financial incentives for Member States to set up instruments with a larger capital endowment or which extend beyond the regional level. If the entire priority axis of an OP is delivered through a financial instrument, an incentive of a 10 % top-up of the maximum co-financing rate can be applied. If a separate priority axis is set up to be delivered through a financial instrument at EU level and managed directly or indirectly by the Commission, the axis qualifies for a 100 % co-financing rate⁴⁸.

61

The Commission and the Member States should use the possibilities provided by the legal basis to set up larger specific ERDF and ESF financial instruments, wherever possible, in order to take advantage of the significant economies in the cost of operating these instruments. However, with more regions and bodies involved, the legal structure may be more complex, which in turn could mean new risks of delay that need to be considered by Member States when designing the most appropriate funding structure. The 2007-2013 regulatory basis already allowed for contributions from more than one programme to the same financial instrument⁴⁹. However, such constructions have not proven popular to date due to their perceived additional complexity. Based on the responses to our survey, additional Commission guidance on how to set up EU-level instruments during the 2014-2020 period is needed.

Did financial instruments succeed in attracting private capital?

62

One of the key advantages of financial instruments is the fact that additional funds can be leveraged, i.e. additional private and public funds can contribute to the funds’ capital endowment. The leverage effect measures the extent to which public financing mobilises additional funds. It should inform about the ability of an instrument to attract additional funding, depending on its type, location and final recipients, but also on the choices made by the Commission, the managing authority and/or the fund manager when setting up the instrument. For comparable instruments, a higher leverage would then indicate a better-performing instrument in terms of attracting additional funding.

63

We therefore reviewed the way in which the Commission defines and monitors this leverage effect for both shared and centrally managed instruments and assessed whether the instruments were successful in attracting additional private capital. We also analysed the use made of preferential and risk-sharing arrangements with private partners and of tax agreements in this regard.

Commission’s measure of leverage for financial instruments does not properly take into account the extent to which public financing mobilises additional funds

Need for more differentiated leverage ratios to obtain meaningful measurements

Difficulties in identifying leverage of additional private and public capital for shared management instruments

64

The 2007-2013 legislation did not specify how leverage should be measured for instruments in shared management. In 2011, the Commission took the first steps towards addressing this issue by suggesting a first definition of the ’leverage effect’, and 2 years later in the financial regulation (see Box 6).

65

We consider, however, that counting all public national funding as leveraged amounts, as proposed by the Commission in the case of shared management instruments, is inappropriate: the co-financing rates are already specified at the level of the OP’s priority axis, and the national contribution to the financial instruments’ endowments generally remains within these rates. In that sense, there is no distinction between the ‘normal’ national co-financing and an ‘additional’ national contribution (which goes above the OP rates). However, only the latter could be considered as having been attracted by the EU contribution. We have already noted in a previous report that the Commission’s practice of excluding national public funding through the OPs from the denominator leads to an artificial increase in the measured leverage rate⁵².

66

Moreover, the leverage should serve as an indicator for the performance of a financial instrument in terms of attracting additional private or public funds (again, above those already considered for the OP as a whole). Obviously, an assessment of performance needs to take account of the differences in implementing such an instrument. In particular, the risk sharing and preferential arrangements for private-sector partners play a determining role in this (see paragraphs 74 to 78). Moreover, the leverage rate should also vary between different types of financial support (for example, for guarantees the leverage should be higher than for loans), between types of investment (for riskier investments, it should be lower), between the development stages of final recipients supported (for example, start-up companies are more risky) and between geographical markets (for example, lower in less developed regions).

67

In its current form, the Commission’s ‘leverage effect’ calculation cannot provide a reliable indication of actual performance in attracting additional private or public funds. It therefore does not allow a distinction to be made between successful and less-successful financial instruments in attracting additional private or public contributions to the instrument’s capital endowment.

Inconsistent measurement of leverage for centrally managed instruments

68

For centrally managed financial instruments, our analysis shows that the Commission uses various ways to calculate the leverage effect for different instruments, as illustrated in Table 5⁵³.

69

As a result, the leverage ratios reported by the Commission for centrally managed instruments are not comparable between themselves, and also not comparable with those for shared management instruments.

Table 5

Leverage effect for centrally managed financial instruments as reported by the Commission

Instrument	Type of instrument	Method of calculation	Leverage ratio as of 31 December 2014
LGTT	Guarantee	Total amount of finance attracted by the project divided by the EU contribution paid to the facility	57
PBI	Guarantee	Similar to the LGTT	9
EEEF	Equity	Total amount of finance attracted at fund level divided by the EU contribution	2
Marguerite Fund	Equity	Total amount of finance mobilised by the instrument (both equity and debt) at the project level divided by the EU contribution paid	157
EPMF Guarantee Facility	Guarantee	Value of new microloans supported by the guarantee divided by the guarantee cap	7
EPMF FCP-FIS	Loans	Value of new microloans supported by the guarantee divided by the EU contribution paid	2
Source: ECA, based on 2015 Commission data1.
1 SWD(2015) 206 final.

Not only sources of finances which are the result of the EU and/or national contribution to the financial instrument are taken into account

70

Not all sources of finances attracted by a project are the result of the EU and/or national contribution. However, no attention is paid to this in the Commission’s calculation of the ‘leverage ratio’. In 2015, the OECD’s Development Assistance Committee has proposed an alternative methodology, with calculations depending on the type of instrument (loans, guarantees or equity)⁵⁴. The differences between these two approaches are illustrated in the example in Box 7.

According to the Commission’s methodology, the leverage effect is 39 (total finan­cing of 7 846 million euro divided by the EU guarantee of 200 million euro).

We consider that it is unrealistic to assume that the national grants, accounting for the largest part of the project financing, were triggered by the limited EU guarantee. This issue affects the Commission’s reporting on financial instruments in both central and shared management, although it is more visible for centrally managed financial instruments, as private co-investment is involved to a lower extent in projects under shared management.

Addressed in the 2014-2020 programme period?

71

For the 2014-2020 programme period, as regards instruments in shared management, the CPR does not explicitly refer to the definition of the leverage effect in the EU’s financial regulation. However, the concept defined in Article 37(2)(c) of the CPR is essentially identical: ‘[…] an estimate of additional public and private resources to be potentially raised by the financial instrument down to the level of the final recipient (expected leverage effect)’. The Commission therefore continues to consider national co-financing as leveraged by the EU’s funding of the OP. There are also no changes to the way in which the amounts mobilised from the private sector are to be measured. In our view the Commission should reconsider its methods of calculating the leverage effect of EU and national public funding through financial instruments, taking into account the alternative methodology proposed by the OECD in 2015.

72

We also note that Member States are now required to specify each instrument’s ‘expected leverage effects’ (see Box 8). These elements will provide the Commission with data to monitor how actual leverage compares with the target leverage rate. However, in the absence of a consistent Commission methodology on how to calculate the leverage effect, it is doubtful that this exercise will result in meaningful data which could be used for comparisons.

Difficulties of attracting private-sector investors to financial instruments in both shared and central management

73

One of the stated aims of financial instruments is to attract additional private-sector funding to complement the available public funds since it allows more projects to benefit from the same level of public investment. We have therefore sought to determine for both shared management and centrally managed instruments the extent to which additional private financing has been effectively mobilised by public contributions to the instruments.

Specific arrangements for private investors in financial instruments during the 2007-2013 programme period did not succeed in attracting significant additional financing

74

Our interviews and literature review confirm that during the 2007-2013 programme period the private sector remained reluctant to invest in financial instruments since these instruments were considered to be too strictly regulated (e.g. specific EU and national regulations, State aid, public procurement). It should be recalled that the goals of the two parties differ: while the public sector aims to implement specific policy and investment objectives, the private sector must be oriented towards profitable activities. Moreover, there may be a lack of know­ledge on both sides. The public sector is not necessarily equipped with advanced financial background, while the private sector is not necessarily familiar with EU legislation. The Commission considers that one of the ways to attract private capital is to offer preferential treatment and/or ‘risk premiums’ to private invest­ors. We therefore examined the specific arrangements for private-sector invest­ors to see whether risks were shared between the public and private in a reasonable manner.

Lack of Commission guidance on how to set out arrangements on preferential treatment for ERDF and ESF instruments

75

For the 2007-2013 ERDF and ESF instruments, the legislation provided a possibility for returns on investments to be allocated preferentially to investors operating under the market economy investor principle⁵⁶. Preferential treatment may be exercised, for example, through contracts that do not grant the public funding partner the same repayment rights as private partners, or through an unequal share in profit and loss between private and public partners.

76

Preferential treatment can be justified if it is needed to attract private investment in failing markets, where private funding can contribute to the achievement of public policy objectives. If unjustified, preferential treatment may result in a drain on the initial capital endowment of the financial instrument and thus reduce the legacy funding available for the next investment cycle after the instrument is wound up. However, neither the legal basis for the 2007-2013 programme period nor the Commission’s guidance notes provide any indication as to how risk-sharing arrangements should be set out in the funding agreement or how the appropriateness of preferential treatment is to be checked.

Despite Commission assuming higher risks, only limited private contributions to the capital of centrally managed instruments

77

As a general practice, for centrally managed instruments, the governing legislation approved by the European Parliament and the Council includes only general terms in relation to the risk sharing and/or preferential treatment. The detailed arrangements related to the Commission’s contribution in these instruments (including the risk-sharing percentages) come only later as part of a separate agreement which does not need to be approved by the budgetary authority (see Box 9).

78

For some centrally managed financial instruments, we found that nearly all effect­ive risks are shifted to the Commission (see Box 10). However, despite the Commission taking more risk than its partners in this type of instrument, our analysis shows that there was no significant private-sector contribution to them.

Tax rulings used in some cases to make financial instruments more attractive for private-sector investors

79

A tax ruling is a written decision by a national tax authority on how a particular aspect of an entity’s activities is treated under the applicable tax law of that Member State. Such a procedure can be used in several EU Member States to obtain certainty on how activities will be taxed. Generally, individuals or undertakings subject to taxation submit their interpretation of how the tax law applies to them or to a particular transaction or activity, and the tax authority responds with a positive or negative decision. Such tax agreements are also standard practice in the fund industry. While tax rulings can be perfectly legitimate, and they are used in a number of jurisdictions, they have also been used to facilitate aggressive tax planning.

80

Already in 2012 the Commission had issued a recommendation on aggressive tax planning addressed to the Member States⁵⁸. In essence, Member States are encouraged to change their national legislation in order to address ‘[…] artificial arrangements’ and ‘[…] treat these arrangements for tax purposes by reference to their economic substance’. This has been followed by a series of specific measures in this regard.

• Since 2014, the Commission has opened several investigations to examine whether decisions of tax authorities in the Member States with regard to the corporate income tax to be paid by corporations comply with the EU rules on State aid⁵⁹.
• In March 2015, the Commission presented a package of measures to boost tax transparency and to introduce the automatic exchange of information between Member States on their tax rulings⁶⁰.
• In June 2015, the Commission adopted an action plan for fair and efficient corporate taxation in the EU⁶¹. This document discusses, among a number of taxation topics, measures to combat tax avoidance and aggressive tax planning.

81

However, we identified financial instruments for which tax rulings have been obtained (see Box 11).

82

We also note that a number of 2007-2013 ERDF and ESF instruments used SICAV⁶³ or SICAR⁶⁴ entities in their set-up structures. For these structures, tax rulings are common practice. Member States, however, do not report to the Commission whether their instruments made or will make use of advance tax agreements.

Private contributions to the capital endowment of ERDF and ESF financial instruments account for around 2 % of the total

83

In previous reports we noted that the private-sector leverage rate was limited during the 2007-2013 programme period⁶⁵. According to the latest data reported by Member States to the Commission, only 154 out of 1 025 ERDF and ESF financial instruments in 11 Member States attracted private funding in their financing structure as part of the OP contribution.

84

For the private funds contributed through OPs which are reported by the Member States there is also a risk of double counting, since it is possible that the private funding presented at the level of the specific funds is simply a transfer of funds made by the holding fund. If the analysis is restricted to holding funds only, thus eliminating the risk of double counting, only nine out of the 73 existing holding funds in four of the 18 Member States where such funds exist benefited from private contributions. For these nine holding funds the share of private funding in the instrument’s endowment varies from 5 % to 50 %. Overall, 325 million euro in private capital was attracted to holding funds through OPs. At the same time we note that, irrespective of the information reported, there is a legal obligation stemming from State aid rules for the equity investments in SMEs to have a minimum level of private co-financing of 30 % or 50 % depending on the region⁶⁶.

85

Moreover, based on the information provided by 11 Member States on a voluntary basis, the resources paid to financial instruments in addition to those from the OPs (private or public) amount to 342 million euro⁶⁷. Member States are, however, not required to provide such information, and the data reported on a voluntary basis are also not verified by the Commission.

86

We also note that the legislation for the 2007-2013 programme period did not stipulate that funding agreements between managing authorities and fund managers should specify expected leverage rates for additional private contributions. Moreover, fees were generally not linked to the fund managers’ success in attracting private investors (see paragraph 136)⁶⁸. Hence, there was little incentive for the fund manager to get private investors on board.

87

For centrally managed instruments, and in particular for equity financial instruments, attracting private-sector investments as contributors has proven to be difficult, as illustrated by the case studies in Box 12.

Addressed in the 2014-2020 programme period?

88

For instruments under shared management, the provisions in the legislation for the 2014-2020 programme period continue to allow preferential treatment, but also ask for risk to be shared appropriately between the public and the private partners (see Box 13).

89

The obligation for Member States to assess the need for preferential treatment and the risk-sharing arrangements, and to provide some justification for these arrangements, can clearly be regarded as progress towards the more efficient management of financial instruments. Based on our interviews, we consider however that there is a need for the Commission to provide guidance to Member States on how best to use preferential treatment to attract more private capital while not allocating excessive risk to the public contributors to the instruments’ endowments.

90

For some of the centrally managed instruments, the possible extent of risk sharing between the Commission and its partners has also been addressed in the legislation. Here, the regulation specifies that the ‘[…] risk-sharing pattern [must] be reflected in an appropriate sharing between the Union and the entrusted entity’, while ‘[…] the maximum risk covered by the Union budget [must] not exceed 50 % of the risk of the target debt portfolio under the debt instrument’⁷⁵. It remains to be seen whether these modified provisions will be sufficient to attract more private-sector contributions than in the 2007-2013 programme period. As mentioned already in a previous report, we consider that the main aspects of the risk-sharing arrangements between the Commission and its partners (e.g. the EIB) should be defined in the specific legislation for each centrally managed instrument⁷⁶.

91

Finally, as regards tax rulings, the situation remains unchanged from the 2007-2013 programme period. We consider that the continued use of advance tax agreements during the 2014-2020 programme period for centrally managed and/or shared management financial instruments could pose a reputational risk since they may be perceived to go against the Commission’s own recommendations and actions concerning tax arrangements.

Were financial instruments providing revolving financial support?

92

One of the main reasons for using public funds through financial instruments is the fact that the money can be used multiple times: it can ‘revolve’. For instance, if a disbursed loan was repaid after 3 years, the cash could then be used to provide a new loan. We therefore examined whether this revolving effect had actually materialised. The extent to which funds can revolve in practice depends on the type of financial support, but also on the instruments’ investment period. We therefore analysed whether the instrument’s investment periods correspond to normal market practice and what factors contributed to limiting the instruments’ actual investment period.

Delays in the implementation significantly shortened the actual investment period of several ERDF and ESF financial instruments

93

At the start of the 2007-2013 programme period, public authorities in most Member States had only limited experience of structuring and running revolving instruments in partnership with financial intermediaries. Following our audits, we have noted that most delays were caused by the time-consuming internal structuring of financial instruments, lengthy negotiations with financial intermediaries at various levels (often due to negotiations of management costs and fees), complex public procurement procedures, uncertainty about compliance with State aid rules and difficulties in obtaining private-sector contributions.

94

In many cases the various bodies involved experienced a steep learning curve, and it took a good deal of time to reconcile the interests and views of numerous stakeholders in order to reach agreement on the instrument’s investment strat­egies. Several of these issues were also identified by other studies⁷⁷. Our audits over the last years also indicate that more and earlier Commission guidance could have prevented these problems at least in part.

95

The low disbursement rates in many Member States and, as a consequence, the limited capacity of instruments to revolve funds are an obvious result of these difficulties. In some cases, delays in implementation lasted several years, thus significantly reducing the time period during which the financial instrument’s endowment could then be disbursed to final recipients (see Box 14).

Limited revolving effect of ERDF and ESF financial instruments during implementation and uncertain after closure of the 2007-2013 programmes

Less than a third of all ERDF and ESF financial instruments had used their funds more than once by the end of 2014

96

Overall, our analysis showed that there are 316 ERDF and ESF instruments (in the vast majority specific funds) in 19 Member States which had managed to disburse their full endowment to final recipients by 31 December 2014. However, even for these instruments, the revolving effect came very late in the programme period. As a result, only a limited share of the initial endowment will be used more than once until the end of the extended eligibility period (i.e. March 2017). Moreover, the aggregated disbursement rate did not reach 100 % in any of the 25 Member States’ implementing financial instruments (see Table 4).

Time constraints caused particular problems for equity instruments

97

Our analysis also shows that equity instruments experienced particular problems to attain a revolving effect. In Europe the average holding period for equity investments (e.g. the time between the acquisition and the sale of shares) was around six years in 2014⁷⁸. Most of ERDF and ESF equity instruments were however operational for no more than eight years (2009 to 2017). Even if, for instance, operations began at the beginning of 2009 and the exit took place at the end of 2014, there would be only less than three years left before the OP closure to make a new round of equity investments. Therefore, after taking into account the years needed to set up the instrument, it is unlikely that OP contributions to equity instruments will be used again within a programme period.

98

By contrast, centrally managed equity instruments have much longer durations, better reflecting the nature of equity instruments⁷⁹ (e.g. Marguerite Fund has a term of 20 years with the possibility of a two years extension).

The high degree of discretion in the reutilisation of funds for ERDF and ESF financial instruments may cause the revolving effect to disappear once OPs are closed

99

The 2007-2013 legal framework for the shared management financial instruments stipulates that any resources used at least once by the time of closure can be kept by the Member State, but must be reused for the benefit of the target group⁸⁰. The Commission guidance notes on financial instruments⁸¹ and on the closure of the 2007-2013 OPs⁸² suggest that resources from the ERDF and ESF instruments ought to be reinvested indefinitely.

100

We consider however that the 2007-2013 general regulation in relation to indefinite reinvestments cannot be interpreted in this way⁸³. For example, the provisions also allow the instrument’s capital to be reduced and resources of financial instruments to be used in the form of grants. Moreover, legally speaking, any activity after the closure of the programmes which does not concern the EU budget is the exclusive responsibility of the Member State and no longer subject to Commission supervision, unless provided otherwise in the legal base.

Addressed in the 2014-2020 programme period?

101

For the 2014-2020 programme period, a number of issues regarding the reutilisation of funds for ESIF instruments after the end of the eligibility period in 2023 have been clarified in Articles 44 and 45 of the CPR.

102

Moreover, the legislation governing the 2014-2020 programme period expli­citly recognises the intended revolving nature of financial instruments after the eligibility period by including provisions for the reuse of resources paid back during a period of at least 8 years after end of the eligibility period⁸⁴. Through this provision, the CPR sets a minimum period for earmarking the funds allocated to financial instruments, but provides no further details on how this should be done. In our view, the Commission should clarify this aspect.

103

A critical factor for avoiding the mistakes of the past is standardisation: the option for managing authorities to design financial instruments in accordance with standard terms and conditions laid down by the Commission should significantly streamline and facilitate the set-up process.

104

The legal basis for the 2014-2020 programme period also allows financial instruments to continue to be used during the following programme period, rather than requiring that they be wound up and replaced with new ones⁸⁵. This may save both time and money, since the financial instruments are ready and oper­ational at the start of the programme period and the endowment of the instrument could be increased in accordance with the ex ante needs assessment. However, in cases where the fund manager was chosen through an open competitive procedure, time savings may be limited, since a new open procedure would be needed in any case to select the new fund manager. Based on the responses to our survey (see Box 15), additional Commission guidance on how to transfer instruments to the 2014-2020 would be most welcome by fund managers.

105

Finally, during the 2007-2013 programme period, the Commission started to organise a range of presentations and workshops to spread ‘good practices’ and to train Member State officials. In January 2015, one year after the start of the 2014-2020 programme period, the Commission also launched a technical ­advisory platform (https://www.fi-compass.eu) to disseminate expertise about the EU’s legal requirements concerning financial instruments.

Did financial instruments prove to be a cost-efficient method to implement the EU budget?

106

Financial instruments, unlike the traditional grants, are managed by fund man­agers (rather than public administrations). These are generally financial inter­mediaries, such as private or state owned banks. Managing financial instruments comes at a cost, and fund managers are entitled to be remunerated for their services rendered. The level of management costs (reimbursed against evidence of expenditure) and fees (agreed price or compensation for services rendered) for the fund manager are generally set out in the funding agreement for each of the financial instruments. The remuneration should cover the administration costs of the financial instrument (including expenses for investor relations, legal expenses and expenses for auditors) and, in the case of private-sector fund managers, allow for a profit margin. They should vary between different financial products (i.e. guarantees, loans or equity) and their level should be related to objective criteria (e.g. a large number of small loans usually involve higher administrative costs than a small number of large loans).

107

Based on the most recent data reported by Member States to the Commission, we have analysed the level of actual management costs and fees for both shared management and centrally managed instruments during the 2007-2013 programme period and examined whether they were sufficiently linked to the fund manager’s performance. Moreover, as regards the 2014-2020 programme period, we have assessed whether the increased share of funding allocated to financial instruments (and therefore generally not managed by national or regional administrations) has been reflected in setting the level of technical assistance which is paid to Member States for implementing the ESIF.

High level of management costs and fees compared to actual level of disbursement to final recipients

Cumulative management costs exceeding actual disbursements to final recipients for around 2 % of the instruments

108

For some instruments, the management costs and fees even exceeded the actual amounts disbursed to final recipients. Our analysis of the 1 025 ERDF and ESF financial instruments identified 23 such cases (2.2 %) in 8 Member States (Bulgaria, Czech Republic, Germany, Spain, France, Italy, Poland, United Kingdom). Taken together, these instruments charged 28 million euro in management costs and fees in order to disburse 4 million euro to final recipients. At the same time, there are similar instruments where no management costs or fees at all are paid to financial intermediaries (see Box 16).

Cumulative management costs and fees reach up to 75 % of the financial support disbursed to final recipients

109

We have furthermore carried out our own analysis of the Commission’s data whereby we put the management costs and fees in relation to the amounts effectively paid to final recipients. Our results, at Member State level, are presented in Table 6.

110

For 274 of the 1 025 ERDF and ESF instruments in 10 of the 25 Member States (Sweden, Austria, Latvia, Malta, Finland, Lithuania, Romania, Greece, Hungary, Cyprus), we found that the data on management costs and fees reported to the Commission was comprehensive for all financial instruments. For another six Member States (Poland, Portugal, Germany, Slovakia, Bulgaria and the United Kingdom) such information was provided for 392 financial instruments representing 84 % to 98 % of the total capital endowment to financial instruments. For all other Member States plausible information on management costs and fees was reported for instruments representing two thirds or less of the total endowment⁸⁶. For a number of financial instruments data was either not reported at all or was not plausible (such as reported management costs and fees which were 10 times higher than the actual amount disbursed). Moreover, when management costs and fees were reported as ‘zero’ it could be that this was actually the case, or that the data were not reported. These data were eliminated from our further analysis.

Table 6

Analysis of the cumulative management costs and fees per Member State for ERDF and ESF financial instruments as of 31 December 2014

Member State	Total management costs reported (in million euro)	Number of instruments (incl. sub-funds)	Management costs and fees
			% of paid to instrument		% of paid to final recipients
			Cumulative	Average per annum	Cumulative	Average per annum
Slovakia	9	7	9 %	2 %	75 %	16 %
Czech Republic	4	5	9 %	3 %	47 %	16 %
France	14	120	9 %	2 %	19 %	4 %
Sweden	21	11	13 %	2 %	17 %	3 %
Cyprus	2	5	10 %	2 %	16 %	3 %
United Kingdom	124	74	10 %	2 %	16 %	3 %
Spain	43	16	6 %	1 %	16 %	2 %
Austria	2	2	6 %	1 %	12 %	3 %
Latvia	17	15	8 %	2 %	12 %	2 %
Bulgaria	20	10	6 %	1 %	11 %	3 %
Italy	51	128	4 %	1 %	11 %	2 %
Malta	1	2	8 %	2 %	10 %	2 %
Poland	110	248	9 %	2 %	10 %	2 %
Denmark	1	9	9 %	2 %	10 %	2 %
Lithuania	29	36	7 %	1 %	9 %	2 %
Finland	4	1	6 %	1 %	9 %	1 %
Germany	105	45	7 %	1 %	9 %	1 %
Netherlands	0	11	6 %	1 %	8 %	1 %
Romania	8	4	5 %	1 %	6 %	1 %
Portugal	18	56	4 %	1 %	5 %	1 %
Greece	29	32	2 %	0 %	4 %	1 %
Slovenia	3	3	3 %	1 %	4 %	1 %
Belgium	0	9	4 %	1 %	4 %	1 %
Hungary	17	170	2 %	0 %	2 %	0 %
Estonia	0	6	0 %	0 %	0 %	0 %
Total	631	1 025
Source: ECA, based on 2015 Commission data.

No reimbursement from the EU budget of management costs and fees above the regulatory ceilings at closure

Management costs and fees were in principle limited to a maximum of 4 % per annum of the total endowment of the financial instrument

111

In the legal base for the 2007-2013 programme period, the provisions on the remuneration of fund manager were succinct in the main regulation⁸⁷, but ceilings for management costs and fees were already specified in the Commission’s implementing regulation⁸⁸. In particular, the following annual ceilings were set:

• 2 % p.a. of the capital contributed from the OP to holding funds for guarantee funds;
• 4 % p.a. of the capital contributed from the OP or the holding fund for micro-credit instruments directed at micro-enterprises; and
• 3 % p.a. of the capital contributed from the OP or the holding fund for all other cases.

The Commission established these ceilings in its legislative proposal, taking account of the experience of the 2000-2006 programme period. Then, there was an overall ceiling for management costs and fees of 5 % for equity funds and 2 % for guarantee funds⁸⁹.

112

In shared management, when determining the fund manager’s remuneration, managing authorities have to comply with both the Structural funds and the State aid legal frameworks. Moreover, managing authorities must take care that the provisions on remuneration are in line with the instrument’s investment strategy to ensure that the fund manager has a financial incentive to act in accordance with the stated objectives of the OP. Negotiating the funding agreement therefore is not a trivial task and, during our interviews, many managing author­ities stated that they did not have the necessary expertise to do so at the beginning of the 2007-2013 programming period.

113

Under certain conditions the regulatory ceilings for management costs and fees can be exceeded (e.g. if management costs and fees conform to market terms and do not exceed those payable by private investors or if the fund manager has been selected through a public procurement procedure). Based on the Member States’ reporting to the Commission, information on how often the ceilings were exceeded does not exist.

114

Management costs and fees are paid out of the capital endowment of the financial instrument; they are not charged to the final recipient. These costs are considered eligible until the winding-up of the fund, which in most cases is upon the closure of the programme⁹⁰. The eligibility of management costs and fees claimed for the ERDF and ESF funds set up during the 2007-2013 programme period will be checked by the Commission only when analysing the closure documents in 2017 and 2018.

Cumulative management costs likely to exceed the regulatory ceilings in some cases at closure

115

Management costs or fees incurred and paid by 31 March 2017 can be declared as an eligible cost of the ERDF and ESF OP under which the financial instrument has been set up⁹¹. The regulation specifies that the ceilings for management costs and fees are related to ‘the capital contributed from the operational programme’. According to the Commission the ceilings referred to in Article 43 of the implementing regulation are applicable to the total capital contribution to the financial instrument, rather than the actual contribution used to provide financial support to final recipients. The existing guidance for the 2007-2013 programme period on management costs and fees confirms this view⁹².

116

In our view, the Commission should have interpreted the provisions on ceilings for management costs and fees set out in the regulation as applying to the actual used capital endowment contributed from the OP to the financial instrument, i.e. the actual endowment that has been used to provide financial support to final recipients. Fund managers should not be remunerated for not making use of the instruments’ capital endowment.

Performance-based remuneration was not a legal requirement during the 2007-2013 programme period

117

During the 2007-2013 programme period, the sound financial management of financial instruments and the actual performance of the fund manager were only referred to in the Commission’s guidance notes, but not on any regulatory basis, as a factor for determining management costs and fees⁹³.

118

Based on our performance and compliance audits of financial instruments, we found that performance-linked remuneration schemes were the exception rather than the rule: only one out of nine instruments examined in the period from 2013 to 2015 had performance-based remuneration of the fund manager in place.

119

Where the remuneration of fund managers is not performance-based, there is little incentive for fund managers to actually transfer the funds to final recipients. This may have adversely affected the performance of financial instruments during the 2007-2013 programme period. Moreover, managing ERDF and ESF instruments becomes then also quite attractive for inexperienced fund managers (see also paragraph 86).

120

In 2012, the Commission recommended to managing authorities that the fund manager’s remuneration be linked to the quality of investments actually made, as measured by their contribution to the achievement of the strategic OP objectives and to the value of the resources returned to the operation from investments undertaken by the instrument⁹⁴. However, this recommendation was made in a COCOF guidance note and is not legally binding.

Commission’s assessment of management costs and fees does not take due account of differences in types of instruments and actual level of support provided to final recipients

Commission’s estimate of cumulative management costs of 631 million euro since 2007 likely to be understated

121

In December 2015, based on the data reported by Member States for the year 2014, the Commission estimated cumulative management costs and fees of at least 631 million euro for the ERDF and ESF instruments since the start of the programme period⁹⁵.

122

According to the Commission, this represents 4.7 % of the OP contributions paid to the relevant instruments in the 2007-2013 programme period.

123

If the amounts paid between holding funds and the specific funds below are not included in the calculation, having already been included as OP contributions to holding funds, this overall management costs and fees rate increases to 6.2 %. In addition, fund managers can also charge fees to final recipients, but may not have reported these fees to the Commission. Therefore, as the Commission’s calculation is based only on partial data, the actual figures (both for the absolute amounts and the share of the OP contributions) are likely to be higher.

Management costs and fees significantly above the levels reported by the Commission if calculated on the basis of the financial support provided to final recipients

124

Overall, based on the 764 ERDF and ESF instruments in Table 6, we found that the cumulative management costs and fees account for up to 75 % of the financial support provided to final recipients, giving an annual average of up to 16 %.

125

For those 10 Member States which have reported robust data for all their 274 ERDF and ESF funds, we found that the cumulative management costs and fees are between 2 % and 17 % of the financial support provided to final recipients. This gives an annual average between 1 % and 3 %.

Significant differences in the management costs and fees between the different types of financial instruments

126

The level of management costs and fees is also related to the type of instrument. Taking into consideration the plausible data reported by the Commission, we found the average values presented in Table 7. On average the guarantee instruments have the lowest percentage of management costs and fees, while the equity instruments have the largest percentage.

Table 7

Average cumulative management costs and fees per type of financial instrument as a percentage of fund endowment

Financial instrument type	Average cumulative percentage of management costs and fees as of 31 December 2014
Loan	4.2 %
Guarantee	2.7 %
Equity	11.0 %
Source: ECA, based on 2015 Commission data1.
1 European Commission, ‘Summary of data on the progress made in financing and implementing financial engineering instruments reported by the managing authorities in accordance with Article 67(2)(j) of Council Regulation (EC) No 1083/2006 — Programme period 2007-2013 —Situation as at 31 December 2014’.

127

Moreover, as a general rule, financial instruments implemented with a holding fund are more costly to implement since management costs and fees are payable at both levels (i.e. holding fund and specific fund). We also note that the ceilings for management costs and fees during the 2007-2013 programme period do not depend on the scale of the financial instrument investments because they are paid as a percentage of the OP contribution (see paragraph 108).

Based on the financial support provided, management costs and fees for ERDF and ESF instruments are significantly higher than for centrally managed financial instruments or investment funds in the private sector

128

Our analysis also showed that the average management costs and fees for centrally managed financial instruments or private-sector investment funds were significantly lower than those for ERDF and ESF instruments when compared to the financial support provided to final recipients by the end of 2014.

• The cumulative operating cost charged by the EEEF since it started operating in 2011 are approximately 5 % of the total amounts invested. This results in an annual cost of 1.2 %.
• For EPMF (loans and guarantee instruments combined), the Commission estimates that the average annual cost payable from the EU budget is a maximum of 0.5 % to 0.7 % of the capital endowment⁹⁶. This corresponds to an annual cost of 0.2 % of the amount of guarantees provided by the EPMF to final recipients.

129

Our analysis also showed that even the EIB’s and the EIF’s management costs and fees for ERDF instruments were generally higher than those charged by them when they act as fund managers for instruments in ‘centralised management’.

130

Our examination of two studies on fund-manager remuneration in private-sector investment funds published in 2015 showed that the average annual management fee across all types of funds (excluding holding funds) was between 0.6 % and 1 %⁹⁷. Both studies also indicated that management fees have been reduced in recent years. Another study published in 2013 describes that annual management fees for venture capital equity funds range between 2.0 % and 2.5 %⁹⁸.

131

Our analysis also shows significant differences in the management costs and fees charged between individual ERDF and ESF instruments. Based on information available on the actual implementation costs of individual ERDF and ESF financial instruments, the Commission is not in a position to assess whether such cost differences are justified. We previously made similar observations in another special report⁹⁹.

Limitations in reporting of management costs and fees by Member States

Only around 60 % of all ERDF and ESF instruments provide information on their management costs and fees to the Commission

132

In 2011, the Commission introduced an annual reporting obligation for Member States on shared-management instruments¹⁰⁰. Managing authorities had to report this information for the first time in their reports for the year 2011. The data requested by the Commission included, amongst others, information related to the management costs and fees which was optional for the ERDF and ESF man­aging authorities. For the year 2014 data on management costs and fees were presented only for instruments representing 63 % of the total amount of payments from the ERDF and ESF OPs to financial instruments (compared to 50 % in 2013)¹⁰¹.

133

Moreover, we note that only the paid amounts are to be reported as management costs and fees. However, there are also cases of costs and fees accrued but not yet paid. These are de facto excluded from the reporting, affecting its completeness and contributing to an understatement of management costs and fees reported to the Commission.

Addressed in the 2014-2020 programme period?

In relation to the management costs and fees issues a number of measures have been taken for the 2014-2020 programme period.

Reporting deadlines shortened for Member States and extended for the Commission

134

In the 2014-2020 programme period the Member States are required to submit to the Commission the report on the implementation of financial instruments as part of their annual implementation report. This implies that the reporting takes place 1 month earlier (by 31 May, as compared to 30 June during the previous period, when the reporting was not part of the annual implementation report; for 2017 and 2019 the deadline remains 30 June)¹⁰². Moreover, the period for the Commission to review the data reported by the Member States was fixed at 6 months. This means that the Commission’s deadline to present the consolidated implementation report of financial instruments was changed, except for 2017 and 2019, from 1 October to 30 November. This results in a situation where important information on the implementation of financial instruments will become available to the discharge authorities even later than is currently the case.

Managing authorities are required to report to the Commission on management costs and fees

135

For 2014-2020 financial instruments, managing authorities are required to publish data on management costs and fees as an annex to the annual implementation report¹⁰³. This is an important improvement which will allow the Commission to analyse and supervise the cost of implementing financial instruments much better in the years to come.

Reduced ceilings for management costs and fees, differentiated according to the type of financial instruments

136

As regards the ceilings for management costs and fees, we observe two main differences to the 2007-2013 programme period. First, ceilings for the fund manager’s remuneration are differentiated according to the type of financial instruments¹⁰⁴ (see Table 8).

Table 8

Ceilings for management costs and fees of different types of financial instruments under shared management (2014-2020 programme period)

	Ceilings	Base remuneration p.a.	Performance-based remuneration p.a.
Holding fund	7 %	3 % first 12 months	0.5 %
		1 % next 12 months	0.5 %
		0.5 % following years	0.5 %
Loans	8 %	0.5 %	1 %
Guarantees	10 %	0.5 %	1.5 %
Equity	20 %	2.5 % first 24 months1	2.5 %
		1 % following years2	2.5 %
Micro-credit	10 %	0.5 %	1.5 %
Other	6 %	0.5 %	0.5 %
1 This relates to the period after the signature of the funding agreement; the higher rate can be used only within this period but effectively only for the time from the effective payment of programme contributions to the holding fund.
2 For equity, the base remuneration is linked to amounts committed to the financial instrument.
Source: European Commission, Guidance for Member States on Article 42(1)(d) CPR — Eligible management costs and fees (EGESIF_15-0021-01), p. 8.

137

Second, the ceilings (which are now on a cumulative rather than an annual basis) are significantly lower compared to those applicable in the 2007-2013 programme period. Overall we consider the reduced ceilings imposed on the cumulative amount of the fund manager’s remuneration to be an improvement, but the Commission did not justify how these ceilings were determined. Our analysis of actual data reported for the 2007-2013 programme period to date shows lower percentages in practice (see paragraph 120).

Performance-based elements of fund managers’ remuneration only have limited incentive effect

138

For 2014-2020 the CPR also provides that the performance of the fund manager should serve as a criterion for the determination of management costs and fees. In particular, all management costs and fees to be declared as eligible at closure have to be based on a performance-based calculation methodology (see also Table 6)¹⁰⁵.

139

Further details on the performance-based criteria to determine management costs and fees and the applicable ceilings are set out in a delegated act¹⁰⁶.

140

In addition, according to the Commission’s guidelines on risk finance investments¹⁰⁷, this performance-based component of the remuneration must be significant and designed to reward the attainment of the specific policy targets set in advance, as well as the fund manager’s financial performance. The latter should be measured not only in terms of the successful disbursement of the initial endowment or the amount of private capital raised, but also on the basis of the actual returns on investments.

141

We observe, however, that these new performance-based elements play a secondary role in determining the fund manager’s total remuneration which is to be reimbursed from the EU budget, for the following reasons.

• given the normal duration of a holding or specific fund, the ceilings specified in the Commission’s delegated act are generally reached easily without receiving the performance-related part of the remuneration. As a consequence a high-performing fund manager will have reached the maximum remuner­ation already at an earlier stage than a less-performing one, and will from then on no longer be paid for his services.
• there is no underperformance charge which would ensure that the fund manager bears part of any financial losses that the financial instrument may incur. In fact, based on the current remuneration scheme, even fund man­agers that achieve negative returns can obtain the maximum remuneration.
• the regulatory framework does not require that minimum performance benchmarks (or hurdle rates) which must be attained before the fund manager can receive the performance-related part of the remuneration be specified in advance by the managing authority.

Overall, we therefore consider that the performance-based part of the fund manager’s remuneration co-financed from the EU budget currently provides only a very limited incentive effect and needs to be reconsidered.

Management costs and fees are incurred in addition to the administrative cost of implementing ERDF and ESF OPs

142

The management, control, monitoring and evaluation of the ERDF and ESF OPs comes at a cost: this administrative cost for national authorities comprises staff remuneration, operational costs (such as travel and training costs) and costs related to information and communication activities. Member States have the possibility to use technical assistance under the ERDF and ESF OPs to cover these administrative costs¹⁰⁸.

143

During the 2007-2013 programme period, technical assistance could be up to 4 % of the total funding of an ERDF or ESF OP¹⁰⁹. The same level has been kept for the 2014-2020 programme period. It was established on a basis of a study carried out in 2010 on behalf of the Commission for its impact assessment for the 2014-2020 programme period ¹¹⁰. On this basis, the Commission estimates that up to 13.6 billion euro can be spent by Member States on technical assistance during the entire period.

144

However, during the 2014-2020 programme period, a significantly larger share of the ERDF and ESF budget will be implemented through financial instruments (see paragraph 21). This implies that comparatively more technical assistance money will be available for the grant-based funding activities of the ERDF and ESF OPs since the main part of the administrative activity for financial instruments is performed by the fund manager. For these activities, management costs and fees are directly charged by fund managers to OPs (or to final recipients). Therefore, the increase in funding through financial instruments also adds indirectly to the total administrative cost to the EU budget, since it raises the amount of technical assistance support given to Member States from the EU budget for the remaining grant-based funding activities.

145

We also note that, as for the 2007-2013 programme period, there is no obligation for national administration to report in detail on how technical assistance has been spent¹¹¹. In a previous report we already observed that the Commission does not have any comparative information available on the actual administrative costs for each Member State, for each OP or for each funding mechanism (i.e. grants or financial instruments)¹¹². This makes it difficult to assess whether the levels of technical assistance are justified in view of the actual costs incurred by Member States for implementing the ERDF and ESF OPs.

146

We therefore maintain our previous recommendation that the Commission should carry out a comparative analysis of the implementation costs of grants and financial instruments (in central and shared management) for the 2014-2020 programme period with a view to establishing their actual levels¹¹³. Such information would be particularly relevant in view of preparing the legislative proposals for the post-2020 period.

Conclusions and recommendations

147

Overall, we note that financial support provided to final recipients through financial instruments offers significant advantages compared to grants since each euro of funding through financial instruments can in principle be used more than once. Moreover, the fact that loans have to be paid back and guarantees have to be released or, in the case of equity investments, returned should in principle also have an impact on the behaviour of final recipients, leading to the better use of public funds and reducing the likelihood that the final recipients will become dependent on public support.

148

Our audit, however, identified a number of significant issues that limited the efficiency of financial instruments as a mechanism to implement the EU budget during the 2007-2013 programme period.

• a significant number of ERDF and ESF financial instruments were oversized and by the end of 2014 continued to face significant problems to disburse their capital endowments (on average, around 57 % of all capital endowment paid from the OPs to the financial instruments had been used). A contributing factor to the excessive initial capital endowments was the Member States’ intention to avoid de-commitments throughout the 2007-2013 programme period.
• overall, financial instruments in both shared and central management were not successful in attracting private capital.
• so far, only a limited number of ERDF and ESF financial instruments have been successful in providing revolving financial support.
• for ERDF and ESF financial instruments, levels of management costs and fees are high compared to the actual financial support to final recipients and also appear to be significantly higher than those of centrally managed instruments or private-sector investment funds.

149

At the same time, we also note that improvements were made in the legal framework for the 2014-2020 programme period as regards financial instruments based on the expertise gained during the 2007-2013 programme period, but certain issues remain. Our main conclusions for the 2007-2013 and 2014-2020 programme periods are presented following the structure of the report, together with our recommendations.

Were financial instruments appropriately sized in view of market needs?

150

We consider that a significant number of financial instruments were oversized. This indicates that market needs have not always been properly assessed by managing authorities before allocating funds from the ERDF and ESF OPs to financial instruments. This led to excessive capital endowments when setting up the financial instruments, which resulted in low disbursement rates. A contributing factor to these excessive capital endowments was the Member State’s intention to circumvent the n + 2 rule.

The introduction of mandatory ex ante assessments during the 2014-2020 programme period for financial instruments in both shared and centralised management will contribute to preventing excessive endowments of financial instruments on a large scale. Nevertheless its success will depend on whether or not it was built on sound assumptions and analysis. For instruments in shared management the phased payments approach (which links the payments from the EU budget to the disbursement of funds to final recipients) is also aimed at addressing the issue of excessive endowment. Moreover, a regular review of the ex ante assessment in cases of changes in the economic or market environment is provided for as an option in the CPR, but not for the centrally managed instruments. A mid-term review (which could address such aspects) is undertaken for most, but not all, centrally managed financial instruments. Finally, an independent review of ex ante assessments is not provided for in either case.

151

The regional focus of financial instruments contributed to Member States setting up a large number of small-sized financial instruments in the 2007-2013 programme period. Often, these individual ERDF and ESF specific funds did not have the size which in the fund industry is considered appropriate to operate them efficiently (see paragraphs 27 to 61).

Recommendation 1

As regards the ex ante assessments for financial instruments:

(a) the Commission’s ex ante assessment for centrally managed instruments should systematically include an analysis of the ‘lessons learnt’ to date.

Target implementation date: whenever a new instrument is established.

(b) the Commission, in addition to the ‘lessons learnt’, should also assess the effect of major socioeconomic changes on the rationale of the instrument and the corresponding contribution required from the EU budget in the context of their respective mid-term reviews for all centrally managed financial instruments.

Target implementation date: as soon as mid-term reviews are carried out.

Recommendation 2

The Commission and the Member States should aim at optimising the size of specific ERDF and ESF funds to take, wherever possible, advantage of the significant economies in the cost of operating funds. The Commission should provide additional guidance to Member States on how to set up such financial instruments within Member States or at Union level (which are managed directly or indirectly by the Commission).

Target implementation date: by the end of 2016 (for the Commission); when establishing the financial instruments (for Member States).

Did financial instruments succeed in attracting private capital?

152

We found that the Commission and Member States faced significant difficulties in attracting private-sector investors to financial instruments in both shared and central management during the 2007-2013 programme period. In particular, the preferential treatment of private investors for financial instruments did not succeed in attracting significant additional financing. In addition, we consider that the Commission’s measure of leverage for financial instruments does not properly take into account the extent to which public financing from the EU budget mobilises additional funds. Moreover, Member States are not obliged to report to the Commission information on private contributions to the capital endowment of ERDF and ESF instruments.

153

At this stage it seems unlikely that a significant amount of private funds will be attracted for the 2014-2020 programme period, through the OPs or as additional contributions. The guidance issued by the Commission in April 2014 does not sufficiently draw on the ‘good practices’ observed during the 2007-2013 programme period on how best to apply the provisions on preferential treatment to attract more private capital without allocating excessive risks to the public sector.

154

The use of advance tax agreements for financial instruments, which under certain conditions may result in tax avoidance, during the 2014-2020 programme period would go against the Commission’s own policy in this respect (see paragraphs 62 to 91).

Recommendation 3

The Commission should provide in the financial regulation (and subsequently in sectorial regulations) a definition for the leverage of financial instruments applicable across all areas of the EU budget, which clearly distinguishes between the leverage of private and national public contributions under the OP and/or of additional private or public capital contributions, and takes into account the type of instrument involved. This definition should clearly indicate how the amounts mobilised by the EU and national public contributions are determined, possibly following the OECD’s guidelines on the subject.

Target implementation date: at revision of financial regulation and for the sectorial regulation at mid-term review.

Recommendation 4

For ERDF and ESF financial instruments under the 2007-2013 programme period, the Commission should ensure that Member States provide complete and reliable data on private contributions on capital endowments, both through the OPs and in addition to them.

Target implementation date: by the end of 2017.

Recommendation 5

For ERDF and ESF financial instruments, the Commission should provide additional guidance to Member States on how best to apply the provisions on preferential treatment to attract more private capital without allocating excessive risks to public contributors to the financial instruments’ endowments.

Target implementation date: by the end of 2016.

Recommendation 6

For centrally managed financial instruments, the general risk-sharing principles which may have an impact on the EU budget should be defined in the legislation governing the instrument concerned.

Target implementation date: when making its proposals for the establishment of new financial instruments or the revision of existing ones.

Recommendation 7

For all financial instruments funded from the EU budget during the 2014-2020 programme period, the Commission should ensure that only structures which are in line with its own recommendations and actions with regard to tax arrangements are implemented by Member States, the Commission itself and the EIB group.

Target implementation date: by the end of 2016.

Were financial instruments providing revolving financial support?

155

For a large majority of ERDF and ESF instruments, no substantial revolving effect of funds had occurred by the end of 2014. This was due to the fact that implementation delays contributed to ERDF and ESF financial instruments’ difficulties in disbursing their endowments in full during the 2007-2013 programme period. The eligibility period needed to be extended from December 2015 to March 2017 to increase the likelihood that most financial instruments would spend their initial endowments once. Furthermore, after closure in March 2017, the implementation of the financial instruments is at the discretion of Member States and it remains to be seen to what extent a revolving effect will be realised.

156

For the 2014-2020 programme period, the provisions in the legal basis limit the risk of setting up instruments with excessive capital endowments, and consequently also help to increase the likelihood of achieving a revolving effect. This requires however that lessons have been learnt from the shortcomings observed during the 2007-2013 programme period, and managing authorities are more realistic about the share of the ESIF that can be implemented through financial instruments.

157

Other changes have been made which should help to set up instruments more efficiently, but we found that additional guidance is required on two specific aspects (see paragraphs 92 to 105).

Recommendation 8

The Commission should take appropriate measures to ensure that Member States maintain the revolving nature of the funds during the required 8-year period after the end of the eligibility period for the 2014-2020 programme period. This could be achieved by requiring the use of an explicit clause in the funding agreement to ensure that the funding is used for the intended purposes.

Target implementation date: by the end of 2016.

Recommendation 9

The Commission should provide guidance in respect of the provisions allowing financial instruments to continue to be used into the following programme period, in particular for cases where fund managers are selected on the basis of public procurement.

Target implementation date: by the end of 2016.

Did financial instruments prove to be a cost-efficient method of implementing the EU budget?

158

We found that a significant share of initial endowments of ERDF and ESF financial instruments was spent on management costs and fees. Moreover, the fee level was significantly higher than for centrally managed instruments or private-sector investment funds when compared to the financial support actually provided to final recipients. In view of the high levels observed by the end of 2014, there is a significant risk that a large number of ERDF and ESF instruments will exceed the ceilings for management costs and fees specified in the 2007-2013 legal base. High levels of management costs and fees may point to a fundamental problem with the way in which this funding mechanism has been implemented during the 2007-2013 programme period.

Management costs or fees incurred and paid by 31 March 2017 can be declared as an eligible expenditure of the ERDF and ESF programmes under which the financial instrument has been set up. The regulation specifies that the ceilings for management costs and fees are related to ‘the capital contributed from the operational programme’ to the instruments.

According to the Commission the ceilings referred to in Article 43 of the implementing regulation are applicable to the total capital contribution to the financial instrument, rather than the actual contribution used to provide financial support to final recipients. In our view, at closure, the ceilings set out in the regulation should however be interpreted as applying to the actual used capital endowment contributed from the OP to the financial instrument, i.e. the one that has been used to provide financial support to final recipients. Fund managers should not be remunerated for not making use of the instruments’ capital endowment.

159

The Commission does not have a comprehensive overview of the implementation costs of ERDF and ESF financial instruments, and how management costs and fees are determined and whether they are justified. Similarly, the Commission lacks information on the overall administrative costs for each Member State of implementing the ESIF during the 2014-2020 programme period, depending on how use is made of the alternative funding mechanisms (i.e. grants or repayable financial support, mainly through financial instruments).

160

We also note that these management costs and fees are incurred in addition to the general administrative costs for the ERDF and ESF OPs. Since management costs are paid out of the instruments’ initial endowment, they reduce the level of funding from the EU budget which is available for final recipients.

161

For the 2014-2020 programme period, the reporting deadlines for Member States have been reduced since the reporting on financial instruments is now part of the annual implementation report. This report is submitted to the Commission 1 month earlier than the previous reporting on financial instruments, except for the years 2017 and 2019. At the same time the Commission’s deadline for presenting its report to the discharge authorities has been fixed at 6 months. In comparison, during the 2007-2013 programme period, the Commission had 3 months to verify the data and present its consolidated implementation report on financial instruments. This means relevant information on the implementation of financial instruments and their related costs is available later than in the previous period.

162

With regard to management costs and fees, the legislation was significantly improved, providing ceilings on cumulative amounts which are below those applicable during the 2007-2013 programme period. However, the performance-based elements are not yet sufficiently strong and the Commission must provide additional clarification on how managing authorities should make use of these provisions when negotiating the funding agreements (see paragraphs 106 to 145).

Recommendation 10

In view of the upcoming closure of the 2007-2013 programme period, the Commission should:

(a) ensure that Member States report comprehensive information on management costs and fees incurred and paid by March 2017.

Target implementation date: by the end of 2017.

(b) clarify that the ceilings for management costs and fees need to be applied to the actual capital endowment used by the financial instrument, i.e. the contribution from the OP that has been used to provide financial support to final recipients.

Target implementation date: by the end of March 2017.

Recommendation 11

As regards the performance-based remuneration of fund managers in the 2014-2020 programme period:

(a) the Commission should make a legislative proposal aiming at a revision of the existing provisions in the CPR to strengthen the incentive effect of these arrangements.

Target implementation date: by the end of 2016.

(b) Member States’ managing authorities should make extensive use of the existing performance-based elements of the remuneration for fund managers when negotiating funding agreements. This could be complemented by the use of additional elements on a voluntary basis.

Target implementation date: immediately

Recommendation 12

The Commission should carry out a comparative analysis of the implementation costs of grants and repayable financial support, mainly through financial instruments, for the 2014-2020 programme period with a view to establishing their actual levels. Such information would be particularly relevant for preparing legislative proposals for the post-2020 period and determining an adequate level of technical assistance.

Target implementation date: by the end of 2017.

163

Finally, during the 2014-2020 programme period, it will also be vital for the Commission and the EIB to effectively coordinate the use of financial instruments in shared and centralised management funded from the EU budget with the European Fund for Strategic Investment (EFSI), also known as the ‘Juncker plan’. Only then can the financial instruments under the EU budget contribute most effectively to the much needed infrastructure investments in the EU.

This Report was adopted by Chamber II, headed by Mr Henri GRETHEN, Member of the Court of Auditors, in Luxembourg at its meeting of 1 June 2016.

Abbreviations

CEF: Connecting Europe Facility

CF: Cohesion Fund

COCOF: Coordination Committee of the Funds

CPR: common provisions regulation

EAFRD: European Agricultural Fund for Rural Development

EaSI: European Union programme for employment and social innovation

EEEF: European Energy Efficiency Fund

EEPR: programme to aid economic recovery by granting Community financial assistance to projects in the field of energy

EFF: European Fisheries Fund

EFSI: European Fund for Strategic Investments

Egesif: Expert Group on European Structural and Investment Funds

EIB: European Investment Bank

EIF: European Investment Fund

EPMF: European Progress Microfinance Facility for employment and social inclusion

ERDF: European Regional Development Fund

ESF: European Social Fund

ESIF: European Structural and Investment Funds

GBER: general block exemption regulation

Jeremie: Joint European Resources for Micro to Medium Enterprises

LGTT: Loan Guarantee Instrument for Trans-European Transport Network Projects

Marguerite Fund: The 2020 European fund for Energy, Climate Change and Infrastructure

MFF: multiannual financial framework

OP: operational programme

PBI: project bond initiative

PFLP: portfolio first loss piece

SICAV: Société d’investissement à capital variable

SICAR: Société d’investissement en capital à risque

SMEs: small and medium-sized enterprises

SoA: statement of assurance

TEN-E/T: trans-European networks — energy/transport

TFEU: Treaty on the Functioning of the European Union

Glossary

Capital endowment refers to the amount of funding paid to a financial instrument (from the EU budget, the national budget or private investors) to support its operations. It should reflect its capacity for investment and be commensurate to the market that the instrument targets.

CEF regulation: Regulation (EU) No 1316/2013 of the European Parliament and of the Council of 11 December 2013 establishing the Connecting Europe Facility, amending Regulation (EU) No 913/2010 and repealing Regulations (EC) No 680/2007 and (EC) No 67/2010¹.

Cohesion policy in the 2007-2013 programme period covered the European Regional Development Fund and the European Social Fund (i.e. the two Structural Funds) and the Cohesion Fund. In the 2014-2020 programme period, the coordination between cohesion policy and the other EU policies contributing to regional development, namely rural development and fisheries and maritime policy, was improved by the establishment of common provisions for the European Structural and Investment Funds.

The Coordination Committee of the Funds (COCOF) is a standing monitoring committee of the Commission. Its function is to discuss issues relating to the implementation of the regulations governing the European Regional Development Fund, European Social Fund and Cohesion Fund.

Common provisions regulation (CPR) for the 2014-2020 period: Regulation (EU) No 1303/2013 of the European Parliament and of the Council of 17 December 2013 laying down common provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund and laying down general provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund and the European Maritime and Fisheries Fund and repealing Council Regulation (EC) No 1083/2006².

A contingent credit line is a credit line which could be drawn provided that a previously defined event occurred.

Delegated regulation: Commission Delegated Regulation (EU) No 480/2014 of 3 March 2014 supplementing Regulation (EU) No 1303/2013 of the European Parliament and of the Council laying down common provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund and laying down general provisions on the European Regional Development Fund, the European Social Fund, the Cohesion Fund and the European Maritime and Fisheries Fund³.

The European Fund for Strategic Investments (EFSI) aims to mobilise at least 315 billion euro in private and public long-term investment across the EU over the 2015-2017 period, and to guarantee the funding of projects in subsequent years. The EFSI is established within the European Investment Bank (EIB) as a trust fund with unlimited duration to finance riskier parts of projects. A guarantee of up to 16 billion euro, backed by the EU budget, will compensate for the additional risk taken by the EIB. Member States can contribute additional funds to the EFSI.

The Expert Group on European Structural and Investment Funds (Egesif) was created in the Commission with the aim of providing advice to the Commission on issues in relation with the implementation of programmes adopted and implemented in accordance with the European Structural and Investment Funds regulations. It is one of the two groups replacing the Coordination Committee of the Funds (the second one being Coesif — Coordination Committee for European Structural and Investment Funds).

The aim of the European Regional Development Fund (ERDF) is to reinforce economic and social cohesion within the European Union by redressing the main regional imbalances through financial support for the creation of infrastructure and productive job-creating investments, mainly for businesses.

The aim of the European Social Fund (ESF) is to strengthen economic and social cohesion within the European Union by improving employment and job opportunities, mainly through training measures, encouraging a higher level of employment and the creation of more and better jobs.

The European Structural and Investment Funds (ESIF) cover five separate funds that aim to reduce regional imbalances across the Union during the 2014-2020 programme period. The funds include: the European Regional Development Fund; the European Social Fund; the Cohesion Fund; the European Agricultural Fund for Rural Development; and the European Maritime and Fisheries Fund.

Equity investment means the provision of capital to a firm, invested directly or indirectly in return for total or partial ownership of that firm and where the equity investor may assume some management control of the firm and may share the firm’s profits.

A financial intermediary is an entity acting as an intermediary between the managing authority or the holding fund and the final recipients of funds channelled through financial instruments in shared management.

A final recipient is any legal or natural person, other than a holding fund or financial intermediary, receiving funding from a financial instrument.

Financial regulation: Regulation (EU, Euratom) No 966/2012 of the European Parliament and of the Council of 25 October 2012 on the financial rules applicable to the general budget of the Union and repealing Council Regulation (EC, Euratom) No 1605/2002⁴.

General regulation for the 2007-2013 programme period: Council Regulation (EC) No 1083/2006 of 11 July 2006 laying down general provisions on the European Regional Development Fund, the European Social Fund and the Cohesion Fund and repealing Regulation (EC) No 1260/1999⁵.

A guarantee is a commitment by a third party, called the guarantor, to pay the debt of a borrower when the latter cannot pay it themselves. The guarantor is liable to cover any shortfall or default on the borrower’s debt under the terms and conditions as stipulated in the agreement between the guarantor, the lender and/or the borrower.

A guarantee cap rate is a percentage of a total loan portfolio value actually covered by the guarantee.

A holding fund is a fund set up to invest in several venture capital funds, guarantee funds, loan funds, urban development funds, funds or other incentive schemes providing loans, guarantees for repayable investments, or equivalent instruments, for energy efficiency and use of renewable energy in buildings, including in existing housing.

The hurdle rate is the minimum rate of return on a project or investment required by a manager or investor.

Implementing regulation: Commission Regulation (EC) No 1828/2006 of 8 December 2006 setting out rules for the implementation of Council Regulation (EC) No 1083/2006 and of Regulation (EC) No 1080/2006 of the European Parliament and of the Council on the European Regional Development Fund⁶.

Joint European Resources for Micro to Medium Enterprises (Jeremie) is an initiative of the Commission developed together with the European Investment Fund. It promotes the use of financial engineering instruments to improve access to finance for SMEs through the Structural Funds.

Legacy funding is the part of the capital endowment which reached the final recipients, was subsequently returned to the financial instrument and it is thus available for a new round of investments.

A loan means an agreement which obliges the lender to make available to the borrower a sum of money for the agreed amount and time. The borrower is obliged to repay the loan after a certain period. Usually the borrower is obliged to pay interest on the loan amount.

A managing authority is a national, regional or local public authority, or any other public or private body, which has been designated by a Member State to manage an operational programme. Its tasks include selecting projects to be funded, monitoring how projects are implemented and reporting to the Commission on financial aspects and results achieved.

An operational programme (OP) sets out a Member State’s priorities and specific objectives and how funding will be used during a given period, generally 7 years, to finance projects. These projects must contribute to achieving one or more of a certain number of objectives specified at the level of the OP’s priority axis. Programmes have to be in place for each of the funds in the area of cohesion policy, i.e. the European Regional Development Fund, European Social Fund or Cohesion Fund. OPs are prepared by Member States and must be approved by the Commission before any payments from the EU budget can be made. They can only be modified during the period covered if both parties agree.

Portfolio first loss piece (PFLP): when a portfolio of loans is divided in several risk tranches, the PFLP is the tranche which absorbs the first losses of the portfolio (which could be for example the result of loan defaults).

Priority axis: one of the priorities of the strategy in an operational programme comprising a group of operations which are related and have specific measurable goals.

A Société d’investissement en capital à risque (SICAR) is a structure designed for private equity and venture capital investments with no investment diversification rules, nor lending or leverage restrictions.

A Société d’investissement à capital variable (SICAV) is a type of open-ended investment fund for which the value of its capital changes based the number of investors and on the value of its underlying investments. Shares in the fund are bought and sold based on the fund’s latest net asset value.

Specific funds are funds which are not holding funds.

State aid is any form of direct or indirect financial support provided by public authorities to private-sector undertakings. The Treaty on the Functioning of the European Union (TFEU) generally prohibits state aid within the common market unless it is duly justified. The EU State aid rules set out when this support does not distort (or does not threaten to distort) competition. The European Commission has the exclusive competence to assess the compatibility of state aid granted by Member States with these rules. Procedural decisions and actions taken by the European Commission are subject to review by the Court of Justice of the European Union and the General Court.

Audit team

The ECA’s special reports set out the results of its performance and compliance audits of specific budgetary areas or management topics. The ECA selects and designs these audit tasks to be of maximum impact by considering the risks to performance or compliance, the level of income or spending involved, forthcoming developments and political and public interest.

This performance audit was produced by Audit Chamber II — headed by ECA Member Henri Grethen — which specialised in structural policies, transport and energy spending areas. The audit was led by the Reporting Member Iliana Ivanova, supported by Tony Murphy, Head of Private Office and Mihail Stefanov, Attaché; Niels-Erik Brokopp, Principal Manager; Rares Rusanescu, Head of Task; and Agathoclis Argyrou, Marcel Bode, Viorel Cirje and Maria Ploumaki, Auditors.

About

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More information on the European Union is available on the internet (http://europa.eu).

Luxembourg: Publications Office of the European Union, 2016

Print	ISBN 978-92-872-5417-7	ISSN 1831-0834	doi:10.2865/66662	QJ-AB-16-019-EN-C
PDF	ISBN 978-92-872-5399-6	ISSN 1977-5679	doi:10.2865/98596	QJ-AB-16-019-EN-N
EPUB	ISBN 978-92-872-5414-6	ISSN 1977-5679	doi:10.2865/617611	QJ-AB-16-019-EN-E

© European Union, 2016

Reproduction is authorised provided the source is acknowledged.

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