“The European Monetary Union – Return to Stability”Klaus Regling, CEO of EFSF

EESC, 9 November 2011

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The Euro: a success story

Price stability Average inflation over last twelve years close to 2%

Relative fiscal discipline Aggregated fiscal deficit of eurozone before financial crisis at 0.6 % of GDP USA, UK and Japan close to 3% of GDP in 2007

EMU stimulated cross border trade Protection of Single Market against exchange rate volatility

Higher GDP growth*

Second most important world currency

* McKinsey, KFW

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EMU better positioned than other currency areas

Source: IMF April 2011Euro area without Estonia

Fiscal balance, euro area vs USA and Japan (in % of GDP)

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But, EMU needs to function better

Lack of fiscal discipline in some Member States led to sovereign debt crisis

Macro-economic imbalances emerged through loss of competitiveness

Lack of control over data

No crisis resolution mechanism

Problems emerged during first decade and were aggravated by global crisis

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Member States have reacted …

… at national level

Fiscal consolidation/debt reduction

Structural reforms to enhance growth potential

Measures to avoid excessive economic imbalances

Improving the health of the banking sector

… at European level

Better governance of EMU

Stronger financial market supervision

Credible statistics

Crisis resolution mechanism

National measures are showing results

Source: European Commission: Forecast – Spring 2011

Fiscal balance, general government (as % of GDP)

Unit Labour Costs relative to Germany, nominal (1998 Q1=100)

Portugal GreeceIrelandGermany

Current account balance (as % of GDP)

Source:OECD

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Enhanced economic governance at European level

■ Reinforcing the Stability and Growth Pact (SGP)■ Possible sanctions in corrective and preventive arm■ Reduced possibilities for political interference

■ SGP complemented by “European Semester”■ To avoid negative spill-over effects

■ New “Excessive Imbalances Procedure” ■ Multilateral surveillance to tackle imbalances early – also sanctions possible

■ “Euro-Plus-Pact”■ National measures to foster competitiveness■ Introduction of constitutional fiscal rules

■ “Europe 2020 strategy”■ Structural reforms to enhance growth and employment

■ More efficient decision-making process ■ Reinforcing the Eurogroup■ Creation of Euro Area Summit

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A clear commitment to future financial stability

■ Comprehensive regulatory reform agenda for financial markets■ Implementation of Basel III■ Regulation of Rating Agencies ■ Regulation of Alternative Investment Fund Managers (Hedge Funds)

■ New European Institutions■ Three new supervisory authorities – EBA, EIOPA, ESMA – to oversee banking,

insurance and securities markets■ A “European Systemic Risk Board” (ESRB) to monitor macro-economic risks

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European Financial

Stabilisation Mechanism “EFSM”

€60 bn

Available to all 27 EU member states

A new framework for crisis management

€750bn Financial Stability Package

European Financial Stability Facility

“EFSF”

€440 bn

For euro area Member States

International Monetary Fund

€250 bn max

Up to half the amount drawn fromEFSF and EFSM

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EFSF: a lean organisation

Board of Directors*

CEO Klaus Regling + about 20 staff covering:Operations:

Funding strategyLendingRisk management

ResearchLegalCommunicationCorporate governance, Audit, accounting & admin

Finanzagentur (German DMO)

Front/Back office debt issuance

cash managementrisk management

European Investment Bank

Accounting Documentation

Infrastructure (Facility)

ECB (Account opened)

European Financial Stability Facility

Shareholders Euro Area Member States

Founded 7 June 2010 with Tenure of 3 years - up to June 2013

Based in Luxembourg (“société anonyme” under Luxembourgish law)

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EFSF: AAA credit rating

AAA Stable

Aaa Stable

AAA Stable

The top rating and the long-term issuer rating reflect:

Strong shareholder support

Credit enhancement

An organisation supported by the best expertise

Conservative strategy of funding and investment

EFSF bonds are eligible as ECB collateral

Financial assistance programme for Ireland

Objectives of the programme Immediate strengthening and comprehensive overhaul of the banking

sector Ambitious fiscal adjustment to restore fiscal sustainability, correction of

excessive deficit by 2015 Growth enhancing reforms, in particular on the labour market, to allow a

return to a robust and sustainable growth

Financing The total €85 billion of the programme will be financed as follows:

– €17.5 bn contribution from Ireland (Treasury and NPRF*)– €67.5 bn external support

– €22.5bn from IMF– €22.5bn from EFSM– €17.7bn from EFSF + bilateral loans from the UK (€3.8bn),

Denmark (€0.4bn) and Sweden (€0.6bn)

Disbursements will be made over 3 years with an average loan maturity of 7½ years**

Ireland

IMF

EFSM

EFSF+bilateralloans

* National Pension Reserve Fund

** Maturity and lending costs are subject to revision following euro zone summit of 21 July

€35 billion

€50 billion

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EFSF inaugural issue : record breaking investor demand

On 25 January 2011, EFSF placed its inaugural issue in support of Ireland.

Record breaking order book of €44.5 bn

Orders received from over 500 investors

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Breakdown by investor type

Geographical breakdown

Pension fund3%

Private banks2%

Corporate1%

Hedge fund1%

Central Bank/Govt/Sov wealth

fund44%

Insurance10%

Banks13%

Fund managers

26%

UK11%

Middle East2%

USA3%

Americas-others2%

Asia-Japan22%

Rest of Europe9%

Eurozone37%

Asia-ex Japan14%

Amount placed €5 billion

Maturity 18/07/2016

Coupon 2.75%

Initial pricing Mid swap +6bp

Reoffer yield 2.892%

Reoffer price 99.302%

Settlement date 1 February 2011

Lead managers Citi, HSBC, Société Générale

Effective lending cost 5.9%

Amount transferred to Ireland €3.6 billion

Financial assistance programme for Portugal

Objectives of the programme Restore fiscal sustainability through ambitious fiscal adjustment

Enhance growth and competitiveness via reforms and measures, i.e. Freeze govt. sector wages until 2013, reduce pensions over €1500 Reform unemployment benefits and reduce tax deductions Execute an ambitious privatisation programme (TAP, Caixa Seguros …)

Improve liquidity and solvency of financial sector Banking support scheme of up to €12 billion to provide necessary capital for

banks to bring Tier 1 capital ratios to 10% by end 2012 in case market solutions cannot be found

Financing The total €78 billion of the programme will be financed as follows:

– €26 billion from IMF– €26 billion from the EU (EFSM)– €26 billion from EFSF

Disbursements will be made over 3 years with an average loan maturity of 7½ years*

IMF

EU

EFSF

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9,1

5,9

4,5

3

2010 2011 2012 2013

GDP deficit reduction objectives

% o

f GD

P

* Maturity and lending costs are subject to revision following euro zone summit of 21 July

North America1%

UK12%

Asia-ex Japan19%

Euro zone43%

Rest of Europe4%

Asia-Japan21%

First issue for Portugal

On 15 June 2011, EFSF placed its first issue in support of the Portuguese programme

10 year maturity

Orders received from over 100 investors

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Breakdown by investor type

Geographical breakdown

Central Bank/Govt/ Sov

wealth fund37%

Insurance/ Pension funds

10%

Banks25%

Fund managers28%

Amount placed €5 billion

Maturity 05/07/2021

Coupon 3.375%

Initial pricing Mid swap +17bp

Reoffer yield 3.493%

Reoffer price 99.013%

Settlement date 22 June 2011

Lead managersBarclays, Deutsche Bank, HSBC

Effective lending cost 6.08%

Amount transferred to Portugal €3.7 billion

Middle East4%

North America4%

UK5%

Asia-ex Japan24%

Euro zone33%

Rest of Europe8%

Asia-Japan22%

Second issue for Portugal

On 22 June 2011, despite volatile market conditions, EFSF placed its second issue in support of the Portuguese programme

€3 billion issue with a 5 year maturity

Order book in excess of €7 billion

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Breakdown by investor type

Geographical breakdown

Central Bank/Govt/ Sov

wealth fund54%

Others3%

Banks25%

Fund managers18%

Amount placed €3 billion

Maturity 05/12/2016

Coupon 2.750%

Initial pricing Mid swap +6bp

Reoffer yield 2.825%

Reoffer price 99.636%

Settlement date 29 June 2011

Lead managersBNP Paribas, Goldman Sachs, RBS

Effective lending cost 5.32%

Amount transferred to Portugal €2.2 billion

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The new EFSF

Increased guarantee commitments of €780 billion

Effective lending capacity of €440 billion

New instruments linked with appropriate conditionality: Intervention in primary and secondary markets Precautionary programmes Finance recapitalisation of financial institutions through loans to governments including in non-

programme countries

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Primary market purchases (PMP)

Objective: maintain or restore a Member State’s relationship with the dealer/investment community and reduce the risk of a failed auction

Circumstances

Countries under a macro-economic adjustment programme or to drawdown of funds under a precautionary programme.

Primarily used towards the end of an adjustment programme to facilitate a country’s return to the markets

Conditions: Those of macro-economic adjustment programme or the precautionary programme as stated in relevant MoU

Limit: No more than 50% of the final issued amount

Once purchased: EFSF couldResell to private investors once market conditions have improvedHold until maturitySell back to countryUse for repos with commercial banks to support EFSF’s liquidity management

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Secondary Market Purchases (SMP)Objective:

1.Support the functioning of the debt markets and appropriate price formation in government bonds

2.Market making to ensure some liquidity in debt markets

3.Give incentives to investors to further participate in the financing of countries

Conditions:

Programme countries: conditionality of the programme applies as in MoU

Non-programme countries: conditionality refers to ex-ante eligibility criteria as defined in the context of the European fiscal and macro-economic surveillance

framework appropriate policy reforms as in MoU

Procedure:

Initiated by a request from a Member State to Eurogroup president.

Exceptionally, ECB could issue an early warning.

In all cases, subject to an ECB report identifying risk to euro area and assessing need for intervention.

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Precautionary credit linesObjective:

prevent crisis situations by assistance before MS face difficulties raising funds in the capital markets

avoid negative connotation of being a programme country

In line with established IMF practices:

Precautionary conditioned credit line (PCCL) access limited to countries with sound economic and financial situation, Clear track record of access to capital markets, respect of SGP* and EIP* commitments

Enhanced conditions credit line (ECCL) access open to countries with moderate vulnerabilities that preclude access to PCCL

Conditions:

Beneficiary placed under enhanced surveillance during its availability period

All conditions stated in MoU

Size: Typical size 2-10% of GDP of beneficiary country.

Duration: 1 year renewable for 6 months twice

Procedure: lighter request procedure for swift implementation

*SGP: Stability and Growth Pact, EIP: Excessive Imbalances Procedure

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Finance recapitalisation of financial institutions Objective:

limit contagion of financial stress by assisting a country to finance recapitalisation of financial institution(s) at sustainable borrowing costs.

Open to all MS, particularly to countries with disproportionally large financial sector.

Circumstances: Any loans must be requested and disbursed to Member States. EFSF will not loan directly to financial institutions

In order to determine eligibility for an EFSF loan, a three step approach is applied:1.Private sector (shareholders)2.National level (government)3.European level (EFSF)

Conditions:

Sine qua non condition of restructuring/resolution of financial institutions.

Compliance with European state aid rules

Additional conditionality on financial supervision, corporate governance and domesic laws on restructuring/resolution.

All conditions stated in MoU

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A comprehensive approach – the euro summit of 26 October 2011

Optimising the EFSF’s firepower using two options Credit enhancement approach – partial protection certificates for newly issued euro area Member

States’ bonds Co-financing with private investors (CIF – Co-Investment Fund)

Second rescue package for Greece including agreement on Private Sector Involvement Proposal of a voluntary bond exchange with a nominal discount of 50% on notional Greek debt

held by private investors. Exchange to be completed early 2012 Collateral for voluntary bond exchange of up to €30 billion Additional programme financing of up to €100 billion until 2014, including required recapitalisation

of Greek banks

Recapitalisation of the European banking sector Facilitating access to term-funding through a coordinated approach at EU level Increasing the capital position of banks to 9% of Core Tier 1 by the end of June 2012

Governance Strengthening of governance structure – bi-annual Euro Summit Strict surveillance of euro area Member States

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The need for a permanent crisis mechanism

Unlike the US, the Euro zone has no fiscal centre to tackle crises

Europe already had Balance of Payments instruments in place for EU members and EU neighbourhood countries but no financial assistance mechanism for euro area members

The Great Depression and the Gold Standard (fixed exchange rate) made the need for a global institution to provide financial support clear

This is why the International Monetary Fund was established in 1944

Why?

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Creation of a permanent crisis mechanism

The creation of the European Stability Mechanism (ESM)

an intergovernmental organisation under public international law, operational from mid-2013

ESM will take over all instruments of the new EFSF effective lending capacity of €500 billion total subscribed capital of €700 billion, with paid-in capital (€80 billion) and

committed callable capital and guarantees (€620 billion) private sector involvement

– Case-by-case based on debt sustainability analysis– Following established IMF policies– ESM will claim preferred creditor status – Standardized and Collective Action Clauses (CACs) will be included for all new

euro area government bonds from June 2013

ESM treaty to be ratified by euro zone country parliaments in 2012.

Member States took action National austerity packages and reforms to enhance competitiveness Sharpening of Stability and Growth Pact European procedure to tackle macro-economic imbalances Strengthening of Financial Market Supervision New crisis resolution mechanism New powers for Eurostat

Through adjustment, reforms and deeper integration The European Monetary Union will function better Eurozone will play stronger role globally

But is more needed? European Finance Minister? Commissioner for Eurozone? Right of Action to take Member State to European Court of Justice? True Political and Fiscal Union including Eurobonds? Democratic legitimacy?

Conclusions: from crisis to a better functioning euro area

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