Rating action

Scope Ratings GmbH (Scope) has today affirmed the European Union’s and Euratom’s AAA long-term issuer and senior unsecured foreign-currency ratings, along with a short-term issuer rating of S-1+ in foreign currency. All Outlooks are Stable.

For the detailed rating report, click here.

Rating rationale

The AAA rating of the European Union (EU) reflects the supranational’s ‘very strong’ Member support and ‘excellent’ intrinsic strength.

The rating benefits from the largest European economies being the EU’s highly rated key Member States, with a weighted average rating of AA-; the supranational’s track record of and solid legal basis for receiving timely financial support; and extraordinary support mechanisms, ensuring de facto joint and several support from the EU’s Member States. In addition, the EU’s legally enshrined debt service priority combined with its meaningful budgetary flexibility to delay significant amounts of its annual expenditure provides further investor assurance.

The EU’s institutional profile is characterised by its record of excellent governance and its irreplaceable mandate for its Member States. Not only is it at the heart of Europe’s response to Covid-19 and the energy crisis via the SURE and NGEU programmes, but it is also leading the continent’s transition towards a carbon-neutral and climate-resilient economy with its up to EUR 250bn green bond programme.

The assessment of the EU’s financial profile is supported by a very strong liquidity and funding profile including high, prudently managed liquid assets, excellent market access given its global benchmark issuer status, and a diversified funding base. The EU’s high asset quality reflects its direct lending mostly to EU sovereigns, combined with its preferred creditor status and the resulting track record of negligible non-performing loans.

Challenges, which are marginal at the AAA level, relate to an almost tenfold increase from 2020 levels in outstanding debt anticipated over the coming years, which will result in higher debt repayments going forward, and a steady increase in outstanding guarantees, mostly to the European Investment Bank (AAA/Stable).

The Stable Outlook reflects Scope’s assessment of the EU’s financial buffers to withstand shocks. The rating could be downgraded if, individually or collectively: i) highly rated key Member States were downgraded; ii) the EU’s institutional setup weakened; and/or iii) the EU’s liquidity buffers declined.

Key rating drivers

The first driver of the EU’s AAA rating is its very strong Member support.

The EU’s borrowings are backed by the EU budget, which is mostly financed by GNI-based transfers from EU Member States, customs duties, VAT and a plastic based own resource. The largest European economies – Germany (AAA/Stable), France (AA/Negative), Italy (BBB+/Stable), Spain (A-/Stable), Poland (A/Stable), the Netherlands (AAA/Stable), Sweden (AAA/Stable) and Belgium (AA-/Stable) – account for around 75%-80% of the EU’s economy, population and GNI-based national budgetary transfers and thus constitute the EU’s key Member States, with a weighted average rating of AA-.

Scope highlights that the EU’s Member support also includes extraordinary mechanisms that enhance its debt service ability. Debt is usually repaid using the proceeds of repayments from borrowing countries that received back-to-back financing of loans. While this layer of protection continues to apply to loans provided under the SURE instrument and the NGEU recovery fund, it will not apply to NGEU grants.

However, in case a borrowing country fails to repay its loan to the EU on time, or, in the case of bond repayments related to direct grants to Member States via NGEU, ‘the European Parliament, the [European] Council and the [European] Commission shall ensure that the financial means are made available to allow the [European] Union to fulfil its legal obligations in respect of third parties’¹. Scope acknowledges this legal debt service priority to third parties, taking into account the budgetary flexibility of the European Commission to delay significant amounts of the EU’s annual expenditure of about EUR 40bn-60bn from the European regional and cohesion funds.

Moreover, if the EU’s available cash resources were insufficient to service debt, the European Commission would be legally entitled to draw funds from all Member States. In such an adverse event, which Scope deems unlikely, the required funding request ‘shall be divided among the Member States, as far as possible, in proportion to the estimated budget revenue from each of them’². In addition, Member States are legally obliged to ‘execute the Commission’s payment orders following the Commission’s instructions and within not more than three working days of receipt’³. In Scope’s opinion, this is an exceptionally strong and timely guarantee mechanism, with a de facto joint and several support framework that is unique among supranationals. These considerations provide the EU with a very strong institutional setup that underpins Scope’s assessment of the EU’s excellent member support.

The second driver of the EU’s AAA rating is its very strong institutional profile.

This reflects the EU’s excellent governance and irreplaceable mandate for its Members, being at the forefront of the EU’s policy design and implementation. It includes financial assistance programmes to countries in financial distress, programmes to close Europe’s investment gap, financial and policy support to facilitate the recovery from the Covid-19 and energy crises and a central role in fostering Europe’s transition to carbon neutrality. In response to the Covid-19 and energy crises, the EU’s financial activities and liabilities will increase almost tenfold from 2020 levels over the coming years to around EUR 975bn, or about 7% of the EU’s GDP, on account of SURE and NGEU. The SURE instrument demonstrates the solidarity among EU Member States. It became the world’s largest social bond programme having raised EUR 98.4bn by its completion in December 2022. Funds have been disbursed to 19 Member States between October 2020 and December 2022 to help finance increases in public expenditure to preserve employment related to the Covid-19 shock.

In addition, at least 37% of the Recovery and Resilience Facility – which accounts for 90% of NGEU – is set for green investments. As a result, around 30%, or EUR 250bn, of NGEU bond issuance will be directly linked to the objectives of a green and sustainable economic recovery. The REPowerEU Plan launched in May 2022 further supports these efforts by aiming to accelerate the green transition and promoting investments in renewable energies. This will transform the EU into the largest green bond issuer worldwide and underline its commitment to achieving its climate targets. To date, the EU has raised EUR 44bn via green bonds – all based on the EU’s Green Bond Framework, which is aligned with the green bond principles of the International Capital Market Association. These factors highlight the exceptional importance of the EU to its Member States and underpins Scope’s assessment of the EU’s very strong institutional profile.

The third driver underpinning the EU’s AAA rating is its very strong financial profile.

The EU’s conservative liquidity management and budgetary practices result in high and stable liquid assets. Over the past eight years, the cash balance never dropped below EUR 10bn; the lowest recorded balance was EUR 7.4bn in July 2012. As of June 2023, cash stood at EUR 27.5bn. In addition to the cash balance, Scope’s calculation of the EU’s liquid assets also includes the budgetary margin. This refers to the difference between the maximum resources the EU can draw on from its Member States without the need for any subsequent decision by national authorities (the ‘own resources ceiling’) and the annual payment appropriations for EU expenditure. The own resources ceiling is legally binding, and it has never been reached. Thus, Scope has conservatively adjusted this margin for the pro-rata budgetary contributions of Member States rated AA- or above, currently at around 64%.

Critically, Member States decided to increase the own resources ceiling from 1.20% of the EU’s estimated GNI to 1.40%, to account for Brexit as well as potential sudden drops of the economy such as the one in 2020 prompted by the Covid-19 pandemic. In addition, Member States agreed to set aside a further 0.6pp until 2058 to cover repayment of all liabilities from NGEU borrowings. The total ceiling is thus 2.00% of the EU’s GNI, or about EUR 340bn for 2023.

The margin between the potential maximum Member State contribution of the EU’s highly rated members and the actual payments for the 2021-27 period – adjusted for ‘other revenues’ that increase the budgetary margin and the share of Member States rated AA- or above – averages around EUR 119bn over 2021-27. Together with the estimated average cash balance of EUR 27.1bn^a and the NGEU-specific liquidity account of EUR 20bn, this results in liquid assets of around EUR 166bn for 2021-27.

Conversely, for 2023, Scope estimates the EU’s liabilities materialising within 12 months at around EUR 151bn. This includes bond repayments (EUR 9.4bn) and expected disbursements of EUR 140bn, driven mostly by NGEU (EUR 120bn). Looking ahead, Scope estimates that the EU’s disbursements will remain elevated at around EUR 150bn each year during the 2021-25 period on account of NGEU assuming full take up of NGEU loans. On this basis, Scope estimates the liquid assets ratio will hover at around 90%-100% during 2021-25. Critically, once these large disbursements are made, the liquidity ratio will again increase gradually to above 190% by 2027, assuming no additional significant disbursements are made for other financial assistance programmes. These liquidity coverage estimates are very conservative however, as, contrary to most other supranationals, the EU does not face contractually binding disbursements and is therefore only committed to disburse funds after they are actually raised.

Looking further ahead, the EU will gradually repay its outstanding liabilities. Scope estimates that annual bond repayments due each year will likely amount to less than EUR 45bn. This assumes, conservatively, that the EU repays each year the maximum amounts of EUR 8bn under SURE and EUR 27bn under NGEU. Actual figures are likely to be lower, however. Still, even this amount can be fully covered by the EU’s liquid assets due to the high cash balances but particularly because the own resources ceiling will remain elevated at 2.00% of the EU’s GNI until all bond repayments for the NGEU programme are made.

The EU’s financial profile also benefits from its excellent capital markets access. Scope notes that the EU’s debt securities benefit from preferential regulatory treatment as they are: i) designated as Level 1 HQLA assets for liquidity coverage requirements; ii) assigned a 0% regulatory risk weight under the Basel framework; iii) eligible for preferential treatment under Solvency II; and iv) eligible for the European Central Bank’s asset purchase programmes and for collateralised credit operations under haircut category I (the same as central governments and central banks - changed from category II in June 2023), in addition to enjoying appeal among ESG investors. SURE bonds are classified as social bonds under an ICMA-compliant Social Bond Framework, and about EUR 250bn or 30% of the NGEU bonds will be under the ICMA-compliant Green Bond Framework. The EU’s bond issuances for SURE and NGEU have benefited from extraordinary investor demand, being multiple times oversubscribed and resulting in favourable funding costs across the yield curve. In fact, the EU’s issuances have recorded the largest-ever order books for a supranational issuer in the euro market, reflecting investor confidence. In this context, Scope also notes the gradual transition away from the ECB as a key investor given the end of its purchase programmes towards other long-term investors, including foreign central banks attracted by the frequent, high volume and positive-yielding EU securities.

The EU’s financial profile is further supported by its high asset quality and excellent asset performance, reflecting its preferred creditor status and regionally diversified portfolio. The EU’s main risk exposure relates to financial assistance provided via SURE, NGEU, the European Financial Stabilisation Mechanism and the Ukraine-focussed MFA support. Via these programmes, the sovereign exposures to Italy (BBB+/Stable), Portugal (A-/Stable), Ukraine (CC/Negative), Ireland (AA-/Positive), Spain (A-/Stable), Greece (BBB-/Stable), Poland (A/Stable) and Belgium (AA-/Stable) account for around 90% of the EU’s total direct loan exposure. Based on Scope’s sovereign ratings, this corresponds to a weighted-average borrower quality of around BBB+. Looking ahead, Scope expects the EU’s asset quality to remain broadly unchanged; however, in the absence of additional loan disbursements, the EU’s country and concentration risk will markedly shift towards Italy and Spain starting in 2032, when the repayment of its EUR 122.6bn NGEU loans is scheduled to begin.

Despite these credit strengths, the EU also faces the following credit challenges:

First, the EU’s total borrowings are expected to increase almost tenfold from 2020 levels due to the SURE and NGEU programmes, to just under EUR 1trn by 2026 from EUR 93.2bn as of end-2020, and EUR 344.3bn as of end-2022. While this will solidify the EU’s position as the world’s largest supranational issuer, strengthen its ambition to create an EU safe asset, and provide Member States with a targeted, timely and temporary counter-cyclical fiscal stimulus to facilitate the economic recovery from the Covid-19 shock and energy crisis, it also implies that future EU budgets will need to address significantly higher annual debt repayments.

Second, the EU’s ultimate credit risk also includes guarantees related to several funding programs with a guarantee ceiling totalling EUR 105.9bn. These relate to: i) the European Fund for Strategic Investments (EFSI) with a guarantee ceiling of EUR 25.8bn, ii) the InvestEU programme with a guarantee ceiling of EUR 21.3bn, iii) guarantees for the EIB’s non-EU activities under the External Lending Mandate (ELM) with a guarantee ceiling of EUR 30.6bn, iv) the European Fund for Sustainable Development (EFSD) with a guarantee ceiling of EUR 1.2bn, and v) the Neighbourhood, Development and International Cooperation Instrument (NDICI) which includes the European Fund for Sustainable Development Plus (EFSD+) with a guarantee ceiling of EUR 27.0bn.

Scope highlights that the overall size of guarantees has increased substantially since 2015 to around EUR 60bn at end-2021, and again in 2022 to around EUR 106bn due to the introduction of the InvestEU and EFSD+ programmes. Still, Scope notes that the risk borne by the EU budget is significantly curtailed by the assets of the related guarantee funds, which are combined in the Common Provisioning Fund. As of end-2022, the external action compartment (the former Guarantee Fund for External Actions) had assets of EUR 2.7bn, the EFSI guarantee fund had EUR 8.6bn, the EFSD guarantee fund had EUR 728m, the InvestEU fund had EUR 1.7bn (set to increase to EUR 10.5bn), while the fund for EFSD+ had EUR 1.1bn (set to reach up to EUR 10bn). These assets result in a high provisioning rate for the comparatively new programmes, which would absorb any losses before resources would need to be drawn from the EU budget. In addition, Scope notes positively: i) the track record of low annual default payments, which to date have never exceeded EUR 220m in a given year; and ii) the EU’s conservative financial management, including ample liquidity buffers and upfront provisioning of the guarantee funds.

Finally, Scope also notes that exceptional MFA loans to Ukraine (CC/Negative) since the start of the Russia-Ukraine war are provisioned for at a high level of 70%. Of this, 9% relates to paid-in provisioning from the EU budget and 61% to callable guarantees from Member States. The EU’s direct loan exposure amounts to almost EUR 24bn including legacy MFA loans of EUR 4.7bn, emergency and exceptional MFA loans of EUR 7.2bn and MFA+ loans of EUR 12bn with a further EUR 1.5bn payment announced for September. Under the MFA+ support, the EU will provide up to EUR 18bn in funding to Ukraine in the form of highly concessional loans. These are funded through the issuance of EU-Bonds under the unified funding approach and backed by the EU budget headroom which implies no provisioning in the Common Provisioning Fund.

In June 2023 the European Commission proposed a new Ukraine Facility of up to EUR 50bn for the period 2024 to 2027. The disbursement of financial support would be linked to the delivery of sectoral and structural reforms to support an eventual EU accession path. Subject to agreement from the Council and European Parliament, the facility would include EUR 33bn in loans and EUR 17bn in grants. Similar to the MFA+ support, the loans would be guaranteed under the EU budget headroom.

Factoring of environment, social and governance (ESG)

Scope considers ESG sustainability issues during the rating process as reflected in its supranational methodology. ESG factors are explicitly captured in Scope’s assessment of the institutional profile, which Scope assesses as ‘very strong’ for the EU.

Scope’s supranational scorecard

Scope’s supranational scorecard, which is based on clearly defined quantitative parameters, provides an indicative AAA rating for the EU. Additional considerations allow Scope to incorporate idiosyncratic characteristics that cannot be assessed in a consistent and comprehensive manner across all supranationals, but which may still affect the creditworthiness of the issuer.

For the EU, no additional considerations have been identified.

A rating committee has discussed and confirmed these results.

For further details, please see Appendix II of the rating report.

a. This estimate is based on the average cash balance for the 2020-22 period.

Rating Committee
The main points discussed were: i) institutional profile; ii) financial profile, including asset quality, liquidity and funding; iii) member state support; iv) additional considerations; and viii) consideration of peers.

Rating driver references
1. Treaty on the Functioning of the European Union. Article 323
2. Article 14 (4) of the Council Regulation (EU, Euratom) No. 609/2014
3. Article 15 (1) of the Council Regulation (EU, Euratom) No. 609/2014

Methodology
The methodology used for these Credit Ratings and Outlooks, (Supranational Rating Methodology, 3 August 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Rated Entity and/or its Related Third Parties participated in the Credit Rating process.
The following substantially material sources of information were used to prepare the Credit Ratings: public domain, the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Eiko Sievert, Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 1 February 2019. The Credit Ratings/Outlooks were last updated on 9 September 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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