One nation’s annual defence budgetary cycle might end with the calendar year while its neighbour’s starts earlier or later. As a result, several countries can be ready to launch a programme but others cannot do so until money is approved or available. This often leads to launch delays or a reduction in the number of participants in a given programme.

Another impediment to collaborative efforts is the use-it-or-lose-it pressure on a defence ministry (or any other ministry, for that matter) to spend any unused money by cycle’s end for fear of seeing its budget reduced the following year. This leads to unnecessary spending and hasty decision-making.

Whether the problem has been cyclical disparity or lack of funds, both play havoc with a defence ministry’s ability to forecast and plan for collaborative defence capability development. These two issues are about to be mitigated, however, by the European Defence Agency’s (EDA) Cooperative Financial Mechanism (CFM), which should get off the ground in early 2020.

“The Agency’s role is to promote and incentivise collaborative defence capability development in Europe and to help create the right conditions for that. The CFM adds a very powerful instrument to our toolbox,” said Jorge Domecq, EDA’s Chief Executive. “In future, mismatching budgetary cycles or provisional gaps in funding should no longer exclude Member States from participating in multinational programmes”.

So far, 11 EDA Member States have declared their intention to sign the CFM: Belgium, Bulgaria, Cyprus, France, Greece, Hungary, Lithuania, Netherlands, Portugal, Slovenia and Spain, with another five (Germany, Italy, Malta, Poland and Romania) expected to join in the coming months. Once all their national parliaments have ratified their participation, the CFM is expected to enter force during the first half of 2020.

First proposed by the Agency to its Member States in November 2016, the CFM has been designed to support any type of collaborative effort, whether research and technology/development or for a capability’s acquisition phase. It will have a unique structure, with two innovative sources of finance to enable the smooth launch of multination capability projects and programmes.
 

European Investment Bank  

The first will be an unprecedented line of credit to be opened by the European Investment Bank (EIB), the EU’s infrastructure lending arm. Following calls from the European Council to step up its support to the defence sector, the EIB launched in December 2017 its ‘European Security Initiative’. Worth EUR 6 billion over three years, this credit line will provide co-financing of up to 50 percent for eligible national or collaborative R&D projects and defence programmes. Moreover, the EIB signed a Memorandum of Understanding with EDA in February 2018. This foresees that the Agency will support the bank by assessing defence-related projects, or sub-work packages of a given project, against the EIB’s lending policy. In other words, the Agency will provide advice and technical expertise to the bank to help it assess a project’s eligibility for EIB lending.

The EIB’s participation represents a sea-change in the bank’s lending mandate, which has traditionally steered it around any defence-related projects. But the bank’s new policy shift is a recognition by policy-makers of the urgent need to support dual-use technology development in Europe. (See EIB interview, page 37).
 

State-to-state lending

The CFM’s other pillar is all the more surprising for its ground-breaking nature. It will entail state-to-state lending – be it end-of-cycle budgetary resources or fresh money – between national Ministries of Defence for collaborative projects.

“This was a very sensitive thing to pull off, for several reasons,” said Fabio Liberti, EDA Policy Officer for Strategic Analysis. “First, we had to persuade national finance ministries to go along with the idea of potentially supporting partners in a way that is compatible with EU treaties and national budgetary legislations. The great novelty embedded within the CFM is the possibility for countries to use funding – either newly committed or unused year-end leftovers – in a multiannual way to support cooperation. Once a Member State decides to contribute to the CFM, its money can stay there from one year to the next without being pulled back into a country’s general treasury. That was a major political break-through.”

The second area of concern was to frame the CFM’s rules in such a way that its lending would not permanently subsidise one or more Member States’ participation in a programme or offer any bail-out sources of finance. Its operating principle is tide-over lending for launch and programme participation. That means loans will have to be repaid among the Member States and cannot substitute for spending elsewhere that a Member State would otherwise have to do anyway.

To further keep that principle on track, inter-state lending will only take place between a lender and borrower country where both are involved in the same collaborative defence project or programme. Also, a beneficiary CFM country will only be able to request the amount strictly necessary for the project or programme’s realisation, with the total sum of the support it receives not exceeding 70% of its contribution.
 

Individual bank accounts

Putting aside these lending intricacies, the way the CFM will function is fairly straightforward. Each participating defence ministry will open its own CFM bank account where it will decide how much to put there and when it wants to collaboratively lend to another Member State per the latter’s formal request for support (RfS).

The Agency will oversee all the accounts and pre-screen the funding requests to ensure they fall within the CFM’s scope. It will then carry out the inter-ministry transfers and subsequently monitor developments to ensure that each CFM country fulfils its RfS obligations. It will then report annually to its Steering Board about the CFM’s state-of-play from one year to the next.

If the Cooperative Financial Mechanism unfolds as planned, it should offer a trusted platform for inter-state support and outside lending from the EIB in a way that Europe has never before attempted. At the same time, as unused end-of-cycle budgetary amounts from national defence ministries start to accumulate in their CFM accounts, this will increasingly grease the wheels of collaborate programmes and thus begin filling Europe’s gaps in defence capability.

There are few situations that are truly win-win in any domain, but if the CFM works as planned it will be one.

  • © EIB

    Alexander Stubb, Vice-President of the European Investment Bank (EIB)

In the current geopolitical context, how does the EIB see its role in supporting EU defence cooperation?

Europe is confronted with a rapidly evolving environment, where disruptive emerging technologies and the pervasiveness of information such as artificial intelligence (AI), robotic, new materials and information technologies are fundamentally changing the character of the security threats and of warfare. These capabilities are increasingly initiated outside of the defence sector. Several jurisdictions (particularly the US and China) have equipped themselves with tools (notably investment funds) to actively identify and invest in the development of such promising technologies, including within the EU, with the associated risks of ‘technology drain’.

Meanwhile, while defence spending across Europe has been rising in the last four years, research and technology as a percentage of total defence spending has been steadily decreasing. Lack of access to suitable financing solutions allowing to better synchronise joint resources is seen as one of the major impediments to the launch or implementation of defence-related cooperative projects.

Which is why I find it only natural that the European Council in October 2017 encouraged the European Investment Bank, the EU bank, to examine further steps that can be taken to support investments in defence research and development activities. We here at the EIB took this task seriously. The EIB approved the European Security Initiative – Protect, Secure, Defend – which has strengthened our support for research, development and innovation (RDI) for dual-use technologies, cybersecurity and civilian security infrastructure.
 

Last year, EIB and EDA signed a MoU designed to strengthen their cooperation. Where do you see the biggest potential?

Despite a certain degree of consolidation at the level of large players, the EU defence industry is fragmented. This also affects cross-border access to the defence industry supply chains: access for new suppliers, especially for those located in other Member States, remains limited, leading to low levels of cross-border engagement in the defence industry’s supply chains. Barriers to the cross-border participation in the supply chains have particularly negative effects on SMEs’ participation in the defence market.

In that context, The EIB and EDA have teamed up to support the EU’s Common Security and Defence Policy. The objective will be to reap the benefits of the single market for defence by fostering cross-Member State cooperation.

As first steps, EDA and the EIB have signed a memorandum of understanding to strengthen cooperation, and now envisage cooperation in the Cooperative Financial Mechanism (CFM). The CFM is foreseen as a mechanism for EDA Member States to financially support the set up and conduct of the development of military technology. The EIB’s role in the CFM would focus on supporting the development of dual use technologies.

Additionally, the two organisations will exchange expertise, in particular with a view to identify possible financing opportunities for defence and security-related research and technology projects of interest to the Member States participating in EDA. This could include both projects promoted by the Member States, such as those in the context of the recently launched Permanent Structured Cooperation, as well as projects promoted by companies including small and medium-sized enterprises in the defence and security sector.

Given the risks and the emergence of new threats across all areas of the economy, we see it as the EIB’s mission to provide financing for innovative solutions to help tackle some of these challenges. It makes perfect sense that we cooperate closely with EDA on this task.

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