Financial engineering instruments: the way forward for cohesion policy support? Recent experience from the Baltic states

Abstract

1. IntroductionTraditionally, EU cohesion policy support to businesses and local authorities has almost exclusively taken the form of non-repayable grants or subsidies. However, the current structural funds programming period (2007-2013), financial engineering instruments (FEIs) have emerged as a significant support mechanism addition to grant assistance5. Thus, in 2007-2013 the use of different modes of financial instruments has become more widespread. Financial instruments are quickly growing variety, scope and amounts committed to them. In the 2014-2020 period an even wider application is envisaged - the financial instruments can be used all policy areas where feasible (European Commission 2012, p.l). Financial engineering instruments include the following: equity (venture capital), loans, loan guarantees, micro-finance, mezzanine finance and other forms of revolving assistance. final recipients can be SMEs or other recipients of public funding, such as urban development funds and energy efficiency/renewable energy projects, and even individual citizens.The European Union takes a rather favourable view of FEIs. European Commission Staff Working Document puts it the following way: The possibility of using the same funds several times through various revolving cycles contributes to the impact and sustainability of the instruments. As such, the impact of revolving funds can be many times greater than grant assistance, giving them a particular added value and relevance times of budgetary constraints. impact/multiplier effect is further strengthened by the accumulation of interest generated and dividends paid to the funds. revolving character of such instruments creates enhanced incentives for better performance on the part of the final recipients - such as better quality of projects and greater financial discipline. Also, the participation of private sector funding guarantees the input of expertise and know-how. Specific expertise supporting, for example start-up SMEs, can be invaluable. Drawing upon this expertise helps to improve the overall quality of projects. (European Commission 2012, p.2). It should, however, be said that few of the above claims have been empirically tested though the EU policy document recognises the many challenges involved the implementation of FEIs.Furthermore, the academic literature on venture capital and the role of the public sector (see e.g. Lerner 2009) suggests that introduction of market conditions and market mechanisms might improve the efficiency of public SME funding from a resource allocation perspective, thereby strengthening the case for financial engineering instruments as policy tools.During the first four years of the current programming period the use of FEIs has grown quickly. Thus as of the end of 2010 the scale of FEIs can be summarised as follows:* Around 5% of European Regional Development Fund (ERDF) allocations have been committed the form of different types of financial instruments6.* Almost 400 funds have been set up. Most of these funds support businesses but assistance is also available to urban development fund, energy efficiency and renewable energy projects.* All Member States have at least one fund place for enterprises.* 11 Member States have funds for urban development, and one Member State has set up a fund exclusively focused on renewable energy and energy efficiency activities.* Investments have been made over 20,000 businesses (see European Commission 2012, p.3)In short, there is a growing popularity the use of FEIs the implementation of EU cohesion policy, with the Baltic states (especially Lithuania and Latvia) the vanguard of this trend (see Figure 1).Hence, the three Baltic states offer an interesting case study the use of FEIs cohesion policy. Not only are the Baltic states among the more intensive users of FEIs to date but they have taken somewhat different approaches terms of policy focus and implementation mechanisms. …