While last month's European Parliament elections slightly weakened the centrist bloc's majority, S&P Global Ratings expects the next European Commission to continue prioritizing the EU's competitiveness and the digital and green transition, alongside defense, security, and immigration issues.

The EU's revised fiscal rules maintain the previous upper limits for government budgetary deficits at 3% of GDP and government debt at 60% of GDP. Since the EU's energy bill is still 2.5% of GDP higher than in the U.S., further energy market integration remains key in the EU's drive to improve its overall competitiveness.

Advancing the Capital Markets Union (CMU) could also help boost the EU's competitiveness, which is essential for Europe not only to keep pace with China and the U.S., but also to return to its long-term growth trajectory. Lastly, while we can expect some incremental changes to enhance regulatory and crisis management frameworks for banks, we do not see much political will to complete the banking union.

In this Credit FAQ, we address questions regarding the incoming European Commission's likely policy priorities and their potential credit impact.

Frequently Asked Questions

Which policy areas does S&P Global Ratings expect the next European Commission to focus on?

Generally speaking, we expect the next European Commission's roadmap to borrow heavily from the 2024-2029 Strategic Agenda that the European Council adopted on June 28, 2024, ahead of the appointment of a new European Commission.

In particular, we expect that the next European Commission will continue prioritizing the EU's competitiveness vis-à-vis other major countries like the U.S. and China. One key aspect of this will be the further integration of the single market in policy areas such as energy, finance, and telecommunications.

A more active and coordinated industrial policy could emerge, perhaps with a particular focus on emerging technologies, although there is no broad consensus among EU members on an EU-wide industrial policy. In this context, more flexible state aid rules could follow, likely benefiting larger companies in strategic sectors.

Other priorities in the European Council's recent Strategic Agenda include the digital and green transition, largely backed by Next Generation EU funds and programs. The latter are likely to continue running in most member states, albeit at a slower pace than we anticipated at their inception in 2021, due to capacity constraints when it comes to building the related projects in many recipient countries. Each program's policy milestones are unlikely to change by the deadline in 2026, as most of them have already been renegotiated to reflect higher prices in 2022 and remain in line with key EU policy objectives.

Additional areas of focus are defense, security, and immigration. Russia's invasion of Ukraine in 2022 and lingering uncertainty over the U.S.'s long-term commitment to NATO have put the onus on the European Commission to bolster the EU's defense capacities. At the same time, the European Commission is likely to continue tackling EU voters' growing concerns about immigration, as the EU and some recent national elections have brought to light.

The next European Commission will also have to address the EU's enlargement, involving the delicate task of navigating accession talks with Ukraine and Moldova, as well as with other potential candidate countries. However, progress in this contested area might be slightly more difficult than during the last legislative period due to the greater polarization in the European Parliament following the elections.

How will the EU apply its revised fiscal rules?

The EU's revised fiscal rules came into force in earlier this year. They had been suspended from 2020 to allow governments to deviate from the EU's budgetary requirements to support their economies during the COVID-19 pandemic and energy price shocks.

The new rules maintain the previous upper limits for government budget deficits at 3% of GDP and for government debt at 60% of GDP. Yet the new rules also offer somewhat more flexibility than before, meaning that:

Fiscal adjustment targets will be country-specific and fleshed out in a bespoke four-year plan agreed with the European Commission.  The plan can span up to seven years if countries commit to growth-enhancing reforms.

Performance monitoring is primarily based on net primary expenditure.   This limits procyclical fiscal bias, as spending is not adjusted to different stages of the economic cycle. It also avoids raising the fiscal consolidation bar too high for countries with high interest payments. Consequently, for countries facing a hefty interest bill, the required annual structural deficit reduction under an excessive deficit procedure (EDP) might be substantially lower than the official mandate of 0.5%. Indeed, for most sovereigns, applying the new rules is likely to require less budgetary consolidation effort than the previous framework.

Debt sustainability analysis will determine ways of reducing net expenditure.   This will incorporate the impact of growth and investments into the analysis, instead of merely focusing on expenditure cuts that can have an adverse impact on economic growth. Consequently, in its assessment, the European Commission could consider, among other factors, the recent increase in defense spending (see chart 1). With military expenditure varying greatly across the bloc, we expect certain governments to lobby strongly for the exclusion of at least part of their military spending from the deficit calculation.

Chart 1

The longer-term question for the next European Commission will be whether to sanction countries that deviate from their fiscal adjustment plans, with the new fiscal rules allowing a maximum fine of 0.05% of countries' national GDP every six months until corrective action is taken. Due to concerns around member states' fiscal sovereignty, enforceability has proved politically difficult in the past. Even though compliance with the old fiscal framework was mixed at best, no member state was ever sanctioned. This is because the European Council, which must sign off on a potential fine, was never aligned with the European Commission in such situations.

We generally think that the fiscal rules, and the possibility of an EDP that is activated when a country breaches the rules (see chart 2), can provide a fiscal policy anchor in member states, incentivizing them to comply with the agreed medium-term fiscal plans.

Chart 2

The European Commission has recently recommended or proposed initiating an EDP against several EU member states, namely, France, Italy, Belgium, Hungary, Malta, Poland, and Slovakia. In most cases, this is because these governments are in breach of the 3% GDP general government deficit threshold. The budgetary effort that these sovereigns will need to make will be clear after the release of European Council's recommendations. These recommendations will reflect the European Commission's assessment of the sovereigns' 2025 draft budgets and the medium-term fiscal plans that they will deliver this coming autumn.

For eurozone members, being subject to an EDP means that their government debt securities could become ineligible for purchases under the European Central Bank (ECB's) Transmission Protection Instrument (TPI). This could increase their cost of funding in a hypothetical situation of financial fragmentation.

That said, our sovereign ratings will continue to focus on each individual country's fiscal trajectory rather than on the EU's thresholds and regulations. We think that fiscal performance ultimately depends on national economic factors and individual governments, including their ability and willingness to comply with the rules. That compliance may, in turn, rest on the capacity and stringency of the European Commission in tandem with the European Council in enforcing the rules.

How will the EU meet its longer-term investment needs?

Along with the need for fiscal consolidation, the bloc also faces the huge task of financing the green transition and digitization, as well as increasing defense spending to address geopolitical challenges. Most studies, as well as the European Commission's official estimates, point to an investment gap north of €400 billion per year. This signals the need for additional financing at the consolidated EU level. In our view, this gives the European Commission two key options:

Increase or reform the EU budget.   With the initial proposal for a new Multi-Annual Financial Framework due by mid-2025, the next European Commission will have to decide whether to propose an increase of the EU's annual budget for 2028-2035 to further above 1% of the bloc's gross national income. The European Commission could also recommend a reprioritization of expenditure by allocating a greater share to strategic sectors like defense or emerging technologies. EU subsidies could be made conditional on economic reforms, similar to the Next Generation EU program.

The European Commission's longer-term budgetary challenge will be how to adapt the overall framework to the potential arrival of new member states whose level of economic development is substantially below the EU average. Regardless of the ultimate proposal, we expect the negotiations for the new Multi-Annual Financial Framework to remain challenging due to member states' different priorities and the need for unanimity in the European Council.

Initiate a new round of joint borrowing.   A second option would be to increase joint debt issuance to help finance climate, energy, or defense policy goals. The EU could issue debt directly, similar to the €750 billion Next Generation EU program during the COVID-19 pandemic. Alternatively, the European Investment Bank (EIB) could, with an enhanced role, finance such policy goals, as the European Council has already recommended in its Strategic Agenda.

Since the first disbursements from a new Multi-Annual Financial Framework would likely only start to flow from 2030, joint debt issuance would provide a speedier response to the bloc's challenges. As was the case with Next Generation EU, a similar, albeit smaller, program would likely add upside potential to sovereigns' short- to medium-term growth outlooks and increase temporary breathing space for highly indebted sovereigns.

However, recent delays in member states' spending of Next Generation EU funds have also raised questions about the effectiveness of a new joint debt issuance program. The EIB estimates that only 44% of the milestones and targets set for the third quarter of 2023 have been met, leading some member states to call for an extension of the spending deadline beyond 2026.

Among European Council members, we not only anticipate vastly divergent views on the question of new joint EU debt, but also on the continuation of Next Generation EU, which fiscally conservative countries view critically. Our 'AA+' rating on the EU reflects our assessment of the 'aa-' anchor, which is based on the weighted-average sovereign foreign currency ratings on the member states. The rating also reflects our view that the member states that we rate at least two notches above 'AA-' are able and willing to cover any potential shortfall in the EU's debt service.

What is the EU energy union and is it attainable?

The energy union is the EU's strategy to ensure the supply of affordable, secure, and sustainable energy that is as low-carbon and home-produced as possible in an integrated EU market. Because the EU's energy bill is still 2.5% of GDP higher than in the U.S., further energy market integration remains key in the EU's drive to improve its overall competitiveness. The EU has improved its gas-import infrastructure and contracts since the start of the Russia-Ukraine war, and so we generally think that the EU has largely achieved the union's aim in terms of oil and fossil fuel gas.

EU Commission initiatives to foster renewable power generation--from Fitfor55 to RepowerEU and the Green Deal--have helped the EU break records in decarbonizing its power supply mix. In 2023, 44% of power generation was from renewables, and we expect this proportion to rise to 50% in 2024, or about 75% including nuclear. A level of 70% by 2030 would be broadly consistent with the EU's ambition of renewable energy contributing 42.5% of the primary energy supply. The EU should achieve this target on time, or at the latest in the early 2030s.

There remains much more to do to facilitate power supply, with key projects slated for completion this decade. Most challenging will be enabling low-carbon hydrogen generation and flows; and carbon-capture science and technology (CCST). From an industrial equipment perspective, Net-Zero Industry Act goals remain demanding, notably that of increasing Europe's own supply of solar panels and batteries.

While the European Commission can initiate, finance, and coordinate certain efforts, actions by member states and even local actions are key, for example, in authorizing new onshore wind and solar capacity. In our view, the EU is particularly relevant when there is a need to:

• Agree market reforms across member states, such as standardizing power prices or optimizing power price zones, for example, deciding whether Germany should split its single power zone. Since 2022, the European power market design reform has made steady progress;
• Improve cross-border flow capacity where energy sources are located far from their consumption locations;
• Broaden financing sources, including from member states' budgets, to support the adoption of new technologies. Such technologies need subsidizing as they are either less mature--like battery storage, low-carbon hydrogen generation and pipelines, and CCST--and/or less economical--like nuclear newbuilds, or costly cross-country power lines or interconnections; and
• Facilitate a consensus on renewable generation--such as the EU's target for renewables to contribute 42.5% of the primary energy supply--and market-integration targets, including for interconnections. The EU targets a ratio of available interconnection capacity to total generation capacity of 15% (see chart 3 and "Europe's Power Push: Can Project Finance Help Fund Interconnections?," published on Nov. 16, 2023).

Chart 3

What's more, the EU Commission can facilitate coordination with the following key non-EU European energy partners:

• The U.K., as it switches from importing power to exporting power and hydrogen in the rest of this decade;
• Norway, as a key supplier of gas, power, and potentially hydrogen, and as a storage location for captured carbon dioxide; and
• Switzerland, a key power-transit country.

What credit impact could the EU energy union have?

The concept of an energy union may appear vague and its completion ambitious. However, in assessing the potential rating impact of this union, we focus on price convergence and on how institutional coordination can support energy import, generation, and transmission projects.

The EU has essentially achieved oil and gas price convergence, ensuring equal and competitive access by businesses and households, subject to Europe's position as an importer and price-taker. On the power side, in contrast, we think that divergences will persist beyond this decade. Notably, the wholesale fuel component of bills could prove cheaper in Norway, Sweden, and Iberia than in Northwest Europe by a significant 10%-30%, bringing prices closer to those typical in the U.S. Wholesale fuel would remain 10%-15% pricier in Italy.

EU-level coordination will be crucial in determining the degree and pace of development of low-carbon hydrogen generation and pipelines. Given the disparity of renewable generation capacity across countries versus the locations of consumption, no one member state can develop the integrated hydrogen chain alone and at scale.

What are the prospects of advancing the CMU?

Accelerating the integration of European financial markets by advancing the CMU is likely to be one of the next European Commission's agenda items.

The European Council's Strategic Agenda is heading in this direction, and it echoes several reports that the EU has commissioned from former European officials such as former Italian prime minister Enrico Letta and former governor of the Bank of France Christian Noyer, as well as policy recommendations that the Eurogroup, the ECB Governing Council, and the European Securities and Markets Authority (ESMA) have issued recently. The next European Commission's roadmap will borrow extensively from the Strategic Agenda and these policy recommendations.

Advancing the CMU may improve the EU's strategic autonomy by promoting the international use of the euro and reducing the EU's dependence on external sources of funding. It could also support the transition toward a green and digital economy, improve risk-sharing, and mitigate the spread of income shocks between EU countries. Finally, advancing the CMU could help boost the EU's competitiveness, which is essential for Europe not only to keep pace with China and the U.S., but also return to its own long-term growth trajectory.

The European economy was well on its way out of the pandemic before the war in Ukraine derailed it. The European economy is now 2.5% below its historical productivity trend (see chart 4). Although the shortfall is largely due to high energy costs and labor hoarding, the rebound we expect over the next two years will probably only make up for half of it. So, without vigorous economic reforms, some of the current productivity losses could turn into permanent losses.

Chart 4

We see the fragmentation of Europe's capital markets as an obstacle to Europe's economic development. European capital markets are deemed too small, too national and therefore too illiquid, and too expensive for small investors and issuers. This translates into limited cross-border capital flows between EU members, lower private investment than savings alone could provide (see chart 5), and a flight of savings abroad.

Chart 5

The Noyer report recently highlighted the fact that almost 20% of European savings are invested in foreign debt securities. We might add that the eurozone has become the largest foreign holder of U.S. Treasury securities. It is common knowledge that the European economy's market capitalization is about one-third that of the U.S. economy, and even lower in the EU's Eastern region, where capital markets have a short track record (see chart 6).

Chart 6

Private equity in Europe accounts for only one-sixth of that in the U.S. And to underline the relationship between equity capital and investment, the EIB estimates that in the U.S., productive investment--gross fixed capital formation excluding residential investment--has outpaced that in Europe by an average of 1.5% of GDP every year since 2012.

For ten years now, Europe has been trying to integrate and develop its capital markets within the framework of the CMU initiative. It has taken a few important steps, for instance, the introduction of legislation on European long-term investment funds in 2015; the creation of a European single access point for financial disclosure, which should become operational in 2027; and the recent decision to have a consolidated tape for equity markets.

While most observers welcome these measures, all acknowledge that they have not had a transformative impact. The reasons observers often give for this are that policy makers at both national and EU levels have had to prioritize measures in response to the multiple external shocks that have occurred in quick succession since the CMU agenda was launched (Brexit, the COVID-19 pandemic, and the Russia-Ukraine war), and the fact that most of the measures will take time to implement.

What's more, a survey by the Organization for Economic Co-operation and Development and the International Network on Financial Education confirms that financial literacy remains uneven across European countries and underdeveloped in some of them (see chart 7). This doesn't help savers diversify their investments away from bank deposits. Such deposits absorb 34% of household savings in Europe, compared with 14% in the U.S., and have a lower return than other forms of savings.

Chart 7

The Association for Financial Markets in Europe, which regularly reports on the CMU's key performance indicators, finds that compared to five years ago:

• European corporates' access to market-based finance has deteriorated;
• The amount of loans turned into capital market vehicles like securitization transactions has declined significantly;
• Intra-EU integration has deteriorated slightly; and
• The amount of household assets in capital market instruments has not increased much.

The general conclusion is that neither the depth nor the architecture of European financial markets has advanced.

This overall lack of progress on the CMU, together with the need to boost investment at a time when several European governments appear to have limited fiscal space, and the start of a new political cycle following the European parliamentary elections, has given new impetus to the CMU agenda. The recommendations by the Eurogroup, ECB, and ESMA underline this. The impetus takes three directions (see table 1):

Developing pan-European capital market infrastructure.   All three European institutions recommend modernizing the EU regulatory framework for financial services, promoting the attractiveness of listing on stock exchanges in the EU and a convergence of EU capital market supervision, with ESMA assuming a more prominent role.

Ensuring better access to finance for companies to innovate and expand in the EU.   The main avenues that the Eurogroup, ECB, and ESMA envisage are the development of the securitization market and the promotion of EU capital markets as a hub for green finance. The ECB sees these two aspects as complementary.

Broadening investment opportunities for EU citizens.   This would not only improve financial literacy, but also develop simple investment products, reevaluate tax incentives for retail investors, especially in equity securities, and promote the use of employee share schemes across European companies and capital market-based pension schemes.

Table 1

It remains to be seen whether this new impetus will translate into real progress on the CMU. Without such progress, the European economy will not be empowered to tap all of its ample financing resources and could continue to have low potential growth and little capacity to absorb asymmetric shocks without massive transfers of public money.

Does S&P Global Ratings expect meaningful progress on the banking union or other changes to banking regulations?

Ten years after their creation, the single supervisory mechanism and the single resolution mechanism have largely achieved their main objectives of improving banks' financial soundness and ensuring that the most systemic banks can be resolved in case of failure with no systematic recourse to taxpayers' funding. That said, we expect some further incremental changes to enhance these first two pillars of the banking union.

First, the EU Commission and its financial agencies will need to complete the regulatory rollout of the latest Basel accords on banks' capital requirements following the adoption of legislative instruments earlier this year (see "EU Banking Package: Inconsistencies Temper Framework Improvements," published on Jan. 9, 2024).

Second, negotiations between representatives of the EU Parliament, the Council, and the Commission to reform the crisis management and deposit insurance framework are due to start. This reform aims to include midsize banks in the group of banks prepared for resolution. To do that, it proposes to facilitate the use of funds currently held in national deposit guarantee schemes and resolution funds. We expect these negotiations to take time as there are some material differences between the European Council's current position and the European Commission's initial proposal.

Beyond that, at this stage we do not see a clear political will to make further progress toward the completion of the banking union, mainly due to opposition at a national level. In its June 2022 meeting, the Eurogroup once again discussed but did not reach a compromise on the three outstanding issues:

The creation of a European Deposit Insurance Scheme.   The EU Commission tabled a legislative proposal in 2015, but the potential mutualization of bank losses at a European level that could result from the scheme remains a major obstacle in reaching a compromise.

The diversification of banks' sovereign bond holdings in the EU.   Several EU countries consider that a reduction in banks' exposures to their own sovereign is a precondition for envisaging a potential mutualization of bank losses. But such diversification would in turn require risk-weighting government bond holdings, which could prove costly for banks in terms of additional capital. Here again, a compromise is difficult to imagine at this stage.

A greater integration of the banking markets.   The key issue here revolves around the free allocation of capital across EU borders within EU banking groups, which today is not wholly possible. The EU Parliament put forward proposals to waive the capital requirements for the EU subsidiaries of cross-border groups in the last legislature, but these were not agreed. Beyond this, more harmonization of banking products and practices would be necessary to generate more synergies and incentivize further EU banking consolidation. However, this would likely require legislative changes at national levels, which is also unlikely.

Despite the limited progress we expect toward completing the banking union, we believe that the EU authorities will press on with several other important banking regulations. EU banks' management of climate risks remains a priority within the broader green agenda, and banks will soon need to submit transition plans detailing how they will cope with climate change.

The management of operational risks is also a priority, as banks gradually increase their reliance on third parties to leverage technology for example, cloud technology, and face mounting cyber threats. The implementation of the Digital and Operational Resilience Act will be another area of focus for EU banks and regulators in the years to come (see "Supervising Cyber: How The ECB Stress Test Will Shape The Agenda," published on March 6, 2024).

Related Research

• CreditWeek: What Does The U.S.-Eurozone Interest Rate Differential Mean For Currencies And Capital Flows, June 20, 2024
• Supervising Cyber: How The ECB Stress Test Will Shape The Agenda, March 6, 2024
• EU Banking Package: Inconsistencies Temper Framework Improvements, Jan. 9, 2024
• Europe's Power Push: Can Project Finance Help Fund Interconnections?, Nov. 16, 2023
• Thirty Years Of The EU Single Market: Why Cross-Border Capital Flows Remain Sluggish, Despite Positive Developments, May 25, 2023
• How the Capital Markets Union Can Help Europe Avoid A Liquidity Trap, April 15, 2021
• The EU Capital Markets Union Can Turn The Tide in Europe, Feb. 25, 2020

External Research

• AFME, Capital Markets Union Key Performance Indicators – Sixth Edition
• Christian Noyer, Developing European Capital Markets to Finance the Future – Proposals for a Savings and Investments Union (economie.gouv.fr)
• EIB Investment Report 2023/2024: Transforming for competitiveness
• Enrico Letta, Much more than a Market – empowering the Single Market to deliver a sustainable future and prosperity for all EU citizens (April 2024) (europa.eu)
• European Council Strategic Agenda 2024-2029 (europa.eu)
• Nicolas Véron, Capital Markets Union: Ten Years Later, an in-depth analysis requested by the ECON Committee at the European Parliament
• OECD/INFE 2023 International Survey of Adult Financial Literacy, OECD Business and Finance Policy Papers, No. 39, OECD Publishing, Paris
• Statement by the ECB Governing Council on advancing the Capital Markets Union (europa.eu)
• Statement of the Eurogroup in inclusive format on the future of Capital Markets Union (europa.eu)