Plan for leveraging euro zone bailout fund takes shape
* Guarantee of between 20 and 30 pct seen most likelyBy Luke BakerBRUSSELS, Oct 18 (Reuters) - Euro zone leaders are likely to
agree to leverage their bailout fund at a summit on Sunday by
allowing it to guarantee a portion of newly issued euro zone
debt, euro zone officials and the expert who first developed the
plan said on Tuesday.Under the scheme, the European Financial Stability Facility
(EFSF) would promise investors who buy Spanish, Italian or other
higher-risk euro zone debt at auction that it would cover a
portion of any losses they made if the country were to default.”This idea is the main contender,” one euro zone official
said, but added there were other projects under consideration
for how best to increase the EFSF’s firepower, with markets
unconvinced it is big enough to handle the widening crisis.By guaranteeing the first 20-30 percent of any losses, for
example, the EFSF could stretch three to five times further.With about 300 billion euros of its 440 billion-euro
capacity still deployable, the fund could be expanded to more
than 1 trillion euros, enough to support the refinancing needs
of Spain and Italy for at least the next year or longer.However, rather than leaders fixing the degree of leverage
as many in financial markets expect, the EFSF is more likely to
be given flexibility to decide how much it is leveraged on a
case-by-case basis — depending on which country’s debt is being
guaranteed and the prevailing market conditions.”It is at the point of the transaction that the EFSF would
provide the figure,” said Sony Kapoor, the managing director of
Re-Define, an economic think-tank which first set out the idea
to use the EFSF and its permanent successor, the European
Stabilization Mechanism, as bond insurers.If the fund is used to provide partial rather than full
insurance, a ‘guarantee against first losses’ would be the most
credible method, Re-Define has argued.”The EFSF needs to retain the flexibility to decide how much
they will guarantee of any particular debt issue. The number
would depend on the issuing country, the duration of the bond
and the timing of the issue,” Kapoor told Reuters.For example, if Italy were scheduled to issue 5 billion
euros of bonds in mid-November, the EFSF would discuss with
institutional buyers in the days ahead what proportion of the
issuance it would guarantee. If Spain were issuing 5 billion
euros the same week, the guarantee might be larger or smaller.RESTORING CONFIDENCE?The idea is for the operation to boost market confidence in
the paper of euro zone sovereigns, turning sentiment back in its
favour after nearly two years of adverse conditions.”You get leverage if investors are reassured and trust the
scheme. If, for whatever reason, investors are not convinced,
you get nothing,” a second euro zone official said.When it first presented its proposal several months ago,
Re-Define suggested a possible guarantee on the first 20 percent
of losses — giving rise to talk of the EFSF being leveraged
five times. But market conditions have deteriorated since then.A third euro zone official confirmed the amount of
guarantees under discussion was between 20 and 30 percent.Kapoor said a balance needed to be retained in making the
EFSF more credible in terms of size, which calls for higher
leverage and lower borrowing costs, without threatening France’s
triple-A credit rating, which calls for lower leverage.”A leverage of around three times may provide a suitable
compromise to try to square this circle,” he said.”There will be specific mechanisms and we might get a range
of numbers, but it would be premature and irresponsible for the
EFSF to bind itself to a specific number, because it needs to
retain flexibility to react to changing circumstances.”Negotiations among member states and with institutional
investors on the plan continued on Tuesday, leaving details open
to change before leaders gather for what is expected to be a
make-or-break summit on Sunday afternoon.Kapoor said that even if euro zone leaders did decide on
Sunday to scale up the EFSF using a first-losses guarantee, it
might not be enough to get on top of the two-year crisis.”It’s coming a bit too late. It would have worked before
Italy and Spain got sucked in, but now that the crisis has
turned systemic, the EFSF can only do so much,” he said.”The correct way to think about this mechanism is not as a
mono-line insurer but as a political signalling device. EU
leaders don’t tire of saying that Spain and Italy are solvent,
but they said the same for Greece, which is not.”“EFSF guarantees for Italy and Spain would signal that all
17 euro area states are ready to put money where their mouth is,
and that can help restore confidence by demonstrating that they
feel comfortable putting themselves in harm’s way between
bondholders and any possible losses.”At the same time, the ECB needs to make an implicit or
explicit commitment to go on buying Spanish and Italian debt in
the secondary market to keep their funding costs from soaring.
