BRUSSELS (Reuters) - The euro zone is working on two options for how to boost the firepower of its 440 billion euro European Financial Stability Facility bailout fund without putting more money into it.
Rather than buy all the bonds of distressed sovereigns itself, the EFSF aims to increase private demand for them by offering partial guarantees in various forms.
The EFSF now has only about 250 billion euros left to help countries under market pressure like Italy or Spain because it is already committed to financing programs in Ireland and Portugal and will be the main financing vehicle in the second Greek emergency loan program.
Euro zone leaders said in October the EFSF's firepower could be boosted four to five times over to about 1 trillion euros.
But recent political turmoil in Greece and Italy has cut that leverage potential to three or four times, the EFSF said.
Below are the main features of the leveraging options, approved by finance ministers on November 7, that are to give the EFSF more intervention capacity from the start of December.
EFSF help would be provided only after the sovereign agreed to reforms and monitoring. The sovereign would also pay all the EFSF's operational costs for the assistance.
OPTION 1
The EFSF guarantees a percentage of the value of a bond issued by a euro zone sovereign at a primary auction, partially protecting investors in the event of a sovereign default.
The bonds should be seen as a safer investment, increasing demand at the auction and lowering funding costs for the sovereign. In effect, the EFSF guarantee would have a bigger impact than if the fund was buying the bonds.
The sovereign bonds at the auction would be issued with a partial protection certificate attached. The certificate could be separable and freely traded after issuance to avoid splitting the bond market of the sovereign into safer and less safe bonds.
However, in case of a default, the holder of the certificate would only get paid if holding the same value of the sovereign's bonds that the certificate was issued for, meaning no "naked" guarantees could be redeemed.
The issue of whether the certificate should be tradable separately is one of the points that euro zone finance ministers want to consult markets, rating agencies and other institutions about, before taking a final decision.
Separating the certificate after issue might solve the problem of negative pledge clauses in some existing bonds and other financial instruments.
A negative pledge clause guarantees the investor that the issuing sovereign will not offer a more secure paper to investors later, or only do so if it offers the same terms on the old bonds.
It may also resolve the issue of having bonds on issue without guarantees and other newer issues that are partly protected, effectively creating a two-tier bond market.
What would constitute a trigger event for the payout of the certificate and what the terms of payment would be remain to be decided following the market consultations.
OPTION 2
The second option would be to set up one or more Co-Investment Funds (CIFs) that would attract public and private funding to boost the seed money from the EFSF, though the fund has had little success so far in drumming up such support.
The aim would be to attract sovereign wealth funds, risk capital investors and potentially some long-only institutional investors.
The CIF would buy sovereign bonds in the primary or secondary markets. Purchases of bonds at primary auctions could give governments money for bank recapitalization.
The CIF would normally hold the bonds of the distressed sovereign to maturity, but could sell them earlier if their prices on the market returned to more normal levels.
Private investors could be attracted to put their money into the CIF together with the EFSF, because the EFSF would absorb the first losses the venture could make, making the investment safer for the private sector.
EFSF head Klaus Regling said on October 29 in China, where he travelled to drum up interest in the CIF idea, that the EFSF would absorb the first 20 percent of losses.
But China's Vice Finance Minister Zhu Guangyao said in late October that Beijing was awaiting details on the leveraging options for the EFSF before deciding its next move.
Euro zone sources said they received a similar response from G20 countries at a summit on November 3-4 -- showing interest, but without concrete commitments until details of the leveraging are decided.
According to the agreement of the euro zone finance ministers from November 7, the CIF would have a nominal equity capital, with a first loss layer provided by the EFSF, above which would be a capital instrument, or participation unit, which would participate in the majority or all of the gains made by the CIF.
There could be a third layer of capital made up of senior debt instruments.
The participation units and the senior debt instruments would be freely traded and mature in line with the life of the CIF. The size of the capital and debt instrument tranche would not be pre-determined, but depend on demand from investors.
If the CIF had just the EFSF and capital instrument tranches, without issuing senior debt, it cold be channelled through an IMF trust fund or administrative account.
The CIF would have a board of directors appointed by the EFSF, a specified investment policy and rules on how investor interest would be protected through the CIF's decision-making.
yahoo.com
Rather than buy all the bonds of distressed sovereigns itself, the EFSF aims to increase private demand for them by offering partial guarantees in various forms.
The EFSF now has only about 250 billion euros left to help countries under market pressure like Italy or Spain because it is already committed to financing programs in Ireland and Portugal and will be the main financing vehicle in the second Greek emergency loan program.
Euro zone leaders said in October the EFSF's firepower could be boosted four to five times over to about 1 trillion euros.
But recent political turmoil in Greece and Italy has cut that leverage potential to three or four times, the EFSF said.
Below are the main features of the leveraging options, approved by finance ministers on November 7, that are to give the EFSF more intervention capacity from the start of December.
EFSF help would be provided only after the sovereign agreed to reforms and monitoring. The sovereign would also pay all the EFSF's operational costs for the assistance.
OPTION 1
The EFSF guarantees a percentage of the value of a bond issued by a euro zone sovereign at a primary auction, partially protecting investors in the event of a sovereign default.
The bonds should be seen as a safer investment, increasing demand at the auction and lowering funding costs for the sovereign. In effect, the EFSF guarantee would have a bigger impact than if the fund was buying the bonds.
The sovereign bonds at the auction would be issued with a partial protection certificate attached. The certificate could be separable and freely traded after issuance to avoid splitting the bond market of the sovereign into safer and less safe bonds.
However, in case of a default, the holder of the certificate would only get paid if holding the same value of the sovereign's bonds that the certificate was issued for, meaning no "naked" guarantees could be redeemed.
The issue of whether the certificate should be tradable separately is one of the points that euro zone finance ministers want to consult markets, rating agencies and other institutions about, before taking a final decision.
Separating the certificate after issue might solve the problem of negative pledge clauses in some existing bonds and other financial instruments.
A negative pledge clause guarantees the investor that the issuing sovereign will not offer a more secure paper to investors later, or only do so if it offers the same terms on the old bonds.
It may also resolve the issue of having bonds on issue without guarantees and other newer issues that are partly protected, effectively creating a two-tier bond market.
What would constitute a trigger event for the payout of the certificate and what the terms of payment would be remain to be decided following the market consultations.
OPTION 2
The second option would be to set up one or more Co-Investment Funds (CIFs) that would attract public and private funding to boost the seed money from the EFSF, though the fund has had little success so far in drumming up such support.
The aim would be to attract sovereign wealth funds, risk capital investors and potentially some long-only institutional investors.
The CIF would buy sovereign bonds in the primary or secondary markets. Purchases of bonds at primary auctions could give governments money for bank recapitalization.
The CIF would normally hold the bonds of the distressed sovereign to maturity, but could sell them earlier if their prices on the market returned to more normal levels.
Private investors could be attracted to put their money into the CIF together with the EFSF, because the EFSF would absorb the first losses the venture could make, making the investment safer for the private sector.
EFSF head Klaus Regling said on October 29 in China, where he travelled to drum up interest in the CIF idea, that the EFSF would absorb the first 20 percent of losses.
But China's Vice Finance Minister Zhu Guangyao said in late October that Beijing was awaiting details on the leveraging options for the EFSF before deciding its next move.
Euro zone sources said they received a similar response from G20 countries at a summit on November 3-4 -- showing interest, but without concrete commitments until details of the leveraging are decided.
According to the agreement of the euro zone finance ministers from November 7, the CIF would have a nominal equity capital, with a first loss layer provided by the EFSF, above which would be a capital instrument, or participation unit, which would participate in the majority or all of the gains made by the CIF.
There could be a third layer of capital made up of senior debt instruments.
The participation units and the senior debt instruments would be freely traded and mature in line with the life of the CIF. The size of the capital and debt instrument tranche would not be pre-determined, but depend on demand from investors.
If the CIF had just the EFSF and capital instrument tranches, without issuing senior debt, it cold be channelled through an IMF trust fund or administrative account.
The CIF would have a board of directors appointed by the EFSF, a specified investment policy and rules on how investor interest would be protected through the CIF's decision-making.
yahoo.com
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