Euro zone eyes leveraging options for ESM bailout fund

by on September 26, 2012 11:13 am GMT

BRUSSELS, Sept 26 |
Wed Sep 26, 2012 7:13am EDT

(Reuters) – Euro zone countries are
working on allowing their permanent bailout fund to boost its
lending firepower with the same arsenal used by the region’s
temporary fund, the head of both facilities said.

But policymakers are also insisting the European Stability
Mechanism (ESM) be granted preferred creditor status which,
while minimising the risk of it incurring losses, would also
make it harder for the fund to set up co-financing projects.

The ESM, which will have a lending capacity of 500 billion
euros, will replace the temporary European Financial Stability
Facility (EFSF) as the euro zone’s main bailout vehicle next

To maximise the EFSF’s firepower, euro zone governments
agreed to let it offer insurance certificates for bonds sold by
troubled governments at auctions, guaranteeing 20-30 percent of
potential losses.

Similarly, the EFSF can set up co-investment funds with
private investors to buy euro zone government bonds on the
secondary market with the proviso that the EFSF would cover a
percentage of potential losses in case of a default.

The ESM was always expected to have similar leverage at its
disposal, and discussions on exactly what the ESM will be
capable of doing are now drawing to a close, said Klaus Regling,
the chief executive of the two bailout mechanisms.

“Our member states are considering extending to the ESM the
options introduced last year to maximise the capacity of the
EFSF: the partial protection certificates and the co-investment
funds,” he told an investor conference call on Tuesday.

“Technical work is under way and will be considered in due
course by the ESM governing bodies once the ESM is operational.”

Unlike the EFSF, the ESM will have a preferred creditor
status, which will place it at the head of the repayments queue.

But if the ESM offers to cover the first loss on a bond
bought at a primary auction or the first loss in an investment
fund buying bonds, it gets paid last, rather than first.

Finland, whose parliament has asked for collateral for its
part of any new bailouts after Portugal, objects to the ESM
using these leveraging instruments as incompatible with the
fund’s senior creditor status.