Euro zone eyes leveraging options for ESM bailout fund

BRUSSELS Wed Sep 26, 2012 7:16am EDT

BRUSSELS (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 minimizing 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 month.

To maximize 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 maximize 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.

(Reporting By Jan Strupczewski; Editing by John Stonestreet)

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