BRUSSELS (Reuters) - Euro zone countries want to finish legal and technical preparations for leveraging the EFSF bailout fund to around 1 trillion euros by the end of November to deploy it in December, a document prepared for euro zone finance ministers showed.
The document, dated Nov 7 and entitled “Terms of Reference for Consultation with Market Participants. Maximizing the capacity of the EFSF” said that in the coming weeks euro zone countries, market participants, rating agencies and other stakeholders would be consulted to solve the remaining technical issues relating to the leveraging.
“In its next meeting, the Eurogroup will then decide on the terms and conditions of the two approaches. Subsequently the aim is to complete legal and operational work by the end of November, followed by implementation in December,” the document, obtained by Reuters, said.
“Member States will be further consulted in finalizing terms and reviewing the specific technical issues which may arise on an individual sovereign basis,” it said.
“Consultations are taking place with Eurostat which will decide on the treatment of both options for Member States’ debt statistics,” it said.
The document outlines in more detail the two options for leveraging the 440 billion euro EFSF approved by euro zone leaders in late October. The two options could be used together as well.
The first option is for the EFSF to guarantee part of a bond issue of a sovereign to ease concerns about the liquidity position of a government, increase demand at the primary auction and lower the sovereign’s funding costs.
The guarantee for part of the bond could be later detached from the bond and traded separately but would only be accepted for payment if the holder of the guarantee also held bonds of the sovereign -- no “naked” guarantees could be redeemed.
The guarantee would triggered by a missed payment of principal or interest due in case a government fails to make full and timely payments, in case of a repudiation or moratorium, or where there is a reduction or deferral of amounts due under the bond.
“The holder of the certificate would then be entitled to compensation in relation to the principal amount of bonds held, up to the maximum amount covered by the certificate. Work is continuing on finalizing the details of the trigger events and terms of payment,” the paper said.
The second option would be to set up one or more Co-Investment Funds (CIF) that would attract public and private funding to boost seed money from the EFSF. In an earlier paper on the options such Co-Investment Funds were referred to as Special Purpose Investment Vehicles (SPIV).
The CIF would buy bonds in the primary or the secondary markets. Purchases of bonds at primary auctions could give governments money for bank recapitalization, the paper said.
The CIF would normally hold the bonds of the distressed sovereign to maturity, but could sell them earlier if their its prices on the market returned to more normal levels.
“These vehicles are designed to attract external capital sources, maximizing EFSF resources and to provide a degree of credit protection to investors,” the paper said.
The document said that the risk sharing would be achieved through different capital layers with different loss absorption.
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 particiption units and the senior debt instruments would be freely traded and mature in line with the life of the CIF.
“The size of each tranche will be determined in the light of take-up from investors in the Participating Tranche and bond investors’ demand for any Senior Debt Tranche,” the paper said.
“If the CIF comprises a two tranche structure, the vehicle may be channeled through an IMF trust fund or administrative account,” the paper said.
The CIF would have a board of directors appointed by the EFSF, would have a specified investment policy and would provide investors with clarity about how their interests would be protected through the CIF’s decision-making.
Reporting by Ilona Wissenbach; Writing By Jan Strupczewski