Exclusive: Germany open to ESM changes if budget rules tightened

BRUSSELS (Reuters) - Germany is prepared to soften language in the euro zone’s permanent bailout mechanism compelling bondholders to accept losses in exchange for much stricter budget rules, four sources have told Reuters.

The shift would not completely remove the possibility of private bondholders having to accept losses in the future, but it would align the statutes of the European Stability Mechanism more closely with IMF rules, creating a more-level playing field for private buyers of euro zone sovereign debt.

The hope is that will reassure private bondholders that they are not being singled out for losses by European policymakers, bolstering their confidence in buying euro zone bonds - and potentially helping Italy and other under-pressure borrowers.

Following the insistence earlier this year that private bondholders should share the cost of a second Greek bailout, investors had feared that a precedent had been set which could be repeated any time another euro zone sovereign ran into trouble.

The ESM, which will have a capacity of 500 billion euros, is scheduled to come into force in mid-2013 and will replace the current bailout fund, the European Financial Stability Facility, which the euro zone is struggling to leverage into a more effective fighting force.

While acknowledging movement in Germany’s position, a senior euro zone source emphasised that it depended on securing agreement among the 17 euro zone countries on stricter budget oversight, including sanctions for those that miss macroeconomic targets and the possibility of taking transgressors to court.

The source said private sector involvement (PSI) -- the ability to have banks and insurance companies share losses when a sovereign defaults or restructures its debt -- would not disappear from the ESM, “but the wording could be eased.”

The changes are being discussed as part of wider negotiations about deeper and more rapid fiscal integration in the euro zone, which German Chancellor Angela Merkel sees as critical to combatting the sovereign debt crisis.

Discussions on the ESM, on deeper fiscal integration and on changing the EU treaty to enforce stricter rules for the euro zone will build to a head in the coming week, with a summit of EU leaders in Brussels on December 8-9.

Merkel will meet French President Nicolas Sarkozy in Paris on Monday to discuss positions ahead of the summit.

A second source said the aim was for the language in the ESM’s treaty, which has already been drafted, to be altered so it was more closely aligned with international practice, a move that would reassure bond markets.

“We hope to have the PSI rules in the ESM being fully in line with international practice and IMF rules,” the source, a senior European Union official, said.

“There is also a French push to have PSI written down not in the ESM treaty itself but in the annexes” of the treaty, although it remains unclear whether that will be accepted.

The argument being deployed is that if iron-clad fiscal rules are adopted by the 17 euro zone members, the threat of default should be negligible and so, therefore, should the threat to bondholders.

There is a push to bring forward the ESM, possibly to as early as July next year, but doing so will depend in large part on securing full backing from all 17 euro zone member states for the proposed changes to the mechanism’s framework.

That may not be straightforward. Finland, for example, is adamant about the need to retain in the ESM so-called “collective action clauses” (CACs), which make it easier to enforce losses on bondholders in the case of default.

“They (Paris and Berlin) are discussing about the CACs and about the PSI ... and about decision-making within the ESM, with some special majority rule being enforced,” said another EU official involved in the discussions.

“(PSI) is one of the elements under consideration. We expect a move from the Germans,” he said, underlining that Germany was showing a willingness to shift, but it depended on securing stricter budget rules and the wording needed finalising.


French President Nicolas Sarkozy made it clear in a speech in Toulon last week that he wanted the private sector to be given a more-level playing field when it came to the threat of having to bear losses on their investments.

He said Greece, where there have been drawn-out negotiations between the government and the private sector over how much of a hit banks and insurance companies should take under a debt restructuring, should be a unique case.

“It must be clear that what has been done for Greece, in a very particular context, will not happen again, that no other state in the euro zone will be put into default,” he said.

“It must be absolutely clear that in future no saver will lose a cent on the reimbursement of a loan to a euro zone country.”

As part of the discussion about bringing forward the ESM, there are also suggestions about granting it a banking licence, which would allow it to access European Central Bank funds and act more aggressively to buy at-risk euro zone debt.

Reporting by Julien Toyer and Luke Baker in Brussels, Andreas Rinke in Berlin and Paul Taylor in Paris, editing by Mike Peacock