BERLIN (Reuters) - Detailed operational rules for the euro zone’s bailout fund, the European Financial Stability Facility (EFSF), are ready for approval by euro zone finance ministers on Tuesday, documents obtained by Reuters showed on Sunday.
The documents spell out rules for EFSF intervention on the primary and secondary bond markets, for extending precautionary credit lines to governments, leveraging its firepower and its investment and funding strategies.
The approval of the rules will clear the way for the 440 billion euro facility to attract cash from private and public investors to its co-investment funds in coming weeks, which, depending on interest, could multiply the EFSF’s resources.
The bailout fund will also be able to offer partial protection for private investors on their purchases of euro zone sovereign bonds, like those of Spain or Italy, at primary auctions, boosting demand and lowering sovereign funding costs.
Euro zone leaders agreed on Oct 27 that the EFSF should be leveraged through the partial insurance scheme and the co-investment funds to around 1 trillion euros.
But the EFSF itself has played down that number as difficult in current market conditions of high aversion to euro zone debt exposure.
Outside investors have shown no concrete interest in investing in the fund, although some of said they would look closer when the operational details were made public, and analysts say it risks underwhelming the markets with insufficient firepower.
The European Central Bank, which is now buying bonds of Spain and Italy on the market to prevent borrowing costs for the two countries to get out of control, has been urging euro zone ministers to finalize the technical work on the EFSF quickly.
Officials have told Reuters that even once the details are agreed, the complexity of the mechanisms means the fund may not be operational until January.
That may be too late. With Germany rigidly opposed to the idea of the ECB providing liquidity to the EFSF or acting as a lender of last resort, the euro zone needs a way of calming markets, where yields on Spanish, Italian and French government benchmark bonds have all been pushed to euro lifetime highs.
The documents specify that the EFSF would offer partial protection to investors buying a country’s bonds at a primary auction of around 20-30 percent of the principal amount of the bond, depending on market circumstances.
The protection certificate would be detachable from the bond and could be traded separately, but the investor would have to hold bonds of the country before cashing it in.
The certificate could be paid if the bond issuer triggers a credit event under the full definition of the International Swaps and Derivatives Association. It would be paid in cash or EFSF bonds by a special purpose vehicle based in Luxembourg.
The documents also say that the protection certificate could be paid in case of a “modified sovereign restructuring,” which is defined as a voluntary restructuring, exchange or debt buy-back or other event affecting a sufficiently high percentage of the private holders of one or more bonds.
This would mean that any Greek-type of voluntary debt restructuring would also trigger a pay-out of the guarantee.
The documents also says, however, that for the modified sovereign restructuring to be triggered, the total amount of bonds affected must reach a threshold to be specified — presumably by euro zone finance ministers.
The documents also said that the EFSF would need to ready cash of around 10 billion euros to be able to react quickly to face the more urgent needs.
“The aim of this strategy is to provide EFSF with the necessary flexibility to carry out the new funding requirements through the issuance of short-term instruments,” the document prepared for the finance ministers’ meeting said.
This would allow the bailout fund to better manage lending needs through issuing short-term notes and then rolling them over into new short-term or long-term bonds.
“In addition, the issuance of short term instruments would allow EFSF to progressively achieve a permanent precautionary liquidity buffer which can be used to cover urgent and unexpected needs,” it said.
“Loans and funding instruments could have different structures and therefore would necessitate the implementation of micro-hedge mechanisms,” it said.
The EFSF could start regular, monthly auctions of bills, for example for 3, 6 and 12 months according to a calendar published quarterly with maximum monthly issuance of 20 billion euros.
“Furthermore, the issue of unsecured money market instruments as well as committed credit line facilities from banks are also required to complement the short-term funding for exceptional purpose,” the document said.
The EFSF currently has a capacity of 440 billion euros but is already committed to providing assistance to Ireland, Portugal and Greece, and needs to set aside money in case it needs to help recapitalize European banks as well.
As a result, it only has about 250 billion euros available, not nearly enough to help Italy and Spain.
Additional reporting by Gernot Heller, writing by Jan Strupczewski, editing by Mike Peacock