The European Financial Stability Facility

What’s at stake: On Monday, the Finance Ministers of the Euro-area states signed documentation establishing the European Financial Stability Facility (EFSF) in line with the actions taken by the Economic and Financial Affairs (ECOFIN) Council last month, providing more details about how this will work. Most notably, they plan to create a joint eurozone "special purpose vehicle"(SPV) which will issue up to €440bn in bonds, if needed, to provide loans which can then be used to support countries. Together with €60bn from the European Union and €250bn from the International Monetary Fund, it provides a total of €750bn – initially for three years – which troubled Eurozone members can borrow from in times of need. After three years the fund will be replaced by a permanent crisis mechanism – the form of which is currently being debated by a high-level task force led by European Council President Herman Van Rompuy. The task force conclusions as well as further details on the functioning of the SPV will be presented at the next European summit on Thursday.

The terms of reference of the eurogroup EFSF establish the EFSF as a limited liability company under Luxembourg law. The objective of the EFSF is to collect funds and provide loans in conjunction with the IMF to cover the financing needs of euro area Member States in difficulty, subject to strict policy conditionality. Euro area Member States will provide guarantees for EFSF issuance up to a total of € 440 billion on a pro rata basis. The obligation of euro-area Member States to issue guarantees for the EFSF debt instruments will enter into force as soon as a critical mass of Member States, representing 90% of shareholding, has completed the relevant national parliamentary procedures. Ministers have agreed on a number of measures to ensure the best possible credit quality and rating for the debt instruments issued by EFSF, such as a 120% guarantee of each Member State's pro rata share for each individual bond issue and the constitution, when loans are made, of a cash reserve to provide an additional cushion or cash buffer for the operation of the EFSF. See also Reuters which has a good Q&A on how the EFSF will work.

Lex argues that the danger is that the EFSF structure proves too cumbersome or collapses under the weight of its central contradiction: that one group of financially stretched countries should be expected to bail out another.  First, securing a triple A rating – and holding on to it is a leap of faith. Only two of its top four owners – Germany and France – enjoy that status. Second, any conditions it sets on loans to borrowers may need to be approved in those countries. That could be a tall order if, say, the condition for a loan to Spain were reform of the Spanish labour market.  Alphaville argues that with the beggar-thy-neighbour quality of the SPV duly avoided with some structured finance flattery, there’s just one problem left: the threat of legal challenges to the debt guarantees of the SPV.

Gillian Tett raises some issues about how the EFSF will work in actuality. It has yet to be determined where the debt that is issued by the EFSF will stand in seniority to existing sovereign debt. If the SPV made loans to Greece, would these be senior to existing Greek bonds? Would joint eurozone SPV issued bonds undermine investor appetite for national bonds? If so, could Europe be inching towards an American-style "two-tier" market, where part of the market would be highly liquid (like so-called "on the run" US Treasury bonds), but the rest an illiquid backwater (like, say, US municipal bonds)?

Jean Quatremer writes that France is unhappy about the Germanic terms of the SPV, which is now created under Luxembourg law and is likely to be run by a German. The fund is limited to 4% to the eurozone’s GDP, and there is no joint solidarity. Everybody is only responsible for their own share of the fund. But at least Paris managed to negotiate away the German insistence that national parliaments should sanction each payment.

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