BRUSSELS (MNI) – The European Union should create a European Crisis
Resolution Mechanism (ECRM) which includes a procedure for restructuring
sovereign debt, a Brussels-based think tank said on Tuesday.

European leaders agreed last month to create “a permanent crisis
mechanism to safeguard the financial stability of the Euro area as a
whole” but are divided over how private sector bond holders should be
made to share the burden if a country falls in to difficulty.

At the moment, if a government were to have problems paying its
debts, it could seek aid from a E440 billion financial stability
facility set up earlier this year for three years.

A replacement for this mechanism, to commence in 2013, is currently
under debate in Europe, with France and Germany preferring a deal which
would see investors shoulder the burden.

The Bruegel economic think tank has published a paper
advocating a two-pronged approach to the problem: firstly, a procedure
to allow debt restructuring handled by the European Commission and the
European Court of Justice, and secondly, a set of rules governing
financial assistance to Eurozone member states handled by the European
Financial Stability Fund.

“One of the main benefits of creating an ECRM would be the public
acknowledgement that the default of a government on its debt is a real
possibility in the Euro area, which along with the necessary changes in
financial regulation and supervision would strengthen market discipline
and help prevent further debt crises,” the think tank said in its
proposal.

“Additionally, in the event of a crisis, the existence of this
mechanism would guide market expectations on how governments and
European institutions can respond, minimising volatility in financial
markets,” it added.

“The ECRM would have to balance the interests of the debtor and its
lenders and to keep moral hazard problems on both sides to a minimum,”
the think tank said.

The orderly default procedure would “determine whether a sovereign
is in need for restructuring because its debt has reached unsustainable
level,” the paper said.

It would then “initiate and conduct negotiations between a
sovereign debtor with unsustainable debt and its creditors leading to,
and enforcing, an agreement on how to reduce the present value of the
debtor’s future obligations in order to re-establish the sustainability
of its public finances,” Bruegel said.

“This would require a special court to deal with such cases,” it
added, saying that the European Court of Justice “is the natural
institution for this purpose and a special chamber could be created
within it for that purpose.”

To complement this default procedure, Bruegel proposes a “set of
rules for the provision of financial assistance to be managed by the
European Financial Stability Facility.”

That would require making the EFSF a permanent institution. The
E440 billion fund, designed to provide loans with strict conditionality
to Eurozone members that fall in to financial difficulty, was set up
for three years in May 2010.

The Bruegel report said that the ECRM would require a change to
EU legislation, as set out in the treaties, and noted that “this
implies, inter alia, that the new arrangement would not apply to debt
contracted before its entry into force.”

–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com

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