–EFSF Guideline Draft Foresees Two Different Leveraging Models

BERLIN (MNI) – The European Financial Stability Facility (EFSF)
rescue fund likely will only be able to leverage its disposable capital
by three to four times and not, as previously hoped, by up to five
times, a senior lawmaker from German Chancellor Angela Merkel’s
CDU/CSU-FDP coalition said Monday.

The budget committee of Germany’s lower house of parliament, the
Bundestag, will approve today the new guidelines of the EFSF, which
foresees the fund insuring 20% to 30% of the sovereign bonds of troubled
Eurozone member states, Norbert Barthle, the CDU/CSU’s parliamentary
budget speaker, said ahead of the committee meeting here.

The upper end of that range is higher than what was previously
foreseen and makes it unlikely that the EFSF can be leveraged to up to
E1 trillion. Barthle said the increased insurance portion is due to the
difficulty of finding outside investors for Eurozone government bonds.

According to the draft of terms and conditions, obtained by Market
News International, two models exist to leverage the capacity of the
EFSF.

Option 1 is a credit enhancement for primary sovereign bonds issued
by Eurozone states, aimed at increasing demand for new issues of
sovereign bonds.

Option 2 is the creation of one or more so-called Co-Investment
Funds (CIF) to allow the combination of public and private funding to
enlarge the resources available to the EFSF’s financial assistance
instruments.

The CIF would aim to create additional liquidity and to enhance
market capacity to fund loans. It would purchase bonds in the primary or
secondary markets. Whereas the CIF would provide funding directly to
Eurozone states through the purchase of primary bonds, this funding
could be used for bank recapitalisation.

Financing under options 1 and 2 will be linked to a Memorandum of
Understanding entailing policy conditionality appropriate to the
financial instrument chosen, and monitoring and surveillance procedures
as specified in the EFSF guidelines.

Under option 1, Eurozone member states’ bonds would be issued in
combination with a “partial protection certificate” of the same maturity
as the bond to which it was attached.

The sovereign bond and the certificate would initially be offered
together to investors. The certificate could then be detached after
initial issuance and be traded separately.

The certificate gives the holder an amount of fixed credit
protection equal to 20% to 30% of the bond’s principal, to be determined
in the light of market circumstances.

The exact percentage of the fixed credit protection must still be
agreed upon by the Eurogroup. If the Bundestag budget committee approves
the 20% to 30% range today, the German government will be allowed to
accept such a range on the European level.

Option 2 foresees establishing a so-called Co-Investment Fund (CIF)
to invest in sovereign bonds of Eurozone member states. The CIF would
have one or more compartments. Each compartment could either be
dedicated to a single Eurozone member state or to more than one member
state. The CIF would have a pre-defined lifetime.

The purpose of the fund would be to attract external capital to
Eurozone member states’ sovereign debt markets, maximising EFSF
resources while providing a degree of protection to investors.

The CIF would invest in the sovereign bonds of an Eurozone member
state which had entered into a Financial Facility Assistance Agreement
(FFA) with the EFSF.

As a rule, the fund would hold the bonds to maturity, but it could
have some flexibility to sell them earlier in pre-defined circumstances
under normal market conditions.

The CIF is to have three layers: a first loss tranche, a
participating tranche — freely tradable — and potentially a third
layer of rated senior debt, also freely traded. Selected CIF
compartments could adopt a two tranche structure if needed to meet
investor preferences.

All tranches would have maturities equal to the life of the
respective CIF compartment, although maturities in the potential third
tranche of senior debt could be linked to the underlying sovereign bonds
acquired by the CIF.

–Berlin bureau: +49-30-22 62 05 80; email: twidder@marketnews.com

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