– Draft Focuses On Insurance Solution and Special Purpose Vehicle
– The Two Options Do Not Exclude Each Other

BERLIN (MNI) – Germany’s lower house of parliament, the Bundestag,
will vote Wednesday on the broad outlines agreed to at the EMU leaders’
summit over the weekend to enlarge the capacity of the European
Financial Stability Facility (EFSF) without extending the guarantees
underpinning the E440 billion fund.

The draft is to be finalized later the same day at another summit
of Eurozone leaders in Brussels.

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

“A more precise number on the extent of leverage can only be
determined after contacts with potential investors. Two more specific
options — a credit enhancement approach and the setup of an SPIV
(special purpose investment vehicle) could be further pursued in order
to increase the effective capacity of EFSF in implementing the
instruments as described in the EFSF guidelines,” the draft states. The
options outlined do not exclude each other.

Under the credit enhancement approach, basically a form of
insurance, so-called partial protection certificates would be attached
to a Eurozone member state’s bond issuance.

“Both items could be issued as a combined package, but would be
separable and intended to be freely traded after issuance. The coupon on
the sovereign bond should be lower than current market yields because of
the protection afforded by the attached certificate, and thereby
contribute to the sustainability of financial flows,” the draft

The mechanisms to implement this approach should be compatible with
the operational model of the EFSF, the draft says.

“This could be achieved by the EFSF extending a loan to a member
state in order for the member state to acquire EFSF bonds which back the
effective guarantee. The bond would then collateralize the partial
protection certificate and could be held by a Trust or SPV on behalf of
the member state. In the event of a default (to be defined), the
investor could surrender the partial protection certificate to the
Trust/SPV and receive payment in kind with an EFSF bond,” the draft

Under the second option, one or more special purpose investment
vehicles (SPIV) would be established.

“Each dedicated SPIV would have a mandate to facilitate funding of
member states through loans, and invest in sovereign bonds of a specific
country in the primary and secondary markets. This vehicle could be
funded by different classes of instruments with distinctive risk/return
characteristics,” the draft explains.

The instruments could include a senior debt instrument and a
participation capital instrument, both of which would be freely traded
instruments. In addition there would have to be an EFSF investment,
which would absorb the first proportion of losses incurred by the
vehicle, according to the draft.

“The SPIV structure should be set up so as to attract a broad class
of international public and private investors,” the draft underlines.
For that purpose, the senior debt instrument could be credit rated and
targeted at traditional fixed income investors.

“The participation capital instrument could be junior to the senior
debt instrument but rank ahead of the EFSF investment. This might
attract Sovereign Wealth Funds, risk capital investors and potentially
some long-only institutional investors. This tranche will potentially
share with EFSF any upside generated by the investments,” the draft

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

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