The European Financial Stability Facility (EFSF) released a statement late on Tuesday describing two new tools that will allow it to leverage up to €250 billion in order to increase its current €440 billion lending capacity, which experts agree is insufficient to settle markets.
The EFSF unveiled a “sovereign bond partial risk participation” program and the creation of “one or more Co-investment funds (CIF) [to] allow the combination of public and private funding." The former is essentially a bond guarantee program, while the later an investment vehicle that could buy bonds in both primary and secondary markets.
Bond protection offered under partial risk protection would consist of a tradable certificate given to a buyer of newly issued bonds of a member state. The certificate would give the bond holder credit protection of 20% to 30% of the principal amount.
There are two major issues here, the first, the fact that the certificate is tradable, making it prone to market volatility. The second, and deeper, issue is about credit events. It is still unknown whether these certificates will work like credit default swaps (CDS, regulated by ISDA), or other instruments, and what will trigger the protection.
Under the second option, CIFs would be created to purchase bonds in primary and/or secondary markets. CIFs would group private and public funding and could either provide funds directly to member states, or be used for bank recapitalization, according to the press release. These CIVs, which assimilate special purpose vehicles (SPVs), would comprise a first loss tranche financed by the EFSF.
Klaus Regling, CEO of Europe’s bailout facility, noted “both options are designed to enlarge the capacity of the EFSF so that the new instruments available to the EFSF can be used efficiently”. Both tools should be available for use in early 2012 and would be used “following a request from a member state.” In other words, the EFSF isn’t pulling a Hank Paulson and forcing distressed sovereigns to take the money, it is asking them to beg for it.
Another sticking point is the EFSF’s total firepower. Currently at €440 billion, the EFSF’s structure has been criticizing for not counting with the appropriate funds to support large European economies like Spain and Italy. Nouriel Roubini noted that Europe’s bailout program should top €2 trillion in order to avert a possible default in Italy, Spain, and Belgium, if either or all of these lost market access for twelve months. From the press release:
The Final amount of “firepower” achieved through the use of the options will depend upon the concrete use and mix of the instruments and particularly the exact degree of protection between 20% and 30%. EFSF has currently a lending capacity of €440 billion and firm commitments regarding Ireland and Portugal totaling €43.7 billion.
Details as to how the EFSF will actually work and be funded remain hazy. The EFSF has issued €8 billion in bonds maturing in 2016 at a yield of 2.75%, €5 billion in bonds maturing in 2021 yielding 3.375%, and €3 billion in bonds maturing in 2022 at a rate of 3.5%.
Without real details as to where all the money will come from, the EFSF did say investors “covering all types and geographic regions” had expressed positive views and willingness to participate. Trade the News reports the EFSF will enter short term funding in December, and quotes Regling warning that private investors won’t initially commit large sums.