EU plan to insure against bond losses

EUROPEAN POLICY MAKERS are moving towards a plan that would enable the euro zone’s €440 billion rescue fund to insure investors against some losses on government bonds, arguing it presents the fewest legal and political hurdles to increasing the fund’s firepower quickly.

Officials have focused on the insurance plan after European Union legal staff determined that other proposals – including turning the fund into a bank so it could gain access to unlimited funding from the European Central Bank – were not allowed under EU regulations.

ECB president Jean-Claude Trichet and senior German officials have also objected to plans that would lean on the ECB for financing, arguing it is not the central bank’s role to provide funds to an agency that many envision as a nascent euro zone treasury.

“The [ECB] governing council does not consider it to be appropriate for the ECB to leverage it [the fund],” Mr Trichet said last week. “We believe that governments have all necessary capacity to leverage it [the fund] themselves.”

Jean-Claude Juncker, the Luxembourg prime minister who heads the group of euro finance ministers, said after their most recent meeting that plans involving the ECB had largely been ruled out.

Under the insurance plan, the euro zone fund, formally known as the European Financial Stability Facility (EFSF), would guarantee 20-40 per cent of losses on bonds for struggling euro zone countries, particularly Spain and Italy, instead of buying them, as the ECB does.

Depending on how high the guarantees are, such a scheme could leverage the EFSF’s resources to between €1,000 billion and €2,900 billion, the latter proposed by German insurer Allianz.

“Issuing partial guarantees is signalling euro area countries consider Spain and Italy to be fundamentally solvent and are willing to put their money where their mouth is,” said Sony Kapoor, head of economic consultancy Re-Define and one of the first to propose such a scheme.

Plans on how to use the fund’s limited resources more broadly have been debated for weeks, but officials are hoping to decide on a single scheme at a summit next week.

When it was unveiled, the EFSF was viewed as a temporary firefighter in peripheral euro zone countries such as Greece. However if Slovakia signs off later this week, as expected, the fund will soon be used to shore up faltering euro zone banks and prevent runs on sovereign bonds of some of Europe’s largest economies.

Analysts have argued that the EFSF needs anywhere from €2,000 billion to €4,000 billion for the new roles.

Because more cash cannot be poured into the fund without threatening triple-A debt ratings of countries such as France, officials have agreed to “leverage” the fund’s current assets instead. – (Copyright The Financial Times Limited 2011)