Launched to great fanfare a year ago, the eurozone rescue fund could soon be overtaken by events.
Eurozone finance ministers meeting in Brussels on Tuesday night agreed on another incarnation of the European Financial Stability Facility, replete with new elements aimed at making the money it can draw on go further.
However, many in financial markets have become increasingly dismissive of what only a few months ago was being hailed as the potential solution to the eurozone debt crisis.
“Yesterday’s solution” is how Gary Jenkins of Evolution Securities describes the EFSF, currently a €440bn fund backed by eurozone member states to bail out troubled countries. Has it been left behind by the rapid escalation in the crisis that has engulfed Italy and Spain and threatens to suck in “core” countries such as France and even Germany?
The option of offering partial insurance on government bonds sold at auction by certain countries – the most likely candidates being Italy and Spain – is in the EFSF’s new rules. Investors would be given a 20-30 per cent guarantee. That would allow the facility to use its current €250bn capacity to cover up to five times as many bonds, although EFSF executives and ministers have conceded that it is unlikely to be able to guarantee much more than €500bn because of market volatility.
Investors’ main concern, though, is whether the EFSF has enough money to do all that could be demanded of it. After the recent bail-outs of Portugal, Ireland and Greece are factored in, only about €250bn would be left. Italy and Spain’s bond markets are in a different league, with combined funding needs of about €1,000bn in the next three years alone.
“The current numbers for the EFSF don’t even come close to covering that next level. EFSF’s is yesterday’s debate,” says Neil Williams, chief economist at Hermes, the UK fund manager.
Another issue is the size of the guarantee. Given that Italian 10-year benchmark bonds were on Tuesday trading at 83 cents in the euro, analysts are asking whether an insurance policy for just 20-30 per cent would help.
One investor points out that typical sovereign restructurings involve losses of up to 60 per cent while Greece is trying to make banks accept one of at least 50 per cent. That means valuing the bonds would become a complex matter of evaluating default risk, something few government bond investors are used to doing.
The EFSF’s €250bn capacity is also unlikely to be limited purely to offering guarantees on new debt, meaning it is unlikely to be able to guarantee as much as €1,000bn in bonds as some supporters of the scheme have claimed. The EFSF will also be able to give loans to countries for bank recapitalisations, buy bonds in both the primary and secondary markets and offer precautionary credit lines.
On its own funding, however, there are innovations. The EFSF will start issuing bills, short-dated debt of less than a year, at the rate of about €10bn-€20bn a month to supplement its bond programme. The EFSF could use any bonds it buys in the markets in repurchase agreements, or repos, with commercial banks.
Problems still persist with own funding, however. As doubts have increased about the triple A status of France, which along with Germany is the big guarantor of the facility, so the EFSF’s implied borrowing costs have risen. Its three bonds – two for five years and one for 10 – all trade between 143 basis points and 158bp over the equivalent maturity of German bonds, even after the latter have sold off.
Analysts report that investors are starting to shun eurozone assets in a wholesale way, raising the question of how cheaply the EFSF will be able to fund, especially if Paris loses its top rating.
Still, some believe the new rules may serve a purpose. “The impact is perceived [by the market] to be limited. But importantly the political step has to be taken,” says Norbert Aul, European rates strategist at Royal Bank of Canada.
He thinks a likely solution to the eurozone crisis will need EFSF involvement alongside the European Central Bank and International Monetary Fund.
Others in the markets are convinced that the immediate answer does not lie with the EFSF but with the ECB. Mr Jenkins says the ECB may be restricted in scope compared with the EFSF – not being able to buy sovereign bonds in auctions, for instance – but that its firepower is theoretically unlimited. By contrast, the EFSF is broader in scope but limited in money.
He argues that in the long term, fiscal union – and thus common eurozone bonds – could well be the answer.
But in the short term only the ECB has the ability to change markets’ perception. He says: “Ultimately this whole crisis revolves around restoring confidence to investors. If they can’t do that, markets are always going to be in a fragile state. You need to cause a fundamental shift in people’s thinking.”