Eurozone summit proclaims bail-out fund of €1 trillion

Leaders agree in principle on strengthening EFSF.
Banks to take 50% hair-cut on Greek bonds.

● What they agreed

The eurozone countries reached agreement in the early hours of this morning (27 October) to strengthen their bail-out fund to potentially €1 trillion.

Herman Van Rompuy, the president of the European Council, said that they had agreed to multiply by up to five-fold the power of the European Financial Stability Facility, which has a nominal capital of €440 billion, but whose current lending capacity is considerably less.

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The agreement follows a lengthy stand-off between France and Germany over how to strengthen the lending power of the EFSF. But the technical and legal details of how the EFSF money will be leveraged have still to be worked out.

Nicolas Sarkozy, the president of France, said: “These are truly historic decisions…in order to pacify and stabilise the markets.”

José Manuel Barroso, the president of the European Commission, said: “I believe that now we have a very solid way forward.”

Van Rompuy also announced a breakthrough on how much pain should be inflicted on private banks holding Greek government debt. After difficult negotiations last night with representatives of the lending institutions, a “hair-cut” of 50% has been agreed in principle. The summit’s conclusions state that “we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors”. The eurozone member states said that they were ready to contribute “up to €30bn” to help support the private sector involvement.

In addition, the eurozone countries said that they would support a second programme of loans to Greece. The first programme, agreed in May 2010, was for €110bn – €80bn from the EU and €30bn from the International Monetary Fund. The eurozone said that the second programme should be for €100bn up to 2014.

Sarkozy said: “France wanted to avoid a tragedy. If Greece had defaulted, it would have been a tragedy.”

Fact File

The EFSF will be ‘leveraged’ in two ways.

First, it will be used as an insurance that investors could opt for when they buy sovereign bonds in the primary market. Officials hope that this will reduce member states’ borrowing rates. The insurance would cover a portion of the principal value of the bond but the precise amount will depend on market conditions and circumstances of the country. Officials say that a widely reported figure of a 20% portion “will have to be confirmed”.

Second, one or several special purpose vehicles (SPVs) could be set up which will be able to fund EFSF operations. A dedicated SPV would have a mandate to fund member states in trouble and buy sovereign bonds. Its capital would come from existing EFSF funds as well as international investment from the private and public sector. Officials say that this could attract sovereign wealth funds, risk capital investors and “potentially” some long-term institutional investors. The SPV would be able to buy bonds on the primary and the secondary market. Officials said discussions with “a range of investors” would continue “as the scheme is further developed”.

The Eurogroup of finance ministers in the eurozone, the European Commission and the EFSF are to contact the International Monetary Fund to “look into available options of closer co-operation with the EFSF support packages”.

Officials say that “further discussions” will need to be held with investors and the ultimate firepower of the EFSF “will depend on the exact structure of the new instrument”.

They say that the leverage “could be up to €1tr under some assumptions about market conditions, the instrument structure and investors’ responsiveness”.

 The exact terms of the EFSF leveraging will be finalised by the end of November by eurozone finance ministers.

The eurozone leaders had already – at their meeting on Sunday and at their earlier meeting on Wednesday with the EU countries that are not in the eurozone – agreed on a recapitalisation for the largest of the EU’s banks. The estimate of the European Banking Authority is that the banks must put in place a capital buffer of €106bn.

The last element of the measures announced last night was an affirmation of budgetary and fiscal discipline. The eurozone council’s conclusions put on record support for Spain’s austerity programme and for measures promised by Italy.

The conclusions “commend Italy’s commitment to achieve a balanced budget by 2013 and a structural budget surplus in 2014, bringing about a reduction in gross government debt to 113% of GDP in 2014, as well as the foreseen introduction of a balanced budget rule in the constitution by mid-2012”.

“Peer pressure is working,” said Van Rompuy, saying that the council had taken note of Italy’s declared aim of increasing the retirement age to 67 by 2026.

“The important thing is implementation,” he said.