A note on European Financial Stability Facility

This is a very interesting topic and have missed writing on this despite the hype. I covered it in May 2010 but not after that.

As Greece crisis shaped up and Europeans threw the bailout towel after months of denial, European Financial Stability Facility was set up. EFSF was agreed on 9 May 2010 and incorporated in Luxembourg on 7 June 2010.

 The facility is a SPV structure.  The funding structure is like this:

  • Eur 440 bn – comes via guarantees from 16 EMU members. Country-wise contribution is like done in ECB with Germany and France contributing largest at 27.13% and 20.38% respectively. Lowest contribution comes from Malta at 0.09% of 400 bn. (See this)
  • Eur 60 bn – comes from European Financial Stability Mechanism (EFSM) which is funds raised by European Commission
  • Eur 250 bn from IMF

If you realise, much of this structure is based on guarantees. It is nothing but a credit enhancement scheme.

Next comes the lending scheme:

  • Based on these guarantees, EFSF will issue bonds and sell the bonds to market participants for financing the needy government.
  • So say Ireland asks for EUR 100 bn finance from EFSF. EFSF will then issue bonds worth EUR 100 bn to market participants. In case Ireland does not pay up, then 16 governments will contribute the 100 bn in their agreed proportion.

Very interesting arrangement. The various EMU govt pays only in case some country defaults. It becomes a structured obligation in corporate finance terms. The FAQs say that EFSF will not be a preferred creditor and will have the same standing on sovereign claims like other creditors. Just that the loans are guaranteed by the governments.

Also, most European policymakers blame the financial markets for their short-termism strategies. But are finally bailed out by the financial market themselves. As Greece got its own bailout of EUR 110 bn pooled by EMU countries, it has so far not used EFSF. Ireland could be the first user of this facility.

There are FAQs here. It says most loans and bonds would be for 3-5 years. The pricing of the loans is also explained:

The blueprint for EFSF support – although not binding – is the financial aid package to Greece where, for variable-rate loans, the basis is three-month Euribor, while fixedrate loans are based upon the rates corresponding to swap rates for the relevant maturities. In addition there is a charge of 300 basis points for maturities up to three years and an extra 100 basis points per year for loans longer than three years. A one  time service fee of 50 basis points is charged to cover operational costs.

I was also checking the EFSF organisational structure. Again we have a typical structure seen in European institutions. Klaus Regling Chief Executive Officer is a German. Christophe Frankel CFO, Deputy CEO is a French.

Addendum:

From today’s Eurointelligence edition. There are rumors that EFSF balance sheet is increased from current EUR 750 bn:

One of the reasons behind yesterday’s panic were comments by Axel Weber at a German embassy dinner and Paris, when he said that, if necessary, the EU would increase the ceiling of the EFSF. A few hours later, in Berlin, he tried to clarify his position, by producing an interesting calculation. The total EFSF/IMF lending ceiling plus the ECB bond purchase came to €925bn. The maximum possible default mass in the eurozone is €1070bn. There is a theoretical difference of some €140bn to €150bn. The euro will not fail due to this gap, he said according to FT Deutschland.

We have no idea how he got to these figures. They suggest that the EFSF could lend up to its ceiling (which it cannot do if it wants to retain a triple-A rating), and he also makes implicit, and unknown to us, assumptions about the ECB’s involvement. His statement that the euro won’t fail due to a gap of €140bn suggest that he is not, in principle, ruling out an increase in the EFSF’s ceiling (especially given the triple-A constraint.) His calculation confirms what he said in Paris. It is not a retraction at all. He says effectively that an increase in the EFSF would constitute an emergency stop gap measure. The German government was keen to clamp down on speculation of an increase in the size of the EFSF, according to a story in Reuters.

A separate story in Die Welt suggested that the European Commission was also pondering to propose an increase in the size of the fund, so the story had some traction during the day yesterday.

Reuters this morning reports that Wolfgang Schauble rejects calls to rise the ceilings of the rescue fund.

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3 Responses to “A note on European Financial Stability Facility”

  1. Tirath Says:

    You are a gem of a source for knowledge-hungry people like me.
    Thanks!

  2. Ireland Bailout Basics… « Mostly Economics Says:

    […] EFSF was developed as the main facility for future bailouts and was made a EUR 750 bn fund. But its contribution is just about EUR 17.7 […]

  3. Ireland Bailout basics « Mostly Economics Says:

    […] was developed as the main facility for future bailouts and was made a EUR 750 bn fund. But its contribution is just about EUR 17.7 […]

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