Global investors have to support Eurozone bad bank bonds

By Neil Behrmann

November 2011

The latest Eurozone rescue bid will crucially depend on the support of global investors.

China, Sovereign Wealth Funds and other global investors are awaiting more details about the leverage of the European bailout fund before committing money to its bond issues.

The markets’ focus of attention will be on the coming Group of  Twenty (G20) meetings  in Cannes, France, November 3-4 when more specifics are expected to emerge.

Dollar against the Euro - 10 years (click to enlarge)

The key issue is the agreement to leverage the European Financial Stability Fund (EFSF). So far the details are vague and Germany, France and other nations need to spell out EFSF guarantees against losses. The seventeen members of the Eurozone have agreed to raise the capital of the EFSF to €440 billion and the statement after the meeting said that the capital could be leveraged up by four to five times. Since a sizeable proportion of  EFSF capital has already been used to fund Greece, there is inadequate capital to finance Spain, Portugal and Italy. Leaders at the summit agreed that the EFSF could issue bonds to meet the shortfall. The aim is to attract European and outside investors by offering partial guarantees against losses.  Although equity markets surged after the Brussels Eurozone summit last Thursday, the bond market was reticent. Greek ten-year sovereign bond yields were 24.2 per cent (a default rating), Portugal, 12 per cent, Ireland, 8.4 per cent, Italy 6 per cent, Spain 5.5 per cent and France 3.2 per cent. This compared with 2.2 per cent for Germany and 2.6 per cent for the UK and Netherlands.

Klaus Regling, chief executive of the EFSF has been negotiating with Chinese government officials for the issue of a “Beijing bond” denominated in Yuan.  The bond would be protected from the first 20 per cent of losses.

Mr Regling hinted at details of an EFSF “Beijing bond” issue in a speech to students at Tsinghua University on Saturday.

“We have so far issued only Euro bonds but we are authorised to use any currency we want if it seems efficient,” he said.

To allay investor fears Mr Regling has stated that the rating agencies, Moody’s S&P and Fitch had given the EFSF a Triple A rating. The top rating was confirmed on October 18 on the basis of amendments decided in July that raised the capital of the EFSF to €440 billion. An EFSF press release also stated that the three rating agencies had assigned the highest quality short term rating to the bail out fund.

“Confirmation of the highest possible credit rating shows the confidence in the strategy of the Euro area to restore financial stability,” said Mr Regling. “The amendments to the EFSF will allow it to contribute in more ways to implement this strategy”.

S&P confirmed that the EFSF had received a top rating as there was an “almost certain” likelihood that EU governments would back the EFSF “in the event of financial distress.”

The rating, however, was based on the €440 billion capital and guarantees of under €1 billion. The rating agencies, so far have not commented on the much higher leverage that was planned at last week’s Euro-zone summit.

Fitch warned, for example, that the 50 percent write down of Greek debt held by banks which was also agreed at the Summit “could, despite claims to the contrary, see Greece ruled in default”. Such an event could trigger “a cascade of damage throughout the financial system due to the activation of default insurance contracts”.

Illustrating investor caution, Zhu Guangyao, a Vice Finance Minister of China said in a press briefing: “We of course must wait until its structure is extremely clear.  Moreover, this investment must be decided on after serious, technical discussions.”

Mr. Zhu added that more details were needed on the EFSF insurance scheme.

“How much is this insurance? That’s still not clear,” he said.

Jin Liqun, chairman of China Investment Corp (CIC) said a few weeks ago that the sovereign wealth fund, wouldn’t offer handouts. Any investment would have to be secure. The CIC and other Asian sovereign wealth funds have already lost huge amounts in investing in vulnerable European and US financial institutions.

Several analysts also said that support from China  are also likely to be conditional on economic and budgetary reforms and potential trade and investment deals. Mr. Regling and Nicholas Sarkozy, the French President, claimed however that there would not be concessions. Despite their promises, Amnesty International fears that members of the Eurozone may stop criticising China’s poor human rights record.

George Soros said that the new Brussels Summit “deal” to solve the debt crisis will only last between “one day and three months”.

“Given the magnitude of the crisis it is again too little too late,” Mr Soros said of the Brussels deal at a dinner organised by Pi Capital investor network. “It will bring relief partly because the markets were so obsessed by the lack of leadership. The mere fact that something was achieved was a major relief and it will be good for any time from one day to three months.”

“Unfortunately it is not the last crisis because the fundamental issues have not been settled. It is clear that the amount of debt that Greece has accumulated and is accumulating is untenable and the country is effectively insolvent.”

Mr Soros is gloomy about the continent’s economic prospects as governments force through austerity measures when jobless levels are already high.

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