Investors worried by the lack of details on how the EFSF will work in practice can expect them to be “mostly clarified by early October,” according to the fund’s chief financial officer, Christophe Frankel. But he warned Euromoney’s Global Borrowers and Asia Investors Forum in Singapore that the changes to the EFSF are subject to parliamentary ratification, which could delay implementation beyond October. Finland, for example, has been debating whether to ask for collateral against its participation in the second Greek bailout – a matter that Frankel says the EFSF has “no direct involvement with”.
Uncertainty over these details has been contributing to market volatility in the eurozone since June, when the European Council in charge of the EFSF – which is charged with providing funds to euro area member states in difficulty – made two announcements expanding the scope of the facility. On June 24, the Council announced that the EFSF would increase its guarantee commitments to €780 billion; and on July 21 the council expanded the scope of the fund’s activities to make it the primary agent of the second Greek bailout and a source of loans to troubled financial institutions via governments. Then summer holidays intervened. As analysts from Barclays Capital noted on September 14: “Nervousness in the market is partly fuelled by the approval processes for the enlarged and enhanced EFSF functions. The envisaged changes were proposed in June (size) and July (scope), but due to the summer holiday of parliaments and other delays, there is some confusion about the EFSF’s exact and actual functions as of today.”
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| “The EFSF is not a solution but a means to gain time.” -EFSF CFO Christophe Frankel |
It is these concerns that Frankel sought to address in Singapore. The new EFSF has the ability to intervene in secondary bond markets. Analysts are unclear whether the fund’s board can decide on the scope and size of interventions itself, or must seek approval from the relevant governments. “We will need preliminary approval from the countries involved, in consultation with the ECB,” says Frankel. “Within those constraints, the fund will have the capacity to decide on the nature of these interventions.”
Meanwhile European markets await the approval of the national governments involved in the EFSF for the changes to the fund. As well as an increase in the size and scope, these changes include raising the guarantee ratio provided by each country from 120% to 165%. This removes the need for a loan-specific buffer to protect the triple-A rating of the bonds. RBS analyst Frank Will notes that since this change is not retroactive but will apply only to new bonds, it has the effect of creating two classes of EFSF notes: bonds backed by loan-specific buffers and those completely guaranteed by triple-A countries. Will expects the new bonds to trade inside the old ones, but says that worries about a potential downgrade of triple-A countries could hold back the performance of EFSF paper.
Since its inception, the EFSF has been dogged by accusations that its bonds are difficult to evaluate because they are backed by six triple-A rated countries, as well as lower rated sovereigns. Several prominent market sources compare them to a CDO in as much as the bonds are triple-A rated paper with some lower-rated credits (as well as triple-As) backing them.
The EFSF rebutted that accusation in a public letter, stating that there is no subordination in EFSF debt. Nonetheless, investors question if raising the size of the fund will dilute that triple-A backing and make its paper effectively a proxy for the eurozone.
“Investors have to be clear that the EFSF is guaranteed by 17 countries of which some are triple-As,” says Frankel. “If it became clear that we needed to increase the size of the fund, we could call on all the guarantors to participate at the same level as now, according to their own share. We know that whatever happens to the non- triple-A countries, the quality of the triple-A rating for our bonds relies on the triple-A countries.”
Either way, Frankel is clear that the EFSF is only a temporary and a partial solution: it is to be phased out in favour of the European Stability Mechanism by mid-2013. “Ultimately the solution to this problem in the eurozone has to come from the countries themselves,” he says. “The EFSF is not a solution but a means to gain time.”
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