The European Financial Stability Facility was set to be good to go as Euromoney went to press. As detail on the framework becomes clearer, many market participants are asking what the potential issuance of its bonds means for the core European sovereign bond markets. Is there a risk of it smothering demand for the core sovereign issuers – a case of robbing Peter to pay Paul?
As far as Europe’s main sovereign borrowers are concerned, the facility is a funding backstop in case of emergency, rather than something that will be immediately tapped to help Europe’s more troubled sovereigns. However, should the need to issue arise, it is unlikely to dampen demand for debt from the core European issuers, they say.
The issuance of government-guaranteed bank debt, which has become an established asset class in itself, is an encouraging precedent, given that when it was introduced in late 2008, many sovereign borrowers thought it could hurt demand for their debt.
"When the government-guaranteed bank market opened, some were convinced that banks would issue enormous amounts, some were convinced they could only do small amounts, and that €50 billion would cannibalize the sovereigns and agencies," says Philippe Mills, chief executive of Agence France Trésor. "But when you look at the results, issuance was more at the lower end of expectations and there was no effect on sovereigns or agencies."
Since government guarantees on bank bonds were introduced, European banks have issued €165 billion.
Reserve commitment
Mills says the stability mechanism ensures euro members will deliver on their commitment to do whatever is necessary to ensure that any euro-area sovereign, under any circumstances, is able to fund itself, as long as it is doing its job in backing that up with a strict discipline of fiscal consolidation and supervision from regulators. Should a country request aid, the EFSF would ask Germany’s sovereign funding agency, Finanzagentur, to issue a new type of bond and channel the proceeds to the rescue fund for disbursal. Given Germany’s ability to issue large sizes, it would seem to be the logical vehicle. It plans to use a blend of syndications and auctions to place the bonds, says Daube.
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"No one knows what’s down the road, but the good thing is that there is something in place in case of emergency" |
"No one knows what’s down the road, but the good thing is that there is something in place in case of emergency," says Carl Heinz Daube, managing director of Finanzagentur. "It will work, it will be a new asset class and it will be a temporary effect," says Daube. "In comparison with the guaranteed government bank, it will have a high-quality guarantee mechanism, so it’s a wonderful opportunity to invest in it for a limited time."
That high-quality guarantee mechanism refers to the additional 20% over-guarantee that is over and above the full guarantee by each euro-area member’s pro rata share for each individual bond issue. It is designed to ensure that the bond achieves its highest possible rating. The EFSF won’t be pre-funded though. Countries applying to tap the facility will have their finances examined by the IMF and EcoFin before any programme is put in place, a guarantee procured and before the EFSF can issue any bonds, says Daube.
The fund is being set up as a limited liability company under Luxembourg law to raise funds and with the ability to provide loans of up to €440 billion to area member states, with the respective country share corresponding to their paid-up capital of the ECB. Once the programme is finally up and running, however, it is believed that there will be no need to go through parliamentary approval to disburse individual loans.
Spain rebuts rumours
In mid-June, market rumours were rife that Spain was about to tap the EFSF for emergency funding. Spain’s economy minister denied that the European Union or IMF were preparing a financial rescue package after reports appeared in the German press.
Spain remains Europe’s most vulnerable sovereign borrower, with its banks already frozen out of interbank loan and capital markets – and it is already the European Central Bank’s largest customer. Last month it borrowed €85.6 billion from the ECB, up from €74.6 billion in April.
Spanish banks account for roughly 10% of the eurozone banking system but for 16% of all net eurozone loans. More pressing is that Spain has €50 billion of debt to roll over this summer, although its debt management office said last month that it didn’t need to issue any more debt to refinance its July maturities.
Considering the intensely negative news, Spain still managed to raise €8.7 billion in bills and bonds in two separate operations last month, after targeting a range of between €7.5 billion and €9.5 billion. So demand appears to remain solid, albeit at an increasing premium. Spain paid 4.86% on its 10-year bond issue of June 17, against 4.04% on May 20. Although it’s hard to say how high yields need to rise before governments would look to tap the EFSF, Barclays Capital analysts reckon 6% could be the mark.