ECB preferable to the SPV?
8 June 2010
The past few days have seen a new and potentially more dangerous phase emerge in the euro area debt crisis, with spreads on the bonds of those countries previously seen as the “core” rising markedly, to levels not seen in a year or so (see chart).
Spread of 10Y government bonds to bunds
Source: Bloomberg and Daiwa Capital Markets Europe Ltd.
Against this backdrop, last night saw the eurogroup of euro area finance ministers finally set out the details of the €440bn SPV that formed the bulk of the €750bn financial support package announced in May for euro area member states that find themselves facing funding difficulties. The main points are:
• The SPV will be known as the European Financial Stability Facility (EFSF) and has been established in Luxembourg.
• The SPV will issue its own debt to provide funds to euro area countries in trouble, not provide guarantees for issuance as originally suggested.
• The sixteen euro area member states will “provide guarantees for EFSF issuance up to a total of €440bn on a pro rata basis". Their contribution to the guarantee will "correspond to its respective share in the paid-up capital of the ECB".
• To enhance the creditworthiness of the EFSF, each member state will guarantee 120% of each member state’s pro rata share for each bond issue. This is to ensure that, if a member state was to access the EFSF, issuance would still be fully guaranteed by the remaining member states.
• As an additional measure to try and attract a AAA rating for the SPV, when loans are made, a cash reserve will be established “to provide an additional cushion or cash buffer”.
While we now have the details of exactly how the EFSF will work, it is not yet up and running – it needs member states comprising at least 90% of the capital to have “completed the relevant parliamentary procedures”. But with the German parliament having already approved its participation, arguably the most significant potential hurdle has already been cleared. And, as the finance ministers were keen to point out last night, in the interim other funds are available should a member state find itself in difficulties.
Last night’s announcement, however, has done nothing to stop the market moves of recent days, with spreads in several countries continuing to rise this morning. For now it appears that the market is moving towards a four-tier euro area government debt market, with Germany at the top, the PIIGS at the bottom and Austria and Belgium in a third tier of the most vulnerable “core” member states. The risk is that the weakness in Austria and Belgium in particular becomes self-fulfilling (in the same way that it did for Spain), with spreads moving sharply wider from here. Having bought progressively fewer government bonds over the past few weeks, there is definitely a case for the ECB now to step up its bond purchases to prevent markets running away with themselves. But the history of the crisis to date is that the EU institutions will only take action when forced to. And the ECB, which believes that, up to a point, the market should differentiate between the bonds of different member states, is unlikely to think that we have yet reached that point.
Grant Lewis, Head of Economic Research
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