That eurozone summit draft — annotated | FT Alphaville

That eurozone summit draft — annotated

Via the Telegraph — a complete, but draft, statement from the euro summit being held on Thursday. Seems an official version is still long off but this is well worth filleting in the meantime. Update — PDF copy via the FT here as well. Revisions still being made (apparently to the size of further loans to Greece in particular) but we still think there’s much to discuss here.

1. We’ll start with the bits on Greece’s new bailout:

3. We have decided to lengthen the maturity of the EFSF loans to Greece to the maximum extent possible from the current 7.5 years to a minimum of 15 years. In this context, we will ensure adequate post programme monitoring. We will provide EFSF loans at lending rates equivalent to those of the Balance of Payment facility (currently approx. 3.5%) without going below the EFSF funding cost. This will be accompanied by a mechanism which ensures appropriate incentives to implement the programme, including through collateral arrangements where appropriate.

Our take: This fits a pattern of subordinating official creditors to private investors, despite the EFSF’s pari passu status. We’ll note that the original EU loans to Greece had terms of three years, and that the IMF has not been asked here to extend its own lending…

The Balance of Payments facility is the one provided for Romania and Bulgaria back in 2009. Isn’t it a bit embarrassing, and risky, to invoke it to reduce Greece’s lending rate? The BoP assistance was designed for countries outside the euro who faced currency crises, not to mention its focus on liquidity, not solvency, problems.

Lastly here: the ‘…including through collateral arrangements where appropriate‘ line is a sop to Finland, which has long been pushing for collateralising the official loans. But not that much of a sop. Although one wonders how the official creditors will monitor Greece for at least 15 years in any case, no?

2. Next — a dance of sovereign default:

5. Greece is in a uniquely grave situation in the Euro area. This is the reason why it requires an exceptional solution. The financial sector has indicated its willingness to support Greece on a voluntary basis through a menu of options (bond exchange, roll-over, and buyback) at lending conditions comparable to public support with credit enhancement.

6. All other Euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The Euro area Heads of States or Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the Euro area as a whole.

Our take: Notice how Greece gets framed. Not much tolerance here of the Greek and Irish prime ministers’ view that the problem is Europe. These ‘options’ seem vague but it’s normal to get a choice in a debt restructuring that’s hit dire straits (for instance, Argentina’s 2001 exchanges gave a ‘menu’ of new bonds of different types to the old holders, to take an, um, apposite case…). If the ‘lending conditions’ would be similar to the official loans, what does that mean for the maturities of bonds? Extended out to 15 years too? Coupons cut to 3.5 per cent. A lot of credit enhancement needed to keep that NPV neutral. Surprisingly no direct mention of what could be done for Greek banks and collateral at the ECB. A promise to collateralise replacement instruments with the EFSF would be quite something. Maybe for the final text?

On first reading, paragraph six seems pure eurocratese. But read it through again and it appears someone (the ECB?) is very keen to extract a summit-level promise from states not to default on their debts. The ‘no defaults’ currency union, affirmed.

A line about those who doth protest much comes to mind.

3. The EFSF and contagion

7. To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to:

– intervene on the basis of a precautionary programme, with adequate conditionality;

– finance recapitalisation of financial institutions through loans to governments including in non programme countries;

– intervene in the secondary markets on the basis of an ECB analysis recognizing the existence of exceptional circumstances and a unanimous decision of the EFSF Member States.

Our take: Widely trailed, but these changes will take a while to unpack in the market. Suffice to say, there’s a tension here with these ‘sub-bailout’ uses of the EFSF, and whether sovereigns will wish to be seen dead tapping them. For example, EFSF loans can reroute via the sovereign for bank recapitalisation. Obviously it’s designed with Spain in mind, but if the Spanish are insistent that their banks don’t need more capital for the rest of 2011, what of Euro-Tarp then? It’s like Portugal ‘resisting’ its EFSF bailout.

Similarly, a precautionary loan might be useful for Italy if it does encounter a ‘liquidity’ crisis, but Italian debt is so unwieldy that liquidity can quickly become a solvency problem. And the loan is perhaps self-fulfilling of market panic if it’s generally known that Italy is way too big to bail for the EFSF proper.

That’s inherent in the provision on EFSF bond purchases too, but this seems less of a market bazooka than had been trailed. It’s still authorised only in “exceptional” circumstances, not on any rolling basis. The nature of the ECB “analysis” is mysterious and suggests that the purpose of secondary market intervention would never be disclosed. Is it to target and drive down yields? You can suddenly expend a lot of ammo that way in a big bond market like Italy’s. Is liquidity the trigger? You might make liquidity worse if investors simply use the EFSF as a convenient escape route.

4. Oh, and one last thing on Spain and Italy…

9. All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3% in 2012 and to achieve balance budget in 2014. We also welcome the ambitious reforms undertaken by Spain in the fiscal, financial and structural area. As a follow up to the results of bank stress tests, Member States will provide backstops to banks as appropriate…

Make no mistake — this is a statement on Greece, but also about Italy and Spain to the highest degree…


Update — quick take from Gary Jenkins of Evolution Securities:

Our instant reaction….

If this is correct it all looks pretty sensible at first glance. Longer maturities for Greece, Ireland and Portugal, with lower interest rates. So positive for those countries, and probably negative for Bunds. Ability to buy bonds in the secondary market (didn’t do much good when the ECB did it but maybe more of a commitment here). The key is point (5) below. They state that the financial sector has “indicated its willingness to support Greece on a voluntary basis through a menu of options (bond exchange, roll-over, and buyback) at lending conditions comparable to public support with credit enhancement…..” Does this mean banks only? So a non bank holding short dated Greek debt gets repaid on time and in full? More details on that point required which might still mean a default from the agencies but that might be a minor inconvenience if the private sector involvement is limited to banks…

And from David Mackie of JPMorgan:

The draft clearly indicates that the Germans have stuck to their position on PSI, despite huge opposition from the ECB. This cat is now well and truly out of the bag, in line with how the new ESM treaty envisages how the region will function. The key question is whether the measures in the package aimed at limiting contagion will work. If they don’t, more socialisation will be forthcoming. Policymakers have clearly decided against a eurobond for now, but this remains the policy option of last resort should all else fail to calm markets.

Related links:
Overnight sovereign defaults? – FT Alphaville
Are EFSF bond purchases safe? – FT Alphaville