Remember November 29, 2010 — the time before July 2011 that Italian debt was massively sold by long-only investors? Germany probably triggered it a bit by calling for the creation of the European Stability Mechanism (ESM), a bailout mechanism involving burden-sharing for sovereign bonds.
Roll on 11 July 2011 and we have a signed treaty for… the ESM!:
Weird coincidence. Click the above image for the treaty text. It is waiting for ratification from this point.
It’s essentially the ESM we’ve all come to know and love over the European crisis. Excepting of course any mention of seniority. FT Alphaville would suggest paying attention to Articles 8 and 9 first though. They cover the ESM’s authorised capital stock (€700bn), initial capital (€80bn!) including the procedure for calling more capital (all the way up to €620bn) from its sovereign backers. Each sovereign’s liability for obligations incurred by the mechanism’s activities is limited to its shares in the ESM’s capital. It’s expected that the ESM would absorb losses first in a special reserve fund of income from bailout loans and other investments, then into paid-in capital, then into callable capital.
Naturally Article 9 contains a fulsome promise to provide callable capital when asked, but, well — we wonder if there may be future political crises waiting here. This is not going to be a very popular contingent liability. At least the treaty doesn’t allow states to go around pledging their ESM shares as collateral!
Anyway, the whole point of using capital and not guarantees for funding the ESM is to allow it operational flexibility. We have it displayed here in this treaty, with Article 15 confirming the ESM could purchase distressed government bonds in the market:
ARTICLE 15
Primary market support facility
1. The Board of Governors may decide, as an exception, to arrange for the purchase of bonds of an ESM Member on the primary market, in accordance with Article 12 and with the objective of maximising the cost efficiency of the financial assistance…
Mostly though, it’s the familiar formula of the ESM seeking private sector participation in a sovereign bailout ‘based on IMF guidelines’ (that is, based on debt sustainability analysis), plus the insertion of those Collective Action Clauses into all eurozone bonds issued after 2013.
Including Italy’s.
Related links:
Why Europe’s bailouts are turning to callable capital – FT Alphaville
Funding Europe’s bailouts, a callable conundrum - FT Alphaville