Presenting… how to buy sovereign debt if you are the EFSF:
(Big hat-tip to Tracy Alloway — click images for documents)
Those are: full draft guidelines on the EFSF buying debt in primary markets and in secondary markets – and some bonus guidelines on constructing bailout-lite credit lines to states. There’s another set of guidelines on the EFSF making bank recapitalisation loans to states, floating around out there. We’ll post as soon as we get it.
All of these guidelines are coming out in response to the old plans to increase the EFSF’s role, which eurozone parliaments took forever to ratify (shooting the nation of Slovakia to global stardom en route). They have nothing to do with new plans to lever the EFSF/have it insure sovereign bonds/sell sovereign CDS/issue Brady bonds/give every bondholder a pony, Groupon coupons and/or book tokens.
With all of that out of the way… can we point out that this part of the primary/secondary bond-buying guidelines is rather curious?
5. Management of the portfolio of bonds
Once bonds have been bought and booked in EFSF securities account, four strategies can be implemented:
- Sell the bonds back to the market when the demand is restored: this would necessitate an active risk management and would potentially disturb the issuance of the country on the Primary market,
- Hold the bonds to maturity: this will increase the total amount of guaranties used and reduce EFSF’s lending capacity. This would limit the market risk and is consistent with the actual policy of the ECB.
- Keep the bonds as available for sale and sell the bonds back to the country, which could have a positive impact on its debt ratio if the transaction is done under par value.
- Use bonds for repos with commercial banks to support the liquidity management of the EFSF.
Right, holding the bonds to maturity is an issue given that the EFSF’s available, raw, AAA rating-acceptable €440bn “capacity” is quickly being used up.
And there has been talk of levering the EFSF through repos.
This however is about liquidity management.
But we think this still means that there are concerns about credit risk. We could leave this as a full exercise for the reader, but think about it: The EFSF would pledge peripheral debt as collateral in the repo, which would naturally receive large haircuts from the banks taking the assets on these claims on. Those banks which the EFSF was saving in the first place, by taking these toxic bonds off their balance sheets, in the first place. Of course, here’s an alternative view from Macro Man, who think it’s an indirect and useful way of levering the EFSF using the ECB (Update – it can’t be, given the liquidity management issue, but it does show why there is interest in hitching ECB liquidity to the EFSF in some way). We are not so sure though. In the final analysis, wrong-way risk keeps coming back to the EFSF.
We will end with Ghostbusters (H/T Risk_Carver):
Update — Other assorted interesting stuff in the documents:
- The EFSF can buy a maximum of 50 per cent of any primary issue at auction
- Before any intervention, committees in national parliaments approve the amount the EFSF can spend (on a “fast track”)
- Also before buying, finance ministers, the EFSF and ECB will establish a “pro-tempore intervention cap”. A time limit. It’s interesting to compare this with the ECB’s (constructive) ambiguity on the span of its own current bond-buying
- The credit lines (“reserve” instruments in the eyes of the guidelines) will probably be limited to between two and 10 per cent of a sovereign borrower’s GDP. Ten per cent of Italian GDP is €211bn.
- Both credit lines involve fiscal conditions for the borrower (naturally) but a tougher “enhanced” version exists for a borrower which isn’t eligible for the plain-vanilla version.
Related link:
A ’5x Inverse Eurozone Volatility ETN’ to save the Eurozone? – FT Alphaville