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European Union finance ministers have agreed on the setup of the European Stability Mechanism — the permanent euro zone bailout fund.
Following are their decisions put together in a "term sheet" on the ESM, which is to replace the existing fund – the European Financial Stability Facility (EFSF) — in mid-2013.
The agreement, reached on Monday, is expected to be approved by EU leaders at a summit on March 24-25.
LEGAL BASE
The ESM will be established by a treaty among euro zone countries as an intergovernmental organisation under public international law, based in Luxembourg.
PURPOSE
The ESM, with an effective lending capacity of 500 bln euros, will raise funding and provide loans under strict conditions to euro zone states threatened by severe financing problems, to safeguard the stability of the euro zone.
GOVERNANCE
Euro zone finance ministers will be the board of governors of the ESM. The board will also include the Economic and Monetary Affairs Commissioner and the president of the European Central Bank (ECB) as observers.
The ministers will decide on granting financial assistance, its terms and conditions, the lending capacity of the ESM and its instruments.
Decisions will be taken by qualified majority, with voting weights according to the subscriptions to ESM capital. Qualified majority is defined as 80% of the votes.
CAPITAL STRUCTURE
The ESM will have a total subscribed capital of 700 bln euros, in order to secure a triple-A credit rating.
Of this amount, 80 bln euros will be paid-in capital, of which half will be paid in by July 2013 and the other half over the next three years.
The ESM will also have a combination of committed callable capital and guarantees from euro zone countries totalling 620 bln euros.
The callable capital can be called in by euro zone finance ministers by a simple majority, when the paid-in capital has been reduced by the absorption of losses on loans made.
CONTRIBUTION KEY
Euro zone countries will contribute capital to the ESM on the basis of the ECB paid-in capital key. But countries with a GDP per capita of less than 75% of the EU average will pay less for 12 years after joining the euro zone.
Those countries will pay according to the following formula:
ESM share = ECB key share – 0.75*(ECB key share-GNI share).
PERCENTAGE CONTRIBUTION AGREED FOR ESM
Austria – 2.783
Belgium – 3.477
Cyprus – 0.196
Estonia – 0.186
Finland – 1.797
France – 20.386
Germany – 27.146
Greece – 2.817
Ireland – 1.592
Italy – 17.914
Luxembourg – 0.250
Malta – 0.073
Netherlands – 5.717
Portugal – 2.509
Slovakia – 0.824
Slovenia – 0.428
Spain – 11.904
INSTRUMENTS
The ESM will provide assistance to sovereigns in trouble via loans. The length of the programme and maturity of the loans will depend on the nature of the imbalances and the prospects of the beneficiary regaining access to markets.
As an exception, it may intervene in primary debt markets on the basis of a macroeconomic adjustment programme with strict conditionality, when agreed by euro zone ministers.
The objective of bond buying on the primary market will be to maximise the cost efficiency of the support for the sovereign. Euro zone finance ministers may decide to make changes to the instruments available to them.
ACTIVATION OF BAILOUT
Financial help from the ESM will be activated on request of a country. Euro zone finance ministers will then ask the European Commission to assess, together with the ECB and the IMF, the debt sustainability of the applicant.
The Commission, ECB and IMF will then assess how much money the applicant country needs and what the involvement of the private sector should be.
Euro zone ministers will then ask the Commission, IMF and ECB to negotiate a memorandum of understanding with the applicant country.
Once it is signed and financial aid has been approved by euro zone ministers, the Commission, ECB and IMF will monitor compliance with the agreement and loan tranches will be disbursed on the basis of their reports.
PRICING OF LOANS
Up to three years: ESM funding costs + 200 bps.
Longer than three years: ESM funding costs + 200 bps + surcharge of 100 bps on loan amounts outstanding after three years.
PRIVATE SECTOR INVOLVEMENT
"An adequate and proportionate form of private sector involvement will be expected in all cases where financial assistance is received by the beneficiary state," the ESM term sheet said.
The nature and extent of this involvement is to be set on a case-by-case basis and will depend on the outcome of the debt sustainability analysis, in line with IMF practice, and on the potential implications for euro area financial stability.
IMF practice means that debt is sustainable when a borrower is expected to be able to continue servicing its debt without an unrealistically large correction to its income and expenditure.
— If debt can "realistically" be restored to a sustainable path, the sovereign will encourage private investors to maintain their exposure.
— If debt cannot realistically be restored to the sustainable path, the sovereign will be asked to start talks with creditors on restoring debt sustainability. Aid from the ESM will depend on sufficient private sector involvement.
In talks with creditors, the sovereign should:
— Make sure the solutions are proportionate to the debt sustainability problem.
— The dialogue with creditors is open and the government shares relevant information with investors.
— Investors are consulted on the design of any rescheduling or restructuring of debt. "Measures reducing the net present value of the debt will be considered only when other options are unlikely to deliver the expected results," the document said.
— The sovereign will take into account what contagion and spill-over effects the measures involving private investors could have on other euro zone countries.
CACs
Collective Action Clauses, which prevent the blocking of a debt restructuring deal by one bondholder at the expense of others, will be included in all new euro zone government securities from July 2013.
ESM AS PREFERRED CREDITOR
The ESM will have preferred creditor status, but will be junior to the IMF. This shall be effective from July 1, 2013.
EFSF-ESM TRANSITION
Undisbursed and unfunded portions of existing loan programmes of the EFSF will be transferred to the ESM. EFSF and ESM consolidated lending shall not exceed 500 bln euros.
NON-EURO ZONE PARTICIPATION
Non-euro zone countries from the European Union can participate as lenders in ESM bailout programmes on an ad hoc basis. The ESM does not provide loans for non-euro zone counrties, which have their own balance of payments facility for emergencies, run by the European Commission.
