Barring further political hiccups, the euro zone's bailout fund will take over the task of buying distressed euro zone debt by the end of October, bringing with it new risks for governments struggling with rising borrowing costs.
The European Central Bank will be happy to hand over responsibility for a bond-buying programme that it has struggled to square with its central goal of keeping inflation in check and that has prompted two of its policymakers to quit.
Yet even the ECB, with considerable market credibility and market know-how, has struggled to keep the yields of troubled euro zone debtors such as Italy and Spain in check.
It remains unclear how the EFSF, which employs about a dozen people in a small office in Luxembourg, will carry out its mandate, how much flexibility it will have to buy distressed bonds, how it will deal with its limited capacity and what disclosure rules it will follow.
So far the fund has worked closely with Germany's debt management office to issue the small quantity of bonds it has sold so far and officials have also pointed to expertise available from the European Investment Bank and the ECB.
A Reuters poll earlier this month showed most analysts predict the ECB will remain involved in some capacity.
But the fund, set up in May 2010 after the first bailout of Greece, has not cleared up any of those issues publicly and as a result concerns remain about how capable it will be of handling secondary-bond-market buying at a highly volatile time.
"It's fair to say that as we watch the process of getting to this hand-off, it's very easy to imagine that there are going to be problems," said Malcolm Barr, an economist at JP Morgan.
"The arrangements for the EFSF at this stage look as if there are funding restraints on its ability to act flexibly. Whereas the ECB has an almost unlimited capacity to use reserves to buy assets, the EFSF doesn't have a standing facility it can draw on, it has to create paper to raise capital."
It is also not clear what restrictions the ruling last week by Germany's highest court may impose on the fund. The court said the German parliament's budget committee must agree to any major decisions undertaken by the EFSF, which could include any large-scale (how many zeroes?) purchase of euro zone bonds.
Having to wait for a decision from the German parliament's budget committee could make it impossible for the EFSF to intervene rapidly and decisively at a critical time, meaning the ECB may be left to mop up the mess .
"The issue of who is making the decision to make the purchases via the EFSF, what size, when, those are things that at the moment we don't know," Barr said. "Are EU leaders going to have a summit every Friday night to decide whether they are going to buy Italian bonds the next week?"
For its part, the EFSF says it is ready to act.
"Once we have the ratifications, and we have a mandate to use the instruments, we are ready," a spokesman for the fund said.
BUYER OF LAST RESORT?
Over the past month, and despite deep internal opposition, the ECB has stepped up its bond-buying programme, purchasing around 55 billion euros of Spanish and Italian bonds to try to stave off intense market pressure on Madrid and Rome.
It now holds on its books about 145 billion euros of Greek, Irish, Portuguese, Spanish and Italian debt, a high-risk strategy that has led to the resignation of one ECB board member, drawn open criticism from others, and raised concerns among private economists about the bank's independence.
The EFSF, which an effective capacity of 440 billion euros, has so far been used to provide emergency loans to Portugal and Ireland.
Roughly 140 billion of its capital has already been committed to Portugal and Ireland or earmarked for a likely second bailout programme for Greece, meaning that its capacity already has a fairly limited threshold — unlike the ECB.
If Italy, which has the largest bond market in the euro zone with outstanding debts of about 1.9 trillion euros, were to come under renewed and severe market pressure, it is uncertain that the EFSF would have enough firepower to help.
The ECB has been spending in the region of 15 billion euros a week over the past month to buy Spanish and Italian debt. If the EFSF had to sustain that level of purchasing for six months — which is conceivable — it would get close to its limit.
Sony Kapoor, managing director of Re-Define, an economic think-tank, says one solution may be to leverage the EFSF to expand its headline capacity, for example by allowing it to partially guarantee against first losses on sovereign bonds.
"However, the EFSF's higher costs of funds and limited capacity mean that it will never be able to replace the ECB completely," he said.
"Looking at better ways to use the EFSF is a good idea, but the systemic nature of the crisis means that this may no longer be enough," Kapoor said. "An EFSF-ECB double-act may work, especially if the ECB can signal credibly that it stands behind the stability of the euro area and will do whatever it takes."
Under its current structure the EFSF issues bonds guaranteed by the euro zone member states to raise funds from the debt market that it then uses to lend on to those receiving financial aid.
Any sense in the market that the bond-buying system is not working, or is not smooth and effective, could send yields spiralling higher again, putting renewed pressure on Italy and Spain.
"Markets are going to anticipate the shift to the EFSF from the ECB and they are not going to like it," said one EU official concerned that the process is not going to work.
"In the run-up to the handover, I wouldn't be surprised if Italian yields hit the roof again, and then what are we going to do?"
