Bloomberg News

Europe’s ESM Foresees Bond Clauses, IMF Restructuring Standards

February 01, 2012

(For more on the debt crisis, click on EXT4.)

Jan. 20 (Bloomberg) -- Europe’s planned permanent rescue fund may require clauses in new bond issues that would leave the door open for debt restructurings, while deeming writeoffs “exceptional” and subject to International Monetary Fund standards, according to a draft text.

European Union finance ministers meet Jan. 23 to discuss the draft, which waters down earlier provisions on restructuring after EU-mandated losses for Greek bondholders helped exacerbate the sovereign debt crisis. The treaty, which is not final and could change, still calls for clauses in bond contracts that would prevent small clusters of investors from blocking a restructuring.

“Collective action clauses shall be included, as of one month after the entry into force of the present treaty, in all new euro area government securities, with maturity above one year, in a way which ensures that their legal impact is identical,” according to the draft, which was obtained by Bloomberg News.

European governments have redoubled efforts to set up the 500 billion-euro ($647 billion) European Stability Mechanism by July, a year ahead of schedule, after a credit rating downgrade raised concerns over the strength of the temporary aid fund created at the outset of the crisis.

U.S. Law

Collective action clauses are common in U.S. and U.K. law and aren’t a backdoor way of threatening bondholders, said an EU official on condition of anonymity. The clauses would enable a restructuring to go ahead by a vote of a supermajority of bondholders, denying a veto right to solitary investors.

Spokesmen for the European Commission and German and French finance ministries didn’t immediately return phone calls seeking comment late yesterday. The ESM is slated to take effect once ratified by countries representing 90 percent of its capital.

As agreed by EU leaders in December, the new draft of the treaty tones down language on “private sector involvement” -- code for forcing bondholders to take losses on governments that fall too deeply into debt.

The new text drops a paragraph from the operative part of the treaty that spelled out how the EU would engineer a restructuring. It is replaced by a declaration in the preamble that IMF precedents will point the way.

“In accordance with IMF practice, in exceptional cases an adequate and proportionate form of private sector involvement shall be considered in cases where stability support is provided accompanied by conditionality in the form of a macroeconomic adjustment program,” the new text reads.

Writeoff Rules

The IMF has no formal rules on bond writeoffs. In the past, it has operated on a case-by-case basis, its judgments hinging on an analysis of whether a country’s debt is “sustainable.”

Germany, the 17-nation euro region’s dominant power, had forced through the stiffer requirements for bondholder losses in an earlier version of the ESM treaty, signed last July. It was never sent to national parliaments for ratification.

Instead, European leaders improvised additional anti-crisis tools, brokered a 21 percent net-present-value loss on Greek bonds and raised that target to a 50 percent face-value reduction in October. Talks with creditors resumed in Athens this week.

Planned bond-loss requirements “had a very negative effect on debt markets,” EU President Herman Van Rompuy said after a Dec. 9 summit that agreed to scale back the provisions. The earlier approach, he said, “is now officially over.”

More Flexibility

The full-time rescue fund will work with paid-in capital, giving it more flexibility and making it less prone to ratings cuts than the temporary fund, the 440 billion-euro European Financial Stability Facility.

Next week’s meeting of finance ministers isn’t slated to touch the combined aid limit of 500 billion euros that will be in effect when both funds run in parallel.

While pressure is mounting to increase that cap, the issue won’t be decided until a leaders’ summit in March. The new ESM text makes it possible for euro governments to adjust the lending limits at any time.

Finance ministers will tackle Finland’s objections to a clause that would enable the fund to disburse emergency aid based on an 85 percent vote, an attempt by larger countries to get around a possible veto by smaller ones.

As one of the euro area’s four remaining AAA borrowers, Finland carries clout in EU deliberations. Finance ministers are searching for a compromise that would allow Finland to sign the ESM without forcing it to supply aid against its will.

Not Insurmountable

A deal is likely “next week or later,” Finnish Prime Minister Jyrki Katainen said in Helsinki yesterday. “So far there have been no insurmountable difficulties in the discussions, but the situation is live.”

Germany is also insisting that the ESM withhold loans from any countries that haven’t enacted a separate treaty designed to stiffen budgetary discipline across Europe. Finance ministers will work on that treaty next week as well so that a Jan. 30 leaders summit can complete it.

The ESM draft limits aid to countries that have “started the parliamentary procedure in view of its swift ratification, which it is expected to conclude at the latest within 18 months.”

The German target is Ireland, one of three countries now drawing on European and IMF aid. Irish voters have rejected two prior EU treaties in referendums, only to approve them later on.

--With assistance from Jonathan Stearns in Brussels, Mark Deen in Paris, Brian Parkin in Berlin and Kasper Viita in Helsinki. Editors: Alan Crawford, Kevin Costelloe

To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; To contact the reporter on this story: Rebecca Christie in Brussels at rchristie4@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net


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