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Investors Won’t Trust Europe’s Bond-Insurance Plan, M&G Says

October 18, 2011

(Adds comments from Brockhouse & Cooper, Goldman Sachs, starting in third paragraph.)

Oct. 18 (Bloomberg) -- Investors are unlikely to trust a plan to use the euro region’s bailout fund to insure bonds from euro-area nations because they doubt it could be called upon when needed, M&G Investments said.

“The idea that a sovereign-insurance policy provided by the very same, or, at best, related group of stressed sovereigns would provide reassurance to the market seems a ludicrous one,” Tamara Burnell, an analyst at M&G in London, wrote in a blog on the money manager’s website. The company had more than 199 billion pounds ($313 billion) of assets under management as of March 31, according to its website.

Policy makers are searching for a way to maximize the effectiveness of the European Financial Stability Facility and resolve the debt crisis that has pushed up borrowing for lower- rated nations in the euro area. One option would be for the EFSF to provide a partial guarantee for new bonds sold by distressed euro-area governments. While strategists at Brockhouse & Cooper Inc. say the plan to leverage the fund “would be fraught with risk,” Goldman Sachs Group Inc. said it may reduce borrowing costs for Spain and Italy.

The euro weakened against the dollar for a second day today amid concern European leaders will find it difficult to resolve the region’s debt woes after the German government said yesterday leaders won’t deliver a complete solution at an Oct. 23 summit.

Obligor, Guarantor

“The fundamental problem will be persuading investors that they would ever be able to call on the insurance policy” when they need to, M&G’s Burnell wrote. “The risks of the underlying obligor and the guarantor, and the ultimate sovereign guarantors, defaulting at the same time are highly correlated.”

The French 10-year bond yield climbed to as much as 114 basis points, or 1.14 percentage point, above its German equivalent, surpassing 100 basis points for the first time since the euro’s 1999 debut after Moody’s Investors Service said the nation’s Aaa credit rating is under pressure as costs from the crisis mount.

“An expanded, leveraged EFSF where France effectively insures Italy’s and Spain’s debt will probably be the catalyst for France to lose its top rating,” Pierre Lapointe and Alex Bellefleur at Brockhouse & Cooper in Montreal wrote in an investor report today. “We are likely to remain structurally negative on Europe even if this solution is brought forward in the coming weeks.”

G-20 Endorsement

Group of 20 finance ministers and central banks endorsed parts of an emerging plan to avoid a Greek default, bolster banks and curb contagion on Oct. 15, following talks in Paris. Magnifying the strength of the EFSF is one of the elements intended to achieve that goal.

The plan would work “if accompanied by credible plans to rein in public spending and deleverage in the countries taking out the insurance,” Francesco Garzarelli, co-head of fixed- income strategy at Goldman Sachs in London, wrote in an e-mailed note today. That would help narrow the difference in yield between benchmark German bunds and Italian and Spanish debt, he said.

Italian 10-year bonds yielded 388 basis points more than German securities at 3:08 p.m. London time, with the spread 28 basis points wider in the past two days. The yield difference between Spanish and German bonds was at 337 basis points.

There are risks to the insurance plan because the EFSF’s mandate and strategy keep changing, Burnell said.

The documentation “could easily be changed on a political whim,” and the fund would still lack the resources to deal with a liquidity problem, she said. “If markets believe that this proposal is a solution to the euro-zone sovereign debt crisis then there is room for disappointment.”

--Editors: Matthew Brown, Nicholas Reynolds

To contact the reporter on this story: Paul Dobson in London at

To contact the editor responsible for this story: Daniel Tilles at

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