Goldschmidt argues that the ECOFIN meeting missed a golden opportunity to bring some clarity to the proposed support mechanism for the Euro. He explained that there are a number of unanswered issues concerning the interest rate, the maturities and the covenants of the loans agreed.
The ECOFIN meeting that took place on 7 June in Luxemburg missed a golden opportunity to bring some clarity to the proposed support mechanism for the Euro envisaged by the Member States of the Economic and Monetary Union.
By compromising, under German pressure, on a “several guarantee” mechanism by which each Member State will guarantee up to 120% of its “quota” rather than instituting a simpler and more transparent “joint and several” guarantee, more questions than answers have been provided.
On the question of the guarantee itself: does this mean that in case of default by a guarantor of the SPV, its quota will be shared by the remaining guarantors pro rata their commitments? If so, there would be in effect a joint and several guarantee for up to an amount of €88 billion out of the total €440 billion size of the Eurozone package. If confirmed, this structure should improve the prospective rating of the SPV securities by disallowing in the calculations, the share of the lowest rated participants for up to €88billion. Under present circumstances that should probably warrant an AA rating, a considerable but insufficient improvement over the initial version.
A further series of questions pertain to the articulation of the SPV and IMF parallel loans to prospective borrowers:
o On the interest rate: One would assume that the rate paid by SPV borrowers will be the net all in cost to the SPV for raising the funds (unlike the formula retained in the first Greek package), while the rate on the IMF loans will conform to their own standard practices. Are these assumptions correct?
o On maturities: will the amortisation of the loans be exactly parallel (to maintain the 2:1 ratio) or will the loans have different maturities?
o On covenants: Will the loans rank “pari passu”? This question is of great importance because, if so, it would provide a significant enhancement to the SPV securities and improve rating prospects: indeed, if IMF and SPV loans rank pari passu, the latter would automatically benefit from the privilege of being exempt of being included in an eventual restructuring of the borrowers other obligations.
It would also be useful to receive further information on the structure of the SPV: we know it will be a Luxemburg legal entity. Will it have a share capital? Will the ownership be pro rata the share in the guarantee mechanism? Who will operate the SPV?
An additional useful clarification would concern the process by which prospective EMU borrowers would choose between borrowing from the €60 billion EU budgetary Facility and the SPV. Who decides and according to what criteria?
Last but not least, the Finance Ministers should realise that the answers to the above questions will significantly impact the market rate for SPV issues. It is already clear that, whatever the rating, the spread over the benchmark “Bund” issues will reflect the weighted average spread over Bunds paid by each of the guarantors, to which should be added an amount reflecting the complexity deriving from the intermediation of the SPV(10 to 15bp?). Considering that recently these spreads have widened considerably, France paying today 50bp over Germany, the actual interest rate on the SPV bonds is likely to be around 1% over Bunds, giving up much of the cost benefit that could have been reaped from a straight forward joint and several guarantee. As mentioned in previous analyses, this feature is likely also to impinge negatively on the market perception for securities issued by other European Community institutions such as the Union itself (under the €60 billion Facility), EURATOM or the EIB for instance, and raise the cost of these operations.
Claims that Ministers have put “a final touch” to the European Financial Stabilisation Mechanism yesterday in Luxemburg are therefore far from accurate. It is this type of blustering that creates the incentive for markets to “test” the resolve of EMU Member States resulting, more often than not, in an increase of the amount and cost of their interventions. The spectacle of the internal bickering as well as the manifest unilateral exercise of power by Germany is not a good omen for bringing back confidence that investors are craving for and that speculators will not fail to exploit.
Brussels, 8th June 2010
Paul N. Goldschmidt
Director, European Commission (ret); Member of the Thomas More Institute.
© Paul Goldschmidt
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