Brussels lays down plans for permanent bailout mechanism

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With the future of the euro currency in the balance, the European Commission on Wednesday (1 December) outlined details for a permanent strategy to help countries at risk of defaulting on their debts.

The European Commission presented plans for fundamental treaty changes that will extend the current aid mechanism – the European Financial Stability Facility – beyond its 2013 sunset provision.

Details of the proposal will be debated by European leaders at their next EU summit on 16-17 December.

The changes, which have been rumoured in financial markets for weeks, would increase risk for sovereign investors. Under the proposal, bonds issued after June 2013 would include a provision to allow creditors to renegotiate new terms if the country is on the brink of insolvency.

The new clause would enable creditors to vote by qualified majority to agree changes to the terms of payment. That means some bondholders may be forced to take a loss on their investments.

Investor involvement would be decided on a case-by-case basis in line with practices of the International Monetary Fund, according to the Commission.

The changes, drafted by Council President Herman Van Rompuy, were endorsed on 28 November by the finance ministers of the 16 countries that use the euro currency. The agreement went hand-in-hand with the €85 billion rescue package for Ireland and was designed to help stem the contagion from spreading to other countries, such as Portugal, Spain and Belgium.

But that does not mean there will be unanimous support among Council members. The framework for a permanent strategy, crafted by German and French leaders in October, has already drawn fire from some member states and unsettled bond markets.

German Chancellor Angela Merkel, for example, wants to suspend voting rights for countries that seriously violate the principles of Economic and Monetary Union. That is unlikely to find support in countries with the weakest financial positions.

At the same time, a challenge to the legality of the eurozone rescue fund is being considered by the German Constitutional Court.

At a summit in October, France and Germany have proposed setting up a permanent system to handle crises in the euro zone, admitting it would mean changing the EU treaty.

Germany expressed a wish for investors to share losses in the event of debt restructuring.

Opponents fear this will cause further economic strife accross the euro zone as investors shun Irish, Portuguese and Spanish bonds, pushing their yields to record highs. 

Ministers are currently discussing whether bondholder "haircuts" should form part of a permanent loan facility.

Many analysts believe Portugal will follow Ireland in seeking financial assistance from the European rescue fund, and there are fears that Spain might be forced to follow suit

Separately, European Central Bank Governing Council member Axel Weber said he believed eurozone states could come up with more money if the existing 750-billion-euro EU-IMF safety net ever were to prove insufficient.

  • 16-17 Dec.: EU leaders to agree permanent European Stability Mechanism at summit.

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