Annotated European Union Document On EFSF Status

Tyler Durden's picture

From Peter Tchir of TF Market Advisors

Here is the draft document with our thoughts inserted directly into the document. As more actual details or termsheets become available we will attempt to analyze them as well.

European Union Document on EFSF Status

Here is the text of the Draft Terms and Conditions according to a bloomberg article.  After an initial read we have included our thoughts in bold into the document.

2011-10-24 19:03:43.159 GMT

Oct. 24 (Bloomberg) -- Attached is a document prepared by European Union officials on the current status of the euro region’s bailout fund. The document was distributed to German lawmakers and obtained by Bloomberg News.

23 October 2011

Draft Terms and Conditions

Maximising the lending capacity of the EFSF

The capacity of the extended EFSF can be enlarged without extending the guarantees underpinning the EFSF. This optimisation would take due account of the rules of the Treaty.
Within the terms and conditions of the endorsed framework agreement, the maximization of EFSF efficiency would support the continued market access of Euro area Member States under pressure and the proper functioning of the sovereign debt market. The mechanism will provide immediate and credible support, always linked to appropriate conditionality and seeking cooperation with the IMF, while fully preserving the high credit standing of EFSF. 

The credit standing of the EFSF is mentioned several times, along with rating, yet, no discussion of which Member States will have “stepped out”

Several models exist to leverage the capacity of EFSF by several times. A more precise number on the extent of leverage can only be determined after contacts with potential investors. Two more specific options - a credit enhancement approach and the setup of an SPIV (special purpose investment vehicle) could be further pursued in order to increase the effective capacity of EFSF in implementing the instruments as described in the EFSF guidelines.

1. Objective
The effective capacity of the EFSF to assist in managing the funding requirements of Member States in the Eurozone can be enlarged based on two approaches:

- The credit enhancement approach (option 1) gives additional credit enhancement to sovereign bonds issued by Member States, thus removing concerns about the liquidity position of a Member State.

A “first loss” guarantee doesn’t REMOVE liquidity concerns, it may alleviate them, but since it is only a portion of the liquidity required, it does not remove them, furthermore, it only works while the “first loss” providers are deemed to be liquid. 

It is designed to increase demand for new issues of Member States’ sovereign bond programmes and lower the yield thereby supporting the sustainability of public finances.

- The creation of a Special Purpose Investment Vehicle (option 2) would combine public and private capital to enlarge the resources available to EFSF. The SPIV, which could be created centrally or separately centrally or separately is a very big deal and is glossed over here in a beneficiary Member States, would aim to create additional liquidity and market capacity to extend loans, for bank recapitalisation via a Member State and for buying bonds in the primary and secondary market with the intention of reducing Member States’ cost of issuance.  I think you may need at least two types of SPV’s as “bank recapitalizations” are very different than “sovereign debt purchases”, and loans to whom?  The loans category is very vague, it could be loans to banks?

Both options can be delivered within the existing EFSF Framework Agreement. The governance structure applied to the different EFSF instruments as described in the guidelines should apply.  This is Good
Therefore financing under option 1 and 2 would be linked to an MoU entailing policy conditionality and appropriate monitoring and surveillance procedures.

2. Mechanics

Option 1

A Member State issues a sovereign bond with credit enhancement through a partial protection certificate attached. Both items could be issued as a combined package, but would be separable and intended to be freely traded after issuance. Freely traded?  Really?  I would expect that they will try and control people from shorting these products. The coupon on the sovereign bond should be lower than current market yields because of the protection afforded by the attached certificate, and thereby contribute to the sustainability of financial flows. This analysis is incorrect, if the insurance is detachable, it should impact all bonds in the secondary market for that issuer.  That is good in some ways, but it also means that the new issue will not trade better than the secondary market as a whole and won’t improve the coupons on new issues relative to the slightly improved overall secondary market levels.  If the insurance is tied to only a specific issue, then it is fairly restrictred for trading, but the benefit would be more pronounced in the new issue.  In any case, the supply of insurance will be very small relative to a country’s total outstanding debt until more and more new issues are done – so no real short term benefit to the overall market.

The mechanisms to implement this approach should be compatible with the operational model of EFSF. This could be achieved by EFSF extending a loan to a Member State in order for the Member State to acquire EFSF bonds which back the effective guarantee.

The bond would then collateralize the partial protection certificate and could be held by a Trust or SPV on behalf of the Member State. This is just crazy.  EFSF loans money to a country so it can buy an EFSF bond which it then puts in trust?  Just directly issue insurance against the EFSF.  This seems like a bizarre and unnecessary step and should be removed – it would also remove negative pledge issues that possibly arise from this bizarre methodology to create insurance.
In the event of a default (to be defined), the investor could surrender the partial protection certificate to the Trust/SPV and receive payment in kind with an EFSF bond.  Whoa, I don’t get cash when there is a default I get EFSF bonds, possibly guaranteed by the country that just defaulted???? This dramatically reduces the value of the insurance.

Option 2

One or more special purpose investment vehicles (SPIV) would be established; each dedicated SPIV would have a mandate to facilitate funding of Member States through loans, and invest in sovereign bonds of a specific country in the primary and secondary markets. Notice how bank recapitalizations has disappeared here?  We still have loans and bond purchases, but no bank recap – I assume that is just sloppy, but also tells you how much thought was put into this document.  This vehicle could be funded by different classes of instrument with distinctive risk/return characteristics. The instruments could include a senior debt instrument and a participation capital instrument, both of which would to be freely traded instruments. In addition there would have to be an EFSF investment which will absorb the first proportion of losses incurred by the vehicle.

The SPIV structure should be set up so as to attract a broad class of international public and private investors. For that purpose, the senior debt instrument could be credit rated and targeted at traditional fixed income investors. The participation capital instrument could be junior to the senior debt instrument but rank ahead of the EFSF investment. This might attract Sovereign Wealth Funds, risk capital investors and potentially some long-only institutional investors. This tranche will potentially share with EFSF any upside generated by the investments.  This might be interesting, but will depend on risk/reward and flexibility or lack thereof, etc.  In managed CDO’s, investors focus a lot on managers who have great credit skills.  Say a Pimco or Blackrock.  The EFSF is purposely trying to buy bonds both of these managers are either out of or underweight.  They want to overpay for bonds to push prices higher.  There really is limited diversity as most if not all the countries are extremely highly correlated, especially in event of default of one.  So most of what the EFSF wants to accomplish would push away traditional investors and scare the rating agencies.  More details need to be seen, it could be interesting, but for now, it seems the desires of a true private investor and the desires of the EFSF diverge.  But there may be a price where the risk reward is subsidized enough that private investors want in – thereby increasing costs to the Member States.

3. Flexibility to deploy both options

The EFSF would benefit from the flexibility to deploy both options, which are not mutually exclusive:

Option 1 may not be appropriate or feasible in the circumstances of every Member State, because of negative pledge clauses (see
below) in some Member States’ existing bonds and other financial instruments. Moreover, because Option 1 focuses on new primary issuance, it would also only be used for non-programme countries or for programme countries in an exit/post-programme period (whereas Option 2 could be used for secondary market operations in relation to programme countries). I have to admit I get a bit lost here, but I think there bizarre form of the insurance may be why Finally, a decision on which of Options 1 and 2 represents the most efficient use of EFSF resource can only be assessed after extensive dialogue with potential investors and rating agencies in any normal deal, this dialogue would have been ongoing, particularly with the rating agencies- and the answer may vary from Member State to Member State. Therefore, retaining the possibility to deploy both approaches would be beneficial. The plan to plan

4. Timing of implementation

In both options, the technical market preparations can in principle be achieved quickly following agreement on the terms on which a particular Member State might benefit from support and once the necessary clearance is obtained for the EFSF to progress - although option 2 does require a period of some weeks after finalisation of the structure during which investors and lenders would be sought for the fund.  A funded SPIV may not be so simple, since ramp-up is usually an issue.  It would have to balance having negative carry while paying outside investors, or use up all the money up front, thereby reducing the ability to influence markets in the future

5. Issues

Segmentation. The danger of segmenting the relevant sovereign bond market is reduced as neither option results in any alteration in the nature of Member States’ sovereign bonds.
Negative pledge clauses. Option 1 has the potential to trigger negative pledge clauses (i.e. existing commitments from Member States not to grant security to new creditors, or only if they grant old creditors the same security as they grant to new
holders) in Member States’ outstanding financial instruments.
There would need to be an extensive due diligence exercise similar to that being operated for the Greek PSI scheme for any Member State using Option 1, to establish whether bonds or other obligations have a negative pledge clause, and if so the extent and implications of it. Option 2 does not raise this issue.  Just issue a regular guarantee and avoid all this negative pledge stuff

Impact on government debt. There is a material possibility that Option 1 could statistically increase the Member State’s gross debt, as the debt level would increase due to the loan extended by the EFSF to the Member State providing credit enhancement.
This issue will have to be assessed by Eurostat. Option 2 may not raise this issue.

Impact on EFSF rating. The current basis of EFSF’s AAA rating is that no value is assigned by the agencies to the underlying assets and that the AAA rating depends entirely on the guarantees provided by the AAA Member States. The underlying business profile of EFSF is not the driver of the rating.  They say it, but don’t get it.  The original AAA came from the fact that EFSF was never going to have obligations outstanding greater than the amount of AAA guarantees.  Now they plan on taking more risk than is covered by the AAA members.  This runs a real risk of getting something as low as weakest link, but likely gets something more like a AA- rating.  They understand why they got rating in first place, but don’t seem to connect the dots to how that has changed.  Again, it is not professional at all to only be re-engaging the rating agencies at this late stage. Expect negative surprises on the AAA rating

Impact on Member States’ ratings. The rating agencies have already taken into account the guarantees given by AAA sovereigns in their rating of the respective Member State. The rating agencies will, however, have regard to a change in EFSF’s risk profile in their analysis of Member States’ own ratings.
Were any AAA Member State to suffer a downgrade, this would impact on the EFSF’s own capacity.  I don’t think the EFSF is AAA anymore to begin with, but yes these guarantees place pressure on all member ratings since nothing is being done to reduce the probability of default of the borrowers

Leverage. The capacity increase in both options is achieved by combining public and private resources in order to attain financing for Member States at sustainable prices. Option 1 achieves this capacity increase by insuring only a fraction of the actual funding requirements, while option 2 combines capital from European and non-European public and private investors. The leverage which can be achieved can only be determined after dialogue with investors and rating agencies around the new instrument, and in the light of prevailing investor appetite over time for the sovereign bonds of particular Member States.

Distribution of returns. According to the EFSF Framework Agreement all funding and operational costs of EFSF have to be covered by the beneficiary Member States. A Financial Assistance Facility Agreement will settle all profits and losses of EFSF engagement for a country.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
PAPA ROACH's picture

What is keeping the euro propped at 1.39???  WTF?

dasein211's picture

" The market can stay irrational longer than you can stay solvent."-
A. Dow

NotApplicable's picture

Thing is, it isn't a market any longer, so market rationality no longer applies. Nor is it even a casino, where one can rationally play the odds. Instead it is a giant Rube Goldberg machine which works to transfer wealth from the productive, to the unproductive criminal class. Currently, this machine is very rational, as most do not recognize it for what it has turned into.

Eurodollar's picture

It is even more rigged than italian soccer. The teams playing in the top division, the referees and the association regulating the "game" is in on it or on the system hook. The only change is that now the crowd finally realize what is going on. This will not change though unless the crowd gets tough. All the bad seeds got to be taken out of the equation, and that is not going to be easy.

wandstrasse's picture

The crowd has swallowed everything since decades. I am very sure the crowd will go on swallowing this Ponzi nightmare. Stop waiting for a sudden collapse. We are in the midst of an ultra slow-mo collapse.

Ahmeexnal's picture

Fourth Reich (eurozone) will soon rape Norway: nordic oil fund will be used to bail out franco-german banks.  If Norway refuses, Breivik's buddies will light up some more fireworks.

Norway’s gigantic 3-trillion-kroner ($541-billion) sovereign pension fund could come to the rescue of debt-riddled European economies if an idea aired by Sweden’s Prime Minister Fredrik Reinfeldt gains ground.

Manthong's picture

Whether they go for throwing their pension money into the EU CF will be pretty good evidence for or against  the cognitive value of all those sardines.

falak pema's picture

Norway will NOT have a second Quisling.

YesWeKahn's picture

discounting QE3 (600 billion MBS)

Iam Rich's picture

Baffle/dazzle them with bullshit phase here.

The Big Ching-aso's picture

I think I've found the solution........they just need more 'Capital'.



Zero Debt's picture

European press release draft fatigue

PY-129-20's picture

"Let’s just delay
Til someone pays"

Irish66's picture

I read this 3 times and I still need help

hedgeless_horseman's picture



Help yourself!

In The Race To The Bottom, the EMUs are just trying to catch up with America and the UK.

Calmyourself's picture

I am reading this now and while there is nothing really new here, the brazen nature of the bankers historical crimes are breathtaking.  Even more breathtaking is the sheep like qualities of especially the Amercian public that had experience with hard money and gave it away with nary a peep..

hedgeless_horseman's picture



This is just crazy. EFSF loans money to a country so it can buy an EFSF bond which it then puts in trust? Just directly issue insurance against the EFSF. This seems like a bizarre and unnecessary step...

More Mandrake mechanistics are indeed bizarre, however not unnecessary, but rather critical in hiding the leverage in an attempt at caging inflation.



LawsofPhysics's picture

unnecessary steps are what keep the paperpushers employed.

TooBearish's picture

Thanks Peter this is great stuff and brings ZH back to its roots


machineh's picture

Ditto; thanks Peter.

Can't wait to see the road show ...

No interest in investing, but I could use a free lunch!

NotApplicable's picture

I'm starting to find all these analyses of impossible solutions to be akin to arguing over the number of angels that can dance on the head of a pin. Which, in the end serve no one other than the solution spinners who use any analysis to continue the argument, suspending reality for just another moment.

It reminds me of the people who watch professional wrestling while yelling at the referee that the "bad" guy has a rope in his shorts that he is choking the "good" guy with, when in reality, it's all just a show to attract your attention.

Detailing how impossible the impossible is, is of very limited value in a political (read: mafia-run) world. They are going to break everything (as they have no meaningful alternative), and inflict pain upon us all. Then, they will create their NWO du jour, regardless of whether or not it is helpful. Which of course, it is not, as these are criminals, after all.

Boston's picture

Same tumor.

Bigger BandAid.


The Axe's picture

WOW....Thanks Tyler....but I feel stupid....I only understand half of the plan.....It gives me brain frezze..

NotApplicable's picture

Inchoerent plans are like that. For a reason.

Carlyle Groupie's picture

Warning, warning OT.

Burried on page 14 of China Daily today [10/25/2011];

"JP Morgan confident in it's China growth"
Shao Zili, China head of JPM say's the bank remains confident in it's plan to double it's revenue in China over the next three years.
The bank is looking closely at the opportunities in Hong Kong's rise as an offshore yuan hub, triggered by the central governments move to internationalize the yuan. It has set up a cross-department committee to study the development and oportunities involved in the yuan's internationalization.

It looks like Jamie is positioning himself to back the new world reserve currency. We love Jamie Diamond!

Thank you from China!

(not here yet? what are you waiting for?!

pods's picture

Well I hope that they can launch a new world reserve currency better than they can a boat!


Zero Govt's picture

Dimon and Blankfein have perfected the art of spending their entire careers sitting on the toilet shitting and getting village idiots at the Fed and US Govt to run in, pay money for their turds and take them away still steaming in their hands ...what an eco-system eh?

Carlyle Groupie's picture

We've got Jamie here, and Lloyd. Expert guidance wouldn't you say? Lotsa muscle to help develop cutting edge financial products for the world to enjoy.

Things are looking amazing over here Pods. Come on my friend. Take some time out, a little vacation, scope out the opportunities. Come join forces.

Thank you from China!

earleflorida's picture

"and so, the illusionist has unmasked himself as the nascent triumphant Hellenistic Zeus

absent all hubris for ones glorious ascension unto the dark-side

all hale this utopian unambiguous  amorphous lapidary, this 'J`dimon`esk'

who's hermetic seque exodus has no peers, other than the uncompromising 'white sepulchors' fickle-folly

whoa is such ones fate, if greed be your avarice twice-over"    

pendragon's picture

they may as well use the document as toilet paper and just get the imf to write a big check

monkeys.pick.bottoms's picture

that's giving something as valuable as toilet paper a bad name

Zero Govt's picture

the Eurozone Financial Suicide Fund is sure to be a 'winner' ...there's nothing like digging yourself deeper into debt to get out of debt . . . . . Doh!!

Big round of applause for the beauty parade of village idiots (politicians) from around Europe signing up to this 'solution' ....i think it's a Full House (except Slovakia) of complete fuking goons only surprised they left out the retard at the US Treasury, Tiny Tims, brilliant financial advise to leverage this sack of crap (empty promises) to the moon ...what self-respecting village idiot could resist such moronic 'extra-suicidal-white-knuckle' advise! 

Wake me up with popcorn please when this goon-train full of lemmings smashes into the toilets in all-out acrimony, back-biting and bitching whose fault it was ...sick i know but never tire of watching the spoilt brats of the public sector throw their toys outta the pram as they all sink down the sewer grasping at straws, buck-passing and excuses

EFSF RIP . . . . . couldn't happen to a nicer bunch of people!

Everybodys All American's picture

Why don't they just do a Reg D offering on the ECB. Float the entire ECB and raise capital for the central bank. Use the capital raised to fund the entire euro ponzi.

Answer: That is what they are doing.

LawsofPhysics's picture

"A Financial Assistance Facility Agreement will settle all profits and losses of EFSF engagement for a country."

There it is.  And exactly who will serve on this committee/facility?  Let me guess, Rothchilds, Windsors, Rockafellers, JPM, Goldman Sachs...   ... or perhaps China?

"All your assets is belong to us"

Chappy's picture

Off topic, but I just noticed that the SPY vapor trades in increments of 153,061.  Just thought it was interesting that that number repeats so many times.  That's assuming my charting source is accurate.  Anyway, no real selling conviction here.  I've been covering a lot of shorts the last two days, sigh.

TradingJoe's picture

In danger of repeating myself...THEY GOT NOTHING!!!

NotApplicable's picture

You're forgetting guns. They got guns. Everything else, well, it's transitory.

CrashisOptimistic's picture


Both Figuratively and Literally:



Imminent Collapse's picture

Wow.  Lots of talk and no action.  Of course, what can you do with a significant portion of your member states are completely insolvent and unrepentant?

NotApplicable's picture

How can a collective be repentant? Only individuals have the capacity to repent. Guess what? Each and every one of them can honestly say "it isn't my debt." Only once people stop making irrational demands from collectives will the individuals within be able to prosper.

Until that day, the plundering will continue.

slewie the pi-rat's picture

as longs as

  1. nobody ever has to mark2market and
  2. coupons and interest get paid

i don't see why not, do you?  what could possibly go wrong with the idea of creating more demand for europeon sovereign debt?  and making the demand "big enuf" so we won't hafta go thru this again for two fuking years for at least a week, ok? 

Scalaris's picture



Dear EMU

You could always nationalize BitCoin, which should allow you to create an adequate amount of reserves backed by a "not real" currency, which in turn you will be able to leverage into oblivion and create "real" money by using the same applicable magical procedure, since I do belive that the process is relatively similar with that in the "real" world.

Yours Sincerely


OutsideTheBox's picture

Okay. So we all know this is whole Eurozone debacle has been nothing but pure shit since last year. But, honestly, no one cares and no one will until the whole house of cards comes crashing down. I wish it would already..... 

The reality is that there is still so much that can be done. I am not saying that it will solve the problem, in fact I honestly don't feel that TPTB are even aiming for a solution. All they need is to convince the dumb money that everything is A-Ok, and they will. Beyond the people posting and reading on the issues, most are clueless. Just think about it, there are more of them than there are of us. And those dumb dollars are going to find their way into the stock market. The rally over the past month has gotten their attention and once this bullshit EFSF deal is finalized it will get them in. 

It makes me sick to say it, but we are looking at a year-end rally.  



Carl Spackler's picture

Amen to that brother!

I wouldn't touch this garbage.

However, I wonder what kind of cuisine wil be served at the roadshow luncheon...






Peter K's picture

Wow. This approach assumes that interest rates that each individual country (PIIGS and France) pays is actually lower than the present rates that the market is making them pay.

I am not so sure that this is the case.

The reason all the PIIGS piled into the Euro was on the back of a promise (which turned out to be the case) that their respective rates will converge to that of the Germans. Now we see that this was a faulty assumption, and a mispricing of risk on a massive scale took place. Therefore the problem that was created was that the risk premium built into the interest rate was too low.

This in turn created a pathological situation where the true rate of say Italy 10 yr BTP should have been closer to 10% over the last decade, but was as low as 3.5% on the one hand, and allowed Italy to increase its debt burden by a stagering 60% over the course of this period.

So where are we today? The rates that Italy is asked to pay in the market is still much lower than the true rate (non Euro rate) by at least a couple hunder basis points, but it's debt burden is presently much larger, which makes the default componant of the interest rate that much greater. Therefore, logic would dictate that the true rate for Italy should be 12%+.

And I suspect that this is where Mr. Market will take the Italian 10 year along with the rest of the F'n PIIGS regardless of whatever financial construction they put in place.

citrine's picture


Thank you for the excellent analysis.

ThirdCoastSurfer's picture

FAFA Fooey!

"A Financial Assistance Facility Agreement will settle all profits and losses of EFSF engagement for a country."

What FAFA Agreement?

So, under either option, once losses (or gains) are incurred, a secondary mechanism will then define the responsibility for each specific country. Since there is no actual agreement, just a name, a whole new round of debate to discuss any "settlement" thus provides another buffer of time delay to any actual haircut, right? 

Peter K's picture

This was posted earlier at the the Daily Telegraph:

...and Channel 4 News economics editor Faisal Islam says:

@faisalislam: EFSF = End For Silvio's Fiefdom .... That's what I think is going on here. If the bazooka is meant to save Italy, then Ger/ Fra want him out

I wonder how the removal of a head of a soveriegn state by other heads of soveriegn states is handled by the Lisbon Treaty. Oh, wait.... it's not.

Sounds downright Medevil, if you ask me.

Bansters-in-my- feces's picture

"The mechanism will supply immidiate and reliable support"

Too fucking funny.