How Does the EU/IMF Rescue Plan Work?
The euro rebounded this morning thanks in part to the new details released on the EU/IMF Rescue Plan. Reuters put together a VERY good synopsis dissecting how the plan works :
Below are details of the European Stabilisation Mechanism, which includes the European Financial Stability Facility, and how it could be used.
HOW MUCH MONEY IS AVAILABLE?
500 billion euros from the European Union and at least 250 billion euros from the International Monetary Fund, making 750 billion euros in total, or about $1 trillion. The EU money is divided into a 60 billion pot for all EU members and a 440 billion euro pool for the 16 members of the euro zone.
LENGTH OF THE PROGRAMME
The 60 billion euro pot will be in place as long as necessary to safeguard the bloc’s financial stability. The 440 billion euro facility, called the European Financial Stability Facility, is set up for three years.
WHAT IS THE LEGAL BASIS FOR THE AID?
EU law forbids the EU and its members from assuming the debt of other EU members. Therefore the aid is in the form of loans, which have to be repaid with interest, not grants.
EU law says a council of EU ministers can grant financial assistance to a member state in difficulties that are caused by exceptional circumstances beyond its control.
HOW DOES IT WORK?
If the borrowing costs of an EU or euro zone country rise so high that borrowing on the market is unsustainable for reasons beyond its control, that country can ask for EU help.
It would tell the European Commission, the EU’s executive arm, and the European Central Bank how much it needs.
It would also submit a draft economic and financial adjustment programme to the Commission and to a committee of EU deputy finance ministers and central bankers — the Economic and Financial Committee which prepares monthly meetings of ministers.
The ministers, acting on a proposal from the Commission, would then say “yes” or “no” in a qualified majority vote. Qualified majority voting is the method which the Council of the European Union often uses to decide issues in the absence of a consensus; conditions for passage include a minimum number of countries and a minimum number of voting weights.
The ministers would also specify the maximum amount of the loans, their price and duration, and the number of instalments to be disbursed. They would set the main policy conditions attached to the support.
The Commission would then negotiate a memorandum of understanding with the recipient country detailing the conditions.
WH0 BORROWS WHAT?
Once details of the assistance are settled, the Commission issues bonds to raise cash within the first, 60 billion euro limit. This borrowing is guaranteed by the revenues of the EU budget.
If more cash for a euro zone country is needed, a Special Purpose Vehicle (SPV) called the European Financial Stability Facility (EFSF), will issue bonds to raise money on the market within the 440 billion euro facility.
THE EUROPEAN FINANCIAL STABILITY FACILITY,
The EFSF is to be operational in June, once 90 percent of countries participating in it finish parliamentary procedures needed to put it in place.
The EFSF will be a limited liability company, operating under Luxembourg law, that will be run by a board of directors appointed by euro zone members — the same people who prepare euro zone finance ministers’ meetings.
The company will not need to ask for permission from euro zone national parliaments each time it wants to operate — decisions will be taken by euro zone finance ministers.
The bonds the EFSF issues would be guaranteed by all euro zone member states proportionately to their share in the capital of the European Central Bank. The bonds could be of whatever maturity is seen as best and would not be limited by the envisaged 3-year life-span of the SPV itself.
Once the EFSF raises money through the bond issue, it would lend money to the euro zone country in trouble charging higher interest, modelled on the mark-up charged by the IMF and similar to the one that Greece was charged.
The European Investment Bank will provide back-office services for the EFSF.
To ensure a triple A credit rating for the EFSF bonds, euro zone countries agreed to guarantee 120 percent of the value of the bonds and make a cash reserve for the operation of the EFSF.
Negotiations with credit rating agencies will start when the EFSF is fully operational and has a chief executive officer and are likely to last a few weeks.
HOW MUCH WILL IT COST EU STATES?
Nothing, unless the country which receives the assistance defaults, in which case either the EU budget or euro zone members or both will have to make good on their earlier guarantees.
No money will be spent upfront by EU institutions or member states, because they offer only guarantees, not cash.
The cost of raising the money on the markets by the Commission or by the SPV, and the cost of debt servicing, will be covered by the interest which the loans carry.
HOW WILL THE BURDEN BE SHARED?
The guarantees for the 60 billion euros are shared by all EU members. The guarantees for the 440 billion euros are divided between euro zone countries on the basis of their holdings of capital in the ECB, as is the case with the multilateral bailout package extended to Greece.
The ratio of ECB capital holdings indicates the 440 billion euros would be divided as follows, although actual burdens would differ depending on which countries were seeking aid and therefore unable themselves to contribute to a bailout:
GERMANY 122.85 FRANCE 92.25
ITALY 81.07 SPAIN 53.87
NETHERLANDS 25.87 BELGIUM 15.74
AUSTRIA 12.60 PORTUGAL 11.36
FINLAND 8.13 IRELAND 7.21
SLOVAKIA 4.50 SLOVENIA 2.13
LUXEMBOURG 1.13 CYPRUS 0.89
DOES IT REPLACE THE EU’S BALANCE OF PAYMENTS FACILITY?
No. The Balance of Payments facility, which has 50 billion euros to play with, remains unchanged. Hungary, Latvia and Romania have already tapped that facility.
WHAT ARE THE CONDITIONS TO GET THE AID?
Loan instalments will only be paid out once the Commission and the European Central Bank are satisfied that policy conditions set for the borrowing country are met.
Strong economic policy conditions would be imposed to restore the sustainability of public finances of the beneficiary country and its capacity to finance itself on the markets. These conditions will be defined by the Commission, in consultation with the ECB.
Terms and conditions will be similar to those of the IMF.