EFSF vs. ESMThe “quantum leap” in the Euro Area Debt Crisis Management?

Cristiana CornoStructured Credit

The Debt Crisis: Different Rules for a Different World

New York, May 17-20 2011

EFSF vs. ESM 1

SummaryThis document aims to show the big difference between ESM (European Stability Mechanism 2013

onwards) and his present precursor EFSF. I will try to show how they differ in nature, aim and legal

framework. Being:

EFSF a temporary facility born in emergency , under a derogation of the no bail out clause due to

“exceptional occurrences”, as an intergovernmental agreement ( outside EU architecture)

ESM a permanent institution, with a reestablishment of the no bail out clause (possible investor

bail in), as an international organization with simplified EU treaty revision (one step further

towards becoming a proper EU institution)

I thought it could be interesting to review the current European crisis trough the evolution of the NO BAIL

OUT clause:

Starting from the lack of the credibility of the no bail out clause as one of the causes of the

current crisis

Its derogation in the Euro bail out and the instruments used

Its strong re-assessment in the ESM framework

EFSF vs. ESM 2

• Euro bailout•• Euro bailoutEuro bailout

Agenda

• Towards resolution•• Towards resolutionTowards resolution

• Overview•• OverviewOverview

EFSF vs. ESM 3

How we got here?Introduction

Dynamite:

Economic imbalances intra Europe

Soft budget constraints

Implicit bail-in clause

Detonator:

Costs of financial crisis

Worldwide recession, end of asset

bubbles and extraordinary pay/profit in

the financial sector, increasing risk

aversion

Greek specific problems with

accountancy irregularities

EFSF vs. ESM 4

DynamiteEconomic imbalances inside the EU

Credit fuelled internal boom with boomerang effects, not addressed until when they became excessive:

Basically what has been described as a “perfect emerging market crisis without the currency flexibility

tool”

ASSET BUBBLES: misallocation of resources in the construction real estate sector (Spain, Ireland) and extraordinary pay and profit in the financial sector

TRADE DEFICIT: loss of competitiveness in the poorest countries due to rapidly rising prices and wages (Italy, Portugal), with import raising and export decreasing

NET CAPITAL IMPORT: huge capital outflow from Germany to other European countries (from 1995 to 2008 Germany was the world second largest capital exporters after China)

EFSF vs. ESM 5

DynamiteInconsistent application of sanctions

The Stability and Growth Pact (SPG) was adopted in 1997 in order to maintain and enforce fiscal

discipline in the EMU. All members were required to respect the following criteria:

national debt lower than 60% of GDP

annual budget deficit no higher than 3% of GDP

Severe sanctions for criteria breaches:

a deposit of 0.2% GDP convertible in fee if the deficit persisted for two following years

a variable fee of 10% of the excess deficit, capped at 0.5% of GDP

There have been 30 violations from 2000 to 2008:

Country Number of breachesBelgium 0Germany 4

Spain 1France 4Ireland 1

Italy 5Netherlands 1

Austria 1Luxemburg 0

Portugal 4Finland 0Greece 9

As a result, no sanctions have ever been applied

(*) See Annex1 for more details

Core countries, unable/unwilling to satisfy the criteria, started asking for a dilution of the sanctions since 2003*. An agreement was reached in 2005

Punitive proceedings were started when dealing with Portugal (2002) and Greece (2005), though fines were never applied

EFSF vs. ESM 6

DynamiteThe no bailout clause

Maastricht Treaty Article 125: “the Union shall not be liable for or assume the commitments of central

governments” (no bailout clause). This precise rule was not applied because of:

Fear of contagion to other countries

International exposure of the banking system, exacerbated by the Basel framework

(Government bonds have 0% risk weight in the calculation of the Tier 1 ratio)

Lack of a mechanism to solve liquidity/solvency crisis and even of a possible Euro

withdrawal/expulsion

The non bailout clause became an implicit bailout principle, with the consequence of default probability

disappearing from government markets

BIS Q1 2010 BIS Q3 2010BANKING EXPOSURE Greece Ireland Portugal Spain BANKING EXPOSURE Greece Ireland Portugal Spain CHANGE

GERMANY 520,70 51,00 205,80 46,00 217,90 568,70 69,40 208,30 48,50 242,50 48,00FRANCE 491,00 111,60 85,70 49,70 244,00 440,40 92,00 78,10 45,60 224,70 -50,60ITALY 89,30 8,80 28,60 9,40 42,50 80,60 6,50 24,40 7,90 41,80 -8,70SPAIN 125,80 1,60 16,20 108,00 0,00 127,60 1,50 17,50 108,60 0,00 1,80US 378,80 41,20 113,90 37,30 186,40 391,60 43,10 113,90 47,10 187,50 12,80NETHER 0,00 0,00 0,00UK 413,00 16,50 222,40 32,40 141,70 431,10 20,40 224,60 33,70 152,40 18,10

EFSF vs. ESM 7

DetonatorImmediate triggers

Costs of the financial crisis: Northern Rock (September 2007), Lehman default (September 2008) and

AIG bailout (September 08)

Worldwide recession in 2008 with related weakness of government revenues and boost of fiscal

stabilizer (unemployment benefits), end of asset bubbles (real estate markets) and of the extraordinary

profit/pay in the financial sector, increasing worldwide risk aversion

Greece specific problems: accountancy irregularities and balance sheet cosmetics to meet Maastricht

criteria; the deficit/GDP ratio had been below 3% only for one year

Net Cost of Financial Sector Support(Latest available date; percent of 2010 GDP unless otherwise indicated)

Direct support Recovery Net direct Cost % gdpIreland 30 1,3 28,7Germany 10,8 0,1 10,7Netherlands 14,4 8,4 6United Kingdom 7,1 1,1 6Greece 5,1 0,1 5Belgium 4,3 0,2 4,1United States 5,2 1,8 3,4Spain 2,9 0,9 2Average 6,4 1,6 4,8Billions 1528 379 1149Sources:IMF

EFSF vs. ESM 8

• Euro bailout•• Euro bailoutEuro bailout

Agenda

• Towards resolution•• Towards resolutionTowards resolution

• Overview•• OverviewOverview

EFSF vs. ESM 9

Euro bailoutGreek crisis escalation

In October 2009 a new credit derivatives index

was introduced in the market: SOVX

WESTERN EUROPE (basket of 15 Euro

sovereign cds)

At the end of 2009, the new government

announced that deficit for the year would have

been 12.7% more than three time higher than

previously declared 3.7%: the crisis started

On the 2nd May, Euro regions agreed a great bailout loan totalling 110b to bring the country through the next 3 years. ECB announced that it would drop all the rating requirements for Greek bonds

Demonstrators set fires in Athens killing 3 people

EFSF vs. ESM 10

Euro bailoutContagion

On the 10th May. The EU presents:

750b programme to secure the stability of the euro area under a European Commission / EURO / IMF parachute, and

the European Central Bank announces the introduction of several measures to preserve market liquidity: Securities Markets Programme, reactivation of swap lines with the Federal Reserve, introduction of additional liquidity-providing operations

Aim was to provide funding in conjunction with the IMF,under strict conditionality to economic and fiscal adjustment programmes.”

Amount Instrument Rate Repayment IMF 30 Stand-By Arrangement facility which

exceptional access to IMF resources, amounting to more than 3,200% of Greece’s quota.

SDR plus 200 basis point under 3years, with a 100bps mark up on amount outstanding over 3y for the amount over 300% of the country quote (approx 3.83%)

3,25 years after after the disboursement, spread in 8 quaterly instalments (2y).

EURO COUNTRIES (Irland and

Slovakia not partecipating)

80 Pool of bilateral loans from European Member states in accordance with their participation to ECB share capital, managed by the European Commission.

The initial rate to be paid on the eu loan was intended to be 300 bps over libor/swap for maturities lower than 3 years and 400 bps over 3 year plus a 50bps charge to cover operational costs (approx 5.5%).

3 years after the disboursement and spread in 8 quaterly instalments (2y).

EFSF vs. ESM 11

Euro bailoutOverview of the Greek facility

In order to avoid restructuring by mid 2012 the institutional sector will hold circa 40% of the Greek debt, the

European holding (30%) will rank “pari passu” with bond holders. This creates incentives for EFSF both to ask for

seniority (formally or asking for collateral) in further loans and to ask for maturity extension of the government

bonds, thereby worsening solvency crisis.

This to stress how a bad designed bailing out system (which does not address solvency but only liquidity) risks

creating unintended consequences by worsening the country solvency and becoming a channel of contagium in

itself. ESM will be a step forward: debt sustainability will be come core in providing financial assistance.

Greek gov debt

EU/IMF debt + ECB

Total Debt

% Institution

today 286 103,00 339,00 30,38%Jun 2011 279 115,00 344,00 33,43%Sep 2011 268 123,00 341,00 36,07%Dec 2011 263 128,00 341,00 37,54%Mar 2012 256 138,00 344,00 40,12%Jun 2012 234 144,00 328,00 43,90%Sep 2012 226 150,00 326,00 46,01%Dec 2012 225 152,00 327,00 46,48%Mar 2013 217 158,00 325,00 48,62%June 2013 203 160,00 313,00 51,12%

Extending now the repayment terms of the EU/IMF loan means making the loan junior to bondholder : Merkel asking “to negotiate an extension of maturities on its bonds before receiving a new European Union aid package“

Disbursements (done and planned) billions2010 31,052011 46,052012 24,002013 8,00

EFSF vs. ESM 12

Euro bailoutThe bill

Big contribution of Italy nothwistanding the small peripheral exposure. Italy is the country making the

greatest efforts

BIS end of q1 2010TOTAL LIABILITIES BANKING EXPOSURE Greece Ireland Portugal Spain

GERMANY 168,55 520,70 51,00 205,80 46,00 217,90FRANCE 129,46 491,00 111,60 85,70 49,70 244,00ITALY 109,28 89,30 8,80 28,60 9,40 42,50SPAIN 70,89 125,80 1,60 16,20 108,00 0,00US 47,80 378,80 41,20 113,90 37,30 186,40NETHER 38,60 0,00UK 32,58 413,00 16,50 222,40 32,40 141,70

EFSF vs. ESM 13

Euro bailoutThe mechanics

Both the facilities were based on a derogation to art.125 of the TFEU contained in art.122.2 which refers

to: “natural disasters or exceptional occurrences. Being born under “exceptional circumstances”, they will

both expire in June 2013. Aim: address liquidity issues and not solvency

EFSM (60b) ‏

usage of the European Union Medium Term Note to borrow from capital markets and lend to Euro states

EFSF (440b)‏funding vehicle to borrow from markets based on intergovernmental arrangement and a complex formalization of the pool of bilateral loan to Greece.

Portugal plan is to be approved on the 16-17 European Council meeting.

EXTERNAL AID IMF EFSM EFSF BILATERAL28 November Ireland 67,5 22,5 22,5 17,7 4,8

7 April Portugal 78 26 26 26

EFSF vs. ESM 14

• Euro bailout•• Euro bailoutEuro bailout

Agenda

• Towards resolution•• Towards resolutionTowards resolution

• Overview•• OverviewOverview

EFSM

EFSF

EFSF vs. ESM 15

The EU is empowered by the EU Treaty to borrow from the markets. It enjoys a preferred creditor status.

The EFSM is the facility to grant loan/credit lines to the Member States (Council Regulation 407/2010, 11 may 2010).

EU enjoys a AAA credit rating by the three major rating agencies.

Direct and unconditional obligations of the EU and guarantees by the 27 Member States (joint and several liabilities, established by Treaty Law). EU Member States are legally obliged to ensure that the budget always has sufficient funds to meet the EU‟s obligations, for this purpose the Commission may draw on all Member States.

Investors are only exposed to the credit risk of the EU

Loan Characteristics

Under the EFSF facility the fund raised is passed on to the Member States borrowing. This back-to-back imposes constraints on EU issuance (timing, amounts, maturities…) The big difference between the BOP facility and EFSM is that in the former there is no penalty rate

Euro bailout: EFSMCharacteristics

EFSF vs. ESM 16

Euro bailout: EFSMActivation

EFSM and EFSF enjoy a similar activation process with the differences outlined below due to different legal framework

Application for aidFormal requesto to Euro members

Economic stabilisation programmeNegotiated by EC, in cooperation with IMF and ECB

Includes strong conditionality

Memorandum of understandingAgreed between EU, IMF, beneficiary country

Approved by ECOFIN/Eurogroup (qualified majority 55% countries and 65% population), IMF, national Parliament of beneficiary country

Loan TermsBased on the EC porposal the European Council determines the amount of the country programme and the loan terms

Final TermsBased on the specific borrowing transaction.

Qualified majority decision, being EU an international institution

Unanimity consensus, being EFSF an intergovernamental agreement

EFSF vs. ESM 17

Under the Eu medium term programme (previously EEC and Euratom programme) a first benchmark

has been issued in December 2008 to finance partially a loan to Hungary and then to Latvia and

Romania

Funding in euro only. Maturity driven by features of underlying loan : we know exactly the average

duration of the issuance (7,5 years)

Total market outstanding amounts to 22b euros with average issue size 1-2b

The 2011 issuance (2015 and 2018) related to Ireland ( and partially to Romania) has seen an increase

in the issue size to 4,5-5b

Euro bailout: EFSMMarket and Issuance

CPN ISSUE_DT MATURITY OUTSTANDING ASW AT ISSUANCE ASWEUROPEAN UNION 3,25 09/12/08 09/12/11 2.000.000.000 15,00 -53,76EUROPEAN UNION 3,125 25/02/09 03/04/14 1.000.000.000 30,00 -13,10EUROPEAN UNION 3,25 26/03/09 07/11/14 2.000.000.000 35,00 -9,72EUROPEAN UNION 3,125 27/07/09 27/01/15 2.700.000.000 25,00 -9,33EUROPEAN UNION 2,5 12/01/11 04/12/15 5.000.000.000 12,00 -7,88EUROPEAN UNION 3,625 06/07/09 06/04/16 1.500.000.000 40,00 -1,08

EFSF 2,75 01/02/11 18/07/16 5.000.000.000 6,00 0,51EUROPEAN UNION 2,375 22/09/10 22/09/17 1.150.000.000 8,00 2,67EUROPEAN UNION 3,25 24/03/11 04/04/18 4.600.000.000 8,00 8,49EUROPEAN UNION 3,375 11/03/10 10/05/19 1.500.000.000 20,00 8,01

EFSF vs. ESM 18

Spread in primary market ranged from Euribor6m+ 8 bps (in recent issues) up to Euribor6m +40 bps in

correlation with the AAA universe spread at time of issuance

Usually issued at discount to comparables and performed strongly in secondary market

Spread behaviour in secondary market highly correlated with the AAA credit universe (0.89% as

represented by JpMorgan index,”Maggie all” of the same maturity)

Low and negative correlation with a proxy of euro government risks (represented by SOVX Western

Europe)

Historically Issuance trades in line with the rating category rather than underlying risk.

Euro bailout: EFSMSpread behaviour

ASW AT ISSUE ASW_AAA_ON_MTYEU3,2512/2011 15,00 26,05EU3,1254/2014 30,00 54,45EU3,2511/2014 35,00 62,93EU3,6254/2016 40,00 34,97EU3,1251/2015 25,00 20,95EU3,3755/2019 20,00 20,71EU2,3759/2017 8,00 15,15EU2,512/2015 12,00 -0,25EU3,254/2018 8,00 12,02

1° bond issue for Ireland

Cheapest ever

EFSF vs. ESM 19

High positive correlation with AAA rated securities rather than underlying risk:

Euro bailout: EFSMTrading with AAA risk

-20

0

20

40

60

80

10017

/02/

09

17/0

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1/11

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17/0

4/11

EU3.125 apr14 asw

AAA spread same maturity

EFSF vs. ESM 20

Low and negative correlation with underlying risk:

Euro bailout: EFSMNot with underlying risk

-16

-14

-12

-10

-8

-6

-4

-2

0

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1/11

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4/11

0

50

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EU3.125 apr14 asw sovx

EFSF vs. ESM 21

EIB most direct comparable. 156b outstanding market. Owned by the 27 Eu countries with share in line

with the country's share of GDP within the EU. Due to different legal framework (EIB multilateral

development bank) difficult to make a relative value comparison.

Like other multilateral development banks only a fraction (5%) of subscribed capital is paid in. The

remaining can be called. EIB has 263b of subscribed capital (2009 capital increase). The payment of

called capital is an obligation under the Eu treaty and the obligation to answer to capital being called

prevails on national laws

Euro bailout: EFSMComparables (1)

Eu issuance should trade cheaper than EIB (on underlying basket).

At present we are at tight level and given supply outlook on Eu issuance it make sense to exit EU to buy EIB

Still personally I prefer EU issuance based on:

1. Transparency of loan portfolio2. Lower leverage then EIB3. Temporary facility

EFSF vs. ESM 22

Euro bailout: EFSMComparables (2)

EIB shareholders 5y 5yShareholder % EIB ASW EU_BC ASW

France 16,17% -10,82 16,44% -10,82Germany 16,17% -41,29 21,11% -41,29

Italy 16,17% 100,21 13,64% 100,21United Kingdom 16,17% -34,05 13,05% -34,05

Spain 9,70% 156,47 8,51% 156,47Belgium 4,48% 69,28 3,83% 69,28

Netherlands 4,48% -28,51 5,28% -28,51Sweden 2,97% -52,72 2,69% -52,72Denmark 2,27% -50,81 2,02% -50,81Austria 2,25% -10,72 2,19% -10,72Poland 2,07% -9,43 1,99% -9,43Finland 1,28% -28,08 1,47% -28,08Greece 1,22% 1135,97 1,79% 1135,97Portugal 0,78% 570,79 1,37% 570,79

Czech Republic 0,76% 52,73 0,89% 52,73Hungary 0,72% 11,91 0,95% 11,91Ireland 0,57% 718,60 1,27% 718,60

Romania 0,52% 43,84 0,00% 43,84Slovakia 0,26% 76,22 0,37% 76,22Slovenia 0,24% 53,96 0,29% 53,96Bulgaria 0,18% 225,00 0,00% 225,00Lithuania 0,15% 172,54 0,21% 172,54

Luxembourg 0,11% -38,03 0,23% -38,03Cyprus 0,11% 285,86 0,15% 285,86Latvia 0,09% 0,00 0,11% 0,00

Estonia 0,07% 0,00 0,00% 0,00Malta 0,04% 0,00 0,00% 0,00Total 1,00 40,15 1,00 48,92

Based on underlying risk the EU issuance should trade wider than the EIB.

EFSF vs. ESM 23

Euro bailout: EFSMIssuance

The first issue EU2.5 dec15 performed quite well in secondary market (issued at euribor6m + 8bps) and

is performing better than 18 issue with curve steepening, given loan maturity to be hedged

EFSF vs. ESM 24

• Euro bailout•• Euro bailoutEuro bailout

Agenda

• Towards resolution•• Towards resolutionTowards resolution

• Overview•• OverviewOverview

EFSM

EFSF

EFSF vs. ESM 25

Euro bailout: EFSFThe criticized EFSF (1)

Finalised in June 2010 between the 16 euro area member with the famous “EFSF framework

agreement”

The EFSF is a supranational financing vehicle to raise funds backed by a pool of bilateral guarantees of

the individual EURO member states. It is a "société anonyme" (limited liability company), start up

capital of 30 million, subscribed by the EAMS based on their share in the ECB capital.

The individual guarantees are “irrevocable and unconditional guarantees" of the EAMS, the Guarantor, in

proportion to their share in the capital of the European Central Bank, “contribution keys”.

These contribution keys are adjusted for each support operation, to take in account the stepping-out

member (the borrower ),”adjusted contribution keys”.

Unanimity is the rule (2/3 of total guarantee commitment attending)

Two observer from the ECB and the European Commission sit on the board.

Debts instruments issued by the EFSF must be accounted as government debt of the MS according to

their contribution key as guarantors (Eurostat opinion).

EFSF vs. ESM 26

Euro bailout: EFSFThe criticized EFSF (2)

The granting of the loan terms and condition have to be approved by unanimity by the EAMS.

The EFSF is only charged with raising the funding on the market and making the loan, with the technical

assistance of other institutions, notably the European Investment Bank (legal and administrative) and the

German public debt agency (risk management).

The average rating of the guarantors is AA (not dissimilar form EIB and EU underlying risk), but due to

legal framework, it had to provide further credit enhancement mechanism to get to the AAA rating necessary for:

reputation

being able to fund in distressed and highly correlated market

The debt issued by EFSF is serviced by the underlying loan. In case of default of the borrower the debt is

serviced by the guarantors pro-rata, then from the a buffer and finally it is envisaged the possibility of

further credit enhancement mechanism

EFSF vs. ESM 27

Euro bailout: EFSFCdo or not cdo (1)

Over guarantees. Each guarantor issues unconditional and irrevocable guarantees to the amount of:

ADJ Contribution Key* x 120% x EFSF Nominal Obligation. Hence the guarantees provided exceed the

debt issued by 20%. If one of the guarantors is enable to meet its share the remaining guarantors will

increase their contribution up to 120% of their pro-rata share, making the 20% over guarantee fungible

between guarantors

AAA Guarantees

EFSFbond

Non AAA Guarantee

Different debt issue will have a different mix of guarantors depending on the borrower stepping-out and amount of cash buffer

EFSF vs. ESM 28

Euro bailout: EFSFCdo or not cdo (2)

Cash buffer. A cash reserve will be retained from the amount disbursed in order to size the gap between

the debt nominal amount and the AAA grossed up-guarantee. In this way a structure which resembled

correctly a cdo becomes a fixed basket of AAA securities and cash with an over guarantee from non AAA

countries (details in annex2 on cash buffer decomposition)

AAA GuaranteesEFSFbond Loan

Cash buffer =+

AAA Guarantees

Non AAA Guarantee Non AAA Guarantee

Cash buffer

EFSF vs. ESM 29

CDO SEMPLIFICATION

Debt issued is fully covered by AAA guarantees and cash. Strong commitment to further credit

enhancement mechanism in case of rating migration: the CDO features have been considered irrelevant for rating purposes but they are important for precise pricing

ACCOUNTANCY ISSUE

Notwithstanding the fact that the non AAA guarantees are useless to get the AAA rating they do

account for national debt in the guarantors accounts

REDUCED LENDING CAPABILITIES

Due to over-guarantee mechanism the amount the EFSF can borrow is nearly 366b (440/1,2).

The lending power goes down to roughly 213b. The overall Euro rescue is reduced from 750b to

410b enough to save Greece, Ireland, Portugal, Belgium but not Spain

INCREASE CORRELATION AND CHANNELS OF CONTAGION DUE TO BAILOUT SYSTEM

Euro bailout: EFSFEFSF weaknesses and strength

EFSF vs. ESM 30

Euro bailout: EFSFOn lending capabilities

Based on our assumptions, gross financing need the rescue package should be of around 643b to

include Spain, 1,5 trillion to cover also Italy

Font: BIMI reaserch

EFSF vs. ESM 31

Euro bailout: EFSFEFSF rating agencies opinions

Weaknesses:

reduced lending ability

risk that the guarantee is not enforceable against the guarantor (German constitutional law ruling

on legality of the statute enabling Germany to guarantee EFSF's debt obligations still pending)

great dependence on AAA rated countries

Strengths:

strong political support from European countries; commitment to maintain EFSF creditworthiness

(provision of additional credit enhancement mechanism in case of rating migration). programme

conditionality and monitoring from EC, ECB

reduced operational risks due to German DBO acting as facility agent, with treasury and risk

management tasks, EIB providing administrative and legal support

the multi guarantees mechanism should enable the facility to fund herself easily also in difficult

market.

base for permanent ESM

EFSF vs. ESM 32

Euro bailout: EFSFEFSF pricing as AAA basket (1)

For construction each debt issued will be a basket of AAA rated guarantees, cash, plus non AAA

guarantee. The basket will be homogeneous through tranches, but the cash buffer will vary in size.

Maxiumn commitment

Original contribution

keys

Out Greece & Ireland

Over guarantees

Out Greece,

Ireland & Portugal

Over guarantees

Out Greece, Ireland,

Portugal & Spain

Over guarantees

Belgium 15292,18 3,48% 3,64% 4,36% 3,73% 4,48% 4,28% 5,14%Germany 119390,07 27,13% 28,38% 34,06% 29,15% 34,98% 33,42% 40,11%Ireland 7002,4 1,59% Out Out OutSpain 52352,51 11,90% 12,45% 14,94% 12,78% 15,34% OutFrance 89657,45 20,38% 21,32% 25,58% 21,89% 26,27% 25,10% 30,12%

Italy 78784,72 17,91% 18,73% 22,48% 19,24% 23,08% 22,05% 26,47%Cyprus 863,09 0,20% 0,21% 0,25% 0,21% 0,25% 0,24% 0,29%

Luxembourg 1101,39 0,25% 0,26% 0,31% 0,27% 0,32% 0,31% 0,37%Malta 9562.33.36 0,09% 0,09% 0,11% 0,10% 0,12% 0,11% 0,13%

Netherlands 25143,58 5,71% 5,98% 7,17% 6,14% 7,37% 7,04% 8,45%Austria 12241,43 2,78% 2,91% 3,49% 2,99% 3,59% 3,43% 4,11%Portugal 11035,38 2,51% 2,62% 3,15% Out OutSlovenia 2072,92 0,47% 0,49% 0,59% 0,51% 0,61% 0,58% 0,70%Slovakia 4371,54 0,99% 1,04% 1,25% 1,07% 1,28% 1,22% 1,47%Finland 7905,2 1,80% 1,88% 2,26% 1,93% 2,32% 2,21% 2,66%Greece 12387,7 2,82% Out Out Out

Total Guarantee 440000 100,00% 420609,9 1,2000000 409574,52 1,2000000 357222,01 1,2000000AAA Gurantees 255439,12 58,05% 72,88% 74,84% 85,81%

Pricing

EFSF vs. ESM 33

Euro bailout: EFSFEFSF pricing as AAA basket(2)

Forgetting the non AAA guarantees we can price the EFSF as a fixed AAA basket (using the asw level

and a cash level of euribor6m + 8bps) we get the pricing below. In term of underlying risk the EFSF

should trade richer than EU and EIB issuance, but they are not comparable directly.

In the market EU and EFSF issuance are trading almost flat, due probably to perceived complexity,

weaker legal framework of the guarantees. Also we can expect the EFSF issuance to be highly

dependent to AAA rating migration issues. The correct way to look at EFSF is a convex replica of

underlying portfolio.

Out Greece & Ireland

Out Greece, Ireland & Portugal

Out Greece, Ireland,

Portugal & Spain

Out Greece, Ireland,

Portugal & Italy

AAA Gurantees 72,88% 74,84% 85,81% 92,67%

AAA Pricing -27,45 -27,45 -27,45 -27,45

Cash buffer 27,12% 25,16% 14,19% 7,33%

Cash pricing 8,00 8,00 8,00 8,00

Pricing -17,83 -18,53 -22,42 -24,85

EFSF vs. ESM 34

Euro bailout: EFSFEFSF pricing as AAA basket(3)

The correct way to look at EFSF as an investment product is as a replica of the underlying basket of AAA

guarantees and cash. In this way it offers 3 main advantages:

1. It trades cheaper than underlying basket almost 25 bps

2. It has a convex feature in case of AAA rating migration due to the non AAA guarantees.

3. The transaction cost (bid/offer) are lower than the replicating basket’s

In this way EFSF issuance can be useful to replicate a AAA exposition ( for example in a government

fund) or mixed to replicate a benchmark index.

EFSF vs. ESM 35

Euro bailout: EFSFChallenges and March 24-25 meeting decision

LENDING CAPABILITIES INCREASE TO ORIGINAL SIZE. Details postponed to next June meeting.

Possible solutions:

increase the total amount of guarantees: by 72% to get to original 440b.

non AAA guarantors to deposit cash

take off the non AAA over-guarantees from ESFS debt and mix the EFSF funding instrument with

bilateral loan from weaker countries

leave the AAA rating: the weighted average of the guarantors is consistent with AA rating

a mix of increased AAA guarantees and upfront cash or collateral commitments from lower rated

countries.

SCOPE EXPANSION

government bonds purchase only in primary market under strict conditionality

No decision on pre-emptive short term loan

EFSF vs. ESM 36

Euro bailout: EFSFEFSF for Ireland

To lend €17.7 billion to Ireland, the EFSF has set up a 27b billion programme. The first tranche of the

programme for Ireland was issued on 25 January 2011

2%

36%

5%

46%

11%middle east

asia

america

europe

uk

The amount transferred to Ireland was exactly the issuance amount multiplied by the grossed-up percentage of AAA member states (73%).Therefore the cash reserve is 1.3b roughly, made up by 0,87b of fungible cash (0.5% of debt amount plus npv of margin) and 0,43b of loan specifi buffer.

Amount issued €5 billionIssue price: mid swap +6 bpsEffective lending cost to Ireland 5.9%Applied margin: 2.47% on all maturitiesAmount transferred to Ireland €3.6bCover ratio of 9.

EFSF vs. ESM 37

Euro bailoutEuropean Issuance & Market Impact

On assumption EFSF programme for Portugal 35b, lending front loaded (60% in 1° year)

Ireland 2011 Done Q1 Remaining Timing 2012EFSF 16,50 5,00 11,50 Next tranche secondo quarter, 2 benchmarks in first half 10,00

Benchmark bonds 3,00 1,00 2 2,00EFSM 17,60 8,40 9,20 4,90

Benchmark bonds 4-5 2,00 2-3 benchmark transaction in first half 2011, at least one 10y bon 1-2Portugal 2011 Done Q1 Remaining Timing 2012

EFSF 10,40 10,40 17,33Benchmark bonds

EFSM 7,80 7,80 13,00Benchmark bonds

Total 52 13,40 38,90 0,00 45

MARKET IMPACT

Issuance well perceived by the marketSpread tightening (core – big peripheral) due to increase perceived correlation and core marketlosing safe heaven bid, asset swap widening in core markets with asset swap curve flatteningNo significant crowding out on supranational market

EFSF vs. ESM 38

• Euro bailout•• Euro bailoutEuro bailout

Agenda

• Towards resolution•• Towards resolutionTowards resolution

• Overview•• OverviewOverview

EFSF vs. ESM 39

Towards resolutionA comprehensive response to sovereign crisis

Dynamite.

Economic imbalances intra Europe

Soft budget constraint

Implicit bail-in clause

Addressed by:

New level of economic governance and Pact for Euro

Strengthening of the Stability Pact

Making orderly restructuring possible and less costly

via ESM and stronger banks

EFSF vs. ESM 40

Towards resolution:ESM One step forward (1)

On 24-25 March 2011, the European Council confirmed to establish a permanent crisis resolution

mechanism the European Stability Mechanism (ESM).

ESM is built entirely on the EFSF framework. The ESM will assume the role of the EFSF in providing

financial assistance to Euro area Member States after June 2013. EFSF will remain operational until it

has received full payment of loans to Member States and repaid all liabilities. Any undisbursed or

unfunded portions of existing loan facilities will be transferred to the ESM.

“EU INTERNATIONAL INSTITUTION”

The ESM will be an intergovernmental organisation under public international law, set up by a treaty change (art. 136) via a simplified revision procedure by end of 2012. The following wording will be added to art.136:

“The member states whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro as a whole. The granting of any required financial assistance under the mechanism will be made subjectto strict conditionality”

Revision procedure requires unanimity in the EU council (all 27) by end of 2012, national approval but no referenda.

New structure: EUROPEAN UNION INTERNATIONAL INSTITUTION makes the TRICK:

Contrary to the case of EFSF the debt of borrowing country will be recorded as due to the ESM and notrerouted to Member states (Eurostat opinion)

EFSF vs. ESM 41

Towards resolution: ESM One step forward (2)

STRUCTURE WITH CALLABLE CAPITAL (similar to multilateral development banks) should be

consistent with AAA rating without need of overcollateralization

LENDING CAPABILITY. Effective lending capacity will be 500b with 700b subscribed capital, unchanged

under original EFSF/EFSM facilities, but better efficiency ratio (48% 212 over 440, 71% 500 over 700)

PREFERED CREDITOR STATUS, JUNIOR ONLY TO IMF. This step is necessary to limit loss and could

limit negative effects of restructuring via debt buy-back

PRIVATE SECTOR INVOLVEMENT. Public acknowledgement that restructuring is a REAL

POSSIBILITY. ESM will be able both to:

provide liquidity to solvent states

bridge finance to states in process of negotiating a debt reduction.

Note that callable capital/ guarantee from AAA will be 360b, plus 80b cash and probably some convergence of EFSM 60b facilities

“The ESM will have a capital structure similar to multilateral lending institutions. It can be expected thatthis will be reflected in the assessment by credit rating agencies in line with their general standards forsubscribed capital and operating procedures of such institutions. “ from EFSF faq.

EFSF vs. ESM 42

Towards resolutionEFSF vs. ESM

TemporarySpecial vehicle Capital endowment 30m (only 18m subscribed)No decision making power -------------------------------Individual guarantees Liquidity assistance ----------------------------------------Primary market bond purchase under strict conditionality--------------------------------------------------------------------440b guarantees ----------------------------------------------------Triple AAA 255bPari passuUnanimity of EMSECB share contribution

PermanentEU international institution Capital endowment 700bDecision making power based on mutual agreementIndividual guarantees Liquidity assistance and bridge finance in debt restructuringPrimary market bond purchase under strict conditionalityPrivate holders bail in if debt sustainability analysis negative (CAC from 2013)Mix of paid in capital (80b) and callable capital and guarantees (620b)Triple AAA 360bCredit preferred statusMutual agreementECB share contribution with small adjustment

EFSF vs. ESM 43

“QUANTUM LEAP” in the euro area debt crisis management?

ESM capital accumulation (pre-funding): as before the guarantees/callable capital scheme activation risks creating contagium when activated.

Secondary market purchase and short term pre-emptive loan not addressed.

EU institution arrangement with single individual guarantees (unanimity), not join and several as in EU institution (qualified majority)

Lending capability almost unchanged

“It takes courage to jump”

Solid legal base with Treaty change

Accountancy issues solved

Preferred status and private holders involvement with risk that bailout system becomes a source of contagium in itself decreasing

Better efficiency ratio between total commitment and lending power

Still to comeOne step forward

EFSF vs. ESM 44

Annex1. Changes to the SP existing rules by Eurogroup, Ecofin and the ECouncil, on 20 March 2005

SP rules dilution:

While the official deficit threshold will be maintained, there will be a derogation – allowing a member state to exceed

temporarily the 3 per cent figure to a limited extent – in the event of slow economic growth (no precise figures being

provided).

A temporary (period of time not defined) deficit will not be declared excessive if the member state concerned

devotes considerable public expenditure to one of several ‘other relevant factors’ 1) investment; 2) research and

development; 3) structural reforms (only those which have a long term impact on the solidity of public finances will

be taken into account); 4) EU policy goals; 5) European unification; 6) international ‘solidarity’ (which the French

insisted would include spending on both aid and military). Further consideration would be given to these ill-defined

spending categories. Once the 3 per cent deficit limit is reached the Council and Commission will examine the

extent to which spending on these ‘pertinent factors’ contribute to the deficit in question.

A member state which has achieved a public spending surplus during periods of relatively strong economic growth

and which has a relatively low debt burden will be treated more leniently

A member state exceeding the 3 per cent threshold will obtain a delay of 3 years to bring its deficit down again. The

objective remains to bring the deficit below the threshold within a year following the launch of the EDP but a

government can obtain a delay of a year if there are particular circumstances that should be taken into consideration

(notably slow economic growth). Before advancing to the sanctions procedure the Commission will prepare a report

to determine whether a supplementary delay of a year should be allowed.

EFSF vs. ESM 45

Annex1. Changes to the SP existing rules by Eurogroup, Ecofin and the ECouncil, on 20 March 2005

Following the identification of an EDP by the Commission and the Council, a member state will have 6 months (not

just the current 4) to propose corrective measures.

As in the Commission’s recommendation, member states are to avoid pro-cyclical budgets in good times (when real

growth is superior to potential growth) but there is to be no obligation for these member states to achieve a budget

surplus.

More effort will be demanded from member states with a relatively heavy debt burden which have not undertaken

structural reforms.

The mid-term objective of each member state will be determined with regard to two factors: 1) those member states

with low debt levels and strong growth are allowed a medium term deficit of 1 per cent; 2) those member states with

high debt levels and weak growth prospects will have to move to a deficit close to balance or in surplus (as is

currently the case but this objective will be redefined every four years). Member states which have not yet attained

their medium term objective will have to reduce their structural deficit – depending upon the level of economic

growth – by 0.5 per cent of GDP. 13

EFSF vs. ESM 46

Annex2. Greek crisis escalation

Dec 9: Fitch downgrades to BBB+ and S&P follows suit

Feb 10: Goldman Sachs scandal becomes public. Ackermann (DB Ceo) meets Papandreou and proposing Merkel’

economic advisor a Greek bailout from private banks, Germany and France each lending 7.5b. The proposal is denied since

not complaint to art.125 of the TFEU.

March 10 New tax and salary cut to civil servant in return of some sort of solidarity fro European states. Situation more

pressing with 20b debt redemption in May. The European countries and ECB would have come in support of Greece.

April 10:Germany agrees to subsided a 30b Emu loan to Greece with additional 15b coming from IMF. On the 22th Apr EU

announces that Greek deficit for 2009 was at 13.6 higher than already reviewed number. On 23-Apr a 45b EMU/IMF plan

gets activated, on the 27-Apr National Bank of Greece and EFG Eurobank Ergasias get downgraded to junk from Moody's.

Greece is downgraded to junk status, Spain lowered to AA from AA+, Portugal from A+ to A-.

On the 02 May Euro regions agree a greater bailout loan totalling 110b to bring the country through the next 3 years. ECB

announces that it would drop all the rating requirements for Greek bonds. Demonstrators set fires in Athens killing 3 people.

EFSF vs. ESM 47

Annex3. Cash buffer decomposition in EFSF

The cash buffer is made up by two component:

a general cash reserve (fungible cash reserve). An upfront fee of 0.5% applied on the principal amount of the loan plus the

net present value of the loan margin (2,47 for Ireland) is retained by EFSF from the cash amount disbursed to the borrower.

It will be the ultimate remuneration of the guarantors, but it is retained as loss absorbing capital and credited to a general

cash reserve together with any interest income. As loan get repaid and the cash reserve exceed the amount necessary to

repay the loan it becomes “free cash” and can be used to reduce the loan specific cash buffer for new loans. It will be

distributed only when all the funding instruments issued by EFSF have been repaid.

a loan specific cash buffer. It is sized in order to fill the gap between the nominal amount of the funding instrument, net of

funding cost (negative carry) and the 120% of the AAA rating guarantees plus the cash reserve. It will be used to cover

shortfalls in payments by a borrowing country should the guarantees be insufficient. If there will be no default, it will be used

to redeem the debt instrument. If the guarantees are called, the funds available under the LSCB may be transferred to the

guarantor Member States or maintained in the EFSF for possible future operations.

Cash investment guidelines.

For construction the EFSF will potentially have large amounts of cash. The guidelines investment policy have two objectives:

1) cash to be invested in high quality liquid debt instruments issued in euros, 2) reduce the negative carry between the cost

of funding and the investment holdings