Nomura Global Economics
10 October 2011
but on the other hand providing sufficient liquidity to ensure that key countries, such asItaly or Spain, do not lose market access. If they were to do so, the survival of the euroarea would become more uncertain. So, the SMP needs to provide a minimum backstopuntil a sustained solution is found.
ECB is scheduled to pass the SMP baton to the EFSF 2.0,which is unable to grasp it
Given the ECB‟s obvious restraint in terms of its SMP intervention, the scheme has had a
success proportionate to the modest scale of its ambition. It has played an important rolein helping to maintain market access for countries such as Italy and Spain since it haslimited the rise in yields, but the scheme has clearly not been large enough to transformmarket sentiment towards the semi-core countries since it is not a solution to the debtcrisis. While maintaining the current SMP is not a substitute for a credible and broad-based EU policy response to the crisis, were the ECB to halt its programme the risks ofItaly and Spain losing market access would increase significantly. In this respect, the
outlook for the ECB‟s SMP is a crucial area of market risk.
Unfortunately, there are question marks about the longevity of the SMP. As we wroterecently(
,6 September 2011), the ECB currentlyplans to halt its SMP and to hand over responsibility for secondary market bond-buying tothe EFSF once Euro-area parliaments approve planned changes to its structure. This is aconcern because the proposed new structure of the EFSF (EFSF 2.0) is ill-suited to the
task of taking up the baton of the ECB‟s bond buying program
in our view. At
440bn inusable/investible resources,
147bn of which have already been allocated to bailoutprogrammes, we think it is too small to comprise a significant buttress against marketweakness in non-
core debt. Moreover, the EFSF lacks the ECB‟s flexibility since it would
need to pre-fund its interventions, and there is uncertainty about how the EFSF wouldchoose which bonds to buy.
Does the EFSF 3.0 option change our view of the ECB's SMP?
When looking at the many and varied options for EFSF 3.0, below we divide them intotwo broad categories: (1) options which by definition address the issue of the SMP bymaking this scheme a central component of the new EFSF; and (2) options such asleverage-based options which require a separate view on whether or not we expect theSMP to be maintained and in what size.
The ECB indemnity option
(29 September 2011), we noted that of the proposedchanges to the EFSF, one of the most appealing could be to transform the EFSF into amechanism for indemnifying the ECB against losses from its bond holdings. The benefitsof this approach would be threefold:
More efficient use of EFSF capital
. This scenario would not need the EFSF toissue AAA debt for the purpose of its indemnification operations. Hence the fullvalue of guarantees
could be utilised rather than the
440bn whenthese assets are over-collateralised to form
440bn of investible funds.
SMP uncertainty is removed
. Under this scenario, the SMP becomes a central
element of the EU‟s EFSF
-related plans for addressing the euro-area crisis. Thisoption also addresses (depending on the scale of the indemnity provision) theECB's concerns about the credit risk implicit in its SMP.
. The plan also allows for EFSF funds to be allocated toadditional uses, such as bank recapitalisation, and hence for the policyresponse to comprise a more comprehensive package of measures.We explore this option first as it would allow us to quantify the potential impact on theSMP.
SMP has helped limit therise in yields, but is nosubstitute for a crediblesolutionEFSF funds can be usedto indemnify the ECB forits bond purchases