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The Globe and Mail

EU negotiators weigh doubling financial firewall

European Central Bank headquarters in Frankfurt


Eleventh-hour negotiations have begun to create a much bigger financial "bazooka" to present at this week's European Union summit that could include running two separate rescue funds and winning increased support for the International Monetary Fund.

This three-pronged rescue system would form part of a carefully crafted package EU leaders hope will win over financial markets, just two months after a similar summit failed to convince bond investors Europe could contain its spiralling debt crisis. The rescue system would be introduced alongside proposals to rewrite EU treaties with far tougher budget rules for the euro zone.

According to senior European officials, negotiators are considering allowing the euro zone's existing €440-billion ($590-billion U.S.) bailout fund to continue running when a new €500-billion facility comes into force in mid-2012, almost doubling the firepower of the bloc's financial rescue system.

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The proposal, being debated by "sherpas" ahead of Thursday's crucial euro zone summit, could also include speeding up cash payments into the new €500-billion fund – known as the European Stability Mechanism (ESM) – to give it more heft and improve its creditworthiness in the eyes of credit rating agencies.

Supporters of the proposals acknowledge they are controversial and the subject of intense debate by officials negotiating new ESM treaty language. Some northern creditor countries, where bailout backlash has threatened to topple national governments, have shown reluctance.

But the proposals' backers argue that allowing the ESM to run alongside the current bailout fund could strengthen Europe's financial firewall when combined with new euro zone funds for the IMF to increase its capacity to aid struggling countries. The current bailout fund, known as the European Financial Stability Facility (EFSF), was originally supposed to wind down when the ESM came into place.

Under the plans being considered, the ESM is unlikely to have its headline €500-billion from the start, now envisioned for July. But leveraging up the existing EFSF, which could raise its disposable resources to about €600-billion, and adding new IMF and ESM resources could create the so-called "bazooka" effect leaders have been searching for.

Creating a credible financial firewall has been a key demand by Mario Draghi, president of the European Central Bank, to increase the bank's intervention in euro zone bond markets.

In order to make the new ESM even more potent, some European negotiators are also exploring whether to give it access to ECB funding – something the ECB and Germany ruled out for the existing EFSF.

Some officials say that since ESM will be a treaty-based international organization like the IMF or the European Investment Bank – both of which can get loans from the ECB – this would be more acceptable to Frankfurt and Berlin. Paris has long argued for the ECB to act in this way, given its ability to print unilimited amounts of euros. But the ECB is expected to reiterate its objections.

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Negotiators are also close to finalizing ESM treaty language to weaken significantly its requirement that debt holders swallow losses on bonds when euro zone countries receive bailouts. The current ESM treaty language requires such "haircuts" for insolvent countries, but officials said the new treaty would revert to IMF practice, which involves a more subjective case-by-case evaluation.

Provisions for collective-action clauses, which would give governments more control over bondholders in insolvency cases, would remain, however.

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