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Brussels, 1 December 2010

European Stability Mechanism (ESM) – Q&A

A new permanent crisis mechanism, the European Stability Mechanism (ESM), will be set up in the euro area as of mid-2013. Following a proposal by the European Commission, this was agreed by the euro area Ministers of Finance on 28 November 2010.

This agreement will be reflected in the proposal for an amendment to the Treaty that will be submitted by President Herman Van Rompuy to the European Council in December 2010.

What is the ESM?

The ESM is a crisis mechanism set up to safeguard financial stability in the euro area. Its main features will build on the existing European Financial Stability Facility (EFSF).

The ESM will complement the new framework for reinforced economic surveillance in the EU. This new framework, which includes in particular a stronger focus on debt sustainability and more effective enforcement measures, focuses on prevention and will substantially reduce the probability of a crisis emerging in the future.

When will it be operational?

The ESM will become operational as of mid-2013 following the expiry of the existing EFSF.

An overall evaluation of the new mechanism will be performed by the Commission, in liaison with the ECB, in 2016.

How will the ESM work?

The ESM will be able to provide assistance to euro area Member States in financial distress. Assistance will be conditional on the implementation of a strict economic and fiscal adjustment programme, in line with existing arrangements.

What form will private sector involvement take?

Private sector involvement will be decided on a case-by-case basis, fully in line with IMF usual practices. There will be no automatic solutions and no prior requirement. The exact form of the participation by private creditors will depend on the specific nature of the problem to be addressed and will be fully consistent with IMF practices.

What type of crises will be addressed?

A distinction will be made between liquidity and solvency crises. This will be based on a debt sustainability analysis (DSA) conducted by the European Commission and the IMF, in liaison with the ECB. DSAs are usual practice in IMF-led assistance programmes.

In case of a liquidity problem, ESM support will be provided conditional to an adjustment programme and private creditors will be encouraged to maintain their exposure, in line with the current EU and IMF practice. Voluntary arrangements to maintain the exposure in a country under financial assistance were for instance already put in place in Hungary, Romania and Latvia (the so called 'Vienna initiative').

In the unexpected event that the debt sustainability analysis reveals that a country could be insolvent, the Member State will have to negotiate a comprehensive plan with its private creditors, in line with IMF practices, and liquidity assistance under the ESM may be provided.

What happens in the extreme and unlikely case of insolvency?

Collective Action Clauses (CACs) will be included in the terms and conditions of all new euro area sovereign bonds starting in June 2013. These clauses will be standardized and identical for all countries and will provide the legal basis for the negotiation process with creditors.

CACs will enable the creditors to pass by qualified majority a decision agreeing a legally binding change to the terms of payment. This could take the form of a standstill, extension of maturity, interest-rate cut and/or haircut, depending on the specific case.

CACs will be consistent with those common under UK and US law after the G10 report on CACs. They will include aggregation clauses allowing all new debt securities issued by a Member State after 2013 to be considered together in negotiations.

Loans under the ESM will enjoy preferred creditor status, junior only to IMF loans.

Will private sector involvement apply before 2013?

No. The provisions for private sector involvement will not apply before mid-2013.

Will CACs increase the risk of debt restructuring?

No. The insertion of collective action clauses does not per se increase the risk of restructuring. The clause is a simple tool to facilitate the discussion between a debtor and its creditors. The risk of restructuring depends on one thing and one thing only: the sustainability of the debt of the Member State concerned. The implementation of the new economic governance package will precisely help ensuring that the debt level of the Member States remains on a sustainable path.

Are CACs a new idea?

No. It is by no means a new idea. Following discussions at the G10, the Ecofin Council had already concluded in 2003 that the Member States should include collective action clauses in their government bonds issued under foreign law or jurisdiction.

The EU itself has today collective action clauses in all its bond issuances.

Full statement by Eurogroup:

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