The comments hereunder are organised in the same order as they appear in the term sheet published on March 21st 2011, following the extraordinary meeting of Eurozone Finance Ministers.

1. Institutional Form

It is intended to be a Treaty under “international law”. It can therefore be assumed that its terms will only be binding on the signatory countries and on those parties who “contractually” accept to be bound by its provisions.

An important question arises about the impact of this new Treaty on the obligations of non EMU Members. Under the present Treaty (with the exceptions of the UK and Denmark benefitting from an “opt out clause”), all other Member States must converge to meet the “Maastricht criteria” and join EMU.

By agreeing to this new Treaty, the existing Members of EMU substantively change the conditions for joining EMU, since it can be surmised that the applicant will be under the obligation to join the ESM. Does this situation not constitute a unilateral Treaty change (bypassing the normal procedure)? Does it – as a consequence – automatically give the right to a non EMU Member to refuse to join EMU (violating his existing Treaty Obligations)?

2. Function and funding strategy

Would a new Member State joining EMU after 2013 be obliged to turn over to the ESM his share of fines received under the EU sanctions regime prior to his accession?

3. Capital Structure

The amount of “subscribed capital” totalling €700billion is welcome. It is however difficult to understand how “guarantees” can be considered part of “subscribed capital”. Maybe a better way of expressing this idea would be to state the ESM would benefit from firm “commitments” of its “shareholders” totalling €700 billion – representing an increase of € 200billion over the current EFSF and EFSM - composed of subscribed capital (of which €80billion will be paid in) and guarantees.

It remains necessary to specify whether the EFSF procedure of “stepping out” is maintained and the enhancement of guarantees up to 120% of guarantee commitments remains applicable. Indeed, what will be the position of Greece and Ireland? According to the “key”, they are committed to provide respectively €19.72 and €12.26 billion as their share of “subscribed capital” (as defined), including €2.25 and €1.40 billion cash up front, which represents a significant additional burden for these highly indebted countries.

For the sake of transparency, answers to these questions should be provided to the market to avoid any misunderstanding.

4. Instruments

“Primary market support facility” (“PMSF”): It is very difficult to understand the underlying purpose of this instrument. Clearly, the conditions outlined must mean that the “primary issue” purchased from the “Member State experiencing severe financing problems….” is a stand alone issue, not being otherwise “distributed” to other investors.

If this is indeed the case, in what way does the PMSF differ from the normal ESS? After all, the existence of an ESS loan will also facilitate access to the market by the Borrower.

5. Activation of financial assistance, programme monitoring and follow-up and Consistency with the EU multilateral surveillance framework

The imbrications of the procedures involving the Council – the Commission – the Board of Governors are “messy” at the very least. It is obviously the result of the necessity to provide “consistency” with the EU multilateral surveillance mechanism. It makes abundantly clear the weakness of trying to force a newly-created “intergovernmental” EMU-based procedure into the existing EU framework for macro-economic adjustment programmes.

Council decisions on these matters are taken by “qualified majority”, while the approval of the Board of Governors must be unanimous to grant the aid. What happens if a MoU is approved by the Council but is not sanctioned by the Board of Governors?

6. Pricing

The envisaged 200 to 300 bp “risk premium” is tantamount to instituting a fiscal “Transfer Union”, in which the weaker Members are asked to subsidise the stronger ones. The image projected to the investment world is highly negative. If the idea of EMU solidarity cannot be sold to the public opinions of Member States, and a strong case made that it is in their own best interests, then the prospects for ensuring the long term survival of monetary union are severely compromised.

7. Private sector involvement

1.”Modalities for involving the private sector”: This amounts to little more than a statement of good intentions based on IMF practice. However, one should weigh the requirements listed against the possibility that “urgent” intervention may be needed, leaving little time to initiate comprehensive discussions with private sector creditors.

2. “Collective Action Clauses”: The real effectiveness of these clauses will be postponed until the greatest part of outstanding debt has been retired, as differentiated treatment between creditors of equal standing will not be possible because the creditor status of lenders “will not be affected by the inclusion of CACs”.

The fact that the CACs will be “consistent with the CACs that are common in New York and English law” is important, but not the determining factor. Rather, it is the jurisdiction chosen to enforce the provisions of the loan agreement (or “trust indenture”) that is the key. Most “international investors” show a marked preference for US or UK jurisdiction. This should be considered in conjunction with the discussion below of the “preferred creditor status” of the ESM, because the competent jurisdiction will be an important factor in ensuring the widest possible marketability of an issue.

8. Preferred Creditor Status of the ESM

This is probably one of the most controversial points in the proposal to be submitted later this week to the European Council for approval.

 

The comparison with the IMF is dubious: first of all the IMF’s “privileged creditor status” is not established by Treaty or any other legal instrument, but has been “accepted” and - so far - never challenged in court.

 

It appears questionable whether there exists a firm legal base for imposing such a privilege, in particular on parties not legally or contractually subject to the EMS Treaty. If therefore the privilege was challenged, it could lead to a prolonged period of uncertainty pending final resolution, creating significant market disruptions. This would heavily penalise the issuing conditions of any debt that could become “subordinated” to ESM loans, including issues by the strongest EMU Members.

 

The privilege could of course be included contractually in the CACs of issues after 2013, but that would contradict the statement that creditor status is not affected by the CACs. Such inclusion would also be translated into higher issuing costs.

 

There would also be serious questions raised by extending such a privilege to non-EMU Member States that wish to participate in operations in parallel to the ESM. It is clear that the latter will insist on being “pari passu” with the ESM as a condition of their involvement.

 

Serious consideration should be given to dropping this specific proposal, as it is likely to create significant market turmoil and overshadow all the progress otherwise made in establishing the ESM.