Europas stora plan

The highly anticipated EU crisis summit has delivered headline agreements in the three key areas: a Greek bailout, an expansion of the EFSF, and bank recapitalisations. Agreements were reached between EU leaders at around 4am on Thursday morning; eleven hours after the summit began. European equities rose strongly and the spreads on Spanish and Italian government bonds tightened relative to German bunds. Here are the highlights:

A new €130 billion bailout for Greece
- €100 billion is to come from the EFSF and €30 billion from the IMF

 A voluntary 50% haircut on Greek government bonds for private bond-holders
- The write-down is expected see Greek government debt fall to 120% of GDP by 2020.
- Official support (EU/IMF/ECB) will amount to €30 billion

Agreement was reached that banks need to raise €106 billion to boost core Tier 1 ratios to 9% by June 2012
- The Euro Banking Association has suggested several ways to raise new capital: going to private markets; retaining profits and withholding discretionary payments; and substituting existing hybrid instruments with higher quality capital instruments
- The 9% tier 1 ratio target exceeds the 7% level that world leaders have agreed to phase-in from 2013
- Banks have until the end of the year to tell supervisors how they will make up the capital shortfall by the June 2012 deadline

The EFSF is to be leveraged and provide “risk insurance”
- The EFSF will provide “risk insurance” for new bonds issued by struggling eurozone economies       
- It could be leveraged “4 or 5” times suggesting  a capacity of about €1 trillion

Questions that still need answering:

• Headline agreements have been reached but much of the details of implementation are still to be worked out.
• The impact of a voluntary 50% haircut on Greek government bonds on CDS contracts that protect against outright or technical default is unclear. If these contracts are not triggered, many investors might view them as worthless. If they are, it could help to spread contagion. Although exposures are known and are thought to be relatively limited, while the ECB would ultimately act as lender of the last resort.
• The focus of attention is moving toItalywhere the debt-to-GDPratio is 121%. EU leaders have been pushing Berlusconi hard to deliver concrete austerity measures. Berlusconi’s hastily-put-together plans are focused on raising the retirement age and accelerating the programme to privatise state assets. Markets will monitor progress on these plans closely.
• Beyond revealing plans for the EFSF bailout fund to be extended, it remains to be seen exactly how this will be implemented.

Key upcoming dates for the eurozone:

3 Nov
ECB meeting, followed by a press conference
3-4 Nov
G20 Summit in Cannes
7 Nov
Eurogroup
8 Nov
ECOFIN
15 Nov
Italy to present new economic plan
18 Nov
ECOFIN
20 Nov
Parliamentary elections in Spain
29 Nov
Eurogroup
8 Dec
ECB meeting, followed by a press conference
9 Dec
European Council
10 Dec
Banks to present recapitalisation plans

Initial thoughts from our experts…
"It looks like we have an agreement on three key elements: a new €130 billion Greek bailout, €106 billion bank recap and a voluntary 50% write-down on Greek government bonds for private bond-holders. Markets have reacted positively to the intent shown by policymakers, yet my overall view is that the deal is not the game changer investors are looking for. Italy's 120% debt-to-GDPdoesn't look any more sustainable today than yesterday. Europeis destined for a multi-year workout during where economic growth will be very restrained and equities are likely to remain cheap. The path of equities will therefore require better news else where. Earnings growth in the UScontinues to surprise on the upside and we may be approaching a policy shift in China. The catalyst for higher equity values lies outside Europerather than within." Dominic Rossi, Global CIO, Equities, Fidelity Worldwide Investment

"The EU leaders surprised positively after the squabbling of recent days but were low on detail on the critical point of leverage for the bail out fund to backstopSpainandItaly. We may have to wait until November for specifics of possible BRIC/IMF involvement alongside a partial insurance scheme for primary issuance. The critical test will be what happens to the Eurozone economy. Provision of liquidity goes hand in hand with further austerity in the periphery withItalynow the focus. Meanwhile, if theUKexperience is any guide it will be hard for national regulators to prevent banks deleveraging their balance sheets now forced public capital injections are threatened." Trevor Greetham, Multi Asset, Fidelity Worldwide Investment

"The EU leaders summit has provided a degree of comfort to the market as it has shown a resolve to address many of the financial and sovereign problems Europefaces. However, although heavy on headlines, the details behind many of the announcements are lacking.  A positive has been the intention to provide a term funding bank guarantee scheme which would allow banks access to the wholesale funding markets and to rely less on short term ECB financing operations.  Also the leaders have agreed to the flexible use of the EFSF and also to develop a complementary Special Purpose Vehicle, both of which should increase the available fire power to assist peripheral government funding needs. Although the markets have reacted positively, it is too soon to believe these solutions are enough to allay the markets’ longer term fears over the financing and economic management of peripheral sovereigns.  The full details and mechanisms of the new financing vehicles and schemes will need to be provided in order for a full assessment of the impacts to be made." David Simner, Fixed Income, Portfolio Manager, Fidelity Worldwide Investment

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