Option 1 – Credit enhancement
E11 – What will be the scope of the protection under option 1?
The partial protection certificate will cover a portion of the principal value of the bond. The precise amount will depend on market conditions and the country circumstances. In the public discussion, often a value of 20% has been mentioned, which however will have to be confirmed.
E12 – How will the event of default be defined?
The event of default could be defined differently from the one set by the International Swaps and Derivatives Association (ISDA). A credit event (default) could be defined as the Member State failing to pay either a scheduled interest or principal payment.
E13 – How and when will the certificates pay out?
Following a default event, the incurred loss per bond will be determined. The certificate will entitle the holder to claim their entitlement against this loss in EFSF bonds.
E14 – Will the certificate cover both principal and interest of the underlying bond?
The intention is that it will cover part of the principal value of the underlying bond.
E15 – Will the certificate cover more than one country?
E16 – What will be the cost of the certificate?
The investor will be receiving a lower coupon from the Member State than current market yields reflecting the intrinsic value of the certificate on day 1.
E17 – Will there be a cap for intervention in secondary markets?
There is no ex-ante cap, but the amount of interventions will ultimately depend on the degree of leverage and hence on the enhanced capacity of the EFSF.
E18 – Why should an investor participate in this scheme rather than buying a newly issued bond and simultaneously buying protection in the CDS market?
This is for investors to judge. The main difference is that the partial protection certificate will be backed by EFSF collateral and therefore the investor will have counterparty risk to the EFSF (AAA) rather than the provider of a CDS.
E19 – Why should an investor participate in the scheme rather than buy a plain vanilla bond issued by the Member State?
Whilst existing member state market yields are higher than the coupon under the scheme, investors holding the partial protection certificate will enjoy a degree of credit protection
provided by EFSF bond collateral with a AAA rating.
E20 – Who are the likely users of the scheme?
Institutional investors willing to take European sovereign risk with credit enhancement.
E21 – Doesn’t this scheme segment the sovereign bond market?
The bonds issued by Member States under this scheme will be identical in every respect to existing bonds issued by that country. This is the reason why the partial protection certificate could be detachable and separately traded.
E22 – How does EFSF expect the newly-issued bonds to trade in relation to existing
The bonds will be identical to existing bonds and are expected to trade in line with them. However the actions of the EFSF in support of sovereign bonds for that country is intended to have a positive impact on investors’ perception of all sovereign bonds issued by that country.
E23 – How will EFSF ensure a liquid market for the certificates?
This will be a relevant consideration for the EFSF in deciding how to activate the scheme in relation to a particular country, and EFSF will engage closely with relevant market
E24 – What will be the effect of this scheme on the CDS market for the Member
That is a matter for investors, who will have different preferences; the two instruments are not identical. The partial protection instrument offers superior protection as a risk management tool to a CDS in a certain respect, as explained above.
E25 – How will negative pledge clauses relating to existing Member State obligations
affect the scheme?
This will be determined through due diligence in relation to the circumstances of any specific country before the EFSF decides to implement the scheme in relation to that country.
E26 – Will this scheme increase the headline debt figure of the Member State?
Any statistical effect of this sort will be determined in discussion with Eurostat.
E27 – How will the scheme reduce the cost of issuance for the member state?
EFSF is providing loss protection for investors in newly-issued bonds and thus the risk profile of these bonds for investors is reduced; this will be reflected in pricing.
E28 – Has EFSF had direct conversations with investors and what were their
Initial conversations have been held with a number of investors; these have informed the design of the scheme. More detailed soundings will now take place.
Complete FAQ [ EFSF ]