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Kinky spivs

24 October 2011 By Neil Unmack

The euro zone’s financial alchemy is getting spivvy. The euro zone is considering seeding funds, or special purpose investment vehicles, to finance bailouts. SPIVs could boost demand for sovereign debt. But Europe may need to get comfortable with using taxpayer funds to subsidise hedge-fund type returns.

Critics of financial alchemy may be appalled at the euro zone’s latest plans to solve its crisis. The name alone seems to be unintentionally derived from old UK slang for a black-marketeer that has also been applied to some in banking. The plan, according to a paper seen by Reuters, is for the European Financial Stability Facility to seed funds for countries shunned by markets. They would leverage EFSF capital by issuing senior debt, and a middle-ranking capital. The funds would in turn buy sovereign bonds in the primary or secondary market. It’s a bailout fund repackaged in a bailout fund, or a bailout squared.

The plan is similar to the euro zone’s other scheme to revive sovereign debt, in which indebted countries partially collateralise their bond issues with risk-free assets. Both seek to bring down funding costs for larger countries like Italy and Spain, while leveraging the resources of the EFSF, which has less than 300 billion euros left.

The idea is that the SPIV could channel funds to countries shunned by markets, slicing up risk to appeal to different kinds of investors. Risk-averse investors would buy the senior debt. Sovereign wealth funds and more risk-hungry asset managers would buy the middle-ranking capital.

But SPIVs face challenges. The EFSF’s ratings could be endangered. Currently, the bailout fund lends directly to countries, and has a senior claim in case of default. A SPIV would relegate the EFSF to the bottom of the pile. The new-type funds will also have to find investors for its riskier, middle-ranking tranche. If investors believe the bailed out country is solvent, the middle-ranking tranche could offer high returns. But losses would be severe in case of default.

Investors would probably need something in return. Sovereign wealth funds might be happy with political concessions. But other investors might need a sweetener. For example, the EFSF could subsidise SPIVs by accepting a return close to its own, low cost of funds, leaving a higher yield for other investors. Such a subsidy could attract private capital, but taxpayers may balk at the prospect of subsidising high-rolling asset managers. Or even, heaven forbid, hedge funds.


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