EUROPE - The EU is facing criticism from asset managers over its plans to raise its part of the €750bn (US$922bn) rescue package for embattled eurozone nations.
Managers claim the EU's proposal to issue bonds through the use of a special purpose vehicle known as the European Financial Stability Facility (EFSF) is ill-considered and too risky.
As part of the plan, countries seeking financial support are immediately relieved of the burden of being co-guarantors. This managers argue, is the package's Achilles' heel.
Paul Brain, fixed income team leader at Newton Investment Management, said if several of the larger member countries failed, the EFSF and the remaining guarantors of its bonds could see their credit ratings hit.
"Pension funds could buy the EFSF's bonds when they are issued, assuming they are able to buy supranational issues issued by bodies such as the European Investment Bank," Brain said.
"As soon as countries go to the EFSF for support, they are kicked out of it, increasing the burden on those left in it.
"If a larger guarantor such as Spain, Portugal or Italy - which account for €81.1bn ($9.9bn)- or 18.4% of the facility's original size - required assistance, the burden on remaining guarantors would likely become too great, thereby threatening that country's credit rating, and endangering the whole house of cards."
Phil Irvine, co-founder of pension consultants PiRho Investment Consulting, said the issue of a decreasing group of countries being left to carry the burden of their struggling neighbours had always been a concern for the EU.
"The question is, if most of the eurozone becomes submerged, can the remaining people keep bailing the boat out?" Irvine says. "It is not easy, but it an issue that has always been there for the EU.
"Whether you buy German or Spanish or Greek bonds, you have to take some sort of view on the robustness of the finances behind them. The risk is buying the bonds as if they were completely equivalent to German bonds. There are scenarios where the creditworthiness gets impacted for the last one in the rowing boat if most of it goes under.
"People priced all EU countries off German bunds and kept a small margin, but that assumption has been tested to the extreme over the last six months."
Filippo Nencioni, senior partner at hedge fund Onslow Capital Management, said he would prefer to buy sovereign bonds directly.
"If an ECB bond or an SPV bond were to be issued, I would certainly want to read the prospectus and its terms to understand who the ultimate creditors are," he said.
"It is easier to follow the dynamics at a political level and budgetary level of one country than this entity. If you buy a French bond, for example, you have a pretty good understanding of where it trades. I would feel much more comfortable buying the risk of a single entity."
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