Exclusive: European rescue fund struggling with low returns

[May 29, 2015]  By Matthias Sobolewski

BERLIN (Reuters) - Europe's rescue fund is seeking to revise its investment guidelines to allow it to buy lower-rated debt as it grapples with record low interest rates, according to documents from the so-called ESM and German finance ministry seen by Reuters.

At the end of March, more than half of the ESM's paid-in capital of 80 billion euros ($87.6 billion) was invested in assets with negative yields, the document from the European Stability Mechanism (ESM) showed.

To avoid incurring losses, the ESM wants to change its investment guidelines so that it can invest in riskier assets that generate higher returns. The ESM was set up in 2012 to provide financial aid to euro zone member states in difficulty. It is backed by capital from euro area countries.

The German finance ministry has written to the parliamentary budgetary committee asking them to approve the changes, according to a ministry document seen by Reuters. Changes to ESM guidelines require parliamentary approval in some euro zone countries.
 

In the letter, Deputy Finance Minister Steffen Kampeter says the revisions are necessary due to the very low interest rate environment. "This could lead to losses on the paid-in capital," Kampeter says.

The European Central Bank's bond-buying program has pushed down the yields on government bonds with top-rated paper earning ultra-low or even negative returns.

The ESM estimates that negative yields would knock roughly 31 million euros off its total gains this year, and wipe out a further 24 million euros in gains should it hold these securities to maturity.

It has already implemented measures to reduce its exposure to negative yields, including investing in non-euro instruments. Despite these steps, about a third of the assets will remain invested at negative interest rates.

As a result the ESM board of directors agreed on May 20 to loosen the investment policy guidelines, to include a greater share of bonds from non-euro countries. It will also lower the minimum rating to A from AA.

The ESM does not expect the proposed changes to have a significant impact on the credit quality of its portfolio.

(Writing by Caroline Copley; Editing by Noah Barkin)

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