ESM, Europe's future financial firewall now

(BRUSSELS) - The European Stability Mechanism (ESM), due for adoption at Monday's EU summit, is to be the bloc's permanent safety net as of July -- its financial "firewall."

A key barrier in the European Union's defences against any repeat of the sovereign debt crisis, there are still issues that need to be resolved -- not least how big it needs to be.

- Its mission

The ESM will eventually take over from the prototype European Financial Stability Facility (EFSF), the vehicle for eurozone funding of bailouts for Ireland and Portugal. The idea is basically the same: using a mix of stakeholder governments' capital and guarantees, these funds borrow on money markets then lend to stressed eurozone governments. They do this at a profit, but not one considered prohibitive for under-pressure administrations. By undercutting, they theoretically moderate commercial lending rates.

The ESM is a more sophisticated version. Unlike the EFSF, over and above buying sovereign bonds in sell-on markets, it will be used to finance aid programmes for countries before they enter dire straits -- the idea being that earlier intervention to normalise a state's risk premium costs less.

However, only governments that have ratified a parallel treaty obliging broadly balanced budgets will have access to ESM finance. They must enshrine legally-binding "golden rules" restricting their capacity to run up deficit and debt.

- Lending capacity

The ESM's effective lending capacity was agreed at inception as 500 billion euros. Unlike the 440-billion EFSF which lost its Triple-A credit rating with Standard & Poor's this month, there will be 80 billion euros of paid-in capital in the ESM, as well as the guarantees put up by governments.

This cash bedrock is to be paid, pro rata depending on states' sizes, in five instalments over four years. This timetable may be accelerated, its biggest contributor Germany indicating a willingness to move faster.

- Calendar

The ESM is to enter service in July this year, 12 months earlier than first planned. As the funds in the EFSF are not yet exhausted, with perhaps 250 billion untapped, the IMF, the United States and other powerful G20 members including non-euro Britain appear united in suggesting the overhang from the EFSF should be added to the ESM. With this greater firepower, non-European partners suggest they will increase their IMF funding. No-one wants to see a big economy like Italy or Spain hit profound problems.

This question will not be dealt with until the next EU summit on March 1-2, after G20 finance talks.

- Decisions on use

Unlike the EFSF, which could be held hostage by any one stakeholder, the ESM gets to work on the say-so of 85 percent of its capital shareholders. Model eurozone economy Finland has secured an effective opt-out, with a deal to offset risks and returns where it is out-voted.