Europe's future financial firewall

(BRUSSELS) - The European Stability Mechanism (ESM), due for adoption at Monday's EU summit, will be the bloc's permanent rescue fund from July.

A financial firewall against any repeat of the sovereign debt crisis, there are still issues that need to be resolved, including its ultimate size.

-- Its mission

The ESM will eventually replace the temporary European Financial Stability Facility (EFSF), which was used to bail out Ireland and Portugal. The idea is basically the same -- using a mix of stakeholder governments' capital and guarantees, the funds borrow on the money markets and then lend the proceeds to stressed eurozone governments at much lower interest rates than such nations would get with private investors.

The ESM is a more sophisticated version. Unlike the EFSF, it will be allowed to buy sovereign bonds in secondary markets as well as finance aid programmes for countries before they run into serious problems.

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

-- Lending capacity

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

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

-- Calendar

The ESM is to come into force in July this year, 12 months earlier than first planned. As the funds in the EFSF are not yet exhausted, with perhaps 250 billion euros untapped, the International Monetary Fund, the United States and other powerful G20 members including non-euro member Britain appear united in suggesting the remaining funds at 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 and so they are prepared to go further this time.

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 in check by any one stakeholder, the ESM gets to work if shareholders representing 85 percent of its capital give their approval. Model eurozone economy Finland has secured an effective opt-out, with a deal to offset risks and returns if it is out-voted.