BRUSSELS (MNI) – An outline for a permanent crisis mechanism to
“safeguard” the stability of the Eurozone, a potential capital hike for
the European Central Bank, and fiscal surveillance are the chief topics
for European Union leaders at their summit on Thursday and Friday in
Brussels.

At their two-day gathering, EU leaders will hammer out an outline
for a permanent crisis mechanism and are likely to agree to a change in
the EU treaty to accommodate it. They are expected to grant the EU
finance ministers a mandate to “finalise” the mechanism at their March
meeting.

Leaders will also discuss the economic and financial situation in
Europe over dinner on Thursday evening when it is likely, according to
diplomatic sources, that European Central Bank governor Jean-Claude
Trichet will again raise the issue of a capital increase to bolster the
bank’s reserves.

According to press reports, the ECB has already decided to double
its capital from E5.8 billion to around E11.6 billion. The extra
capital, assuming approval by EU leaders — which is likely — would be
provided by the national central banks of the Eurozone in proportion to
the financial weight in the ECB of each member country.

The capital increase decision shows the ECB is nervous, or at least
being very cautious, with regard to its ongoing purchases of peripheral
EMU government debt to shore up confidence in Eurozone bond markets. As
of last week, the ECB had accumulated E72 billion worth of such bonds.
The risk of eventual losses on those bonds and the need to gird the bank
financially at a time of great market stress helps explain the hike in
capital.

The ECB is also quite exposed to foreign exchange markets, which
have also been volatile of late. But the volatility is particularly
pronounced in the sovereign EMU bond markets.

On Tuesday, Standard & Poor’s revised its outlook on the Kingdom of
Belgium to negative from stable, saying, “we anticipate that prolonged
political uncertainty could hurt Belgium’s credit standing.”

Meanwhile, Moody’s put Spanish government bonds on review for a
possible downgrade, citing concerns about the country’s high refinancing
needs, a potential increase in the public debt ratio and its ability to
achieve sustainable and structural improvement in government finances.

TREATY CHANGE

Draft conclusions for the summit, read out to Market News
International by a well-placed source, reiterate the agreement made at
the November council of finance ministers for a mechanism to replace the
existing, temporary European Financial Stability Facility.

Leaders are set to back this agreement, granting finance ministers
a mandate to deliver on the details and “finalise” the mechanism at
their March 2011 meeting. This will include a timetable for the
ratification of the treaty change.

As currently conceived, the permanent mechanism, referred to as the
European Stability Mechanism, would provide a specific procedure by
which private creditors might ultimately be called on to share the
financial burden of future bailouts – but not until after 2013.

To create the mechanism, leaders must agree to a change in the
Treaty of the European Union, as outlined in an annex to the draft
conclusions. They will add the following text to Article 136 of the
Treaty:

“The member states whose currency is the euro may establish a
stability mechanism to safeguard the stability of the euro area as a
whole. The granting of financial assistance under the mechanism will be
made subject to strict conditionality.”

Member states outside of the Eurozone may, according to paragraph
four of the draft conclusions, “participate in the mechanism on an ad
hoc basis.”

FISCAL SURVEILLANCE

In the draft conclusions, a paragraph is devoted to economic
governance and calls for an “acceleration” of the Council and European
Commission’s progress on legislative proposals in this area with a view
to reaching an agreement by June 2011.

Following Tuesday’s General Affairs Council, one diplomatic source
said this paragraph was likely to be reworded in the light of Poland’s
request that its systemic pension reforms be taken into account when
determining whether it has breached the terms of the EU’s Stability and
Growth Pact.

European Council president Herman Van Rompuy has announced that the
summit agenda will be limited to the permanent crisis mechanism, a
stock-taking of progress in EU legislative proposals on fiscal
surveillance, and external relations.

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