Euro zone leaders struck a deal with private banks and insurers on Thursday for them to accept a 50 per cent loss on their Greek government bonds under a plan to lower Greece's debt burden and try to contain the two-year-old euro zone crisis.
The agreement was reached after more than eight hours of hard-nosed negotiations involving bankers, heads of state, central bankers and the International Monetary Fund. It aims to draw a line under spiraling debt problems that have threatened to unravel the European single currency project.
Under the deal, the private sector agreed to voluntarily accept a nominal 50 per cent cut in its bond investments to reduce Greece's debt burden by 100 billion euros, cutting its debts to 120 per cent of GDP by 2020, from 160 per cent now.
At the same time, the euro zone will offer "credit enhancements" or sweetners to the private sector totalling 30 billion euros. The aim is to complete negotiations on the package by the end of the year, so Greece has a full, second financial aid programme in place before 2012.
The value of that package, EU sources said, would be 130 billion euros -- up from 109 billion euros when a deal was last struck in July, an agreement that subsequently unravelled.
"The summit allowed us to adopt the components of a global response, of an ambitious response, of a credible response to the crisis that is sweeping across the euro zone," French President Nicolas Sarkozy told reporters afterwards.
As well as the deal on deeper private sector participation in Greece -- which emerged after Sarkozy and German Chancellor Angela Merkel engaged in the negotiations with bankers -- euro zone leaders also agreed to scale up the European Financial Stability Facility, their 440 billion euro ($600 billion) bailout fund set up last year.
The fund has already been used to provide help to Ireland, Portugal and Greece, leaving around 290 billion euros available. Around 250 billion of that will be leveraged 4-5 times, producing a headline figure of around 1.0 trillion euros, which will be deployed in a variety of ways.
Leaders hope that will be enough to stave off any worsening of the debt problems in Italy and Spain, the region's third and fourth largest economies respectively.
Riskier assets across the board rallied in Asia, with stocks outside Japan up nearly three per cent at 0600 GMT in response to the agreement. The euro hit a seven-week high.
Earlier, U.S. stocks rallied after news emerged of the intention to boost the power of the EFSF fund.
The EFSF will be leveraged in two ways, either by offering insurance, or first-loss guarantees, to purchasers of euro zone debt in the primary market, or via a special purpose investment vehicle that will be set up in the coming weeks and which is aimed at attracting investment from China and Brazil.
The methods could be combined, giving the EFSF greater flexibility, the euro zone leaders said.
"The leverage could be up to one trillion (euros) under certain assumptions about market conditions and investors' responsiveness in view of economic policies," said Herman Van Rompuy, the president of the European Council.
"There is nothing secret in all this, it is not easy to explain but we are going to more with our available money, it is not that spectacular. Banks have been doing this for centuries, it has been their core business, with certain limits."
PROOF OF THE PUDDING WITH MARKETS
Japan and Canada welcomed the euro zone agreement. China's official Xinhua news agency said the outcome was "positive but filled with difficulties".
As with the July 21 agreement, which quickly broke down when it became difficult to secure sufficient private sector involvement and market conditions rapidly worsened, the concern is that Thursday's deal will only work if the fine print can be promptly agreed with the private sector, represented by the Institute of International Finance.
Charles Dallara, the managing director of the IIF, said those he represented were committed to making the deal work.
"On behalf of the private investor community, the IIF agrees to work with Greece, euro area authorities and the IMF to develop a concrete voluntary agreement on the firm basis of a nominal discount of 50 per cent on notional Greek debt held by private investors with the support of a 30 billion euro official ... package," he said in a statement.
"The specific terms and conditions of the voluntary PSI (private sector involvement) will be agreed by all relevant parties in the coming period and implemented with immediacy and force. The structure of the new Greek claims will need to be based on terms and conditions that ensure (net present value)loss for investors fully consistent with a voluntary agreement."
Euro zone leaders will be hoping the agreement, which will also be accompanied by a recapitalisation of the European banking sector by around 106 billion euros, will finally draw a line under a crisis that has roiled financial markets and threatened to tear apart the euro single currency project.
"While the headlines look good, the devil is in the details," said Damien Boey, equity strategist at Credit Swisse in Sydney.
"It's great news that they've managed to increase the bail-out fund to 1 trillion euros plus agree on some sort of haircut arrangement for the private investors in Greek debt.
"The problem is, we don't actually know how they are planning to increase the bail-out fund size from 440 billion euros to a trillion. On top of that, there are some questions as to whether one trillion euros in itself is enough."
Jose Manuel Barroso, the president of the European Commission, said the final details on the Greek package, which follows a programme of 110 billion euros of loans granted to the country last year, would only be worked out by year-end.
And EU finance ministers are not expected to agree on the nitty-gritty elements of how the scaled up EFSF will work until some time in November, with the exact date not fixed.
As part of efforts to attract investors into the special purpose vehicle attached to the EFSF, Sarkozy said he would talk to Chinese President Hu Jintao in the coming days. Beijing has so far been a big buyer of bonds issued by the EFSF, which is triple-A rated by credit agencies.
As well as the three-way package to strengthen their crisis fighting powers and try to resolve the situation in Greece, euro zone leaders called on Italy to take more rapid action on pension reforms and other structural measures to try to avoid the economy heading the same way as Greece.
Prime Minister Silvio Berlusconi has promised to raise the retirement age to 67 by 2026, and pursue other adjustments to the country's economic model, steps the EU praised but said would only be positive if they were implemented.
"The key is implementation. This is the key. It is not enough to make commitments, it is necessary now to check if they are really implementing," said Barroso.