HONG KONG/NEW YORK - China is expected to steer clear of Europe's bailout fund and its investment vehicles as regulators and politicians scramble to pull together a plan aimed at expanding the debt clean-up.

Instead it will continue to focus on specific countries and on specific assets in Europe, attaching diplomatic strings wherever possible and heeding the call from within its borders to be careful of wading too deeply into the euro zone mess.

I think you can see China participating possibly country by country because it's easier for them get concessions on investments and imports and trades and other things at the sovereign level than from the EU, said Paul Sheehan, chief executive of Hong Kong-based hedge fund Thaddeus Capital.

Sheehan, a veteran of the region who specializes in analyzing banks, said the most likely scenario is a China-Italy, China-Belgium-style deal. Beijing will want to be able to buy European companies and assets on an expedited basis, with a guarantee that anti-China hurdles won't pop up should any deal be reached.

So one way you could see China possibly come in is buying out state-owned assets from places like Greece if they do a sort of SPV holding, Sheehan said.

China has already been an active investor in Europe, something politicians are keenly aware of as they try to come up with a plan to increase the firepower of the 440 billion euro ($611 billion) European Financial Stability Facility (EFSF) bailout fund, now deemed too small to keep the crisis from spiraling.

Ahead of Wednesday's European summit, they have launched a two-pronged plan to lure investors to the fund through a special purpose investment vehicle (SPIV) in combination with an insurance model for sovereign debt. Euro zone sources said on Tuesday leaders were likely to approve both options, or a combination of the two.

Investors globally are expected to be wary of the plan. Brazil has already said it will not buy European bonds as part of the rescue.

That has turned attention, once again, to China, with Klaus Regling, head of the European Financial Stability Facility, traveling to Beijing on Friday.

The cost of any support is not a major issue for Beijing. China's two main investment vehicles are China Investment Corp. (CIC), the nearly $300 billion sovereign wealth fund, and the State Administration of Foreign Exchange, or SAFE, the body that manages its $3.2 trillion in foreign exchange reserves.

They'd prefer to do something more diversified across the European countries rather than something like the EFSF. I don't think China wants to be standing out as owning 40 percent of Portugal's debt or anything like that, said James Ellman, portfolio manager at Seacliff Capital in San Francisco.

At the same time, Ellman said that a China move into the euro zone was a perfect marriage on paper. Europe is Beijing's biggest export market and Chinese leaders have a vested interest in avoiding a financial meltdown in the European Union that could trigger a world recession.

China, which has been courting more and more business in Europe over the last few years, wants to diversify its $3.2 trillion in foreign reserves away from U.S. Treasury bonds.

You need to marry up the Europeans' need for new debt offerings at lower rates with China having the euro/dollar firepower and having a need to keep the European economy going, Ellman said.

EU officials managing the debt crisis say privately that China is one of the few big foreign investors continuing to buy bonds of some euro zone countries in the secondary market, although its purchasing practices are shrouded in secrecy.

A senior EU official described as in the ballpark a report in the French newspaper La Tribune in January, based on a rare leak about Chinese currency holdings, suggesting that Beijing held just over seven percent of euro zone government bonds.

CHINA IS GOING TO BE RESTRAINED

China's overseas investments have been the subject of much scrutiny since Beijing began to move more aggressively in buying foreign assets roughly five years ago.

CIC's first two investments were in U.S. private equity firm Blackstone Group and U.S. investment bank Morgan Stanley, in 2007. Both holdings plunged in value when the financial crisis set in shortly afterwards, an event that caused Beijing a fair deal of embarrassment.

When Morgan Stanley's shares dropped below $10 and went into free fall in the days when the post-Lehman panic set in, it was Japan's Sumitomo-MUFG that rescued the bank -- not CIC.

CIC has since steered away from financial investments and more toward natural resources.

China already owns about $2 trillion in U.S. debt, independent economists estimate, a stake that came into focus this summer when U.S. markets dropped, politicians struggled with a plan to pay back its debt and S&P downgraded the country's credit rating.

The majority of concern about Europe's crisis is centered on its banks. Few analysts or China experts expect any of China's Big Four banks -- which are four of the ten largest banks in the world by market value -- to play a major role in the European debt crisis.

China is going to be restrained in terms of how much money it can put into this for domestic political reasons. They're not going to want to be seen as the savior of Europe, said Nicholas Consonery, Asia analyst at Eurasia Group.

We're talking about a country that has 400 million poor people. Politically, the notion that Beijing is bailing out European banks is not a very safe narrative for the government right now.

For some watching the European debt crisis play out, it is not a matter of if the Chinese will invest somehow, it is a matter of when.

I'd make the bet that a better bargain could be had in six months than right now with a distressed seller -- private sector or public -- in Athens. So, to Beijing, what's the hurry? said Donald Straszheim, head of China Research at ISI Group in Los Angeles.

For now, Straszheim believes China will sign a bland statement of encouragement for Greece and Europe, and will not put any money down -- especially given that its own financial system is beginning to wobble a bit under a debt load and other global market pressures.

If China does sign on, any agreement is expected to be precise in its scope, and with ample room for Beijing to have a say on the terms of the deal.

If I am advising China, I am going to say you definitely want preconditions in addition to making sure that the scheme works, said Sheehan, of Thaddeus Capital.

You want to make sure you are getting something out of it. As a Chinese leader, if I agree to assist in a bailout, I do not want to hear anything more about the RMB (yuan) and currency manipulation for the next five years, or maybe ever.

(Additional reporting by Nishant Kumar and Umesh Desai in Hong Kong, Paul Taylor in Brussels; Editing by Brian Rhoads and Nick Macfie)

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