Efforts to amplify the power of the euro zone's rescue fund and convince markets the bloc can handle its debt crisis risk being undermined by delays, surging bond yields and limited investor interest, potentially ruining the plan altogether.
A leveraged EFSF bailout fund of 1 trillion euros (855.45 billion pounds), agreed at an emergency summit last month, was supposed to be the euro zone's biggest weapon yet to protect indebted Italy and Spain from market attacks.
But in another case of deja vu in the bloc's two-year crisis, the latest deal to save the euro zone has been overtaken by events. Italian and Spanish bond yields are already nearing levels seen as not sustainable and longer-term investors are trying to cut their exposure to euro area bonds.
That makes plans to offer bond insurance more costly, and harder to entice private money into the European Financial Stability Facility (EFSF). The fund has already signalled it may not reach the targeted 1 trillion euro level.
Euro zone leaders agree the fund, first set up in 2010, should be leveraged to raise its firepower. Plans centre on two options after a scheme to turn it into a bank so it could draw upon European Central Bank financing was rejected by Germany and others:
-- Using the fund to guarantee a percentage of the value of bonds issued by a euro zone sovereign, partially protecting investors in the event of a sovereign default.
-- And/or using EFSF money to set up Co-Investment Funds (CIFs) that would also attract outside public and private funding to invest in euro zone bonds.
The most pressing obstacle is the lack of detail on how the leveraging would work, partly because of its complexity.
Interest in the co-investment idea of the EFSF is limited, because investors want to know the detail before committing, said one euro zone official.
The EFSF's head Klaus Regling said last week it would have its plan in place by December, and euro zone officials meeting in Brussels on Thursday are expected to push for that.
Another euro zone official was cautious. We are still in the design phase, the official said.
Regling said confusion about the EFSF's plans to leverage its remaining 250 billion euros ($340 billion) -- after deducting its existing or planned emergency funding programmes -- complicated the fund's bond sale on November 7. Yields in that sale were the highest of the EFSF's four bond issues so far.
There is more and more of a sense that this is not going to work, said Juergen Michels, an economist at Citigroup. This probably won't lead to market panic, but the market is increasingly unwilling to play along while the euro zone comes up with one short-sighted solution after another.
BACK AT THE ECB'S DOOR
Euro zone leaders have signalled their aim is to attract sovereign wealth funds, portfolio managers and institutional investors to invest in the special purpose investment vehicles to buy the distressed debt of euro zone governments.
Regling travelled to China last month to court Asian investors and French President Nicolas Sarkozy said Beijing had a major role to play. But like many, China's Vice Finance Minister Zhu Guangyao said in late October that Beijing was awaiting details before deciding anything.
Under the plan, the EFSF's co-investment funds would buy sovereign bonds in the primary or secondary markets, holding them to maturity, but could sell them earlier if their prices stabilised.
The EFSF hopes its offer of absorbing the first losses of the CIF venture could be a winning card. Regling said in China the EFSF could take the first 20 percent of losses.
But investor concern that a euro breakup would trigger chaos similar to, or worse, than the collapse of U.S. investment bank Lehman Brothers in 2008, prompted the EFSF last week to warn it may need to offer a higher degree of cover to lure buyers.
That would reduce the potential for leverage and the fund might only reach up to 750 billion euros, an EFSF source said. Compare that to Italy's 1.8 trillion euros or more of debt and the potential lack of ammunition is clear.
Even as scepticism grows about the EFSF plan, euro zone officials say no alternatives are being considered and that it is too early to declare failure.
The demand (for participation in a CIF) has not been tested yet. The discussions (now) are on design, not on participation, a third official said.
The perceived flaws in EFSF leveraging and the difficulty of rushing the plan through quickly puts the ECB firmly back in focus, economists and policymakers say. French calls to make the EFSF a bank, with ECB funding, could be reconsidered.
Although intensely resisted in Germany, the Frankfurt-based ECB is the only euro zone institution with the funds to buy Italian, Spanish and potentially French bonds in sufficient size to give markets pause for thought.
I don't think we should assume that option of the EFSF as a bank is ruled out, said Alastair Newton, an analyst at Nomura.
Back in September, both German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble said there was no question of leveraging the EFSF. Yet a month later, Europe's leaders approved the leveraging, he said.
(Writing by Robin Emmott, editing by Mike Peacock)