European Union leaders will agree next week to insert two sentences into the EU treaty to pave the way for the creation of the European Stability Mechanism from 2013, draft conclusions of the summit showed.

The ESM is to open the way for private sector investors to take a loss in case of a sovereign debt restructuring, which will put market pressure on governments to conduct sound fiscal policies and prevent another sovereign debt crisis.

The ESM would also provide financial support to euro zone countries which suffer liquidity, but not solvency problems, through a fund that is likely to be bigger than the current 750 billion euros bailout fund the euro zone has at its disposal.

But to create the ESM, Germany and France insisted that the EU's highest law, the EU treaty, has to be amended so that its operations are not deemed unconstitutional by German courts.

The conclusions, obtained by Reuters, said leaders of the 27-nation bloc would agree to amend the treaty by adding the following sentences to the existing article 136:

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.

The ESM will be based on the agreement reached by euro zone finance ministers on November 28. For a full text of the agreement see: http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/118050.pdf

MEMBERS' POWERS

The leaders' conclusions, which are always prepared in advance of a summit and almost never changed, said the amendment did not increase the powers conferred on the European Union by member states.

This means that the change would not have to be subject to a referendum in Ireland and also satisfies Britain which insisted the change should not entail any transfer of power to Brussels.

The leaders, who meet Thursday and Friday in Brussels, will also agree that the ESM would replace the European Financial Stability Facility and the European Financial Stability Mechanism, which will be operational until June 2013.

The leaders would like consultations with the European Parliament, the European Commission and the European Central Bank on the change to the treaty to end in March 2011 and for approvals in individual countries to finish by end 2012, so that the new law would be in place from the start of 2013.

Euro zone finance ministers are also to finish work on setting up the ESM through an intergovernmental arrangement by March 2011.

The mechanism will be activated by mutual agreement of the euro area Member States in case of risk to the stability of the euro area as a whole, the draft leaders' conclusions said.

The EU summit will also decide that while the mechanism will be for euro zone members, other EU countries can be involved in the work setting it up if they want to and can take part in ESM operations on an ad hoc basis.

This is similar to the case of Ireland, where the euro zone countries, acting through the EFSF, lent to Dublin, but Britain, Sweden and Denmark, all non-euro zone members of the EU, also provided bilateral loans.

(Reporting by Jan Strupczewski)

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