* Guarantee of between 20 and 30 pct seen most likelyBy Luke BakerBRUSSELS, Oct 18 (Reuters) - Euro zone leaders are likely to agree to leverage their bailout fund at a summit on Sunday by allowing it to guarantee a portion of newly issued euro zone debt, euro zone officials and the expert who first developed the plan said on Tuesday.Under the scheme, the European Financial Stability Facility (EFSF) would promise investors who buy Spanish, Italian or other higher-risk euro zone debt at auction that it would cover a portion of any losses they made if the country were to default.”This idea is the main contender,” one euro zone official said, but added there were other projects under consideration for how best to increase the EFSF’s firepower, with markets unconvinced it is big enough to handle the widening crisis.By guaranteeing the first 20-30 percent of any losses, for example, the EFSF could stretch three to five times further.With about 300 billion euros of its 440 billion-euro capacity still deployable, the fund could be expanded to more than 1 trillion euros, enough to support the refinancing needs of Spain and Italy for at least the next year or longer.However, rather than leaders fixing the degree of leverage as many in financial markets expect, the EFSF is more likely to be given flexibility to decide how much it is leveraged on a case-by-case basis — depending on which country’s debt is being guaranteed and the prevailing market conditions.”It is at the point of the transaction that the EFSF would provide the figure,” said Sony Kapoor, the managing director of Re-Define, an economic think-tank which first set out the idea to use the EFSF and its permanent successor, the European Stabilization Mechanism, as bond insurers.If the fund is used to provide partial rather than full insurance, a ‘guarantee against first losses’ would be the most credible method, Re-Define has argued.”The EFSF needs to retain the flexibility to decide how much they will guarantee of any particular debt issue. The number would depend on the issuing country, the duration of the bond and the timing of the issue,” Kapoor told Reuters.For example, if Italy were scheduled to issue 5 billion euros of bonds in mid-November, the EFSF would discuss with institutional buyers in the days ahead what proportion of the issuance it would guarantee. If Spain were issuing 5 billion euros the same week, the guarantee might be larger or smaller.RESTORING CONFIDENCE?The idea is for the operation to boost market confidence in the paper of euro zone sovereigns, turning sentiment back in its favour after nearly two years of adverse conditions.”You get leverage if investors are reassured and trust the scheme. If, for whatever reason, investors are not convinced, you get nothing,” a second euro zone official said.When it first presented its proposal several months ago, Re-Define suggested a possible guarantee on the first 20 percent of losses — giving rise to talk of the EFSF being leveraged five times. But market conditions have deteriorated since then.A third euro zone official confirmed the amount of guarantees under discussion was between 20 and 30 percent.Kapoor said a balance needed to be retained in making the EFSF more credible in terms of size, which calls for higher leverage and lower borrowing costs, without threatening France’s triple-A credit rating, which calls for lower leverage.”A leverage of around three times may provide a suitable compromise to try to square this circle,” he said.”There will be specific mechanisms and we might get a range of numbers, but it would be premature and irresponsible for the EFSF to bind itself to a specific number, because it needs to retain flexibility to react to changing circumstances.”Negotiations among member states and with institutional investors on the plan continued on Tuesday, leaving details open to change before leaders gather for what is expected to be a make-or-break summit on Sunday afternoon.Kapoor said that even if euro zone leaders did decide on Sunday to scale up the EFSF using a first-losses guarantee, it might not be enough to get on top of the two-year crisis.”It’s coming a bit too late. It would have worked before Italy and Spain got sucked in, but now that the crisis has turned systemic, the EFSF can only do so much,” he said.”The correct way to think about this mechanism is not as a mono-line insurer but as a political signalling device. EU leaders don’t tire of saying that Spain and Italy are solvent, but they said the same for Greece, which is not.”“EFSF guarantees for Italy and Spain would signal that all 17 euro area states are ready to put money where their mouth is, and that can help restore confidence by demonstrating that they feel comfortable putting themselves in harm’s way between bondholders and any possible losses.”At the same time, the ECB needs to make an implicit or explicit commitment to go on buying Spanish and Italian debt in the secondary market to keep their funding costs from soaring.