By Chris Vellacott and Martin de Sa'Pinto
LONDON (Reuters) - A demand that Cyprus seize money from depositors to help rescue the island's banks is a wake-up call for those who believed the euro zone crisis was solved, institutional investors and hedge funds said.
One of the world's biggest money managers, PIMCO, has already reduced its euro currency allocations in response to the planned levy unveiled at the weekend, a senior executive told Reuters on Tuesday.
Saumil Parikh, managing director and member of PIMCO's investment committee, said the proposed terms for the banking bailout "suggest a more bumpy road for Europe."
"We've reduced our allocations to European currency (in the last 24 hours) because it makes sense to think about this as not only a policy mistake but also a recognition that the euro is far from being a perfect reserve currency," Parikh said in an interview in London.
Bail-outs in Greece, Ireland, Spain and Portugal since the financial crisis have not imposed losses on small depositors.
The chairman of euro zone finance ministers said on Tuesday there would be no need for levies on assets elsewhere in the single currency bloc and Deutsche Bank's chief executive said the Cyprus move was unlikely to be a model for other EU states.
For many analysts, however, it sets a worrying precedent that shows the continued risk of a renewed crisis of confidence that could prompt savers in peripheral euro zone states to withdraw deposits.
Several money managers contacted by Reuters after Cyprus announced the tax on bank accounts under the 10 billion euro (8.6 billion pounds) bailout by the European Union said it had exposed over-optimism for a return to stability in the euro zone.
Parikh said he had not made major changes to overall allocations since the planned levy was announced, but said imposing a levy on depositors would represent "a significant departure" in euro zone policy from other reserve currencies.
"The entire capital system is based on the trust and the belief that once you put money in a bank as a deposit, it's risk free. So that has significant implications for foreigners investing in Europe," he said.
"Investors need to change or adjust their view for what they think is a normal risk premium for European assets, as opposed to U.S. assets, Japanese assets or UK assets," he added.
The development has increased the appeal to investors of "the very few clean triple A countries" as safe havens, namely Australia, Canada, Switzerland and Singapore, he said.
Pacific Investment Management Co, or PIMCO, is a unit of European financial services company Allianz SE and had $2 trillion in assets as of the end of last year, according to the firm's website.
CYPRUS A TEST FOR POLICYMAKERS?
Financial markets suffered bouts of turmoil throughout 2012 over worries about the systemic risks to the banking system emanating from a sovereign debt crisis in Europe's peripheral countries.
After ECB President Mario Draghi pledged to do "whatever it takes" to save the euro, markets calmed and some stock markets climbed to multi-year highs.
"Draghi said he would do whatever it takes. I think we're getting a lot closer to finding out what "whatever" means," said Chris Cruden, CEO of Swiss-based hedge fund Insch Capital.
"Perhaps the EU leaders decided Cyprus was so small it was the best place to use as a test case, rather than say Spain or Italy."
Like inconclusive elections in Italy last month, which sent markets reeling on fears political stalemate would prevent resolution of its financial crisis, Cyprus has reminded the world all is not yet well in Europe, the investors warned.
The Cyprus bailout terms show "that the pricing of risk in markets had become complacent," said Mark Parry, senior investment manager at Aberdeen Asset Management.
Peter Doherty, partner at London-based bond fund manager Tideway Investment Partners, pointed to an erosion of rights for holders of bank risk and warned that "risk premia for investing in euro zone banks will have to increase".
Lee Robinson, founder of hedge fund firm Altana Wealth, said in emailed comments that it was worrying that the senior members of the euro zone and IMF seemed to have ignored the "huge risks" of destroying euro zone guarantees.
"All the good work over the last six months to stabilise the fund flows from the (European) periphery has just been nuked," he said.
"The cost to Europe of wider banking spreads leading to less money for sovereigns and hence wider spreads for governments will cost Europe multiples of the money saved in Cyprus."
Norman Villamin, Chief Investment Officer for Europe at Coutts, the private banking arm of Royal Bank of Scotland also warned the move will undo progress in rebuilding investor confidence in other peripheral countries.
"People became much more comfortable with the peripheral banking system. Deposit flow started to come back in to Spain and Italy," he said. But "the crisis has not been resolved. A lot of issues remain."
(Additional reporting by Laurence Fletcher; Editing by Tom Pfeiffer)