UPDATE 2-Italy has nothing to fear from ESM reform, PM Conte says

Italian Prime Minister Giuseppe Conte dismissed criticisms of planned reforms to the euro zone bailout fund on Wednesday, saying the proposals, which have been heavily attacked by right-wing opposition parties, posed no threat to Italy.

Critics of the planned changes to the European Stability Mechanism (ESM) say they would make it more likely that Italy will have to restructure its debt - the highest in the euro area as a proportion of national output after Greece. "Italy has nothing to fear... Its debt is fully sustainable, as the main international institutions, including the (EU) Commission, have said," Conte told parliament ahead of a European Council meeting this week to discuss the reform.

He spoke after the ruling parties agreed on a resolution instructing the government not to sign off on the ESM changes before seeking parliament's approval on the final deal it agrees with Italy's partners. The reform was due to be finalised by EU leaders this month, but they agreed to delay their approval to early next year because of Italy's internal political dispute.

At the end of heated debates, the coalition's resolution was approved in both houses of parliament, although four senators from the 5-Star Movement voted against their party, complaining that parliament had been sidelined during the ESM negotiations. It remains to be seen whether any of them intend to leave 5-Star altogether, which would deplete the government's already narrow Senate majority.

Conte said Rome would not agree to any restrictions on bank holdings of sovereign debt. During his speech to the Chamber of Deputies, he sharply rejected criticisms by the right-wing League and Brothers of Italy parties, saying they appeared aimed at undermining Italy's membership of the single currency.

"Some of the positions that have emerged during the public debate have unveiled the ill-concealed hope of bringing our country out of the euro zone or even from the European Union," Conte said. DEBT FEARS

The League and Brothers of Italy have attacked the planned reforms to the ESM, which they say will open the door for a forced restructuring of Italy's public debt that would hit Italian banks and savers who invest in government bonds. Salvini told the Senate that the League had no intention of taking Italy out of the euro and, to jeers from coalition ranks, read out a list of more than 30 university professors who signed a declaration against the reform.

Some members of the anti-establishment 5-Star Movement have made similar criticisms, adding to tensions with their partner in the ruling coalition, the centre-left Democratic Party (PD). Lawmakers from 5-Star and the PD appeared to have smoothed over their differences on Wednesday, however, agreeing to drop demands for a veto on measures that could make it easier to reach a debt restructuring accord.

In their parliamentary resolution, the ruling parties scrapped calls for a veto on so-called single limb collective action clauses (CACS), that limit the ability of individual investors to delay any restructuring agreement by holding out for better terms. Under the reform, restructuring would go ahead after a single, aggregate vote by bondholders regarding all affected bonds. The clauses currently in place require an aggregate vote as well as an individual bond-by-bond vote.

Raphael Raduzzi, a prominent 5-Star lawmaker, said this did not mean his party had accepted that single-limb CACs would remain. The ruling parties will revisit the question before the next meeting of euro zone finance ministers, he said, adding that the coalition's final stance on the ESM reform "remains to be decided".

Italy has asked to clarify that the new CACs clauses will not rule out the so-called sub-aggregation, allowing separate votes for different groups of bond issuances to protect small investors, a government official told Reuters. The coalition resolution also called on the government not to agree to any measure that would involve banks having to contribute more to the European Deposit Insurance scheme (EDIS) on the basis of how much sovereign debt they hold. (Additional reporting by Gavin Jones; Editing by Catherine Evans and Nick Macfie)

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