On Thursday 24 May, the European Commission unveiled a proposal aiming to support the emergence of a market for sovereign bond-backed securities (SBBS) issued by Eurozone countries (see EUROPE 12022).
This proposal aims to reduce financial risks in the banking system by supporting the diversification of investments in sovereign debt instruments, explained the Commissioner for Financial Services, Valdis Dombrovskis. He stressed the following clarifications: the proposal will not entail any pooling of the risks between Eurozone countries, which will remain in charge of issuing public debt securities onto the market.
SBBS, which are issued by private banks, consist of a diversified basket of Eurozone sovereign bonds, divided up on the basis of their economic weight (ECB distribution key). When purchasing these securities, investors may opt for higher-risk ('junior tranches') or lower-risk ('senior tranches') securities, depending on their appetite for risk.
Backing these securities only with Eurozone sovereign bonds will help to avoid exchange rate risks, a European official explained. It also makes it possible to consider that SBBS securities are not risky, in the same way as direct exposure to sovereign securities does not oblige banks to hold equity to cover any losses.
Investing in these new instruments would help investors (investment funds, insurance companies, banks) to diversify their sovereign portfolios, the Commission hopes. It would also help to weaken the link between banks and their country of origin.
According to the same European official, the market would be motivated to acquire these securities, whereas it currently prefers to invest directly in the member states' debt. “Sometimes, you have to suck it and see”, he said, referring to the success of the UCITS investment funds, which are harmonised at European level.
The proposal on the table, which was announced in the package of proposals aiming to deepen Economic and Monetary Union presented by the Commission in December 2017 (see EUROPE 11920), takes inspiration from the specific work of the European Systemic Risk Board, which was presented in January (see EUROPE 11950).
The chair of the committee on economic and monetary affairs of the European Parliament, Roberto Galtieri, certainly considers that SBBS could be an additional tool to help banks diversify their holdings. “Due to the lack of any mutualisation, the role of this tool is necessarily going to be limited but it is a market test that is worth doing while avoiding any change in the regulatory treatment of sovereign exposures”, he added. (Original version in French by Mathieu Bion with Marion Fontana)