Sovereign bond-backed securities (SBBS) can contribute to a greater diversification of and a risk reduction for sovereign bond portfolios held by banks and other financial operators. This could have a positive impact on the stability and resilience of the financial system and improve financial market integration.
In a recently adopted opinion, the European Economic and Social Committee (EESC) therefore backs the European Commission's legislative proposal constituting an enabling framework that allows the new financial instrument to be developed by the market, by creating a level playing field for SBBS. While voicing support for the introduction and testing of SBBS in the markets, the EESC urges the Commission to address a number of open questions in the proposal.
"The only way to see whether banks and investors are really interested in SBBS is to test the new instrument in the market", said EESC rapporteur Daniel Mareels. "We believe that the concept of SBBS is an attractive one. SBBS could help to further weaken the close link between banks and their home countries", he added. While acknowledging previous efforts that have been made to weaken this link, the EESC points out that it has been calling for further action on this since the last financial crisis.
The proposal also takes account of the context of the simultaneously declining supply of and increasing demand for sovereign bonds, and fits into the broader context of completing the Banking Union and building a Capital Markets Union. The building of both unions has been strongly supported and advocated by the Committee.
Nevertheless, the EESC stresses the importance of ensuring the clarity, efficacy and effectiveness of the proposed framework and while it agrees with many aspects, like the idea that special purpose entities – private businesses – will issue SBBS, other aspects need to be strengthened. In this regard, the rapporteur points out: "If private entities will be allowed to self-certify the composition of the underlying portfolios of SBBS, monitoring by the European Securities and Markets Authority should be tighter and start earlier."
The EESC opinion on EU SBBS also points to the fact that the Commission's proposals raise a number of unanswered questions about the new financial instrument, which could undermine its potential success and should thus be addressed. These include:
- Will SBBS work effectively under all circumstances, including in times of crisis in one or more Member States?
- What are the consequences of dividing issues into junior tranches, entailing greater risk, and senior tranches, entailing less risk?
- Is there enough demand for junior tranches to place senior tranches on the market?
- Will the creation of an additional market for SBBS lead to fragmentation?
The proposed framework should be further developed in close dialogue with all stakeholders, given that they have been rather sceptical towards the concept of SBBS in previous consultations and that putting the instrument into effect will depend on their support.
Finally, further reflection on whether SBBS should be offered to private savers and consumers is necessary. Given the complexity of SBBS and the fact that only senior tranches present limited risks and are comparable with direct ownership of sovereign bonds by savers and consumers, the EESC would be inclined to recommend purchase to them only for senior tranches.
Sovereign bond-backed securities (SBBS) are securities backed by a diversified portfolio of euro area central government bonds. They have been proposed as a solution to reduce the exposure of banks and other financial institutes to the public debt of their home countries, which, as the euro area debt crisis demonstrated, is advisable.
A comprehensive report published by the European Systemic Risk Board (ESRB) in January 2018, showed that the current regulatory framework effectively impedes the development of a market for SBBS. In order to address this, the Commission presented a legislative proposal on SBBS in May 2018, aiming to level the playing field by removing unjustified regulatory impediments and granting SBBS the same regulatory treatment as national euro-area sovereign bonds. This should pave the way to the market-led development of SBBS, boosting the flow of euro-denominated low-risk liquid assets in the system.