May 25, 2018
The European Commission’s proposal for “sovereign-bond-backed-securities” (SBBS) appears to address an unfolding Italian crisis.
A bond called security
The European Commission envisions SBBS as “securities” to be issued against a pool of sovereign eurozone bonds – of higher and lower risk – depending on the investors’ appetite.
SBBS are not “Eurobonds.” Instead, they are branded as “securities” that reduce risk rather than redistribute it.
In a statement to the Financial Times last week, the outgoing Vice President of the European Central Bank Vítor Constâncio said that the “success of the synthetic European bonds would have significant benefits for financial integration and for the banking and capital markets union.”
However, Fitch Ratings clarified that this is not necessarily a “win-win” scenario, because SBBS could “supplant Bunds as the euro zone’s benchmark asset {and} adversely affect demand for sovereign bonds of the euro-zone periphery.”
Supporters of the European Commissions’ SBBS proposal argue that it would provide eurozone members with access to a pooled sovereign debt market, while banks would also be able to hedge their risks.
The Commission hopes that the plan will reduce the cost of sovereign borrowing and create a more level playing field for national lenders, decoupling bank risk and country risk. In a crisis, Banks would no longer go down with their country.
Critics see this as a form of risk-mutualisation and the proposal is opposed by Germany, but also by the Netherlands, Austria, and Finland, according to the Financial Times. The fear is that this will be in effect if not in principle a Eurobond.
According to Bloomberg, public-debt managers oppose the idea because they are certain that the market would not be big enough to support both pooled government-bond “securities” and every EU country’s sovereign debt.
A timely proposal amidst an Italian crisis
If SBBS was called “a Eurobond,” this would be a timely even if contested proposal.
As the European Commission unveiled its plan on Thursday, the spread between Italy’s 10-year BTP bond and the German Bund rose to 195 points and the yield closed at 2,38%. Spanish and Portuguese bonds were also affected.
But, SBBS could ease some of the imminent threats, given that Italian banks are already loaded with the second biggest load of non-performing loans after Greece.
Setting the scene for another North-South standoff
Last week, markets were spooked by the leak of a draft government programme talked not only of a determination to challenge the fiscal compact, but also to leave the eurozone. While the threat of Italexit has since been formally withdrawn, Matteo Salvini warned that Italy will not abide by EU prescriptions.
Italy does not yet have a position on SBBS. But, Germany does.
Prior to a Eurogroup meeting on Thursday, the German Finance Minister Olaf Scholz argued that the difference between bond yields is not big enough for the product to make commercial sense. Subsequently, the plan is “not convincing” {as a security} Scholz argued. Naturally, Germany would never subscribe to the idea of sovereign debt mutualization.
The economically triumphant Ireland is neutral on the matter. Speaking in Berlin on Wednesday, Irish central bank Governor Philip Lane said the instrument could ultimately be tested by the market “… and see if the market wants it or not.” Mr Lane seems to be suggesting that it is for the consumer to choose whether to go for a triple AAA bond with a lower yield or a hedged “security.”
While the proposal does not seem ready to pass the test of objecting member states, the issue helps to delineate an emerging battleground. The spirit of the Commissions’ proposal is in the spirit of reforms proposed by President Macron, for a leap forward. The opportunity cost of rejecting this proposal is to see the eurozone fragmented among creditor and deficit, north and south, core and periphery. With the crisis of the third biggest economy in the Eurozone looming, this could be an existential question.
This Article was originally published by New Europe: May 25, 2018, https://www.neweurope.eu/article/commission-proposes-euro-securities-critics-dismiss-eurobonds/
