Financial representatives poured cold water on Thursday (24 May) on the European Commission’s proposal to create sovereign bond-backed securities (SBBS), insisting that not all the elements exist yet for a successful market for the product.
The Commission today unveiled the SBBS proposal aimed at reducing the “doom loop” between banks and sovereign debt that could destabilise financial markets in times of crisis.
Commission Vice-President for the Euro and Financial Services Valdis Dombrovskis defended the proposal as a “risk reduction tool” that could help investors diversify their portfolios.
But the Association for Financial Markets in Europe (AFME), which groups 170 institutions in the European wholesale banking sector, said that “a number of essential criteria to successfully develop a market for SBBS have not yet been met”, according to its director of fixed income, Victoria Webster.
She recommended the Council and MEPs involve financial players, including debt portfolio managers and investors, before deciding whether to move ahead with the proposal.
Her comments echoed concerns raised by diplomats and financial players who were sceptical about the practical implementation of the Commission’s financial engineering alternative to the joint debt issuance (Eurobonds), a taboo in member states including Germany.
Financial players can already pool sovereign debt and issue securities.
But in order to attract investors, the Commission proposed granting zero-risk weight to the new products. As a result, the beneficial capital requirements attached to sovereign debt would also extend to these products.
But AFME questioned demand for the new asset as it disregarded this regulatory tweak. Webster said that markets’ SBBS could shift risk more easily than under the Commission’s SBBS proposal, where investors would hold tranches made of a fixed blend of national bonds.
The association also questioned the design of the tranches, as the high risk of contagion between European economies in turbulent times would further decrease the appetite for blended national debt.
The Commission unveiled its proposal as the instability emerging from Italy started to spread to the risk premium demanded also to Spanish and Portuguese bonds.
Criticism of the Commission proposal had also come from the group of countries led by Germany opposing any mutualisation of risks among the member states.
Dombrovskis stressed that his proposal “does not imply any mutualisation of risks or losses”.
He also disagreed that the SBBS would alter existing national markets, for example, by making it more costly for member states to issue their debt given the competition of the new product.
Dombrovskis referred to the conclusions of the European Systemic Risk Board’s report on SBBS, which was the basis for the Commission proposal.
The ESRB said that the SBBS “should not unduly impede the functioning of national sovereign bond markets”.
In order to ensure that, the board said that a competent authority could, if needed, impose limits on the SBBS market size, which could amount to €1.5 trillion or more, depending on the observed impact on sovereign bond markets.