ESRB Task Force Plan for Euro Safe Assets Is Said to Be Ready

(Bloomberg) -- A proposal for a new class of safe financial assets intended to strengthen the euro area will be published imminently after almost a year of delay, according to officials familiar with the matter.

The report, by an independent taskforce under Irish central bank governor Philip Lane, will offer a plan for bundling government debt from the bloc’s 19 nations into a security that could withstand default by one or more countries without sparking contagion. 

The European Safe Bond initiative was commissioned in September 2016 by the European Systemic Risk Board. The ESRB, chaired by European Central Bank President Mario Draghi, hasn’t endorsed Lane’s study.

The taskforce’s aim is to find a way to avoid a repeat of the region’s sovereign debt crisis, after a decade marked by episodes of financial stress that spread across borders and threatened to splinter the currency bloc. Still, so-called ESBies have been met by skepticism from countries such as Germany that fear they’ll end up paying for others’ debts through the back door.

The plan envisages private or public institutions -- such as large banks or the European Stability Mechanism, the euro zone’s bailout fund -- repackaging sovereign bonds as securities with three tranches, the people said, asking not to be named as the document isn’t yet public.

European Safe Bonds Report: Key Points

  • Government bonds repackaged into securities with three tranches
  • Senior tranche would have credit rating of AAA or close
  • Junior tranche rated investment-grade
  • Equity tranche likely to have yield of 5-6 percent

Simulations show the senior tranche would have a credit rating of AAA or close, and the junior tranche would be investment grade, one of the people said. The lowest level would have a yield of 5-6 percent.

The European Commission would need to publish a regulation to allow ESBies to receive the same regulatory treatment as sovereign debt, the person said.

Technical Hurdles

The option of buying euro-area debt aims to reduce the risk of capital fleeing to the safest countries in times of stress, and break the link between governments and domestic banks, which typically invest in their bonds. The Greek sovereign debt crisis that started in 2009 spread around southern Europe, prompting international bailouts and the near-departure of that country from the currency bloc.

Lane’s panel wanted to publish its findings last March, but was delayed by technical hurdles. The ESRB “took note” of the work in December.

“The aim of the report, which will be published in the week of Jan. 29, is and has always been to provide well-founded input to the discussions at the European level about the creation of a safe asset that helps to break the sovereign-bank nexus,” an ESRB spokesman said in an emailed statement.

European banks might be supportive of ESBies. The securities could be a new liquid “near zero-risk asset” that serves as an alternative to sovereign bonds, the heads of Europe’s biggest lenders said in a recent document seen by Bloomberg.

Banking regulators are considering whether to impose limits on banks’ holdings of sovereign bonds and increase the capital they have to put aside to cover their exposure.

Lane will speak at a conference on safe assets, sovereign debt and financial stability on Monday in Helsinki, together with Bank of Finland Governor Erkki Liikanen.

©2018 Bloomberg L.P.