EU Unveils Pooled Sovereign-Debt Plan Amid German Resistance

(Bloomberg) -- The European Commission formally unveiled a proposal to facilitate the development of sovereign bond-backed securities, or SBBS, as it seeks to shield Europe’s bond market from future crises in the face of German opposition to any instruments that would mutualize public debt.

The plan, which comes as Italian bond yields jumped to multi-year highs, foresees the creation of securities backed by sovereign bonds from all euro-area member states according to their economic weight. The securities would be issued and bought by private investors, who would also bear the risks from losses in the underlying pool, according to the proposal.

“When buying SBBS backed by that pool, investors can chose to buy the higher or the lower risk securities, depending on their risk appetite,” the commission, the European Union executive, said on Thursday in Brussels. Losses would accrue first to holders of sub-senior, or subordinated, securities and only after such securities have been completely wiped out would they also accrue to the holders of senior claims.

The commission said SBBS will help banks diversify their sovereign-bond portfolios, as they would enjoy the same regulatory treatment as national euro-area sovereign bonds. It would thus help weaken the link between banks and their sovereigns, which exacerbated the debt crisis.

German Opposition

The commission still has to convince national governments. The German finance ministry declared its opposition hours after the commission’s presentation, saying the securitization of government debt creates new complexity and risk.

The proposal “isn’t convincing,” German Finance Minister Olaf Scholz said on Thursday in Brussels before a meeting with his euro-area counterparts. One reason why government bonds aren’t securitized extensively on private markets is that “differences in interest rates aren’t large enough for the pooling to really make sense,” he said.

Even if the commission’s proposal to standardize the issuance and supervision rules for SBBS clears the hurdle of approval by EU national governments and the European Parliament, some analysts doubt the effectiveness of the tool. “It is not clear how ‘repackaging’ of sovereign bonds into securitized products would reduce risk rather than redistribute it,” Fitch Ratings said in a note last week.

Benchmark Asset

“It is also unclear that the SBBS would supplant Bunds as the euro zone’s benchmark asset, while they may adversely affect demand for sovereign bonds of the euro-zone periphery,” the rating firm added.

Public-debt managers from from all corners of the euro area are also opposed to the idea, according to an EU government official who spoke on the condition of anonymity. One of the concerns is that market demand may not be big enough to support both pooled government-bond securities and every EU country’s own debt, the official said.

Speaking in Berlin on Wednesday, Irish central bank Governor Philip Lane said the changes in regulation would be the ultimate test of whether there is appetite this new class of assets. Lane headed a taskforce that came up with a blueprint for SBBS in January.

“Whether this product is going to exist -- who knows,” he said. “We don’t take as stand on that, because it depends on the demand from investors and the only way to find out about this is to put forward this enabling regulation and see if the market wants it or not.”

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