Securitised portfolios of sovereign bonds could help end the “doom loop” of banks investing too much in domestic government bonds, according to German rating agency Scope.
In a report it welcomed the so-called “sovereign-bond-backed securities” (SBBS) as proposed by the European Commission, defined as “securities backed by a diversified portfolio of euro area central government bonds without mutualisation of debt between countries”.
Introducing SBBS would offer “a likely improvement to the euro area’s institutional framework, enhancing financial stability by supporting increased banking sector portfolio diversification and improving market access for euro area countries”, Scope said.
However, the rating agency emphasised that SBBS would only work in combination with changes to regulatory frameworks.
This support for the SBBS came just days after the German investment association DVFA trashed the proposal for being unfeasible and uninteresting for any investor.
However, Aloys Prinz, director at the institute of public economics at the University of Münster in Germany, disagreed with the DVFA’s assessment.
“SBBS could be interesting for institutional investors as the securities can be taken into the portfolio without risk,” he said.
According to Scope, capital requirements for SBBS would have to be adjusted in some banking regulations to make the new instruments as attractive for investors as German bunds, for example.
Speaking during the institutional investment summit organised by Barbara Bertolini in Vienna last week, Prinz told IPE the SBBS would have to be issued by a new entity, and not by either the European Central Bank (ECB) or individual member states.
“The risk is taken by the issuer and then the investor, but even if the bonds of one state default the burden on the others would not be that great,” he argued. He said SBBS would also be “interesting” for the ECB to use when buying up bonds as part of its quantitative easing programme.
Scope noted in its analysis that there were still a few obstacles, apart from regulation, hindering the successful implementation of SBBS – the “most important” one being the lack of support from the German government: “Opponents to SBBS fear that the securitisation scheme is nothing else than the introduction of joint-liability Eurobonds through the back door.”
It added: “Aside from these fears, the German government might lose its privilege as the safe haven destination because markets could resort to SBBS – which are primarily backed by German bonds.”
What are SBBS?
The creation of pooled euro-zone securities has been one of the most discussed solutions to the problem of banks’ close ties to their local securities markets.
Different to the concept of Eurobonds frequently discussed since the financial crisis, SBBS would not “involve mutualisation of risks and losses among member states”, according to the European Commission.
Its proposal was to create a template for SBBS to which all providers offering such products would have to adhere.
“The underlying portfolio must include sovereign bonds of all euro area member states, with relative weights in line with each member state’s contribution to the capital of the European Central Bank,” the Commission stated.
The products would have to consist of two risk tranches – the junior package getting higher returns for bearing any losses first, as with any other kind of asset-backed security.
The Commission’s proposal now has to be discussed by the European Parliament and Council, and will need the approval of all euro-zone member states.