May 24, 2018 / 9:56 AM / a year ago

EU proposes new sovereign bond-backed securities, faces criticism

BRUSSELS (Reuters) - The European Commission proposed on Thursday setting up a new class of Sovereign Bond-Backed Securities (SBBS) to encourage banks and investors to diversify their holdings of euro zone bonds.

FILE PHOTO: Workers adjust and clean the logo of the European Commission at the entrance of the Berlaymont building, the EC headquarters, in Brussels September 12, 2013. REUTERS/Yves Herman

The plan, which confirms an earlier Reuters report, is meant to address a weakness that came to light during the 2010-2012 euro zone debt crisis, when banks’ high exposure to their sovereigns’ own debt exacerbated the problems facing banks and euro zone authorities alike.

European Union officials said SBBS would reduce investors’ bias towards their own countries and increase the financial stability of the euro zone.

“This is a pragmatic proposal that will strengthen private risk absorption through integrated financial markets and reduce risk in the banking sector,” European Commission vice president Valdis Dombrovskis said.

SBBS would be composed of bonds from all 19 countries that use the euro, with a fixed amount of national bonds from each country.

Risks will not be shared among participating countries, under the Commission’s plan, meaning that bonds from states deemed safer by investors, such as Germany, will continue to carry lower yields than riskier countries, like Greece or Italy.

The new asset would have a senior, more secure tranche, corresponding to 70 percent of the nominal value of the issuance, with the rest being allocated to one or more subordinated, riskier tranches.

This set-up is meant to overcome Germany’s resistance to the plan, as Berlin fears that it could lead to higher borrowing costs for itself to absorb risks of weaker economies of the bloc - a fear amplified by recent high-spending plans of a proposed new eurosceptic Italian government.

Despite the Commission’s insistence that SBBS were not leading to mutualization of risks, Germans remained sceptical.

“Once SBBS are on the way, the next step will be to ask for joint liability. Therefore, SBBS are Eurobonds through the backdoor and must be stopped,” said Markus Ferber, a German lawmaker who is vice-chairman of the European Parliament’s economic committee.

The Commission’s proposal also faces criticism for not being ambitious enough. The lack of risk-sharing would make the new asset indistinguishable from sovereign bonds of each euro zone state, critics said, arguing that appetite for this product was likely to be very limited.

To heed this concern, the EU executive is proposing lower capital requirements for banks that hold these securities. They would not be treated as other securitized products, which require lenders to offset their risks with capital buffers. The Commission, however, refrained from estimating the possible market for SBBS.

“Securitization regulatory charges are not justified for SBBS,” the Commission said, arguing that these new securities would be backed by risk-free sovereign bonds.

Reporting by Francesco Guarascio; editing by Philip Blenkinsop and David Stamp

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