Plans for a voluntary debt exchange of Greek bonds with a 50 per cent writedown have added fuel to a debate among regulators about how sovereign debt is priced.
Sharon Bowles, chair of the European Parliament’s Economic and Monetary Affairs Committee, is leading efforts to eliminate a zero per cent risk weighting afforded to sovereign assets under the Capital Requirements Directive IV, which transposes the Basel III capital rules into European law and which is currently being drawn up in Brussels. Were such efforts successful, they would have huge knock-on implications, especially for the balance sheets of the region’s banks.
Some investors have warned that the moves could trigger a fundamental realignment of the debt markets. Marcus Svedberg, chief economist at East Capital, a European manager with €3.5 billion under management, said: “We need to fundamentally rethink how we price sovereign risk”. Asset managers believe changing the risk weighting makes sense. However, John Stopford, co-head of global fixed income at Investec Asset Management, said: “If enough of a risk premium is added so that the cost of borrowing becomes too high, it can become a self-fulfilling prophecy”.
Dealers have also been pushing for sovereign counterparties to post collateral against their derivative trades in a bid to reduce the risk exposure created by these deals. Dealers currently hedge this exposure by buying credit default swaps.
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