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02 February 2018

European Systemic Risk Board (ESRB) on Sovereign Bond Backed Securities (SBBS)

Graham Bishop analyses the European Systemic Risk Board (ESRB) reports on Sovereign Bond Backed Securities (SBBS)and says that it's a great idea - but has many problems. His Temporary Eurobill Fund proposal has much wider application, he argues.

The ESRB has just published its long-awaited reports (Part I and Part II) on SBBS. They are exhaustive and thorough reports on an intellectually attractive idea that was generated in 2011 by the consequences of the Great Financial Crash. The plan is designed to create a new class of “safe assets” via an elegant securitisation of euro area government bonds. The SBBS would be held principally by banks as an alternative to direct holdings – especially of the banks’ domestic government bonds.

The reports analyse in great detail the motivation to create such securities and highlight the necessary condition of often-contentious regulatory change that would be required to make them economically viable. The changes include (i) amendment of the regulatory treatment of sovereign exposures (RTSE) so that SBBS would benefit from the same risk weighting for the underlying government bonds. But that would require change in the `Basel’ rules and countries like Japan can be expected to oppose strongly any move away from government bonds attracting a 0% risk weighting (ii) The EU’s regulatory framework for securitisation would need to be amended, but would such strong public support imply corresponding support for the SBBS if a default occurred? Will other global regulators follow EU rules? If not, the investor base might be limited to the EU (iii)  The operation of Collective Action Clauses (CACs) in all EU government bonds since 2013 might pose legal difficulties in a default. Moreover, assembling the cover pool could be difficult unless DMOs agreed to co-operate closely in their issuance programme. 

The reports also highlight the usual problem for the tranches of securitisations: who buys the risky, junior tranches? That risk appetite will govern the pace of creation of the senior tranches but the report offers no certainty that there will even be sufficient demand for the senior tranches.

Perhaps the real problem for SBBS in 2018 is that the concept was originally designed to mitigate a narrow – though important – problem. The arguments today for the much wider solutions offered by a Temporary Eurobill Fund (TEF) remain intact: a safe asset; direct contribution to financial stability; global scale issues of great liquidity; flexible and progressive market discipline to enhance economic governance; and last – but certainly not least politically – a genuine fusion of euro area citizens’ economic interests into a `European asset’ that can be a core savings instrument for all.

Many of these issues have been eloquently addressed in a recent Vox paper “How to reconcile risk sharing and market discipline in the euro area” My observations on this paper are here. My latest paper on the politics “Plan for a Temporary Eurobill Fund (TEF): Complementing with a strong European Monetary Fund (EMF); Satisfying the Core Principles that pave the way to a Stability Union” is here and the most recent technical paper“Response to Commission Reflections on Deepening EMU: “Eurobills” as a Safe Asset that blends Fiscal Rules progressively with Market Discipline” is here.

© Graham Bishop

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