May 15, 2018
Commission to press ahead with ESBies
FAZ has a story this morning that the European Commission is putting its weight behind ESBies (European safe bonds). It reports that Valdis Dombrovskis will make a proposal next week for debt instruments backed by sovereign debt, known in the Commission as sovereign-bond-backed securities (SBBS). The paper writes the proposal is based closely on the original 2011 paper by Markus Brunnermeier and others. The idea is to pool the sovereign debt of all eurozone countries in relation to their ECB capital key, and to create two tranches. The larger and more senior tranche would be the so-called ESBies - the more secure bit - while the remainder would be junior. The bonds in the upper tranche would lose their status only if a state failed to service more than 30% of its debt. The junior bonds serve as buffer for the senior bonds.
As FAZ points out, the Commission hopes to increase the supply of top-rated bonds in the eurozone through this device, without going through the inconvenience of having to create a mutualised debt instrument. SBBS are not eurobonds. The Commission emphasises that the sole purpose of these instruments is to reduce risk in the banking sector. They would also help banks diversify away from the national debt of their home state.
FAZ points out that this construction is not acceptable to Germany. The German position is to reduce risk by subjecting bank holdings of government debt to risk-weighted capital requirements, or by limit concentration of banks' holdings of government debt by imposing quantitative ceilings.
FAZ quotes a recent comment by S&P, which wrote that it would not grant an ESBie the top rating desired by the Commission. The paper quoted S&P as saying it would rate the ESBie at the same level as the lowest-quality bond in the upper tranche. The paper also quoted the economic advisory council of the German economics ministry as pointing out that, if there were a genuine demand for such products, they would already have been constructed by the private sector. This is not happening because there is no demand.
Werner Mussler compares ESBies to the attempt to square a circle. He says the Commission knows that its SBBS will not fly, especially in view of the comments by S&P. This leaves only one explanation: that the proposal embeds a hidden agenda to secure the SBBS with a eurobond.