Sovereign debt

EU seeking bundled bonds despite strong opposition

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Starry-eyed. Source: Reuters

The European Commission is going ahead with its proposal to bundle sovereign European bonds and sell them to investors despite widespread opposition from euro-zone member countries. Commission vice president Valdis Dombrovskis will formally present his plan next week, Handelsblatt has learned.

The commission proposal explicitly rules out any mutualization of debt — a sharing of liability that is anathema to Germany and other northern European countries. The bundled bonds — called “sovereign bond-backed securities” or “European safe bonds” (ESBies) — would not even be issued by a government agency, but by a private entity created for the purpose.

The idea is to provide investors, especially banks, with a diversified asset that will keep them from loading up on the debt of their own country. This “doom loop” can turn a country’s debt crisis into a banking crisis, and debt contagion can quickly spread both to countries with similar problems. This is what happened with southern Europe during the euro crisis.

“With this proposal, euro-bonds could be introduced through the back door.”

Jörg Rocholl, advisor, German finance ministry

The concept of a bundled bond has been kicked around for years. Germany has consistently opposed the notion in the belief that sooner or later it will lead to shared liability. Longtime Finance Minister Wolfgang Schäuble led the opposition and there is no indication that his successor, Olaf Scholz, will feel any differently.

Other northern European countries feel the same but even southern European countries oppose the commission’s proposal. It limits the amount of each country’s bonds that can be bundled to the same percentage. Highly indebted countries like Italy would still have a large amount of unbundled debt and may have to pay higher interest on those bonds if investors take up the ESBies.

There is no guarantee, however, that there is even a market for the bundled bonds. Much depends on the regulatory treatment. Unless the bundled bonds, like the individual sovereign bonds, are exempted from any capital requirements, there would be little incentive for banks to buy them. An additional complication is that the bundles are to be divided into tranches, so that low-risk bonds will be in a “safe” tranche, and higher-risk bonds in mezzanine and junior tranches.

The experience of mortgage-backed securities during the 2008 financial crisis, however, was not that inclusion of low-risk mortgages lowered the overall risk of the bundle, but that high-risk loans weakened the security as a whole.

The concern in Berlin is that ultimately any form of bundling would lead to shared liability. “With this proposal, euro-bonds could be introduced through the back door,” said Jörg Rocholl, a member of the finance ministry’s advisory council.

Debt agencies of the euro-zone members wrote a joint letter some months ago in opposition to the bundled bonds, arguing they would not be a reliable method for state finance.

Mr. Dombrovskis’ determination to go ahead with it now in the face of this opposition is probably due to the fact that he must introduce any new legislative initiative before the end of this month. The commission can then only focus on getting existing initiatives wrapped up before its term ends in November 2019.

Ruth Berschens heads Handelsblatt’s Brussels office, leading coverage of European policy. Martin Greive is a correspondent for Handelsblatt based in Berlin. Darrell Delamaide adapted this article into English for Handelsblatt Global. To contact the authors: berschens@handelsblatt.com and greive@handelsblatt.com.

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